Ethereum, Pt 2: The Once and Future King - #WFM 198
Ethereum has grown into the premier utility-focused blockchain
It’s becoming clear that writing a primer for Blockchain technology is going to be a tad more detailed than originally anticipated. To gauge if we’re going into too much detail, please reply to this email and let us know your thoughts. Thanks! - Elliot & Harrison
The Future Of Ethereum
By Elliot Koss, Founder @ Future Mints
Since Ethereum was first launched in 2015, it has slowly and then suddenly begun to fulfill its promise of being a utility-focused blockchain. And while Bitcoin was designed to solely be a store of value (ie “digital gold”), Ethereum was designed for all manners of use cases.
Today, the most valuable and utility-driven NFTs are deployed to Ethereum. The Merge was released flawlessly, representing the first major upgrade to a mainstream blockchain. And more than 4x the number of transactions were processed on Ethereum than Bitcoin in 2022.
All this is to say that Ethereum enjoys a massive amount of attention and focus by users and investors. The question we’re going to explore is what’s next in the evolution of today’s most useful blockchain.
What’s Next For Ethereum
There’s enough material to write an entire book for each topic below, or at least dedicate a newsletter, so we’re going to narrow our focus and cover the highlights of a few key topics. I’m intentionally not going to touch on dApps or Web3 since we’re already going to split the 5 topics over this and next week since we’re tracking well above our 1K word target this week.
Utility vs Store Of Value: Before delving too deep, it’s essential to understand the fundamental reason why Ethereum has an uncapped number of tokens (unlike Bitcoin which will be limited to 21 million).
Payments: Transaction speed and cost have been major limiting factors for widespread adoption of many blockchains and Ethereum in particular, but the next upgrade (aka Sharding) should address the bulk of these limitations. This should increase usage practically overnight, though it may take a tad longer for the masses to catch up. However, one area that requires a big upgrade is how to reverse payments and layer in customer service to help when users run into problems - because it’s going to happen.
Layer 2 & Sidechains (next week): One of the major utilities of Ethereum is the capability for other blockchains to be built on top of it (Layer 2) or to use the same underlying technology to be interoperable with Ethereum (Sidechain).
Smart Contracts (next week): Now we’re getting to the meat of Ethereum’s utility. The ability to establish an independent set of criteria that triggers specific actions is powerful. It’s like taking the internet and giving you your own piece of it. We have only scratched the surface of smart contract use cases, and once Ethereum payments are faster and cheaper, smart contracts will become increasingly more pervasive. I’ll try to make this less abstract.
DAOs (next week): Decentralized Autonomous Organizations will become increasingly better. Today, they are rigid and limiting, but as the technology is used more, we’ll see an explosion of improvements and benefits. It’s likely that the modern company or non-profit structure will eventually be replaced with DAOs, but that adoption will be dependent on how quickly DAO technology can be set-up to be as flexible as today’s companies require.
Utility vs Store Of Value
Ethereum has an uncapped supply of tokens meaning that as the years pass by, new tokens will be issued. This means Ethereum’s supply will always increase which will hurt its price over time. Sounds simple, right? It isn’t, because that isn’t the full story.
Before we dig into the details of Ethereum (and we’ll try to keep them high level), let’s talk about Bitcoin (BTC). The main concept around Bitcoin is that it’s ‘digital gold’, meaning that it derives its value from its scarcity. There will only be 21 million Bitcoin ever created, and over time, it’s likely that BTC tokens will be lost by people who lose access to their wallets (like Silicon Valley’s Russ Hanneman) or burn it by sending Bitcoin to invalid wallet addresses. Like gold, Bitcoin is considered a ‘store of value’ due to its scarcity (until we start mining asteroids and gold supply increases - but that’s a thought for another day).
Back to Ethereum. As we learned last week, the entire purpose of the Ethereum blockchain is utility-driven, and over time, the structure of Ethereum will iterate. Such as on Aug 5, 2021 when Ethereum Improvement Proposal (EIP) 1559 went live. The takeaway is that the fee paid to process a transaction on Ethereum was split in two - a base fee and a tip. The tip is paid to miners (now validators) to increase the priority of the transaction (ie pay a bigger tip, get the transaction processed faster), and the base fee is paid to the Ethereum network AND BURNED. Burning a blockchain token means to remove it from circulation (read the link for more details). What EIP 1559 means is that every year, some percent of Ethereum tokens are going to disappear.
As a result of EIP 1559 burning Ethereum tokens, the net issuance of Ethereum is close to 0% and it’s expected to eventually become deflationary, meaning that more tokens will be burned than issued in the years to come.
So while Ethereum tokens will be created every year, the act of using Ethereum will destroy some small percent of it.
This is good news, because it means that Ethereum has built-in mechanisms to make it sustainable for everyday use while keeping the supply in check, and if for some reason supply gets out of alignment, a new EIP can be submitted, considered, and implemented.
