Opinion | Why ETH Must Have a Currency Premium

Author: David Hoffman

Translation & Proofreading: A Jian, Min Min & A Jian

Source: Ethereum enthusiasts

Translator's Note: In this article, the author uses a lot of words such as "engineered" and "engineering". The author's original intention should be to say that all the characteristics of Ethereum are hard work (not blown out) . But in translation, we turned it into a "programmed", one corresponding to the actual situation, and the other is because some Ethereum supporters quite like the "programmable" feature of Ethereum, this translation is also expressing this This kind of ideology, although it may read a little weird in the specific context.


Currency premium = liquidity

Liquidity is a very broad concept. The so-called liquidity of an asset is the volume (difficulty) with which the asset can be traded without any loss of price when the asset is bought and sold at any time and place. Assets with good liquidity will be used as money by society as a whole.

Although Bitcoin and Ethereum differ in the way they acquire liquidity, they are both rooted in the value of the asset itself . As the price of an asset rises, so does its liquidity.

Therefore, the liquidity of the blockchain asset (crypto-asset) is a function of its price, and the price is determined by demand. Therefore, although the names of liquidity / price / demand are different, they are also the same. The currency of an asset is ultimately determined by its global liquidity, which reflects its market value and the ease with which such assets can be obtained around the world.

Therefore, in the field of cryptocurrency currency, the competition on the total market value is basically the same as the competition on the "Become Currency" track.

In a word, which asset has the highest market value, which asset is the "king of cryptocurrency".

Bitcoin has value before it becomes liquid, and then it acquires currency. Of course, it all stems from its limited supply. Bitcoin's constant scarcity has given people a strong motivation to hoard coins, because people are betting that it will become the next currency. This is all the secrets of Bitcoin, nothing else. If this is not enough to make Bitcoin a currency, Bitcoin has no other cards to play.

Ethereum first created a mechanism that required ETH to drive operations , and then allowed ETH to gain liquidity. In Ethereum 2.0, there will be three major artifacts that program the scarcity of ETH:

  • Locking in the DeFi ecosystem -increasing the usefulness of ETH, thus increasing the demand for ETH
  • Pledged ETH —— increasing the scarcity of ETH and reducing the rate of ETH issuance
  • Burning ETH -increasing the scarcity of ETH and reducing the rate of ETH issuance

These are the three equations that drive the scarcity of ETH, which corresponds to the 21 million cap of Bitcoin (is yin to Bitcoins 21M yang). The important thing is that each equation complements the other two. Bitcoin has only one pillar (21 million cap). Although the three pillars of Ethereum are smaller, they complement each other and strengthen each other.

Scarcity is a precursor to liquidity

Crypto-structured assets like Bitcoin and Ethereum are homogeneous, divisible, and globally mobile; in order to be used as currency, they also need an accounting system from start to finish. For a cryptocurrency to become a currency, the only thing that needs to be overcome is to become the most valuable / liquid cryptocurrency. For crypto assets, there is only one battle for life and death, which is to obtain higher prices , because it is also competing for liquidity, that is, to become currency.

The total market value is equal to the amount of money (Total Market Cap = Money).

Checkmate's article "Why ETH can't maintain its currency premium" (Editor's Note: See the end of the Chinese translation) counts common criticisms of Ethereum as a platform. Most of these criticisms are clichés, and most of them ignore the real point: total value = currency premium . Most of the criticisms of bitcoin fans are just a rigid set of moral criticisms to explain why ETH cannot be a currency. For example, “pre-issuance cannot be a currency because it is unfair” and “PoS = Cantilon effect” are the two most common. Species.

In my opinion, these statements are like saying "why is ETH not worthy of currency status (why shouldn't ETH be used as currency)", or "if ETH can become currency, it must be unfair" rather than "why No currency status will be achieved ". In the final analysis, "how to look at Ethereum" is just a subjective preference , there is no right or wrong; only "What will ETH be" is the problem we can use data and trends to study.

This article is to use real data and trend analysis to tell you why ETH will eventually become currency.

ETH ~ Yes ~ Reasons to become a currency

ETH is on its way to building itself as currency.

As a platform, Ethereum has been looking for a market suitable for power generation; in 2018, we saw the emergence of financial applications driven by the way of locking ETH. The “quantity of ETH locked in DeFi” indicator soon became popular as the Ethereum community began to realize the future of ETH: reserve assets used as a zero-access financial system.

