• Digital Assets

    Q&A: The Bull and Bear Case for Ethereum

    Matthew Sigel, Head of Digital Assets Research

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    We recently hosted a webinar on the bull and bear case for Ethereum and were pleased to welcome over 500 signups.

    Can you explain what a digital currency is actually backed with as there are no assets within a digital currency? Isn't it really just a Ponzi scheme facilitated by the greater fool theory?

    Cryptoassets are, and we quote the Bank for International Settlements’ (BIS’) most recent consultative document1 on the topic, “private digital assets that depend primarily on cryptography and distributed ledger or similar technology.” So the world’s central bankers agree they are assets. We can start there.

    But let’s use some real world examples: Your social capital is an example of an intangible asset that you own: your relationships. Social media let you grow and monetize that social capital into tangible assets (cash) with a bit more ease and scale. But still, even converting 1% of your readers on social media into paid customers counts as success, and it’s tricky to price your product dynamically. That’s a lot of waste! With a smart-contract based solution built on Solidity (an “Ethereum Virtual Machine”)2, you could set the terms of your own content distribution with more precision and take a larger piece of the pie than you might get via existing intermediaries…as long as you are willing to use Ethereum as your medium of exchange. Thus users can win twice: a new path-to-market opens up, plus they enjoy the price appreciation as the unit of account on the platform becomes more widely accepted. This happens even though the disruption is deflationary to existing financial and web 2.0 platforms! In financial services, we believe DeFi platforms are winning3 this business to the tune of a nearly $3B annual revenue run-rate4Music5 and social media6 will attempt this model as well. So will peer-to-peer lodging7 and search8. Decentralized options may not predominate in any given industry, but they will play a role. Consumer welfare may increase from the lower costs and higher autonomy: that’s a tough-to-measure asset, but real.

    Staying on your question (“No assets within a digital currency?”): just as the software that runs the Google search engine is obviously an intangible asset9, so, too, Ethereum’s network produces returns to stakeholders in the form of transactions fees and new currency issuance. It is true that this ecosystem requires more trust in computer code and an appreciation for a higher level of monetary velocity (and leverage) than in the fiat system, but that does not make them (all) Ponzi schemes. Also, more sophisticated governance schemes for allocating value to stakeholders are emerging in smart contract form. We will have more information on these decentralized autonomous organizations10 (DAOs) in later reports.

    Why would the monetary and regulatory authorities allow Bitcoin and Ethereum to even exist?

    The Bank of England wrote in their recent stablecoin primer11: “New forms of digital money could potentially offer benefits in terms of cost and functionality. And there could be potential gains from a shift to more market-based financing. It is also possible that they could enhance the transmission of monetary policy.” Digital assets create new economic growth via the efficiency gains inherent in digital money (most obviously, automation). Some policymakers are likely to embrace this reality, as happened in El Salvador a few weeks ago12. Those that don’t initially may face increasing pressure to do so as the benefits of wider financial inclusion, digitalization, and de-materialization13 become more evident. Global competition for capital may ensure that cryptocurrencies survive.

    From the view of someone who lived through 9/11, many of the steps in your upward-pointing pyramid are there to allow for public safety, i.e. Patriot Act. How is there any provision for public safety in the Ethereum paradigm? And if it cannot be, why would governments ever allow the fullest adoption of a decentralized currency?

    There are many ways to think about public safety. We believe empowering citizens under the thumb of authoritarian regimes to access their hard-earned capital without government oversight might be considered public safety of a sort. Or depending on how the capital is eventually used, it might not be. It depends. But this is a good place to address a falsity that is often repeated—that bitcoin is frequently used for illegal activities. In fact, a very small percent of crypto transactions are related to illegal behavior; a recent Chainalysis estimate14 shows it to be less than 0.25% in 2020, compared to a 2011 United Nations Report15 that 2% to 5% of global gross domestic product (GDP) was associated with money laundering and illicit activity in 2009.

    In any case, enforcing regulatory oversight such as KYC/AML (know your customer and anti-money laundering) standards can indeed protect public safety, as you note. Most exchanges already enforce them. In DeFi, we would expect so-called “permissioned” pools16 to grow alongside public blockchains to satisfy global demand for the public safety oversight component. We will see how much of crypto’s current cost advantages it will erode.

