Ethereum - Enabling NFTs, DeFi, & eventually our Metaverse?

Ethereum - Enabling NFTs, DeFi, & eventually our Metaverse?

By DMoneyCanada | Free Lunch | 27 Nov 2021


With the price of Ethereum hitting another all-time this month, I thought it would be fitting to discuss what Ethereum is all about and why everyone in the Crypto space seems so bullish on it. There is a lot to cover within the Ethereum ecosystem, so feel free to skip sections. As always, this is not financial advice to invest in Ethereum.

Sections

  • What is Ethereum?

  • Network Effects

  • NFTs

  • DeFi

  • Problems with Ethereum

  • ETH 2.0

  • The Metaverse


What is Ethereum?

To understand Ethereum, we first got to understand what blockchains and smart contracts are. A blockchain is simply a database which stores and records information. Rather than the traditional way of having one computer/server hold all the information, every computer in the blockchain network (called nodes) have access to information, making it impossible for anyone to modify or delete. For smart contracts, you can think of this as just code to do a task automatically when certain conditions are met. Think of a vending machine, if you pay, then the snack gets dispensed automatically. This removes the need for a third party to verify whether you paid and give you your snack.

With that in mind, Ethereum is simply a blockchain network with smart contracts enabled. Although both Bitcoin and Ethereum are built using blockchain, Bitcoin uses it to function as a “digital currency” while Ethereum takes it one step further by enabling any developer to build their own programs (called DApps or Decentralized Applications) on top of their blockchain. To run these programs or transact on the Ethereum blockchain, one must pay in its native cryptocurrency which is Ether (ETH).


Network Effects

Since the creation of Ethereum in 2014 by Vitalik Buterin, Ethereum has become the most used blockchain in the world. Although there are many challenger blockchains popping up these days, the majority of blockchain developers are still building their DApps on Ethereum, given they are the oldest and the largest. You might be tempted to think being a first mover is not a sustainable long-term advantage for Ethereum. But in the case of blockchains, I’d argue first mover is indeed a sustainable advantage and that is because of network effects. As more people use Ethereum, more developers are attracted to building on Ethereum, leading to more DApps and functionalities, which in turn leads to more users for the ecosystem.

Network effects are very common in the tech world, where we saw examples like Apple creating an entire ecosystem because of it. More iPhone users led to more developers building for their app store, which led to more apps for users, and attracting more users to create a cycle.

Looking at the Ethereum ecosystem today, we are already beginning to see these network effects. Given the scale Ethereum is at today, it’s looking less and less likely for any other blockchain to catch up to their dominance. Additionally, we are already starting to see many of the Ethereum DApps and use cases hitting mainstream this year whether you realize it or not. The two most popular ones built on Ethereum are NFTs and DeFi, which we will explore in the next two sections.


NFTs

NFTs (Non-fungible tokens) without a doubt has been one of the biggest surprises in Crypto this year. People figured out that with blockchain, creating digital currencies where each token is worth the same amount wasn’t the only innovation, you could also create non-fungible tokens, where each token has unique characteristics which is not interchangeable.

This led people to go from valuing cryptocurrencies to trying to value a JPEG picture of a Bored Ape. Luckily, unlike the rock JPEG which sold for a million dollars earlier this year, the cheapest Bored Ape (like the ones below) would only cost you $150k today. Now just imagine there are another 10,000 of these apes for sell from the Bored Ape Yacht Club collection, and many similar NFT collections with a similar price range. This concept of owning a NFT is indeed mind-boggling for most people.

Bored Ape Yacht Club: The Latest NFT Collectable Craze? - NFT Culture | NFT  & Crypto Artists Curating Ideas

Before I answer the million dollar question, which is whether I personally believe in or would invest hundreds of thousands of dollar on NFTs, let’s first try to understand the full picture (no pun intended) of what we could be missing here. What could the value of an overpriced JPEG possibly be?

Is it because of art? We know traditional artwork is an asset. There are people who willingly invests millions of dollars on physical paintings each year. So if each physical painting is unique and have value, shouldn’t we be able to use the same angle here to view digital artwork?

