Ethereum as a Digital Economy
What makes Ethereum’s narrative so hard to grasp relative to Bitcoin’s, and why Ethereum is the financial platform of the new digital economy
I am often asked to explain Ethereum’s value proposition, or its financial “bull case,” to institutional and retail investors. To technologists and those already immersed in the crypto space at large, the answer feels obvious; we live and breathe it every day, and we struggle to even keep up with the dizzying pace of innovation. It is admittedly more difficult, though, to clearly articulate it to the neutral observer, particularly institutional investors who view Ethereum through the same lens they view Bitcoin: as purely a financial asset. Many in our ecosystem do in fact attempt to convey Ethereum’s value — either as money or as a global settlement layer — but these explanations have failed to land crisply. Where Bitcoin’s store-of-value narrative is by-and-large clear and simple, as recently demonstrated by the wave of institutional investors and corporates entering the Bitcoin space, Ethereum has a “narrative problem.” This article, then, aims to make the case for Ethereum as the foundation of the natively digital economy, and is targeted toward institutional investors and other external observers with at least some elemental knowledge of crypto.
There is perhaps no better starting point than to understand why Bitcoin’s narrative has become so well understood; indeed, it has only crystallized and solidified into its current form over time. Even three years ago, it would have been unthinkable to expect the kind of institutional support we are witnessing today, with the likes of Paul Tudor Jones, Stanley Druckenmiller, and Microstrategy’s CEO Michael Saylor all making significant allocations to BTC in the past few months.¹ To understand this development, I will introduce a basic framework that attempts to standardize what it took Bitcoin to cross the chasm into the mainstream; this standardization will also allow us to consistently compare it to Ethereum. The framework is a simple one:
- There is a real problem to be solved
- There is a convincing solution to that problem
- Solving the problem will create value
- This particular solution to the problem will capture the value created
We will dive into each step more rigorously, but skipping briefly to the answer, Bitcoin solves the problem of the lack of a modern store-of-value asset through a new, packaged set of technologies that issues an asset, BTC, as a product of its qualities as a secure financial ledger. We can retroactively verify that the problem was there given the demand for Bitcoin as an asset (particularly against the macro backdrop of dollar inflation); and the combination of fixed supply and increasing demand both creates and captures value in the BTC asset. In sum, Bitcoin is a modern store-of-value asset that has high, justified demand and a fixed supply.
Let’s unpack that, starting with the problem. Ironically, Satoshi Nakamoto set out to solve a different problem with Bitcoin. As mentioned in the abstract of the “Bitcoin: A Peer-to-Peer Electronic Cash System” white paper, “a purely peer-to-peer version of electronic cash would allow online payments to be sent directly from one party to another without going through a financial institution.”² The emphasis is on cash and payments, orienting Bitcoin towards the medium of exchange property of money, rather than that of the store of value. And yet, Bitcoin’s characteristics — emphasizing decentralization and security over scalability, as well as resistance to change — have gradually redefined it organically as a store-of-value asset. Moreover, this narrative has hardened over time in a seemingly exponential fashion, becoming a paragon of the Lindy effect. What we learn from this shift is that the original impetus does not have to be the final “problem” that is solved by the solution, as long as there actually is a problem to solve. This should not surprise us; it is not uncommon for startups, for example, to pivot several times until they land on the right problem or market.
How do we explain the problem in the first place? In other words, why not just stick to gold, the universally accepted store-of-value asset in current commodity markets? Well, in simple terms, because Bitcoin is a better “gold” than gold, in that it retains the key properties of gold while introducing new ones that meet the modern requirements of a digital-first, globalized economy, where finance and commerce are conducted primarily online, and necessarily across borders.³ Bitcoin, as opposed to gold, is highly portable, fungible, a much more specific unit of account, unseizable, unforgeable, easily exchangeable without intermediaries, and provably scarce — with a definite, visible supply. These last three properties are of particular importance, endowing Bitcoin with its digitally native essence while equipping it with sound and durable economic attributes — in short, making it an ideal solution to our stated problem.
And it is not only its encoded technological and economic properties that make it an ideal store of value, but also its cultural attributes — namely, a certain reliable conservatism manifested in a deep focus on Bitcoin’s primary use case and a strong resistance to change. This consistency in function and motivation, hardened over now more than 10 years, removes uncertainty while increasing confidence in Bitcoin as an asset class. Plainly, if you had heard about Bitcoin 5 years ago, you would still know exactly what it is and does today; and investors today can expect the same from Bitcoin in 5 or even 10 years’ time.
