ETH Is Money? How is it Used?

ETH Is Money? How is it Used?

By Michael @ CryptoEQ | CryptoEQ | 11 Jun 2021


60a46caf07a62b6cb55fb3a72d2148009e1fddab772ecdf496f3f17319fe83e2.png       Ethereum logo

Overview

Ethereum is an open-source blockchain that enables decentralized applications and financial services by leveraging smart contract technology. The original vision behind Ethereum was to create “a platform for the deployment and execution of smart contracts” thereby enabling a decentralized global value-settlement and computational layer. The goal was to extend beyond Bitcoin’s functionality to a decentralized Turing-complete computing platform for smart contracts, programmable money, and decentralized applications (dApps).

Ethereum Strengths

  • Ethereum is the second-largest liquid digital asset, behind only Bitcoin.
  • Ethereum boasts more developers, developer activity, dAppsnode countsettlement value, and aggregate fees than any other digital asset.
  • The flexibility of Ethereum’s smart contracts allows for a multitude of projects to build on the Ethereum blockchain and participate in Web 3.0.
  • Partnerships with prominent enterprises, as well as thousands of dApps built on the platform, have helped boost name recognition and contributed to tremendous network effects.

Ethereum Weaknesses

  • The project is still incomplete and is currently in the midst of a prodigious, multi-year upgrade that comes with substantial risk.
  • Current scaling issues limit the ability of dApps and other projects to grow and create satisfying user experiences.
  • Heavy competition from rival blockchains, such as Polkadot and Cardano, could chip away at Ethereum’s adoption and popularity.

Important Links

Ethereum logo Use Case

Ethereum is an open-source public blockchain cryptocurrency network founded in 2015 by Vitalik Buterin in conjunction with Charles Hoskinson, Anthony Di Iorio, Mihai Alisie, and Joe Lubin. The original vision behind Ethereum was to create “a platform for deploying and executing smart contracts” thereby enabling a decentralized world computer. The goal was to extend beyond Bitcoin’s functionality to a decentralized Turing-complete computing platform for smart contracts, programmable money, and decentralized applications (dApps). These dApps would use the native Ethereum currency, Ether. Ethereum, like Bitcoin, facilitates programmed verification, without the need for third parties or without the possibility of interference.

Ethereum has an intriguing and polarizing history that has had a profound influence on the broader cryptocurrency space. In July 2016, Ethereum split into Ethereum and Ethereum Classic as a result of the intense debate following the infamous DAO incident. Since then, Ethereum has solidified its place in the cryptocurrency mainstream as the second-largest cryptocurrency – behind Bitcoin – and boasts the largest portion of the developers in the space due to its Turing-completeness and smart contract functionality. 

Ethereum has established itself as one of the most groundbreaking technological innovations in not just the cryptocurrency space, but in all of technology writ large. The months and years ahead will eventually determine its ultimate sustainability and the direction of cryptocurrency platforms outside of Bitcoin.

 

Primary Use Case

Ethereum is a decentralized blockchain platform for building and running autonomous smart contracts over a network of nodes, secured by Proof-of-Work (PoW), cryptography, and reaching consensus via Nakamoto Consensus. The most popular implementation of the protocol is written in Go, and the most widely-used smart contract language on the platform is Solidity.

Ethereum is home to the most flourishing developer community of any cryptocurrency, except for arguably Bitcoin. The primary use of the platform and the reason for its proliferation is the ability to code and run smart contracts on the network. Smart contracts were proposed by cryptocurrency pioneer Nick Szabo and are programs that run autonomously on the network, exactly as programmed, without any possibility of downtime, censorship, fraud, or third-party interference. Aggregations of smart contracts built to function within a specific design are known as decentralized applications (dApps). Ethereum is the leading dApp platform by a substantial margin

The Turing-completeness of the platform theoretically allows for any type of computer program to run on the network. This has led to the creation of decentralized, uncensorable dApps such as the Augur prediction market, P2P marketplaces such as OpenBazaar, and Open Finance tools like Dai and Compound (discussed in Network Effects). 