Mechanisms such as proof of stake and EIP-1559 are also mechanisms that drive ETH demand and scarcity; at the same time, the application layer of Ethereum is also becoming a function and liquidity mechanism of Ethereum.

The main point of this article is: All applications on Ethereum will eventually help ETH, helping ETH on the road of organic (or accidental?) Programming of ETH as currency. From the history of the blockchain, accidentally making the project something else is not a contradiction: from 2015 to 2018, Ethereum is equivalent to putting out many dApps, depending on which Can survive. It turns out that the ones that survive are the applications that make ETH a currency.

Programming requirements

Demand for the application layer: This part is a response to Checkmate's "Since the application layer to achieve value accumulation" section.

The application layer of Ethereum will change the financial system of this world. Financial components such as MakerDAO, Uniswap, and Compound are expected to serve global users; as a result of the increasing use, the amount of ETH lock-in will continue to rise.

"DeFi's ETH Locked Amount" is an indicator used to measure the amount of ETH leaving the circulation field caused by the Ethereum application. Every Ethereum application provides incentives to lock ETH (I explained in the article "Ether is Equity"). So basically, the application layer of Ethereum is the sink of Ethereum circulation, causing ETH to leave the circulation field and increase the scarcity of ETH (I also explained this concept in the article "Ethereum: Money-Game Landscape").

One of the identities for currency-commodity trading is MV = PQ (for a full explanation, see the Wikipedia hyperlink attached here). From the perspective of this article, MV = PQ explains the relationship between the speed of money flow (that is, the speed at which money changes hands) and the total value of the total amount of money (also referred to as the "market value" above). Once the speed of money flow decreases, the market value rises accordingly .

The Ethereum application is a sink of ETH flow speed. This is the reason behind the Ethereum community's enthusiasm for "DeFi's ETH Lockup". The more ETH that flows out of the sink, the stronger the currency of ETH . The more sinks ETH has, the more individual applications become like the Federal Reserve, and ETH is the reserve asset they use. With Bitcoin, you can be your own bank; but with Ethereum, whether you or a group of computers acting as NPCs can be a bank!

The magic expenditure of the Ethereum application layer is that there is always room to accommodate more applications! There is no upper limit on the number of applications that generate ETH lock-in incentives, and there is no upper limit on the fees paid to those who voluntarily lock ETH to participate in pledges. Therefore, in theory, the demand for ETH is infinite (Bitcoin fans often say Bitcoin, but in fact ETH has a way to make this a reality).

Look at the picture:

The number of ETH locked into DeFi applications is growing

The ratio of the amount of DeFi lockup to the amount of ETH issuance fluctuates

Ethereum is still PoW mining; migrating to PoS can reduce the ETH issuance rate from 4% per year to about 0.4%. With PoS, the amount of additional ETH will be significantly lower than the amount of ETH locked by DeFi.

0.4% is the upper limit of the issuance rate of PoS Ethereum. Excluding ETH burned from EIP-1559. We do not yet know how to predict this burning rate, but it can be assumed that the 64 additional ETH 2.0 fragments are used, and the net increase of ETH can be negative. I'm looking forward to seeing the yellow line in the above image drop below 0.

2. Scarcity of programming

Two major innovations on Ethereum mark "programmed scarcity."


  • It is generally assumed that PoS can attract 10% to 30% of the total supply of ETH
  • Eric Wall explained in his recent article "PoS Less Waste" (Editor's Note: Chinese version see hyperlink at the end of the article), the pledger group of PoS system will be mainly composed of those who are optimistic about ETH for a long time, because they can accept very Low pledge returns. what does this mean:
    1. Ethereum can guarantee security with the lowest issuance rate
    2. Transaction fees paid to purchase block space will flow to those who are long-term bullish on ETH. PoS rewards the bullish side, and it will strengthen the appreciation of the assets . This is another great example of how Ethereum can realize itself as currency. Unlike some projects, which can only rely on memes.
  • Further complement the sink effect of ETH circulation


EIP-1559 introduces the ETH burning mechanism, which will improve the user experience of Ethereum while burning ETH in proportion to the degree of Ethereum transaction congestion.