We can now faithfully trace a line between the problem and its solution, and extend it to identify its value creation and capture mechanisms. Why is Bitcoin valuable? At its most basic, Bitcoin holds value because there is a visibly fixed supply of the BTC asset and a large and growing demand for that asset. The reader might be unsatisfied with this answer, and press to know why there is demand for such an asset in the first place. The demand comes first from the early visionaries and technologists who understood Bitcoin’s fundamentals from the start, and second (increasingly) from investors siphoned off from gold and other hard assets, who view Bitcoin as a credible alternative based on the properties enumerated above. It’s worth double clicking on the source of that credibility, what tethers it to some conception of “real value,” because ultimately a significant number of investors have enough conviction in it to re-allocate substantial capital into the asset. The credibility comes from two major forces. First, from the real resources that are expended in the form of electricity and mining equipment to keep the Bitcoin blockchain running (ie. to participate in Bitcoin’s Proof of Work algorithm) — this is a very clear and public monetary commitment. Second, from the long-term reliability and lack of fundamental change at the protocol level — this provides clear proof that Bitcoin “works.” Specifically: Bitcoin has never suffered a hostile attack or hack and has never had an “outage” of any kind; there is a deep commitment to maintaining the block size at a certain level (1 MB) to maximize decentralization;⁴ and finally, the BTC supply curve is encoded at the protocol level, and there is a quasi-religious adherence to this standard. Returning now to our original assertion, these factors lend Bitcoin its security and economic soundness; which, in turn, justify the demand for the asset. This demand, juxtaposed with Bitcoin’s supply curve, explains the value creation and capture. (In this case, there is little difference between creation and capture, as all the value is locked in the BTC asset itself — sure, there are exchanges and custodians and an emerging ecosystem creating value around BTC, but these are additive rather than dilutive.)
As an interesting aside, Bitcoin — once it became accepted as a store-of-value asset — has effectively created a category of its own as a financial asset. Given its roots as a gold replacement, it is most obviously an inflationary hedge against fiat currencies (particularly the USD, given its importance in the global petrodollar-based monetary system).⁵ But what’s interesting is that, in the case of a hyperinflationary event, it will not only be the USD that will suffer against BTC, but also any financial asset denominated in USD — ie. bonds, and really any fixed income product. With interest rates at all time lows and the growing possibility of (hyper) inflation, we are sure to witness a shift away from bonds. The question is, where does that money go? The most straightforward options are equities and gold (not including inflation-protected instruments like TIPS — see Figure 2 for other options), but Bitcoin is making an increasingly compelling case for a third category, as it marries elements of gold as a hedge but also the forward-looking, constructive properties of a new technology backed by an increasing amount of intellectual capital. As Paul Tudor Jones has eloquently stated,
I’ve never had an inflation hedge…where you also have great intellectual capital behind it…If you think about it, if you’re effectively short the bond market, you’re really betting on the fallacy of mankind rather than its ingenuity and entrepreneurialism.⁶
Bitcoin is a bet on the future.
In summary, Bitcoin is a technological solution to the need for a modern store of value — a need which is only heightened in this current period of anticipated inflation — which has demonstrated value through technical attributes, sound social and economic properties, and a credible long-term commitment to consistency. These qualities provide Bitcoin with a simple, clear, and consistent narrative.
Before turning to Ethereum, let’s remember that Bitcoin is both a set of technologies and a financial asset (BTC).⁷ The asset is created and secured by the technologies that underpin it, and is at the same time the core of the use case Bitcoin enables — that is, BTC the asset is itself the store of value. Said differently, Bitcoin is a technology that underpins an asset that powers a use case (store of value).
In the same way, Ethereum is a set of technologies — very similar to Bitcoin, but with some novel elements — which creates an asset, Ether (ETH), that powers many use cases. However, in contrast to Bitcoin, the nature of the use cases and the differences in economic and cultural properties produces a different, albeit at least as consequential, value creation and capture equilibrium for Ethereum. Let’s delve into that with the help of our framework.
In keeping with the format we’ve introduced in the section above, we first skip to the answer: Ethereum is the financial platform of the new digital economy. It solves the problem that the internet inadvertently introduced by coming into existence in an emergent fashion without natively embedded financial rails.⁸ That is, Ethereum provides a natively digital financial layer to the rapidly expanding internet-based economy. It creates value, much like the prototypical “platform,” by enabling financial use cases on the internet without any clunky, analog intermediaries, and it captures value in its native ETH asset by requiring its consumption in any economic transaction, hence creating demand for the asset.⁹
So what makes Ethereum so difficult to grasp? Why is there a narrative problem? Cascading across the steps of our framework, we can identify its promise as well as its multiple points of friction.