Is it because of identity? Let’s be honest, the people who are spending 32 ETH on a NFT is not your typical retail investor. Most likely, these are people who bought ETH when it was trading at much lower price or someone who can straight out afford it. So in a way, NFT could be like your digital or social identity. The rare ape you own gives you the feeling of prestige in the crypto world. This understanding is not too hard to digest if you just spend a few hours on Twitter and realize everyone on Crypto Twitter has a NFT profile pic of some kind.

Is it because of community? Similar to identity, could it be the feeling of belonging to a community? We are already seeing some of this today, with sports teams and creators selling out their NFTs within hours. We know it’s not enough to be a “viewer” in a community you believe in, fans want a bigger role and buying a NFT might be the first step.

If I have to rationalize NFTs in a way which makes sense, I would say it is a combination of all these things - value, identity, and community. These are all important factors for NFT adopters, leading to the cult following we are seeing behind some blue chip NFT projects today.

Although it is easy to think we are in a NFT bubble of some kind, I do believe NFTs are just scratching the surface of what they will become. Digital artwork, businesses using NFTs to engage with their customers, and creators making more money are all great uses of NFTs, but I believe the future of NFTs will actually be about owning digital goods in the new digital world.

If you believe in the future idea of the Metaverse, then we know gaming will certainly be a big part of it. Gaming worlds are the closest thing we have to virtual worlds today. This is not a surprise considering we have already seen virtual concerts happening on games like Fortnite. NFTs can make it extremely useful for anyone looking to buy certain game avatars or accessories. Rather than wasting hundreds of dollars on digital goods for one game and getting nothing back when you quit, what if you could actually own these assets as NFTs and trade it to play another game? Popular NFT games like Axie Infinity (a play to earn game) might not be here to stay, but we do know everyone wants to have more control of your digital goods and NFTs open the doors to that possibility.

Axie Infinity - Everything You Need to Know About the NFT Powered "Game"

DeFi

In terms of real world applications, the most popular category for DApps on Ethereum today are related to DeFi or Decentralized Finance. At a high level, DeFi seeks to decentralize our current financial system by removing the middlemen (eg. banks). This allows participants to enjoy lower fees while getting higher returns on their money. To give you an idea of the growth we are talking about here, there was only $25 billion in assets deposited into DeFi at the end of 2020, that number went to $90 billion by October this year, and now many are predicting it to hit $800 billion by the end of next year (almost another 10x to come). DeFi is here to disrupt the financial sector, and whoever doesn’t think so is most likely still working for a traditional bank.

DeFi vs Cefi: How DeFi measures up

But in the interest of getting a free lunch, how do people actually participate in DeFi today and how could you get involved?

Currently, the two most popular ways are through lending protocols and DEX. DeFi lending protocols work similar to how a bank would operate. You deposit your money at the bank (receiving interest), the bank then takes your money and lend it out (charging the borrower an interest). The difference between the interest they charge borrowers and the interest they pay you for your money is how they profit.

DeFi lending protocols work in a similar way except everything is automated without a middleman. You can “deposit” your cryptocurrency on protocols like Compound or Aave to earn interest. You can also borrow against your crypto. For instance, if you happen to own some bitcoin and is looking for cash, rather than selling your Bitcoin (where you will have to pay capital gain tax and lose out on the upside of bitcoin), you can use your bitcoin as a collateral and borrow money against it. Of course, this only makes sense if the money you borrowed has a higher return than the interest rate you are paying to borrow.

The other way to participate in DeFi is through DEX or Decentralized exchanges like Uniswap or PancakeSwap. Similar to centralized crypto exchanges like Coinbase or Binance, where you can buy and sell cryptocurrencies, DEX works the same way without the middlemen. To understand the mechanics of how a DEX works, it’s helpful to compare it with a traditional stock market with market makers. Every time you want to sell a stock, there are actually market markers who will provide “liquidity”, allowing the order to go through even if there is no buyer at that exact moment. The market marker provides this “liquidity” and makes profits on the spread by doing so.