Checkmate believes that there are some big problems with EIP-1559:

  1. EIP-1559 represents a revision of monetary policy. In his opinion (and the idea of ​​many bitcoin fans), it is an absolute mistake to repair monetary policy, and " cannot modify " can produce the best monetary policy.
  2. It represents the Cantilon effect. The definition of the Cantillon effect is as follows: those who are closer to the newly issued currency can use the newly issued currency faster and use the unadjusted purchasing power of the currency to purchase goods. In other words: people who can get the newly issued currency can buy things cheaper than people who can get the currency in the subsequent spread of new currency.
  3. EIP-1559 will make the fees more expensive.

My response:

  1. Again, this is just a moral opinion, saying that "Ethereum is not worthy of getting a currency premium", not a real proposition that says "it cannot get a currency premium."
  2. I totally disagree. The Cantilon effect exists and can be used to criticize the fairness of ETH as an asset, but this criticism is only related to PoS as a security mechanism and has nothing to do with EIP-1559. In fact, EIP-1559's changes to the PoS economic model directly alleviated the Cantilon effect in PoS. If you are really worried about this effect, EIP-1559 is friendly.

I've explained these in Ether is Equity and EIP-1559: The Last Piece of Ethereum's Monetary Policy, but I'll repeat it here:

  • The fee income in the crypto economy system fluctuates greatly, and this cannot be changed. Bitcoin's handling fee was less than $ 0.01 in 2015 and rose to more than $ 100 in October 2017. The miners in October 2017 made a lot of money, while the miners in 2015 struggled to survive with low fees, and they were simply discounting services.
  • EIP-1559 guarantees the stable income of PoS validators in ETH 2 and protects validators from the fundamentally unstable fee market. Moreover, EIP-1559 will take a portion of the profits from the pledgers and redistribute them equally to all ETH holders .
  • When Ethereum's revenue (handling fee) is lower than its expenditure (security budget, block reward), it suffers a loss. Regardless of income, ETH will be issued to validators to compensate them for their contributions to security. This means that when income is low, validators will still be compensated. If EIP-1559 really raises fees, it is also because it raises the price of ETH. Checkmate's point here is that the fee is related to the price of ETH. If the price of ETH rises, the fee will increase. Recall my point: The currency of an asset is a function of its price. If the price of ETH rises, its liquidity will increase, as will its currency. Checkmate seems to accidentally acknowledge that EIP-1559 will help Ethereum gain currency (hands-off).

3. Programmed Liquidity

Bitcoin is the world's first native crypto asset on the Internet. Coinbase, Wyre, Gemini, Kraken and other large exchanges and services such as LocalBitcoins are gathering Bitcoin liquidity. These exchanges also provide external liquidity for Ethereum.

External liquidity: A liquidity between an asset and the outside world. Basically all assets have external liquidity only.

Internal liquidity: The liquidity between an asset and its native ecosystem. To date, only Ethereum has an internal ecosystem .

From an external liquidity perspective, there is no essential difference between Ethereum and Bitcoin. Both rely on the same infrastructure: on-ramp and exchanges. Although Bitcoin currently has the most external liquidity, it does not have its own internal liquidity like Ethereum.

Ethereum can create internal liquidity on its own. I have invested a lot of ether in MakerDAO to create a pledged debt warehouse (CDP), which is a direct beneficiary of internal liquidity. After generating the DAI through Maker, it only takes 1 minute to exchange the Ethereum on Uniswap with the DAI. In the process, there is no need to contact the censors or accept KYC authentication.

Being able to provide sufficient liquidity for transactions between Ethereum / DAI is the first step in building a self-sufficient economy. In such an economy, participants need not seek external liquidity. Personally, there are many times when I want to buy Ethereum, but the liquidation of funds often takes 5 to 7 days, and I don't want to wait so long. I can use the DAI generated by the pledged debt warehouse to buy Ethereum, and then sell the Ethereum to DAI in a few days and return it. All of this is thanks to the internal liquidity of Ethereum.

With internal liquidity:

  1. My needs are met
  2. I paid for Ethereum
  3. I paid Uniswap

When our users pay Uniswap, it creates more liquidity for Uniswap.

The article "Uniswap is Infrastructure" explains the feedback loop formed during the above process:

Uniswap expands based on the economy in which it operates. The size of any market is related to the volume of transactions in that market.

  • The more transactions in a market, the more transaction fees the market receives (0.3% transaction fee per transaction)
  • The more transaction fees the market receives, the greater the incentive for liquidity providers
  • The more liquidity providers, the more liquidity on Uniwap
  • The more liquidity on Uniswap, the more participants will use this platform for large transactions
  • As more participants engage in larger transactions, the total transaction fees received by the exchange will increase.
  • Cycle

Don't forget the theme of this article: Ethereum will become money, and money is liquid . In any case, currency is the most liquid asset in the world, and Uniswap is one of the infrastructures that enhances the liquidity of Ethereum.