1. The Problem
When it comes to the “problem,” many might not immediately understand the need for a new internet foundation with natively integrated, disintermediated financial rails, let alone the need for a decentralized world computer (as Ethereum was originally touted).¹⁰ Several years ago, when I first tried to explain Ethereum to friends and family, the sales pitch started with “the internet is broken” and focused on the ills of data intermediaries like Google and Facebook exploiting our personal information. To which I would be told, rather placidly, “the internet is fine” and “I love Google — what would I do without it?”. And frankly, while we can unquestionably challenge the monopolistic and anti-competitive tendencies of today’s internet giants, whose business models are largely a product of the structural flaws of the internet (ie. the lack of embedded financial rails), we should recognize that, ultimately, these intermediaries do provide a real service to consumers, and perhaps the pitch was misstated in the first place.¹¹
Ethereum thus finds itself in a similar position to Bitcoin, having posited a solution to the wrong (or slightly misguided) problem. Bitcoin, however, benefits from six additional years of world-weariness and social calcification; the question of its “problem” is settled. With Ethereum, we are just now starting to hone in on the real problem: the lack of a natively digital financial layer on the internet. And this problem statement — as in Bitcoin’s case — has been clarified, with time and growing usage, by Ethereum’s key features, which make it particularly well suited as a financial infrastructure foundation. Moreover, we know with a good deal of confidence that this problem is very much a real one, as demonstrated by companies like Stripe and Plaid trying to solve it in a parallel way. The internet as it is — as it was built — is disconnected from the global financial system, which itself exists in myriad disconnected vertical and horizontal silos: retail banks, investment banks, commercial banks, broker-dealers, custodians, clearance houses, credit card companies, ACH, SWIFT, etc.; all serving different purposes, and all built with different back-end systems and ways of communicating with each other. Wouldn’t it be something if all this functionality could be packaged and integrated smoothly into the internet, like one single “automated wall street” in your browser?¹²
2. The Solution
Ethereum is like Bitcoin in that it is a set of technologies that produces a financial asset, Ether (ETH). It uses many of the same technological primitives (distributed ledger, Proof of Work, etc.) underpinning Bitcoin but adds a few new ones, most notably a virtual machine capable of running Turing-complete scripts. In other words, programs can be built and run on Ethereum, and in order to run, they require expending resources called “gas,” which must be paid in ETH. Because it takes on many of Bitcoin’s core characteristics as a blockchain-based financial ledger with a native asset and adds programmability to the mix, Ethereum effectively acts as a programmable financial system, not only capable of issuing a financial asset and transacting it (like Bitcoin), but also of building financial primitives and functionality around it, such as exchanges, credit, derivatives, complex financial contracts, portfolio management, etc. Where Bitcoin is optimized for one use case, Ethereum is designed to enable many, and thus operates much like a platform with a natively integrated payment processing system, enabling applications to live and operate on top of it.
Like Bitcoin, Ethereum has a set of economic properties that govern the supply of its currency. Unlike Bitcoin, however, these properties are not intended to be fixed forever, and are designed to be adjusted to fit the economic needs of the platform. For example, while there is a decreasing supply curve (like Bitcoin), its path has been periodically adjusted based on community-driven consensus. Moreover, entirely new economic rules can be introduced via Ethereum Improvement Proposals (EIPs) to further align incentives across platform participants — such is the aim of EIP-1559, which proposes to burn part of gas fees (rather than transferring them entirely to miners), which would create deflationary supply pressure with increased usage of the platform.¹³ Several Ethereum critics denounce its flexible economic policy, arguing that Bitcoin is the only blockchain that credibly makes a commitment to not adjusting its protocol, a consistency from which it derives value. And while that makes logical sense under Bitcoin’s value creation paradigm, Ethereum’s paradigm is deliberately different, in that to create the most value, it must be able to change. It has to continuously improve both technologically and economically to serve as a modern financialized internet infrastructure; otherwise, it will get outpaced by competitors and the value will move elsewhere. Change is destructive to Bitcoin’s value creation narrative, but is both a requirement and a feature within Ethereum’s narrative.
It’s hard to overstate just how game-changing this idea of a programmable payment processing platform with embedded, dynamic monetary policy is. Borrowing language from Nate Tankus, who himself borrows conceptually from Joseph Sommer: “Payments are the raw materials of economics.”¹⁴ In other words, this “idea” is the foundation of an economy — a natively digital one. We’ve already touched on this idea of a “new digital economy,” but what exactly do we mean by it? Some of this economy is already very much present today: in e-commerce, social media, and much of the economic activity generated by the major internet companies (Google, Facebook, etc.). All of this activity must be processed by payment processing systems and financial infrastructure that are today decoupled from the internet, and would benefit from shifting onto financial rails that are internet-native. In addition, there is an entirely new set of economic activity that is being generated on Ethereum today that is demonstrating the benefits of programmable financial rails coupled to the internet. There’s no better way to visualize the power of this concept than by example, and we will do so shortly.