On top of this, since The Merge, validators (the computers that confirm Ethereum transactions and encrypt them into blocks of the blockchain) are required to stake some Ethereum to participate (hence the term proof of stake aka PoS), which means that some percent of Ethereum will be locked into the system in order to make everything function, further reducing the available supply.
One potential downside to the PoS structure is that SEC Chairman Gary Gensler has stated that PoS may be considered a security under US law. Since regulators haven’t been clear about how they intend to regulate blockchains, it’s unclear what this means at this time. But regulation will have a meaningful impact to the future of Ethereum - and my hunch is that it will eventually be a net positive, despite initial resistance.
From an economic perspective, supply and demand are essential for determining price, so if the supply of Ethereum stays steady while the demand for its utility increases (which can thus drive down supply), there’s potentially positive price pressure for Ethereum to become increasingly valuable. This is not investment advice.
Payments
Today, there is still a problem with using Ethereum for payments or utility - it takes too long for transactions to process and it costs too much. A big reason for both the time and cost to transact on Ethereum is due to the current limit of ~30 transactions per second. The small throughput for transactions means that if you’re paying too little gas (ie the transaction fee), then your transaction will take longer to process. The more you pay, the faster the transaction is processed. Supply / demand at its worst.
But as we wrote about last week, this all changes when the Sharding upgrade completes. We won’t go into the details of Sharding today, but the key takeaway is that Ethereum will increase from ~30 transactions per second to an estimated 100,000. Yes, that’s a big deal.
However, Sharding may not happen for a couple years. Afterall, The Merge was notoriously delayed for over a year, and the original timeline for Sharding targeted the first quarter of 2023 which is definitely not happening.
With that said, the successful and smooth upgrade of The Merge can give everyone more confidence that Ethereum will eventually upgrade its ability to process more transactions and reduce costs. While this action may not make Ethereum suitable for everyday transactions like going to the grocery store (no one knows for certain at this point what the cost savings will be), reduced costs will make it less expensive and more efficient for Layer 2 chains to operate (which we’ll dig into further next week).
If Sharding happens as outlined above, then it’s likely that either Ethereum or a Layer 2 chain will have the infrastructure required for some credit card equivalent to launch making buying everyday goods with cryptocurrency on the blockchain a reality. This would be a major step towards reducing transaction costs for credit card payments today.
You may be aware that credit card companies charge transaction fees to merchants (ie the grocery store) for the convenience of accepting a credit card. Stripe, one of the major tech unicorns who’s core product is to allow anyone to process credit card transactions, charges 2.9% + $0.30 per transaction (volume gets you a discount).
So if Ethereum’s Sharding can reduce transaction costs below this threshold, then every merchant is eventually going to migrate to an Ethereum-based transaction platform. This comes down to simple economics; when merchants are processing millions in transactions, every penny counts. Just ask WalMart who came up with their own payment processor in an attempt to save billions of dollars (“Walmart Pay circumvents credit card transaction costs, usually an inquiry fee between 20 and 35 cents, an additional average of 2.3 percent transaction fee and equipment fees of tens of dollars for each card terminal.”).
If you build a better mouse trap for cheaper, eventually the market will recognize and reward you (assuming an efficient market where regulatory hurdles are handled correctly).
One critical area that currently has no good solution is the customer service component. Blockchain transactions are irreversible today. It’s a known problem, if for instance, you buy something but want to return it later. Because there is no central authority (ie the credit card company), the customer has no recourse to dispute the transaction. If the merchant chooses to not honor a refund, there’s literally nothing that can be done with the way Ethereum and other blockchains are currently structured. This is a known limitation, and one that must be solved before mass adoption is realistic.
Wrapping It Up
Ethereum is being built deliberately to upend the technology that we use today and replace it with a fully decentralized way of operating. This week, we touched on the token supply mechanics and the major improvements to payments that are coming down the pipeline. These may seem like boring topics, but they will have a major impact. And as we’ll see next week, the foundational upgrades to the token supply and payment processing will unlock capabilities and adoption for Layer 2 and Sidechains, Smart Contracts, and DAOs.
The future of Ethereum is bright, and it’s coming more into focus every day.
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News of the Week
Bitcoin rose past $25,000 and Ethereum rose past $1,700 on Thursday. Despite both tokens retreating back down, these prices mark the highest valuation the tokens have been traded at since August of last year.
The long-awaited airdrop from the popular NFT marketplace Blur went live on Tuesday. Creators and traders alike can claim their season 1 $BLUR rewards here. The zero-fee marketplace also published a blog post on Wednesday detailing how creators can earn full royalties on its platform by blocking sales on OpenSea.
As the SEC fights the war on staking, some of crypto’s biggest companies are fighting back. Coinbase detailed their stance, outlining in a blog post why the exchange believes their staking services are not securities.