Again, liquidity is directly proportional to total market value. Assuming a market value of $ 100, an asset is essentially illiquid. Assuming an asset with a total market value of $ 100 billion, that asset is highly liquid. Price is directly proportional to liquidity. Keep the following in mind:

  1. All Uniswap markets are denominated in ether. When the price of Ether rises, liquidity in all markets on Uniswap will increase.
  2. When the price of Ether rises, the liquidity of Ethereum will increase.
  3. When the price of Ethereum rises, the liquidity of the Ethereum / DAI market on Uniswap will increase by a multiple of [1] x [2]. These effects are doubled, not cumulative. When the price of Ether rises, the liquidity of Ethereum on Uniswap will multiply.

Money is liquid.

Ethereum will create liquidity for itself and give it monetary attributes.

The figure above shows how Ethereum has evolved into a currency.

4. Fairness in programming

Ethereum's critics believe that Ethereum's distribution and distribution system is unfair. Although some people have analyzed and pointed out that the ICO of Ethereum has reached a very satisfactory level in terms of distribution / fairness, critics have said that ICO is essentially an unfair new currency distribution method. The nature of money is contrary. In my opinion, this criticism simply ignores the real data we use to measure “fairness of Ethereum ICOs”?

I personally like to analyze the is-ought problem through indicators and data. I found that the Gini coefficient of Ethereum is comparable to Bitcoin, and I am very satisfied with it.

However, DAI is the most fair of all cryptocurrencies.

Since the rise of the modern financial system, this mode of using certain assets as pledges and issuing credits under its endorsement has become the most basic currency generation mechanism. The rationale behind this is hard to explain here. Check out David Graeber's Debt: The First 5000 Years.

In his book, David explains how “debt” and “debt” agencies become mutually beneficial hunters and collectors. The beneficiary owes debts to the beneficiary. In the small hunter-gatherer tribe, those who benefit more than benefit will be seen as burdensome, or "broken people," and others won't help them anymore because they know the other party is not good enough.

MakerDAO is a globally scalable lending system.

Ethereum holders can issue a "debt service commitment", or DAI, through MakerDAO. Because MakerDAO requires a pledge rate of not less than 150%, there is no need to worry about someone being "lost".

Money is essentially a debt-debt relationship. MakerDAO has created a perfect currency system: a currency with guaranteed debt. Think Ethereum lacks fairness? OK, then use DAI. DAI prices are still stable.

Let ’s refute the opponent

In the end, I went straight to Checkmate's point of view.

My conclusion is that the Ethereum project faces two problems, one is that the governance model is more centralized, and the other is that monetary policy is not sound and there are signs of gradual deterioration.

It's just a confusion between the real and the supposed fallacy. First, is the degree of centralization of the Ethereum governance model really strong? For certain regulations, yes. All consensus on modifications / updates is achieved through a centralized process. Ethereum's monetary policy is modified in a centralized manner, but it is also based on a social contract. If you agree with Hasu that all cryptographic economic systems are implemented according to the social contract, then the social contract of Ethereum is to adhere to the minimum necessary issuance principle. Any changes to the rules for the issuance of Ethereum will conform to this social contract. If not, I am afraid that the currency management of Ethereum will be a mess, but at present there has not been any case of not complying with the minimum necessary circulation principle.

EIP 1559's latest experiment seems to contradict the needs of users other than Ethereum holders. This damages the fairness of the system, causing users on the chain to rush customers more and more because of transaction fee premiums.

I have explained above. "… seems to contradict the needs of users other than Ethereum holders." How is this different from earlier Bitcoin holders? Early bitcoin holders also benefited greatly from the scarcity of bitcoin. Of course, due to the nature of the Bitcoin protocol, people may feel that the issuance mechanism of Bitcoin is fair, but if judged by data and indicators, the distribution mechanism of Ethereum can be considered fair. Therefore, I think this argument is not as valid as the one I described above in the section "Programmed Monetary Nature".

Due to protocol complexity, Turing completeness, developer backdoors, and centralized oracles, Ethereum's attack surface is an order of magnitude larger than Bitcoin.