First, however, I’m sure many a skeptical reader at this stage will be just about foaming at the mouth with doubts and questions as to the premise described above. It’s important to acknowledge the challenges Ethereum faces, and where its reality matches up against its aspirations. In order to facilitate comparison with Bitcoin as a financial asset, I will talk through these challenges from a narrative perspective, across two axes: complexity and change. Remember that much of the power of Bitcoin’s narrative draws from its simplicity and clarity of use case as well as its confidence-inducing, long-term consistency.
Ethereum is, by nature, a much more expansive and (dare I say?) ambitious proposition. These factors introduce narrative complexity in several forms: a longer time horizon to a fully featured product, execution risk on a more complex technical roadmap, and a larger surface area for competition.
Longer Time Horizon
Balaji Srinivasan (formerly CTO at Coinbase) has called Bitcoin a “finished product.”¹⁵ Some may have qualms with that statement, but surely no one will disagree that in comparison, Ethereum is still in its fledgling early beginnings — some might categorize it in Alpha or Beta stage. We will touch on roadmap shortly, but what this entails from an investor’s standpoint is that the time horizons for evaluating any potential allocation are much longer, which has real consequences on how to discount back to present value. The response to this concern is simply acknowledgment: yes, we are dealing with a horizontal technology that has a much longer time horizon, and —I would argue — much greater potential impact, which means accordingly steeper (venture-style) discount rates but larger terminal values.
Intimately tied to discount rates, of course, is execution risk; and the more features and functionality a product or technology has, the greater the surface area for execution risk. This is not only true from a purely technical standpoint within a particular development team (vertically), but is also true from a coordination standpoint across teams (horizontally). This article’s purpose is not to dive deeply into Ethereum’s roadmap, as there are plenty of rich, existing resources that explain it in articulate detail.¹⁶ However, suffice it to say that a global, programmable financial layer for the digital economy requires several key features: scalability to be able to handle wholesale and retail payments on a global scale, economic finality to enable low-latency (or instantaneous) settlement, and privacy for obfuscating business logic and private transactions, to name only a few. And yet these capabilities need to be built within the intrinsic limitations of blockchain-based systems — in particular, a sufficient level of decentralization. Despite the very real technological challenges that remain to be solved, there is an enormous amount of capital and effort pouring into R&D dedicated to each of those problems (Eth2 and Rollups for scalability, Eth2 Proof of Stake for settlement finality, zero knowledge circuits of various flavors for privacy, etc.). There are at least 6 different teams working on Eth2 clients, 5 different teams working on rollups (both ZK and Optimistic), over $500M of VC funding going into Ethereum projects, and a community of developers counting in the hundreds of thousands.¹⁷ If, like Paul Tudor Jones, you find the human capital argument compelling for Bitcoin, it is astounding in the Ethereum context.
A larger design surface area equates to more competitive vectors. Different projects can take different approaches to the problem statement, each emphasizing different features, market segments, or use cases. This phenomenon creates narrative balkanization, and increases cognitive overhead for the prospective investor, who must now evaluate each alternative platform (e.g. Polkadot, Cosmos, NEAR, Solana, etc.), gauge its probability of success, and compare risk-weighted returns against their own hurdle rates. While there is certainly merit to this argument, I would counter that the majority of the competitive narrative is noise: Ethereum is far and away the leader in its space — as a financial layer for the internet — in terms of actual traction (number of users, smart contract calls, transaction volumes) and community size.
Some have derided the role of community in relation to its importance to investment narrative. For example, the trader who goes by the moniker Light has recently questioned whether Ethereum deserves to have the “smart contract mantle” because “they’re the nicest,” which he immediately refutes.¹⁸ This ding on Ethereum’s community is rather unfair. Community matters, not because of its “niceness” or for community’s sake, but rather because of the intellectual capital it is able to coordinate, whose effects on innovation (see rollups, etc.) and development (see tooling ecosystem) are exponential.
Our other comparative axis is change. Whereas neither the vision for Bitcoin or its underlying technology has changed much over the past few years, Ethereum has gone through many iterative cycles. First, as the ecosystem has honed in on Decentralized Finance (DeFi) as the first use case for Ethereum, the vision has gradually changed from decentralized “internet computer” to financial layer of the internet. More dramatic even have been the cycles in technology and R&D that have pushed Ethereum forward. Since as early 2014, we have gone through countless different designs of Eth2, Plasma, State Channels, Rollups, light clients, and crypto-economic systems, just to name a few areas.¹⁹ (I leave it to the reader to explore the history of each of these concepts, with some help in the footnotes — it should take no more than a couple of years to cover the bases.) In addition to the obvious cognitive overhead required to keep up with these very real changes occurring in the Ethereum space, an active design space has meant that the goalposts have moved time and again. From an investor perspective, this constant shift in expectations creates uncertainty and undermines confidence in the technology and, by association, ETH as an asset. However, as stated previously, the value creation paradigms of Bitcoin and Ethereum are different, arguably even orthogonal — change in Ethereum represents (at least to date) technological advancement, and it is absolutely required to deliver on its narrative.
