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27 November 2021
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Ethereum

Ethereum Is Not Money And That’s Okay

  • Though Ethereum was never created as an alternate monetary system, ETH tokens meet many of the properties of money and can theoretically be used as a medium of exchange.
  • I do not believe the free market will converge on ETH as money due to an undefined monetary policy, poor fiscal policy, and higher centralization.
  • Ethereum and Bitcoin are not direct competitors, though the idea of a digital barter economy is worth exploring.

The purpose of this article is to establish the fact that Bitcoin (BTC-USD) and Ethereum (ETH-USD) are not direct competitors. I first examine the purpose behind the two cryptocurrencies as stated in their respective whitepapers. I then examine the monetary and fiscal (fees) policies behind each, concluding that Bitcoin is superior money in that regard.

However, there is nuance in this debate. Because Ethereum tokens are data stored on a distributed ledger similar to Bitcoin, anyone can technically use Ethereum as money. Will the crypto economy converge on the soundest money, or enter a pseudo-barter economy? Though I believe in the former, the latter is a possibility worth exploring.

The Stated Purpose of Each

One needs to look no further than the title of the whitepaper to find the purpose of Bitcoin. It is a peer-to-peer electronic cash payment network and a trustless monetary system.

Though popular for cross-border payments and large wire transfers due to its ability to disintermediate the time and fees of legacy systems, Bitcoin is limited as a global medium of exchange because only peers with a Bitcoin wallet can accept payments. Most Bitcoin advocates use it as a store of value due to it being the only currency in existence with an unforgeable supply cap.

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(Source: Bitcoin Whitepaper)

Ethereum is a decentralized application protocol with three stated use cases: 1) financial. 2) semi-financial. 3) non-financial. Financial use cases include stablecoins, derivatives, asset tokens, or sub-currencies. Semi-financial examples include self-executing bug bounties or insurance premium payouts. Non-financial examples include decentralized file storage or decentralized autonomous organizations. Ethereum has an entire sub-economy of network tokens using token standards such as ERC-20 for DeFi and ERC-721 for NFTs. As the whitepaper suggests, Ethereum has more in common with Apple iOS (NASDAQ:AAPL) or similar operating systems than traditional currencies.

(Source: Ethereum Whitepaper)

A Digital Barter Economy

Despite their stated use cases, all Bitcoin and Ethereum tokens are fungible, divisible, durable, portable, scarce, and, for the most part, acceptable. On a technical level, Ethereum solves the gold-dollar dilemma just as well as Bitcoin. While Bitcoin was created as global peer-to-peer money, Ethereum was not. Ethereum tokens are required to interact with the Ethereum application ecosystem. In essence, it is the money of the Ethereum-based DeFi/NFT network.

If all crypto assets are trustless digital value transfer systems, the crypto economy could run on a barter system whereby individuals pay with and accept their preferred token. With increased multi-token wallet capability and atomic swaps, automatic exchange contracts between two different crypto assets, anyone can pay in BTC or USDC (USDC-USD) and receive ETH, DOGE (DOGE-USD), fractionalized real estate, etc.

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The technology will soon exist for any incoming crypto asset to automatically swap to a merchant’s preferred token. For example, a real estate company can use fractionalized real estate as currency if it wished. The idea of a digital barter economy is extremely interesting. However, I see the free market converging onto one form of money for the reasons outlined below.

Why ETH Will Not be Global Money

An economy relies on a single unit of account to measure value for convenience’s sake. When I say something is worth $320.80, that statement means something to every individual. Heterogeneous units of account, on the other hand, make value transfers overly complex. Saying that something is worth 689,199 satoshis, 0.095 ETH, or 1,773.68 DOGE depending on one’s preference is overly cumbersome.

I believe that if any nation or society adopts a crypto asset as its store of value, medium of exchange, and unit of account, it will be Bitcoin and not Ethereum. The free market will converge on Bitcoin for three reasons. 1) It has a defined monetary policy. 2) It has a usable fiscal policy. 3) It is sufficiently decentralized.

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Undefined Monetary Policy: Ethereum does not have a supply cap and the current number of coins in circulation can only be approximated. The approximation results from Ethereum’s use of an account model as opposed to Bitcoin’s unspent transaction output model. Though not exact, an account-based transaction model better supports the complex commerce of smart contracts.

Hard money enthusiasts oftentimes dismiss Ethereum as no better than fiat currency. When asked about Ethereum’s total circulating supply, Vitalik Buterin, cofounder of Ethereum, claimed that “we roughly know what it is according to protocol rules.”

I believe that an unknowable supply and approximate monetary policy makes Ethereum less suitable as a global money. However, as the figure below shows and the whitepaper states, the “supply growth rate as a percentage still tends to zero over time.” Vitalik also pointed out in June 2020 that Ethereum’s supply was 40 million coins less than expected from estimates in the original whitepaper. Ethereum is harder money than the dollar, but its hardness can only be approximated.

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(Source: Ibid.)

Unusable Fiscal Policy: Fiscal policy refers to the transaction fee structure of the crypto asset due to its similarity to a value-added tax. Ethereum currently has high demand for block space and low scalability—at least until the release of ETH2. This results in exorbitantly high fees for executing transactions. The digital art platform OpenSea currently accounts for the highest overall amount of transactions and 10% of all gas fees according to etherscan. Therefore, currently high gas fees are a direct result of the NFT craze.

When a $5 transaction incurs $485 in gas fees, the network becomes unusable for daily transactions. Though this is an extreme example, it goes to show how scalability issues prevent ETH from being suitable money. Gas fees fluctuate, yet the average gas fee is $49.88 as shown below. Unless a protocol has an established scaling solution such as Bitcoin’s lightning network, it cannot be used as transactional money.

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(Source: bitinfocharts.com)

Inadequate Decentralization:

In June 2016, a hacker exposed a bug in The DAO, an Ethereum-based decentralized venture capital organization, to successfully drain $70 million worth of Ethereum. The price of ETH dropped from $20 to $13, as The DAO contained roughly 15% of all tokens in circulation. After a failed soft fork to invalidate the hack, Ethereum developers banded together to hard fork the protocol and return the stolen funds with majority approval from token holders. Ethereum Classic (ETC-USD) is the pre-hack network.

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An active developer team is both a pro and con of the Ethereum protocol. For sound money, it is a glaring con. Choosing Ethereum as money substitutes central banks with the Ethereum Foundation. The DAO was essentially an example of the foundation catering to a “too big to fail” organization.

The above example also demonstrates a willingness and ability to change the protocol if and when necessary. This may be a positive thing for a tech company. However, when the purpose of blockchain-based money is to remove the exorbitant privilege of those who operate close to the monetary spigot, Ethereum is inadequate.

Conclusion

This article is not a bear case for Ethereum. Just as I believe that Ethereum will never be considered global sound money, I believe that Bitcoin-based smart contracts will never surpass Ethereum once they come to fruition. Instead, it is a call to realize the strengths and weaknesses of each and value them accordingly. Ethereum is a decentralized application protocol powering the DeFi and NFT movements. Bitcoin is blockchain-based sound money.

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