In DEX, market makers are replaced by automated liquidity pools. Liquidity pools are essentially pools of money a DEX has so that whenever you want to buy and sell a cryptocurrency, you can with ease. For these DEX to get money for their liquidity pools, they often provide participants with a yield, sometimes even upwards of 100% APY. We will go into liquidity pools and yield farming when we look at specific DeFi projects in the future, but the key takeaway here is DeFi offers many other ways to earn a free lunch, rather than simply buying and holding, believing a coin will go the moon.


Problems with Ethereum

If Ethereum is so great, why are we hearing about so many other blockchains like Cardano, Solana, and Avalanche eventually killing Ethereum? The answer is Ethereum isn’t perfect. Vitalik Buterin famously created the term “The Blockchain Trilemma”, which describes the trilemma developers face when creating a blockchain like Ethereum. In other words, all blockchains have to make trade-offs between three key features which are speed (scalability), decentralization, and security. There is no easy way to ensure a blockchain can have all three.

How Bitcoin solves the Blockchain Trilemma | by Gianmarco Guazzo |  Coinmonks | Medium

With the growth of Ethereum in the last few years, we are actually seeing the problem of scalability in the Blockchain Trilemma. As more and more people use Ethereum, not only are we seeing slower speeds, but gas fees are also becoming more outrageous. Remember that every time you transact on any Ethereum DApp, you have to pay gas fees in ETH. For example, if you are trying to buy a NFT on OpenSea, you will likely be paying hundreds of dollars in gas fees for the transaction (whether it goes through or not). This is not scalable if you consider traditional transaction methods like credit cards only charge 1-2% in fees.

This high cost of transaction is what’s driving so many to other new blockchains looking for an alternative to Ethereum. For example, Solana promotes much faster transaction speeds and much lower cost, but of course, this means they are less decentralized (Blockchain Trilemma). At the end of the day, I do believe these blockchains will eventually co-exist with Ethereum, given there are functions which just makes more sense taking place outside of Ethereum. But will they threaten Ethereum’s dominance? My view is I don’t think it matters how fast, how secure, or how decentralized a blockchain network is if Ethereum still has the most DApps and users because of their network effects.

ETH 2.0

The other answer to whether or not Ethereum could withstand competition comes from the development of ETH 2.0. Ethereum is not perfect, but luckily there is a group of core developers working on improving the blockchain and is in the process of deploying ETH 2.0 (hopefully some time next year). ETH 2.0 will solve many of the problems Ethereum 1.0 has today. I won’t go in depth into this but know that if ETH 2.0 is successfully deployed, it will enhance the speed, efficiency, and scalability of Ethereum while promoting a more sustainable way of verifying transactions (mining) through Proof of Stake.


The Metaverse

Metaverse: the world between technology and reality - Cointribune

We mentioned earlier about the idea of the Metaverse. Facebook even changed their name to “Meta” to focus on this idea. Is the Metaverse really going to look identical to the movie Ready Player One? Unlikely, but we are still too far away to actually know. What we do know though is that crypto will be a key part in creating this Metaverse. Crypto enables more than just digital payments but a decentralized infrastructure that is the core of what Web 3.0 and the Metaverse will be about. And this decentralized infrastructure will most likely be built on top of Ethereum.

For many years, there have been talks about The Flippening. The scenario where Ethereum overtakes Bitcoin by market cap as the #1 cryptocurrency. With Bitcoin’s historical dominance, many believe the Flippening is purely a pipe dream by Ethereum supporters. But in a world where Ethereum successfully outlasts their blockchain competitors and become the underlying infrastructure of the Metaverse, what will the value of Ethereum be?

In my view, this is similar to asking the question of “what is the Internet worth?” in our era. Without the Internet, the millions of use cases and applications we see today would not have existed. Surely, the value of the Internet then must come from not only the Internet itself, but the billions of use cases and transactions happening on it every day. And so if you ask me the question of what the value of Ethereum is, I find it hard for anyone who really believes in the future of crypto and blockchain to be bearish on its potential.

If you found this helpful, feel free to check out https://myfreelunch.substack.com/!

How do you rate this article?


106

0


Free Lunch
Free Lunch

Exploring crypto projects and opportunities in search for a free lunch.

Send a $0.01 microtip in crypto to the author, and earn yourself as you read!

20% to author / 80% to me.
We pay the tips from our rewards pool.