Crypto Market Commentary 

25 August 2019

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Checkmate's Corner

Bull Case for ETH

Core cryptocurrency thesis

Today I want to explore my evolving bull case for Ethereum as a network and how I see the ETH coin fitting into the future crypto-economy. Never in my life have I flip flopped my internal dialogue as often as I have trying to gauge whether Ethereum is genius or a disaster waiting to unfold. I will explore the areas where I think ETH adds value and where it can capitalise on market share. I will also present the dominant risks I see as hurdles the project must overcome to achieve such a vision.


To start, I will outline the context and underlying assumptions for where I see the crypto economy ending up.


Pareto Distribution: Network effects and scale of the biggest and most secure blockchains lead me to believe that there is room for maybe 3-5 blockchains at most in a pareto distribution. The chain that captures sound money is likely to be 60-75%+ of the market share and at this stage, it is undeniably most likely to be bitcoin. Other chains will fill use case specific roles or offer alternative features that are essential but will be smaller markets than sound money.


Consensus mechanisms as Categories: The consensus mechanism of a blockchain is the most important decision of the design, bar none. Decentralisation (especially PoW) is really expensive and thus is unlikely to see more than 1 or 2 chains at the top with the same consensus mechanism. A consensus mechanism must be secure and robust to ensure immutability and security of funds and assets secured by the chain. I expect there to be a dominant chain of each of the primary consensus mechanisms (PoW, hybrid PoW/PoS and pure PoS) at the top of the Pareto Distribution. Find the best chain in these categories for the best shot at the picking the ultimate winners.


Monetary policy is key: I don’t believe in the flippening. I think it is hopium that ETH ever flips BTC for the simple reason of Bitcoins unwavering monetary policy. Ethereum’s ICO, ETC chain split and ‘flexible’ monetary policy have deteriorated its value proposition so heavily compared to Bitcoin I just don’t see it happening. My strategy is therefore to find where ETH fits into the digital economy?


Digitisation of assets and money is inevitable: Once you go full digital, you don’t go back. The only industry to ever go from digital back to analogue with any semblance of sustainable business is vinyl records and even then, more people have a spotify subscription than a record player. The efficiencies, enhanced security and cost reduction make digitization of our future an inevitability in my mind.


Think of the children: They will inherit the earth and most can code before they can talk. Digital assets in games are second nature. They represent the biggest long term opportunity.


With this core thesis set out, lets look at where Ethereum fits into the mix.

A programmable future

The first opportunity where I see Ethereum capturing market share is in the programmability of money, applications and assets. We are seeing this dominant narrative coming out of Ethereum being programmable store of value and programmable money.


This is a powerful meme and no doubt there are some very interesting applications in the DeFi space. The ability for ETH to collateralise loans in MakerDAO and Compound and for programmable interest payments for lenders is incredible technology. There is a strong focus on composability or interoperability of these dapps to create a fully functioning financial stack. Rather than paying someone in DAI, you could pay them with cDAI which is DAI that is earning interest in the compound protocol whilst also using it to swap with tokens on Uniswap.


I expect that we have only scratched the surface of where this technology can go. As more assets get tokenized such as STOs and DeFi dapps, more opportunity for composability open up. As user interface improvements make the experience more seamless, a lot of very clever and valuable systems can be built into the stack without users ever knowing what is going on behind the scenes.


Some key examples of interesting applications for Ethereum’s programmability:

Set Protocol – one click investment strategies, trading bots and portfolio allocations.

Money Markets – such as Maker, Compound and DyDx.

On-chain Derivatives – can be built using smart contracts to achieve a wide variety of systems.


Risks: Programmability creates attack surface for bugs and back doors. Solidity code is notoriously hard to audit. Writing ‘cool’ code does not mean anyone actually wants to use it, there will and has been a lot of malinvestment (see the ICO market….).