The major advantages of building dApps on Ethereum are that they are decentralized, permissionless, uncensorable, have removed the need for intermediaries, and can be integrated with open standards for creating provably scarce virtual items. As an example, Peepeth is Ethereum’s version of Twitter; however, since it is built on Ethereum’s decentralized blockchain, it is not controlled or backed by any company. Instead, it runs autonomously through smart contracts that interact with each other. As a result, it is uncensorable and permissionless, two features Twitter lacks and has sparked controversy

Once blockchains can effectively scale, the potential of dApps to revolutionize the application landscape is enormous. Future iterations of Ethereum may see numerous sidechains and dappchains connected to it, while the main chain functions as the permanent distributed database and consensus layer for the various chains attached to it. Ethereum can perhaps best be visualized then as a massive tree, with individual dApps and sidechains tethered to it as branches.

 

Secondary Use Case 

The primary use case of Ethereum is straightforward; however, evaluating its secondary use case requires more nuance, as its history, novelty, and recent developments with the platform all provide unique insights into its potential uses. Breaking down Ethereum’s secondary use cases requires evaluating two significant trends: 

  1. Innovation/experimentation with rapid evolution
  2. Open standards of a decentralized protocol 

 

Today, Ethereum’s governance has a similar off-chain model to Bitcoin’s, but, unlike Bitcoin, implements changes much more regularly. Ideological positions aside, the result has been that Ethereum has become known as a rapidly evolving experimentation ground for innovating on a vast, decentralized computing platform. It should be stated that comparing the development process and number of updates across projects is not an ‘apples to apples’ comparison. Protocols like Bitcoin get their value from their stability and resistance to change, whereas a project like Ethereum – who’s ultimate vision and product has yet to be completed in full – requires innovation and updates to eventually achieve the goal of building a decentralized world computer.

Specifically, this dexterity in development comes into view when examining Ethereum’s pending transition from proof-of-work (PoW) consensus to proof-of-stake (PoS) in its upcoming ETH 2.0/Casper release. PoS is yet to be proven as a sustainable consensus mechanism on a large-scale network, and Ethereum will be the fascinating case study that attempts to do precisely that. Furthermore, changes to Ethereum’s protocol in the form of other upgrades such as the Difficulty Bomb delay and reducing miner block rewards are also representative of a more rapidly-evolving platform. Comparatively, Bitcoin takes a much more conservative approach to changes and focuses on slow and steady innovation and implementation. 

Additionally, Ethereum has seen its blockchain used more and more to settle stablecoin transactions. Stablecoins, mostly Tether (USDT), on Ethereum exploded in 2020 and now make up a significant percentage of the network’s capacity. 

 

Stablecoins on Ethereum Growth of stablecoins on Ethereum. Image credit: CoinMetrics

One area of experimentation that so far has been a success for Ethereum is the emerging DeFi (Decentralized Finance) or Open Finance movement within the crypto ecosystem, enabling projects to build a stack of financial primitives in a decentralized and open-to-anyone fashion. Inarguably, the biggest success case out of all of these projects is MakerDao, a financial system for decentralized, collateralized loans as well as the stablecoin, Dai. As of Q2 2021, a little over 2% of all ether was locked into loans on MakerDao, who in their first year issued $200 million in loans and now has nearly $10B stored in the project. Other notable Ethereum DeFi projects include money market protocols like Compound, lending tools like Dharma, prediction markets like Augur, and derivative products like dYdX. DeFi/Open Finance is still in its infancy, but the idea looks to be a solid use case for smart contract platforms, and is drawing a good deal of attention moving into 2019.

The other secondary use case of Ethereum pertains to its development of open standards. The proliferation of open standards on Ethereum cannot be understated. Open standards are the basis of the Internet and are proven to drive open-source success. Token standards from ERC-20 to ERC-1155 are built to facilitate a standardized interface for smart contracts to interact and exchange value. The ERC-20 standardization made running an Initial Coin Offering (ICO) on Ethereum so easy, which led to billions of dollars raised in 2017 and 2018 that helped to build out the ecosystem.

Discussions on open standard proposals through the Github for Ethereum Improvement Proposals (EIPs) are thoughtful, innovative, and nuanced. The future implications of open standards further developing on the platform are difficult to project, but have promising potential. Other resources for learning or discussing the more technical components of EIPs and all things Ethereum include eth.researchEthHub.ioethereum-magicians.org, and Ethereum Gitter.

