ETH is Not Money

From our Crypto Theses for 2021 - get the full report here

Ethereum’s acolytes believe they can build the transaction settlement layer for all of the world’s markets. Money and financial applications. Secure, decentralized computing. Digital goods and gaming economies. Intellectual property and personal data. Everything.

To be honest, they’ve earned that swagger. Ethereum, for all its early limitations, has worked, and it’s spawned thousands of high-potential applications in just five short years.

Ethereum is the most important smart contract platform today because it was the first to foster a large community of passionate, well-incentivized contributors. Unlike the early internet, even Ethereum’s “failures” have failed up, as early tinkerers have ridden the wave of ETH from less than $1 to ~$600 today. Ethereum is on pace to process more than $1 trillion worth of transactions this year, including the vast majority of volume in the burgeoning (and increasingly complex) DeFi and “crypto dollar” sectors. It’s been so successful that eth1 is now at max capacity, and must scale by orders of magnitude, quickly, to maintain its market share vs. newcomers, and keep its vibrant ecosystem cost-competitive.

I believe it will succeed. First things first, though, a point of clarification.... ETH IS NOT MONEY... and that's ok!

It will likely prove to be a terrific investment, anyway. A commodity that secures transactions on the world's most valuable computing platform (gas for throttling, staking for processing) and that can be ubiquitously leveraged as collateral within a burgeoning new financial system, is plenty valuable. I love ETH, and I own a bunch.

But here are ten reasons ETH is not money, why it will never eclipse BTC, and why its 2017 flirtation of a “flippening” was a one-time anomaly:

10 Reasons ETH is Not Money

1. History: In 2017, there was a brief period when Ethereum looked like it might *potentially* be more secure than Bitcoin after surviving the previous summer's ETC hard fork and Shanghai attacks. Bitcoin was embroiled in an ugly scaling debate over whether the project would be "peer-to-peer electronic cash," or for high-stakes store of value settlements. The community chose the latter, leading to the Bitcoin Cash hard fork. Bitcoin Cash rallied to 0.45 BCH:BTC before receding, and BTC added a new layer to its anti-fragile armor. During the same period, ETH reached ~50% of BTC's market cap. Just as the BCH threat subsided, ETH will likely never test those highs again.

With the eth2 migration, BTC will be 95% dominant in the proof-of-work monies category, while ETH must compete with dozens of viable platforms to retain its 65% dominance; Substitutes hurt monetary premiums .BTC has few substitutes; ETH may have many.

2. Reserve rotation: Demand for ETH diuring the last cycle was fueled in large part by its reserve currency status for ICOs. Once the market corrected and dollar-denominated Simple Agreement for Future Tokens (SAFTs) agreements replaced mega on-chain ICOs, the reservation demand for ETH leveled off. That demand was only partly replicated in this year’s DeFi boom as ERC-20 crypto dollars largely replaced the need to hold ETH, which is an important (40% of total locked value), but not critical, collateral asset for DeFi applications today.

3. Institutional Mirage: “Smart money” demand for ETH is overstated. Most of the apparent bidding is happening thanks to the Grayscale trade with more than 80% of ETHE (Grayscale’s Ethereum Trust) currently restricted. That means all the institutional AUM growth has been from funds hammering the creation / rule 144 sale arb trade (with leverage) to collect the 60% ETHE premium to spot. Don’t get me wrong, that’s not nothing! But a synthetic trade is not a 5-10 year investment. As a macro hedge, ETH doesn’t come up in conversation. As an uncorrelated asset, ETH is relegated to the bench due to its correlation with BTC.

4. Narrative Complexity: Memes work, and nothing kills a good meme like complexity. Bitcoin has simple narratives that septuagenarian money managers and politicians can sound out. I was even able to turn my 85-year-old grandfather into a BTC holder back in 2014 once I explained it to him because he’s better than your grandfather. On the other hand, I have never even attempted to explain Ethereum to him. It’s not that most people are too dumb or lazy to learn new things (though that’s true); ETH the asset is just tough to grasp because the narrative keeps changing. The “triple point” pitch is cute, but self-defeating because it makes you foie gras people with three concurrent radical investment theses at once.

5. Wrapped Assets: As total value locked in DeFi and on Ethereum continues to swell, so will interest in wrapping synthetic Bitcoin (and other assets) and leveraging them on Ethereum. The same catalysts that should, in theory, drive ETH higher as collateral demand increases, will drive wrapped BTC higher as well. So ETH doesn’t gain ground.

6. Strong Hands: Bitcoin holders have always been Spartans to Ethereum’s Athenians. They eat meat, they’re mean, and they’re specialists at war. The Ethereum community has more diversity and social awareness, I think, which is great for a platform. But that’s bad for weaponry like state-independent money. It’s not like BTC holders are getting weaker, either. The new money inflows are coming from 5-10 year holders. On the other hand, It’s unclear whether eth1 or eth2 will be the blockchain of record next year.

7. Sub-token Leakage: With the eth2 roadmap moving to “eth1.5 with rollups” (more on wtf that is below), every transaction that moves to “layer 2” rollups essentially moves to new blockchains that could include new tokens. If you want those sub-chains secured, you might add transaction fees and security rewards there, too, which would erode value from the core eth2 blockchain.

8. Alt-token Leakage: I cannot overstate how risky it seems that eth1.5+roll-ups look a helluva lot like mainnet competitors that don’t have the whole “existentially risky migration” thing to worry about. To a layperson (and maybe many technologists) Polkadot and Cosmos hub-and-spoke models look very similar to eth2. There are numerous ways these competitors might siphon value.

9. DeFi-token Leakage: Financial applications are fatter and protocol tokens are thinner (less value accretive) than are commonly argued. That’s because capital pools tend to centralize, but transaction rails tend to least-cost route around rent-seekers. It seems possible, if not probable that DeFi applications with lots of liquidity and locked value will capture more fees (proportionately) over time than base layer protocols whose fees are treated more like system imperfections than critical security model inputs.

10. Cumulative Demonetization: If Bitcoin is a prism that attracts different narrative seekers into the same base asset, ETH is the opposite: too many narratives, each of which can be better expressed by a more specialized protocol and token. Demonetisation has arguably been a gradual process already in motion with the explosion of stablecoins, but I think there’s more to leak. The clincher is that you don’t even need to agree with the threats above, just that the perceived threats exist to eventually hurt ETH’s monetary premium.

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There’s one reason I might be wrong: bitcoin fails. Maybe it’s attacked by sovereigns who choke off liquidity providers, criminalize self-custody, hijack mining capacity in order to 51% attack the network (or delay transactions) to oblivion; or the inflation subsidy expires and destroys bitcoin’s security model; or something else. It doesn’t really matter, though, if BTC is overtaken by ETH, we can pack our toys and go home because ETH will not have the memetic resilience or robust sovereign-grade security model to compete as crypto’s primary value store.

(Note that Watkins and Wilson just wrote a BIBLE on Ethereum 2.0, and they disagree with this section pretty much point for point. We’ll have the analysts write a rebuttal piece to absolutely destroy their least favorite takes of mine from this document.)

I'll be debating this with the Bankless guys tomorrow at 2pm ET.

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