Ethereum's Founder Dilemma
April 29th 2022

The following is my opinion on the future of Ethereum.

Poor Ethereum. For the record, this is an unfortunate reality I am about the lay out, and I’m aware. I sympathize with the movement.

I’m just one guy, from Kentucky USA, maybe I’m wrong.

Let’s establish what Ethereum is. Let’s understand where the value comes from.

Ethereum is a platform for operating digital financial infrastructure without middlemen. I intentionally generalize this to “financial infrastructure” because Ethereum — as opposed to Bitcoin — offers a general solution to digital finance. Meaning, Ethereum is useful for building services such as lending, exchanging, asset storage, securities, derivatives, options, etc. If it’s a financial instrument, it can be built on Ethereum.

Digital finance without middlemen is a big deal. Commonly referred to as “DeFi” which stands for “decentralized finance.” The word “decentralized” used in this context is different than its use in the context of Bitcoin. I’m not knocking it, don’t shoot the messenger, I’m making it clear there’s a real world difference in the meaning of that word.

DeFi is a big deal because it makes financial markets more equitable (empowers the sovereign individual). One problem with the global financial system (aside from the money) is the closed-nature of the system. DeFi fixes this by bringing everything out into the open. No longer should $GME investors be screwed by the big man because Citadel calls Robinhood and tells them to shut down trading. Historically, global financial markets have been highly exclusionary and this is inefficient, and therefore ripe for disruption.

Within the Ethereum network, the native currency is ETH (pronounced “eath” like “east” but with a lisp). This is the asset you see on Coinbase. ETH is required if a user wishes to use the Ethereum network. If you want to make an NFT, then you use ETH. If you want to send some stablecoins, then you use ETH. If you want to create a lending protocol, then you use ETH. ETH is used in every Ethereum transaction — where the transaction can be composed of non-ETH financial instruments.

The value of ETH is two-fold.

  1. The "monetary good" value
  2. The "bandwidth" value

First, the value of ETH the asset as a monetary good, as proven by its level of accessibility and the credibility of its monetary policy. The whole point of the original decentralization movement was to create money which can be sent peer-to-peer without a third party. In order to do this, the network must be accessible, and the level of accessibility is measured by “how expensive is it to run my own node?” If one cannot run their own node, then there must be a third party. Furthermore, the monetary policy must be credible, in order for investors to ascribe value. If the monetary policy is subject to change, then this begs many questions. Who has the right to change it? Why is it being changed? Does someone have privileged information which enables them to unfairly profit? Safe to say, ETH the asset doesn’t receive a great grading on either of these measures of its “monetary goodness.” And understandably so because Ethereum has always intended to be a generic financial blockchain, which requires sacrifices in its monetary quality.

Second, the cost to be paid in order to use the network. For example, if I want to use AWS, then I have to pay Amazon in USD, and if I want to use Ethereum, then I have to pay the Ethereum network in ETH. The payment is used as transaction fees, and the fees are collected by the miners (or “validators” once the migration is made to Proof-of-Stake).

A useful parallel in understanding the value of ETH is... consider your mobile phone plan where you buy 5GB of data per month. You’re buying bandwidth. You’re buying the right to participate in up-to 5GB worth of data in the network. ETH the asset is like buying bandwidth of the Ethereum network.

Assuming Ethereum makes the move to Proof-of-Stake, then ETH holders can stake their ETH to earn more ETH. So in a way, ETH offers a free cash flow. Except here, the free cash flow can only be used back within the network. As an ETH holder, I can stake my ETH and collect more ETH, which can then be used to participate in the Ethereum network. It’s circular.

Of course people will claim, “well you can bridge you ETH onto other chains” or “but people are accepting ETH as payment” but these are moot points. Both points are functionally a “sale” of ones ETH. Which, begs the question, what value is the recipient receiving? Which of course, as I mentioned, the recipient is receiving the bandwidth to participate in the ETH network at some point in the future. You see, there is no escaping this fundamental fact which is, the value of ETH is predicated on its ability to be used as bandwidth to participate in the Ethereum network. And usage is the process of getting rid of the asset — presumably in exchange for something more valuable. Ultimately, it’s the utility of ETH which reduces its possible monetary premium. This is in contrast to Bitcoin which is purely a monetary good and has no utility outside of its monetary use case as a form of payment.

And since the Ethereum network has always intended to be useful — as opposed to bitcoin — it’s of higher focus when analyzing the value of ETH. That is to say, Ethereum itself has aimed towards value type #2 over #1.