If you accept the two articles of "The Two Sides of Ethereum" and "Ethereum is Equity," then you will agree that Ethereum has been working to solve the above problems. If the concerns described in this comment are valid, then applications on Ethereum will naturally transition from their current state to a state more suitable for their survival in this environment.

The project vision, direction, and experimental features have been changing, and now we are looking for ways to approach Bitcoin's "sound currency" narrative.

There is no evidence that a sound monetary policy can bring about currency. This is a fabricated statement, and since 2015, Bitcoin fans have been advocating this. But in my opinion, this statement has come to an end. What really matters is the facts and figures, not the narratives and memes. The former is the nemesis of the latter.

Ethereum relies too much on third-party (possibly shut down) applications to accumulate value for Ethereum. But because there is no upper limit on supply and monetary policy is erratic, they have to rely on them.

Those who ignore Web 3.0 do so at your own risk. DeFi is not a subsidiary of Ethereum. Conceptually, DeFi is larger than Ethereum. However, no other platform for DeFi development has yet emerged. Until real competitors emerge and get a share from Ethereum, Ethereum will have a monopoly on DeFi and will fill the gap in DeFi demand. When I saw Checkmate's phrase "(Ethereum) is too dependent on third-party applications", my understanding is that "Ethereum can programmatically implement the currency attributes it needs, and no protocol can do this. "

All Ethereum centralized pools (including managed DeFi applications) may become malicious PoS validators, or they may be hacked and become malicious validators.

Finance must incur risks. If the protocol of my choice provides the application, I'm happy to take that risk. Ethereum is like a Hydra . We have also seen the end of EtherDelta: centralization becomes a fatal weakness. However, EtherDelta was replaced by Uniswap, which was designed to completely avoid the risk of centralization . This is a legitimate concern. The facts show that all Ethereum applications may be replaced or annexed by a new application that is better and more resistant to attacks.

The end result of the secondary system syndrome: the desire to completely rebuild the underlying blockchain. However, integrating one chain into another is a bottomless pit that takes several years to complete.

Definition: Secondary System Syndrome refers to the small and beautiful system that is successfully replaced by a more exaggerated system due to high expectations and overconfidence.

According to this view, Ethereum is trying to "become a better Bitcoin through a system that is over-designed, costly and requires a lot of maintenance."

The concept of the secondary system syndrome dates back to 1975. In my opinion, the lessons of secondary system syndrome are easy to learn and repair before major problems arise. Contrary to some bitcoin fanfare misinformation, it is easy to synchronize and run a full Ethereum node. Bitcoin fans are right in saying that Ethereum 1.x does need to make some changes to avoid deviating from the right direction. However, Ethereum's plan is not just to update Ethereum 1.x, but to launch Ethereum 2.0, introducing a series of new functions and features.

From Checkmate's point of view: Ethereum needs to transition to Ethereum 2.0 because its technical liabilities are increasing.

In my opinion: Ethereum is a financial system that will be updated and upgraded, based on research on cryptoeconomics and user needs. The currency of Ethereum is a product that can be iterated and improved!

in conclusion

The above 4 points demonstrate how Ethereum has become a currency through programming.

You might say, "David, you just explained why the value of Ethereum comes from it, and you didn't explain why Ethereum became money" … My answer is: it's all the same thing.

Always remember the following:

1. Monetary is liquidity

The reason behind it is not important, what is important is that this is the case. If there is one thing that is the most liquid in the world, it is money.

2. Liquidity is directly proportional to value

The higher the market value, the more liquid the asset

3. No other protocol can give itself liquidity and value through programming

Uniswap = programmed liquidity. All DeFi applications = programmed value. Which one do you prefer, the programmed mobility or the memetic mobility?

4. Some bitcoin fans have criticized "why does Ethereum not become a currency?"

There are two ways to generate money: passive adoption and programmed features.

Bitcoin fans generally believe that the popularity of Bitcoin happens naturally, and people will accept that this thing was doomed from the beginning.

But bitcoin is based on gold and is neither innovative nor useful for this information age. People want to solve problems. A protocol that can solve these problems programmatically can adapt to the product market after simple iteration and testing. So far, the application layer of Ethereum has been continuously looking for product markets for Ethereum. Looking at the development history of Ethereum in the past 5 years, I found that the applications that find product markets on Ethereum are the applications that use Ethereum as the currency.

Ethereum has been upgrading based on demand. Good luck to him. This world needs a programmable value store asset that can make itself more useful.


Original link: https://bankless.substack.com/p/why-eth-will-sustain-a-monetary-premium