    If one person can extensively manipulate the cryptocurrency market, how can these currencies be anything other than at best mere speculation or at worst a perfect example of "the bigger fool trade"?

    The stock price performance of bankrupt Hertz and later GameStop and AMC Networks should be proof enough that social media platforms and cheaper trading venues have turbocharged the memetic frenzy for many niche assets, not just crypto, with some volatility as a side effect. If customers can mobilize online to support a bankrupt company’s survival via movie ticket or equity ticket purchases, who is to stop them from leveraging such social capital in whatever asset class? In our opinion, complaints about market manipulation should not be limited to cryptocurrencies.

    Why is Ethereum better than other layer 1 solutions? Are there high switching costs or anything keeping DeFi projects or other things with Ethereum, or can they easily switch to others?

    This is a key question for our $2T bull case. The performance of FAANGM stocks over the past decade demonstrated the relevance of scale in software platforms. Ethereum currently boasts the largest developer community and widest variety of applications, including multiple17 central banks18, among layer 1 protocols. To the extent the scale advantage keeps costs lower than the competition, switching would be unattractive.

    Can you define Etherum revenues? Would you say Ethereum bears a kind of intrinsic value (whereas Bitcoin potentially not), due to its huge ecosystem? How do you evaluate the price of the Ethereum? It costs now €1500, why not €150 or €15K?

    Ethereum revenues comprise the rewards paid to miners in the form of new token issuance plus gas fees19, paid in return for validating transactions on the Ethereum blockchain. By observing the market-cap-to-miner-revenue20 ratio we can observe that the market, so far, places a high valuation premium on Bitcoin’s scarcity, whereas Ethereum price-to-revenues is more similar to Web 2.0 firms despite its topline growing much more quickly.

    Can you touch on the energy use and thus the environmental impacts of blockchain? Could this hinder the growth of Ethereum?

    The risk vs. reward of any energy use comes down to tradeoffs. What costs are generated vs. what benefits received? For many, digital assets are a deflationary innovation that bring consumer welfare by disrupting existing infrastructure (digital wallet vs. ATM machine: which needs more raw materials?). Others like Senator Elizabeth Warren object that even 1 kilowatt of power is too much to spend on Bitcoin. In gauging the tradeoffs vs. benefits, we should remember that the vast majority of carbon-based energy created never touches the electrical grid. The high cost of converting and transporting it ensures that much is actually wasted in the form of cow flatulence or flared gas. To the extent that a poor equatorial nation with no electrical grid to speak of could mine Bitcoin competitively from solar or other renewable energy and sell it to buy textbooks and air conditioners, what ESG manager would object? As for Ethereum, its energy usage is already 93% lower than Bitcoin’s on a per-transaction basis and headed much lower with its transition to proof-of-stake (according to Digiconomist21 based on Cambridge data). For further reading on this topic, I recommend Nic Carter’s piece in the Harvard Business Review22 and the Seetee investor letter23.

    Do you see central bank digital currencies as an existential threat to private projects?

    Central bank digital currencies (CBDCs) are likely to be a competitive threat, but may not be an existential one. We believe that digital money is most useful to the extent that it is programmable, and that requires a developer ecosystem to execute nifty use cases. While the government no doubt will wield significant market power in the space, in our view, usually the private sector produces a better product.

    Sources and Definitions:

    Source: Basel Committee on Banking Supervision

    Definition: Solidity is an object-oriented programming language for writing smart contracts. It is used for implementing smart contracts on various blockchain platforms, most notably, Ethereum.

    Source: VanEck

    Source: The Block

    Source: Audius

    Source: Adweek

    Source: Forbes

    Source: The Verge

    Source: IFRS

    10 Source: Uniswap

    11 Source: Bank of England

    12 Source: VanEck

    13 Source: More from Less: The Surprising Story of How We Learned to Prosper Using Fewer Resources―and What Happens Next by Andrew McAfee

    14 Source: Chainalysis

    15 Source: United Nations office on Drugs and Crime

    16 Source: Cointelegraph

    17 Source: Coindesk

    18 Source: The Chain Bulletin

    19 Definition: Gas fees are payments made by users to pay for the computing energy needed to process and validate transactions on the Ethereum blockchain.

    20 Source: Coinmetrics

    21 Source: Digiconomist

    22 Source: Harvard Business Review

    23 Source: Seetee

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  • Authored by

    Matthew Sigel
    Head of Digital Assets Research

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