3. Value Creation
We’ve hovered over the topic of value creation in Ethereum quite a bit already; it’s time we get concrete. Ethereum is the financial platform for the digital economy, which we’ve broadly defined as the economic activity occurring primarily (natively) on the internet. In the existing architecture of the Web and the traditional finance system, financial institutions and fintech companies enable the creation and operation of businesses and markets in exchange for fees. For example, banks allow businesses to create bank accounts and borrow money. A fintech like Stripe enables businesses to process payments and provide access to a bank’s credit using only an API. A company like Plaid enables end users to link their bank accounts to a payments app like Venmo. And a company like Galileo enables Robinhood to create accounts for its users. By and large, banks and other financial institutions act as financial plumbing for the global economy, and fintechs and other internet companies have provided the finishings to cover the plumbing, creating a middleware layer connecting that financial infrastructure to internet-based businesses. They are decoupled in nature, and the finishings merely conceal the ugly mess that is its plumbing underbelly; but together, they power the global economy — and do so, of course, for a fee in exchange for their services.
In much the same way, Ethereum enables markets and businesses and takes a fee, in the form of gas, for every transaction on its network. The major difference is that Ethereum is internet-native, disintermediated, and universally usable and programmable, meeting the requirements of the modern digital economy. Remember, Ethereum is a development platform with a natively integrated payment processing system. Developers can build applications on (or at least connected to) Ethereum, and any kind of transaction that occurs on these applications is processed in Ethereum’s native currency, ETH. Thus, the more economic activity happens on Ethereum, the more gas is required and paid in ETH, and the more demand is created for ETH as an asset. Ultimately, this demand for the ETH asset is reflective of the value created on the Ethereum platform.
4. Value Capture
To bridge from value creation to capture, we need to understand the supply side of the equation, as well as any potential sources of value leakage. The shape of Ethereum’s supply curve is fundamentally quite similar to Bitcoin’s, with issuance decreasing in stages and trending to zero over time. Ethereum’s issuance schedule differs by being more discretionary in nature, without hardcoding issuance reductions, and by trying to balance economic soundness with long-term security and wealth distribution.
The Ethereum white paper outlined a few principles for supply issuance, aiming to both avoid excessive wealth concentration and discourage depreciation of Ether. The paper also notes: “in the future, it is likely that Ethereum will switch to a proof-of-stake model for security, reducing the issuance requirement to somewhere between zero and 0.05X per year.”²⁰ From the early beginnings, there was a recognition for the need to modify and adapt economic policy over time, as technological foundations of the system advanced. That insight proved prescient, as time and experience has given us much to think about in terms of incentive alignment across participants in the Ethereum network. For example, much care and effort has gone into developing the incentive mechanisms in Eth2’s Proof-of-Stake and EIP-1559, initiatives that represent profound shifts toward a more optimal balance between economic soundness, decentralization, and security. PoS, for example, enables a transition towards a smoother gross issuance curve tied to the number of consensus participants, while also allowing many more consensus participants, increasing decentralization. EIP-1559, on the other hand, aligns incentives between investors (asset holders), users, and stakers (consensus participants), as fees are partly burned, leading to deflationary economics in proportion to network usage. What this means is that gross issuance of Ether can be low-inflationary and reward consensus participants (positive for security and decentralization) while net issuance is close to zero or even deflationary (positive for economic soundness).²¹
These forces result in increasing demand for the ETH asset on the one hand, and a low-inflationary-to-deflationary, dynamic supply curve on the other hand, from which we should expect asset appreciation in the long-term.
As with the “Solution” section, it’s worth touching on the complexities that might stymie this value creation and capture narrative. For one, several critics point to the problem that we have no good valuation framework to value Ethereum (the platform) or ETH (the asset, as a financial instrument) — none of the existing methodologies seem to apply, and we don’t have a convincing new framework. This judgment falls somewhere between lazy and short-sighted. If we have conviction in the idea (the Solution) and the execution behind that idea, we should expect that with time, the market will follow suit. Did we know how to value the impact of the internet or smartphones when they came out? Do we really know how to value Tesla today? Surely not with revenue multiples or P/E, as these figures are even frothier than the crypto markets. More importantly, the biggest opportunity from an investor’s perspective is now, before the rest of the market has caught up. In the preface to Al Rappaport and Michael Mauboussin’s Expectations Investing, Peter Bernstein (author of the great Against the Gods) reminds us that “the fundamental law of investing is the uncertainty of the future.”²² The authors then follow up: “the key to successful investing is to estimate the level of expected performance embedded in the current stock price and then to assess the likelihood of a revision in expectations.” Replace performance and price of the “stock” with that of Ethereum and the price of ETH, and these quotes retain their wisdom. It is our opportunity today to trace Ethereum’s development trajectory and anticipate the resulting revision in expectations embedded in ETH’s price.