DeFi 

One area of experimentation that so far has been a success for Ethereum is the emerging DeFi (Decentralized Finance) or Open Finance movement within the crypto ecosystem, enabling projects to build a stack of financial primitives in a decentralized and open-to-anyone fashion. Wile DeFi remains incredibly nascent, the promise of removing financial gatekeepers and middlemen gives the entire sector great promise. The first success case out of all of these projects was MakerDao, a financial system for decentralized, collateralized loans as well as the stablecoin, Dai. In Q2 2021, a little over 2% of all Ether was locked into loans on MakerDao, who in their first year (2017) issued $200 million in loans. Other notable Ethereum DeFi projects include money market protocols like Compound, lending tools like Dharma and Aave, decentralized exchanges like UNI and 1inch, prediction markets like Augur, and derivative products like dYdX. DeFi/Open Finance is still in its infancy, but the idea looks to be a solid use case for smart contract platforms and is drawing a good deal of attention moving into 2021.

2020 was a record year for the dApp industry. dApp transaction volumes surpassed $270 billion with > 95% transacted on Ethereum’s DeFi ecosystem.  DeFi really exploded starting in Q2 2020 known as “DeFi Summer” in which DeFi projects saw massive adoption and usage starting. These projects included Compound (COMP), Aave (LEND), Yearn.finance (YFI), Uniswap (UNI), and others. The increased adoption was sparked by a new bootstrapping mechanism called “liquidity mining” in which users supply liquidity to the protocol (i.e. lend their funds) and are in turn rewarded by the protocol in a native token. One of the first DeFi experiments in liquidity mining was by Synthetix in 2019 which later inspired a wave of yield farming projects in 2020, most notably after Compound Finance enabled liquidity mining of COMP tokens in their borrowing and lending markets. This mechanism helps eliminate the “chicken or the egg” problem surrounding most financial dApps face: the dApp needs liquidity to be useful for users but there is no liquidity (or value) from the onset.

 

ETH DeFi growth Image credit: DefiLama

 

With a financial incentive to help bootstrap these networks, users quickly began moving their funds to the project with the greatest ROI in what was dubbed “yield farming.” Yield farming exploded amongst the Ethereum community, driving up transaction costs, and quickly becoming profitable for only the most technically-proficient and well-funded users. 

 

DeFi Market Cap

 

Future Use Cases 

Stretching beyond 2021, things become less certain for Ethereum and the crypto ecosystem as a whole. Considering that interoperable framework projects for interconnected blockchains – like Cosmos and Polkadot – are on the horizon, it is challenging to predict Ethereum’s position in the future ecosystem. 

Ethereum has the potential to bridge with both Polkadot and Cosmos, but its future use case may be as more of a worldwide settlement layer than a full-scale dApp platform. Ethereum’s scalability concerns are real, and its pending transition to PoS consensus is undeniably a huge gamble. If it works, Ethereum will be able to scale to support a vast network of dApps and value transfers. If not, then the system will need to re-integrate PoW or transition to another model, and the subsequent fallout effects could prove disastrous.  

Ethereum’s root blockchain could potentially function as the backbone of a network of dappchains, sidechains, and other contracts that exist within their own consensus pegged to the finality of the larger network. Such an Ethereum network would then function ideologically as a global jurisdictional settlement layer for the state transitions of the applications connected to it. However, these developments depend heavily on future upgrades to the digital asset’s protocol, the ultimate result of which is as of yet unknown. 

 

Competitive Advantage 

Ethereum derives its primary competitive advantages over other smart contracts platforms from its profound network effects in several forms. First, Ethereum’s developer community dwarfs any other smart contract platform community. In fact, according to GitHub’s recent 2018 Annual Octoverse Report, Ethereum is the 5th fastest growing open-source project on the platform. Activity on Ethereum’s primary GitHub repository is also only rivaled by Bitcoin among all other cryptocurrency networks. 