Youth mindshare

Decentralised financial services with ‘few’ trusted intermediaries, it is extremely compelling, particularly for the youth who one day will inherit the world. We are already seeing Millennials showing a greater tendency to move between service providers with little regard for company loyalty if the service is poor. Taking financial freedom into their own hands across the full stack, coupled with the ability to efficiently move between services is a huge value proposition.


Not only are young people attracted by the trustless side to this industry, the ability to build and develop tools and applications on-top of Ethereum has shown to be a huge gravity well for developers. I have heard many times that the barrier for entry into coding on Ethereum is so low that web-developers can get on board in a matter of hours.


Ethereum has decimated the competition with regard to active developer teams. I saw a chart recently (couldn’t find it to reproduce here) comparing the number of active developer teams on various blockchains. Ethereum was 3-4x the next in line which was top dog Bitcoin that was trailed by everything else.


I am bullish human intellect and bullish the next generations. Ethereum is a call option on that intellect and those people will build valuable tools and services on the blockchain with the greatest mindshare.


Risks: Just because you build it, does not mean they will come, I have seen a lot of Ethereum products with no reason to exist. Many solutions without a problem. Austrian fixed supply assets like Bitcoin are attracting mind share, I would not underestimate how powerful this gravity well is.

Eth is … money?

Maybe. It is certainly being built up as money in the DeFi applications and it is the dominant Ethereum narrative right now.


The demand model for ETH is being refined. It is intended to be locked up in multiple layers of the financial stack to provide incentive to remove it from circulation in order to achieve some kind of return on investment.


The base layer is the Ethereum 2.0 staking protocol which provides a nominal return that adjusts as more or less validators enter the pool. When the validator pool increases to a large enough extent and rewards start to drop, there is motivation to turn off your validator and instead seek yield higher in the financial stack (such as lending or deploying capital into the network of dapps built ontop.


Given Ethereum is an inflationary cryptocurrency and with a stack designed with the medium of exchange unit (DAI) founded on the concept of debt, the Ethereum system is Keynesian by design, not dissimilar to the fiat money system. This is at the very least a hedge for the strictly Austrian economics standpoint of deflationary currencies like Bitcoin.

Figure 1 – The Ethereum financial stack (after David Hoffman)


Risks: Austrian money sucks all the air out of the room and Keynesian economics is indeed going the way of the dodo. The ‘manufactured’ scarcity of ETH is not enough to overcome BTC fixed supply. ETH token value is 100% reliant on the dapps built on-top, a failure in one of these key players (like Maker) would be disastrous for the whole system.


DAI competes with USD and LIBRA

As more ‘corporation’ coins like Libra come to market and nations create their own cryptocurrencies, people will increasingly question the reality of money. Maker and Dai are well positioned to provide a stable medium of exchange that is indeed not tied to any political jurisdiction. The DAI infrastructure is continuing to be built out with upgrades like the DAI savings rate and multi-collateral DAI coming to market.


Over time, we may see a focus on DAI shifting the peg away from purely the USD and becoming more similar to Libra in that it is pegged to a basket of currencies. This way, it shifts the paradigm away from a single jurisdictions monetary policy and central bank to a more global position. It cannot be understated how important DAI and MakerDAO are to the Ethereum ecosystem. I argue, it is the single most important part of Ethereum and without it, the whole project goes to zero.


Risks: Maker is centralised, the VCs and team who collectively own some 70%+ of MKR tokens are known KYC’s entities. The oracles for ETH price feed that support Maker and are used across the whole DeFi landscape are a technical and central point of failure.

DAOs and tokenised assets

The final combined element of Ethereum which is a significant value proposition is the combination of DAOs and tokenization of assets. These features are not unique to Ethereum, however in combination with the above points, it becomes possible to organize human and financial capital via DAOs to build new projects and systems to strengthen the ecosystem.


DAOs can be spun up and customized fairly quickly using systems like Aragon and forking MolochDAO to achieve whatever application is required. What I am aware of is that Ethereum DAOS tend to be built on donations. It remains to be seen if this is a sustainable model long term as it does usually require the donation from the large ETH holders like Vitalik and Joe Lubin before the DAO gets any traction.