A more interesting question is that of value accrual (and leakage), which is particularly relevant, as Ethereum enables the creation of protocols (with their own tokens) on top of it. Joel Monegro of Placeholder wrote the “Fat Protocols” thesis back in 2016 in an early effort to describe where value would accrue in crypto. He writes:
The previous generation of shared protocols (TCP/IP, HTTP, SMTP, etc.) produced immeasurable amounts of value, but most of it got captured and re-aggregated on top at the applications layer, largely in the form of data (think Google, Facebook and so on). The Internet stack, in terms of how value is distributed, is composed of “thin” protocols and “fat” applications. As the market developed, we learned that investing in applications produced high returns whereas investing directly in protocol technologies generally produced low returns.
This relationship between protocols and applications is reversed in the blockchain application stack. Value concentrates at the shared protocol layer and only a fraction of that value is distributed along at the applications layer. It’s a stack with “fat” protocols and “thin” applications.²³
Joel’s piece has served as thought-provoking fodder, inciting several responses that run the gamut from praise to rejection. Summarizing some of the more nuanced takes: Jake Brukhman from Coinfund stated that “fat protocols are not an investment thesis” in his eponymous 2017 article, arguing against drawing “unqualified boundaries between ‘application tokens’ and ‘protocol tokens’.²⁴ Taylor Pearson, in his own piece, argues that:
In the short run, cryptocurrency protocols will remain fat with the lower-level protocols capturing the majority of the value. In the long-run, interoperability and forking will make the value captured by a protocol roughly commensurate with the value it is creating whether it is at the bottom, middle or top of the stack.²⁵
My own employer, Joe Lubin, has expressed a view that the crypto landscape will be a network formed by many fat, interoperable protocols. My own view falls closest to these more nuanced takes. While Joel’s original piece was insightful and particularly valuable in provoking discussion around value accrual in the crypto space, it oversimplifies (likely deliberately) the existing structure of the internet into protocols and applications. In reality, of course, there are many interlocked layers of code that make up the internet, from a set of foundational protocols (TCP/IP and the like) to a series of interdependent infrastructural components, platforms, APIs, etc. all the way up through to user-facing applications. Joel invokes the “applications layer” and tells us to “think Google, Facebook” — but even those businesses are multi-dimensional, and their business models depend primarily on (or at least as much on) their nature as platforms rather than as applications. Microsoft and Amazon are partly applications, but Azure and AWS make them very much platforms. Stripe is worth $100B today and works primarily as a platform of platforms, enabling other platforms like Shopify to power user-facing businesses.²⁶ Value exists at every layer in this architecture. Depending on how you cut the “app layer,” it can certainly generate more value overall than that generated at the “platform” layer of the internet, situated right above the foundational protocol layer (where Ethereum also sits). Today, most of the user-facing internet runs on a set of core platforms — Amazon (AWS), Microsoft (Azure), Google (GCP, Google Play, Google Ads), Facebook (Facebook Ads); a ton of value exists outside of those companies higher up the internet “stack,” some in the form of applications; yet these companies are all worth near or more than $1T each.
We should expect a similar development with Ethereum and the crypto space at large, with platforms like Ethereum powering many financial middleware protocols and applications on top of it. Not all of the value will concentrate at the platform layer a la “fat protocols,” and we are already seeing signs of a valuable ecosystem developing on top of Ethereum with protocols like Maker, Compound, Aave, and the like enabling specific financial use cases. In a critique on Ethereum, Light (mentioned above) asserts, “only now are people starting to realize that the application layer of [smart contract platforms] is going to be worth the most.” This is likely true, and yet that certainly does not preclude Ethereum from generating and capturing significant value, as platforms like AWS do, through the economics of the ETH asset.
