Last week we looked at the crypto-assets which compete most intuitively with Bitcoin as a future sound money play. Given the future is most definitely uncertain and cryptocurrency is most likely revolutionary, it is important to hedge our bets considering what could happen.

Adjacent to deterministic supply assets like BTC, DCR and XMR, we have an entirely new set of protocols which I class as smart contracting platforms. These blockchains have opted for a focus on expressiveness of code, where developers can build and deploy sub-programs which are executed by the base layer’s computational layer.

Before we dive in, lets break down the nuts and bolts of a smart contracting protocol.

in a Nutshell

Blockchains are essentially organised and incentivised distributed computers. Hundreds to Millions of processing units (CPU, GPU or ASIC) are spread across the globe creating a resilient ‘botnet’ which is typically paid by the protocol for the computational work they do.

For Bitcoin, this work is hashing SHA256 blocks of transactions and solving a complex algorithmic puzzle for which the protocol pays BTC rewards (fees + subsidy). Transactions in BTC / DCR / XMR are in fact ‘smart contracts’ however they are more simple and use things called OPCODES which are pre-defined transaction types. They do a small selection of transaction types which are all coded native to the base layer.

For Ethereum, it is the same concept except using the Ethash hash function and includes an additional layer of executing Turing complete code, otherwise known as a smart contract. Turing complete just means that the code can run more complex loops and is limited only by the amount of GAS the user is willing to pay. The transaction could run infinitum in a perpetual loop until all the gas (fuel) is exhausted.

As a result, the set possible ‘OPCODES’ is essentially infinite and can be coded up and deployed to the chain by any developer. This is how we see applications like MakerDAO, Compound and Synthetix built be developer teams outside the core protocol development. The complexity of the contract has an associated gas price overhead which must be paid by the sender.

These smart contract platforms most certainly enable new and unique transaction types and applications not possible using legacy systems. They gain advantage of a distributed and resilient network of compute and transaction distribution.

Trade-offs

There are notable trade-offs for these smart contract platforms, the most significant being the Complexity and differences in the design of the Monetary Policy and Consensus layer.

With complexity comes risk, both at the protocol layer and in the implications of infinitely variable Turing complete smart contracts. The more things that can be built, the more that can be broken. Whilst enabling infinite possibilities, it also opens up infinite attack vectors. This is a key reason why hedging in this ‘class’ of crypto-assets is quite important.

Overwhelmingly, we are seeing these smart contract platforms switching to or being deployed as a Proof-of-Stake network. This is often in recognition that Proof-of-Work is a very expensive operation to maintain long term and suitable most for hard, sound money type protocols. Additionally, the computational load of smart contracts can be designed and handled better by a cluster of computers meeting a specific set of minimum hardware and networking requirements.

The other less talked about reason is that PoS makes it possible to SELL the tokens so the company can get money upfront, a key reason so many ‘VC chains’ are PoS in my opinion. It is possible to ICO in a PoS network as a mechanism to distribute the coins in exchange for investment, a tactic used and abused by scammers and Venture Capitalists alike (often they are one and the same).

Strong qualities

So within the smart contract platform bucket, what are the key metrics to keep an eye on and which qualities make a platform stand out against the backdrop of massive competition?

To be perfectly honest, there is only one metric that matters in my opinion. Network Effects as measured in Usage and Adoption.

Everything else is smoke and mirrors and can be extremely misleading. It really does not matter that Tezos has already working PoS consensus and it does not matter how many spectacularly correct and well researched conference papers Cardano has released. Ethereum is DESTROYING both of them on the important adoption metrics.

Developer activity, fees paid, block-space demand and mining revenue/holding behaviour all indicate that Ethereum is the primary contender in this market.

When it comes to a smart contract platform, the less friction the better. Moving and holding cryptoassets on multiple chains in some kind of interoperability layer just seems redundant to me and introduces significant complexity, friction and risk. If all the apps and use cases are build on Ethereum, why do I want to be holding Tezos so I can transfer it via the Cosmos network to lock into MakerDAO?