Similarly, tokenisation of assets is likely a trend to continue into the future. ICOs were obviously flawed but STOs have promise and I still think there is some room for utility tokens like MKR and REP that have some use case specific function. They are similar to a form of new equity in digitally native companies so we will have to see what interesting things get built over time.


Risks: DAOs and tokenization are not unique to Ethereum and thus there is competition. STOs may move to a use case specific chain like Ownera or Hyperledger depending on institutional buy in. More tokens = more attack surface = more damage to trust in the event one gets taken down.

Bullish Fundamental summary

The Ethereum narrative is starting to consolidate around DeFi. I think this is the strongest narrative to date and the financial stack becomes more compelling once you look at composability and interoperability. It is an easy sell to the youth generation and significant efforts that have gone into building developer tools and enabling easy access to create developer and user engagement.


Ethereum has an undeniable lead in developer activity and projects being built on the base layer. The core tenant of the Ethereum ecosystem is to make ETH the centerpiece scarce commodity money and the reserve currency of the Ethereum ecosystem. This bodes well as the utility of the token will continue to expand which in theory should drive purchasing power up.


My core bull thesis for is Ethereum as a) Keynesian hedge against Bitcoins Austrian monetary policy b) most likely dominant PoS consensus mechanism blockchain and c) a call option on the young generation mindshare and developer intellect building valuable systems.

Residual risk and uncertainties

No risk no reward. In short, I think relative to the fundamentals, Ethereum is somewhat oversold against the USD (nothing is oversold against BTC right now).


There are some very significant residual risks and uncertainties for Ethereum which I will briefly list in order of magnitude.


Ethereum 2.0 is still just an idea – it has not launched and the technical challenge to do so is immense. It will take longer, be slower and far more painful than the Ethereum community would like to admit. It’s make or break, if it fails, the altcoin market will likely see a very dark winter.


Monetary policy and security is still just an idea – Bitcoin will kill Ethereum unless it sorts out its monetary policy. The narrative is ‘minimum issuance necessary’ to secure the chain. What is ‘necessary’? How much is ‘minimum’? Proof od stake is not a proven security model and I fear that some developers will still have the reigns of what the actual inflation rate is. Not ideal. Im also not convinced about the ‘manufactured’ scarcity for ETH rather than the organic intrinsic scarcity of fixed supply assets.


Keynesian economics is all about debt – If Ethereum grows up to be all it is flexing to be, one day, we may see a financial collapse we don’t even have a name for yet. The whole system is reliant on Ethereum’s price feed and the oracles that feed it. These are central points of failure and the more complex the code gets, the more attack surface it has. Security on Ethereum is not only the main chain its also the dapps built on top and many are woefully unprepared for Bitcoin’s level of resilience.


The Oligarchy – Right now, there are a small group of individuals who participated in the ICO or were core team of Ethereum with over 70% of the supply. Crypto banks will be additional central holders. The pure PoS system has no mechanism to dilute stakers and thus those in power today will definitely be those in power tomorrow. I fear this may become an oligarchy in perpetuity.


Governance – The leadership of Ethereum has been poor to terrible at best with many internal complaints of lack of structure, lack of direction and generally building lots of stuff the world does not need. Those same oligarchy holders will own the security and the governance of Ethereum. Key dApps like Maker have known and named VCs holding 70%+ of the MKR tokens. Censorship and capture is not impossible in this regard and with such a small group with the keys to the castle, the whole network can be captured with enough force.

Closing thoughts

I think Ethereum is oversold vs the USD relative to the fundamental value it has built and is looking to build. MakerDAO is very impressive and DAI and ETH are being weaved throughout the composable DeFi ecosystem.


If the project can consolidate a strong narrative and continue to attract mindshare, it has a shot. The technical and leadership challenge of transitioning to Ethereum 2.0 is not to be underestimated and is the biggest roadblock for the project. This uncertainty is the key reason I believe the market has discounted the project this year.


I’m currently long ETH vs the USD however I proceed with cautious optimism.


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