Visualizing Ethereum: an Example
As mentioned above, there is no better way to grasp the power of Ethereum than by example, and the best examples today make up the building blocks of Decentralized Finance: credit-based stablecoins on MakerDAO, crypto money markets on Compound Protocol, and decentralized exchange on Uniswap.²⁷ These protocols, all built on top of Ethereum, replace intermediary institutions like banks, broker-dealers, and exchanges with self-executing, unstoppable programs. As the term “building block” suggests, they are composable, meaning developers can piece them together to form new applications, leading to rapid iteration and innovation. For example, they can be used together to mint a stablecoin pegged to the USD, exchange that stablecoin against other crypto assets, and finally use these crypto assets as collateral to take on debt. In each of these financial transactions, the counterparty is the protocol itself, and the services that intermediaries typically carry out are delivered by logic embedded in smart contracts that run on Ethereum. From a UX perspective, instead of having to create a bank account or rely on credit scores and other cumbersome components of today’s financial infrastructure, users only need to set up an Ethereum wallet, which serves as a single wallet, account, and sign-on system for any Ethereum application.
The best way to experience DeFi is by using these protocols directly, but a good place to start is by digging into Compound Finance, a money market protocol built on top of Ethereum.²⁸
As this explainer of the protocol outlines, Compound demonstrates a few noteworthy concepts:
- Global access to financial markets and applications without a bank account, using only a non-custodial (ie. user created and controlled) crypto wallet to “log in” and immediately borrow or lend assets. This same wallet can be used across any Ethereum protocol or application, reducing the need to go through account setup with multiple institutions. Moreover, these markets are truly globally accessible: anyone in the world has access to the same interest rates.
- Borrowing and lending of different types of financial assets, all created on top of Ethereum, such as stablecoins like USDC and Dai. The former is backed 1:1 with USD by a group of private institutions (led by Circle, in collaboration with Coinbase and others), while the latter is backed by a basket of overcollateralized assets including ETH and has no institution of any kind backing it.
- Borrowing and lending without an intermediary; the counterparty is the protocol itself, and spreads are automatically determined by the supply and demand of credit for assets. In other words, suppliers of capital can supply various crypto assets to the protocol (see the Supply Markets side above) at a given APY, and borrowers can borrow against the collateral they supply.
Another project to explore in detail is Uniswap, Ethereum’s busiest decentralized exchange (DEX).
As this medium article explains in some detail, the core innovation behind DEXes in general is their removal of any intermediary party between buyers and sellers in any particular market; exchange of assets is handled by smart contracts that make up the DEX. Many decentralized exchanges make use of order books, which can follow online or offline architecture patterns, but Uniswap’s specific innovation is its use of an Automated Market Maker (AMM), rather than an order book, for the exchange engine. Similarly to Compound, the counterparty in a trade is the Uniswap protocol itself; “Uniswap pools everyone’s liquidity together and makes markets according to a deterministic algorithm.” Liquidity providers obtain a small fee on the trades, incentivizing deep liquidity pools. This AMM concept has many desirable traits, such as its ability to always provide liquidity to traders (based on the algorithm) and the fact that pooled liquidity smooths out the depth of the order book, meaning there are no more large gaps in bid/ask spreads.
This is only the beginning; for more complex designs, I suggest exploring Yearn Finance (YFI), which combines several of the primitives depicted in the examples above and effectively acts as an automated hedge fund with yield-optimized strategies across several crypto assets. It is a deliberately rough and experimental project, but what it’s achieved demonstrates the promise of Ethereum as a financial substrate for the internet while simultaneously making clear just how early we are in the evolution of this technology space.
We’ve covered quite a bit of ground, but let’s not lose sight of what’s important. What makes Bitcoin and Ethereum so special? What made Bitcoin so new and difficult to grasp but narratively compelling over time? What makes Ethereum so narratively complex today? And, of course, what is Ethereum’s value proposition?
Here I briefly relinquish the pen and let Nic Carter explain the complexities inherent in Bitcoin’s journey, 12 years after its launch:
Bitcoin has often confused people. It’s perhaps one of the most misunderstood phenomena of the last decade. If you lack sufficient ideological and historical context, you most likely consider it a complete boondoggle or a bizarre, unnecessary waste of computing power and effort. This is the default position. Most people in the West rarely give any thought to monetary policy or banking — why should they? Their currencies depreciate at a slow, barely perceptible rate. Their bank arrangements work fairly well, and they don’t find themselves frozen out of the financial system too often.
Of course, this isn’t the reality for the majority of the world’s population, who suffer under inflationary regimes, or politicized and untrustworthy banking systems. But the views of American coastal elites are far overrepresented in the discourse, so the press is replete with confused assessments of this purportedly useless monetary scheme. But understanding the purpose of Bitcoin is itself a shibboleth. If you don’t get it, it’s probably not meant for you.