Second, Ethereum benefits greatly from the ubiquity of Solidity as the go-to smart contract programming language. Solidity is designed to compile down to Ethereum Virtual Machine (EVM) bytecode, and it is currently the primary choice when coding smart contracts. Solidity has its problems though, and other languages like Vyper and Scilla for coding more secure and auditable smart contracts are on the rise. Despite this, Solidity’s syntactic similarity to JavaScript – one of the most popular programming languages in the world – affords it the unique advantage of having a less prohibitive learning curve compared to other languages. 

The notable leaders within the Ethereum community are also a primary advantage of the platform. Vitalik Buterin is the well-respected and innovative creator of the platform, and other figures like Vlad Zamfir and Joe Lubin hold a large amount of influence in the broader community. Joe Lubin heads up one of the largest blockchain companies in the world – Consensys – an Ethereum-based distributed development company. Vlad Zamfir is the primary Casper researcher at the Ethereum Foundation and prominent figure-head for Ethereum’s ultimate upgrade dubbed Serenity. Strong leadership is a sizeable benefit that the Ethereum community has that other smart contracts platforms simply do not. The various forms and the combined power of Ethereum’s network effects help sustain its lead over other smart contracts platforms despite its scalability concerns.

 

Challenges to Adoption 

Ethereum’s main challenge to adoption stems directly from its well-known scalability problems. Unlike new generation blockchains focusing on high-throughput capacity that are built from scratch, Ethereum is grappling with how to scale the network without compromising decentralization or security. This is commonly known as the Scalability Trilemma, where sacrificing one of the three properties is necessary for the short-term for the other two to be viable. Ethereum has clearly taken the path of decentralization and security over scalability in the short-term.

Scaling woes have also continued to accelerate, as gas costs regularly become prohibitively high for many dApps, and dApp usage remains low compared to its centralized counterparts. Other platforms have the advantage of building their platforms without the stress of meeting network capacity demands. For instance, Cosmos is building their platform as a PoS-based interoperable framework for scalable blockchain initiatives, but it doesn’t have to worry about scaling with high user activity already active on the network, because it is not yet live. 

The eventual transition of Ethereum to PoS via Casper and then to sharding, outlined in the roadmap, will provide a useful gauge as to the long-term viability of Ethereum as a dApp and smart contract network. For now, speculation runs rampant, but it is impossible to predict how PoS will play out at scale. 

That said, because of Ethereum’s slow but measured total overhaul, some developers and users are looking to build and interact with dApps on other platforms, with some even migrating to them. EOS is the largest present competitor to Ethereum as a smart contracts platform, but it has severe decentralization and mutability concerns stemming from its Delegated Proof of Stake (DPoS) consensus. Despite the mounting issues, EOS dApps that require little need for decentralization, such as games and gambling apps, tout high user counts although there’s evidence to suggest these numbers are forged/manipulated

Finally, Ethereum’s continually shifting narrative regarding scalability and upgrades may prove too much for many users and developers to tolerate. Scaling Ethereum has turned into a highly complicated issue that has progressed slower than anticipated, creating prohibitively expensive transaction fees at times.

 

ETH fees vs ETH price Rising ETH fees. Image credit: CoinMetrics

 

Eth 2 

Staking yields from ETH 2.0 began at ~25% and trends down as more validators participate. In these early stages, over $9B in ETH has already been deposited for staking and yields ~8%. With PoS, ETH becomes more institutionally friendly given its robust infrastructure.

ETH staking rate Image credit: Staking Rewards

 

Over $14B worth of ETH has now been staked.

Some stats on network progress:

  • ETH deposited to deposit contract: 5,000,000+ (~4% of all ETH)
  • Current staking yield: 7.5%
  • Active validators: ~160,000
  • Pending validators: 1,000
  • Network participation rate: 99.0%
     

Eth2 TVL Total value staked in the Eth2 Beacon Chain contract. Image credit: CryptoQuant

The daily average of rewards earned per validator dipped to 0.007235 ETH this month. However, due to the price increase of ether, the USD value of rewards earned on the network increased ~80% over the same time period. Ethereum’s price increase looks to be supported by a steady increase in active addresses.

 

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Michael @ CryptoEQ
Michael @ CryptoEQ

I am a Co-Founder and Lead Analyst at CryptoEQ


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