Friction will get forked out and that includes dAPP models with tokens. We can see this in Uniswap and DyDx are DEX type exchanges which have no token and is outcompeting the likes of Kyber Network and 0x. Now that is not to say that token based models cannot prosper, but it does mean that rent-seeking models with tokens and VCs behind them are on the back-foot.

Ethereum Scalability

Despite Ethereum’s clear market dominance, just like Bitcoin, it is not perfect and has challenges ahead in technical developments, governance and long term viability. As we have seen recently, Ethereum gas prices are through the roof. Even a small smart contract can blow out to $10 to $20 these days just in gas fees.

This is primarily being driven by Tether transactions and the MMM Ponzi scheme. No doubt the Ponzi will implode eventually but Tether is here to stay. More to the point, two applications have effectively CryptoKittied Ethereum again and priced out the majority of users as a result. No DeFi is competitive with fees that are greater than a bank wire transfer.

A quick side note – a few people have been commenting in Discord on being confused regarding Ethereum gas and gas limit. Hopefully these summary points help to clear up confusion.

Gas is the fuel used to power a smart contract and the fee (in ETH) is the combination of Gas Limit multiplied by Gas Price == Gas Amount x Priority Fee. Note that Failed transactions still use gas because you still utilised computational power even though it failed for whatever reason.

Gas Limit (Transaction Complexity) – This is the amount if gas REQUIRED by a smart contract and Metamask usually calculates this automatically. Never lower this number below the recommended as your transaction will fail and the gas will still be spent. More complex smart contracts need more gas limit. You can safely raise the gas limit and the transaction will only ever consume as much as it needs. If you put 1Million Gas limit and the contract only needs 100k, it will only spend 100k.

Gas Price (Transaction Priority) – This is how badly you want to jump the queue to get your transaction confirmed. If two people transact the exact same smart contract and one person pays a gas price of 10Gwei and the other spends 9Gwei, the higher 10 price will get mined first. This is equivalent to sats/byte for Bitcoin where the ‘sats’ == Gas Price and byte== Gas Limit

Back to Business – Ethereum is by far and away the number 1 play for smart contract platforms. It has dominance across all metrics for adoption and I am pretty sure everyone reading this is quite familiar with its usage, convenience and capabilities.

The biggest risks that Ethereum faces are:

Scalability – as demonstrated above where Tether has clogged up the chain almost to a standstill. My personal opinion is that Tether is not USD sitting on the sidelines for crypto, it is capital flight into USD from around the world during the chaos of 2020. This is USD demand, not crypto demand. Give me dollars any way I can get them.

I actually expect scalability to be a long standing problem for Ethereum (and all blockchains with adoption) and I want to draw attention to the fact that this is a direct implication of distributed computer networks – they are slow and inefficient BY DESIGN. Blockchains are never going to be quick AND decentralised. Lots of projects may sell this vision, but I am yet to see it in practice.

Governance – As demonstrated by the ongoing ProgPoW debate, the core developers just seem to keep pushing this contentious change into the limelight. The community has openly contested it and it is most definitely a contentious issue. Much like the scaling wars of Bitcoin in 2017, this issue has potential to fork Ethereum. I think it is a low probability of happening but it is a risk nonetheless and a feature/bug of rough consensus.

Privacy – The most underappreciated bug of blockchains. The current privacy solutions for ALL smart contract platforms are shocking and are compounded by the expensive fuel prices to run privacy tech like zk-SNARKs. Ethereum is not viable as a money if your bank account can be seen forevermore when you send someone a payment. No smart contract platform seems to have dealt with this issue at the base layer yet.

Technical Risk – Swapping Eth 1.x into 2.0 is like swapping an engine of a moving jet fighter. They seem bullish on it, I will believe it when I see it. Remember, Proof-of-Stake was supposed to be implemented 18months after the Ethereum launch in 2014. It is 2020 and this is still under active research and development. The problems being solved are gargantuan and will take much longer than people expect.

Centralisation Risk – The transition to PoS is not without long term risk. We are already seeing a record number of ETH tokens in exchange balances and if/when staking goes live, these platforms will offer staking as a service alongside an array of other facilities. With the current scalability issues, DeFi becomes less and less attractive in comparison to centralised alternatives for those seeking yield. Time will tell how this trend plays out.

Tomorrow we’ll finish up with part 2