ETH (and other smart contracting blockchains) conflate the concepts of equity and currency. It’s an equity in that you can stake it to earn more of it (setting aside the right to author blocks as a validator, which acts somewhat equivalent as an equities right to participate in shareholder votes) — like an equity dividend — and it’s a currency in that it’s demanded by the Ethereum network as form of payment. Of course, people outside the Ethereum network can request ETH to be used as a form of payment, but ultimately anyone who demands payment in ETH does so in hopes of either finding a greater fool to sell to (on the basis of its "monetary goodness") or to actually use the ETH within the Ethereum network.

Imagine Walmart only accepted payment in $WMT stock. And then imagine one could earn more $WMT stock with their existing $WMT stock, but ultimately the stock could only be used to pay for things at Walmart. This is functionally equivalent to what ETH is.

I guess my question is... why can’t someone build a DeFi network that uses BTC as the form of payment? There’s a reason Walmart accepts USD as payment and not $WMT stock. Why should every company have its own currency/equity thingy?

Okay, now we know what Ethereum is and where the value comes from. That is, it’s a platform for digital finance without middlemen and the value of ETH comes from the asset’s ability to buy bandwidth in the network.

Here’s the brass tacks... bandwidth is a competitive market where the cheapest solution wins. It’s a race to the bottom.

For example, fun fact, my local internet provider doesn’t make margin from my monthly payment (which is used to buy bandwidth), but instead they make margin by collecting my data and selling it to advertisers. That’s how much bandwidth is a race to the bottom — it’s literally worthless to my local internet provider. Yours likely does this too, and no, it’s not okay.

Another race to the bottom market is food delivery. Just go take a look at the food delivery company valuations.

John Pfeffer’s assessment of ETH (and others) as working capital is most pragmatic.

Anyways, the kicker is that Ethereum has real competition it must concern itself with, and that competition is ultimately a race to the bottom.

The way I see it, there are two credible competitors to Ethereum (right now) — Solana and Avalanche.

Ethereum’s cult-followers (the ones who believe in its monetary goodness) will scream and cry, “NOOO BUT THOSE BLOCKCHAINS AREN’T DECENTRALIZED!!!” Of course, Ethereum 2.0 will put Ethereum at the same technical level as those two... so that argument falls apart. The truth is, “decentralized finance” only needs to be decentralized to the point where corporations are the node operators. In the future, regular Joe-blow from Nebraska won’t be operating an Ethereum node (but he may be operating a Bitcoin node 🤷).  Because again, the real market opportunity DeFi is aiming to capture is enforcement of open operations for financial markets. Solana and Avalanche know that this level of decentralization is optimal, but the Ethereum has the path dependency of spending years competing with the narrative of Bitcoin.

Funny enough, the migration to Ethereum 2.0 is ETH-the-asset shooting itself in the foot, claiming it would rather compete in a race to the bottom against SOL and AVAX than as a monetary good against BTC. Smartest thing for ETH to do is cancel the migration to Ethereum 2.0, lock-in the monetary algorithm, and step back. The total addressable market for a digital store of value is much larger than DeFi, in my opinion, and there’s currently only one credible participant in that space, which is Bitcoin. I digress. There’s more to be said here, but it’s not worth my time.

Ethereum undoubtedly has the largest amount of users, total-value-locked, market activity — use whatever “usage” metric you prefer — but I’m skeptical the network can maintain growth relative to its competition. Asset price can be used for user acquisition — people see headlines “Solana is up 1000%” and it’s free marketing — and AVAX and SOL being Proof-of-Stake already, and with intentional market makers, and with much smaller market cap, have the ability to deploy this tactic. Ethereum’s fees are way higher than Solana and Avalanche, and the total throughput is much less. Ethereum’s latest narrative movement is “layer-2’s” … which they so blindly miss that layer-2’s are chain agnostic. Meaning, these layer-2’s won’t pay rent back to Ethereum if the competition is cheaper. You can see, a competitive market like this is a race to the bottom. Again, there’s more to be said here, but it’s not worth my time.

Okay, so ultimately, Ethereum will suffer from the founder’s dilemma — which is, founders prove the market but rarely do they fully capture it. MySpace proved the market for social media, but Facebook captured the market. Blackberry proved the market for smartphones, but Apple captured it. Napster proved the market for music streaming, but Spotify captured it. This happens again and again in industry. The problem for the founder is they’re faced with the baggage of their wrong decisions — wrong decisions that had to be made in order to prove the market — and their competitors don’t have baggage.

It’s sad really, if you think about it. It’s like the story of sacrifice.

I often hear people say, “Bitcoin is MySpace and Ethereum is Facebook” but this is naive. Hashcash and E-Gold proved the market for digital money, but Bitcoin captured it. Bitcoin is digital money, nothing more. Ethereum is digital finance. These are two totally different things.

Ethereum proved the market, but Solana, Avalanche, and likely others, will capture it.

Sorry 😢