Even among acolytes, Bitcoin’s true nature is hard to pin down. It’s a fast-settling payments and settlements network, which led people to believe it would be suitable for petty-cash style payments on the internet, or even at brick and mortar points of sale. It’s a highly-available, replicated, and consistent database, which led many to envision it as a tool for the storage of arbitrary data. It’s highly innovative, and relies on new discoveries and improvements in computer science, cryptography, and peer to peer networking, yet it is perceived as antediluvian, a relic almost. These contradictions are core to the nature of Bitcoin. Something unowned, with no one to speak for it, will appear multitudinous in the minds of its users. It’s a glittering prism, refracting the opinions of observers, spitting out radically different visions of itself based on their perspectives.²⁹
Bitcoin is complicated; it is both technology and financial asset, and it has taken nearly 12 years to settle into its core use case as a modern store of value. Despite its complexities, Bitcoin’s core intrinsic and extrinsic properties have allowed it to sharpen its narrative, which time and experience have only hardened.
If Bitcoin is digital gold, then Ethereum is a digital economy; or, more precisely, it is the financial platform of the digital economy. Where Bitcoin is complicated, Ethereum is even more so — onto Bitcoin’s base, more functionality has been added, transforming Bitcoin’s basic decentralized ledger into a fully programmable, scalable financial ledger, capable of supporting a digital-first, internet-based economy. Where Bitcoin is a “finished product,” Ethereum is still very much a work in progress. The combination of added complexity and inherent change makes Ethereum’s narrative harder to latch onto and introduces execution risk and longer time horizons. Finally, however, where Bitcoin promises to replace gold and other hard assets with a more modern alternative, Ethereum promises to transform the digital economy with an internet-native financial platform at its core. That is a value proposition worth betting on.
Ethereum’s opportunity is massive, but there are many more “ifs’’ along the way, conditions that need to be satisfied, than with Bitcoin. Valuing this opportunity then rests on the level of confidence we have in Ethereum overcoming its short-term complexities and delivering on its promise. While I have, in this post, done my best to convey that Ethereum is structurally sound (technically, economically, socially) and constantly delivering proof points that should give us confidence in the ecosystem’s ability to execute, a logical next step would be to dive deeper into these proof points; that work, however, we will save for another post. Instead, I have primarily focused on explaining the narratives and the value creation paradigms that underpin each of these technologies. Why so much focus on narratives? Don’t underestimate their power; stories and narratives are what entire civilizations are built on.
A parting thought — in this post I have primarily focused on Ethereum’s functionality as a financial layer, because it is the first real use case that has found Product-Market-Fit on Ethereum, and it alone justifies significant value. But I would be remiss if I said I thought that was all Ethereum could do. Just as money as we know it (and as Gaeber has eloquently detailed in 5,00 Years of Debt) is entirely based on a ledger system, and just as our entire financial system is really an interrelated set of ledgers or balance sheets, Ethereum’s core functionality is a ledger. Ledgers can be used for many use cases (not just financial), such as digital registries and other repositories of data. In fact, it’s worth noting that the Ethereum white paper anticipated this progression back in 2014:
In general, there are three types of applications on top of Ethereum. The first category is financial applications, providing users with more powerful ways of managing and entering into contracts using their money. This includes sub-currencies, financial derivatives, hedging contracts, savings wallets, wills, and ultimately even some classes of full-scale employment contracts. The second category is semi-financial applications, where money is involved but there is also a heavy non-monetary side to what is being done; a perfect example is self-enforcing bounties for solutions to computational problems. Finally, there are applications such as online voting and decentralized governance that are not financial at all.³⁰
A truly decentralized web requires a decentralized ledger at its core, and Ethereum has the promise to be just that — more so than any of its recent competitors. It suffers from scalability and privacy issues today, but progressively we will see more use cases unlocked. This is the work of years and perhaps even decades, but we are already seeing the early fruits of these efforts. Investors today must value the future, despite all of its uncertainty; that future is massive. While you would be right to discount it thoroughly back to today, do not make the mistake of understating its potential.
Thank you to Max Marshall, Eli Geschwind, and Rina Azumi for comments on an earlier draft of this post.
 This recent wave of institutional purchases was preceded by several early visionary investors, with the likes of Chamath Palihapitiya, John Pfeffer, and Jack Dorsey leading the way as vocal proponents of Bitcoin. More recently, Paul Tudor Jones and Stanley Druckenmiller have been at the forefront of Wall Street investors making allocations to Bitcoin. This is representative of a much wider trend, however, as evidenced by Grayscale’s latest Digital Asset Investment Report, which states that “institutions accounted for 93% of capital inflows, or $3.0 billion” in Q420, representing a large increase in YoY inflows. Another significant development was brought about by Microstrategy’s CEO Michael Saylor, who not only allocated most of the company’s treasury to Bitcoin — becoming the first public company to do so at this scale — but also raised $650B in convertible debt for the explicit purpose of buying BTC. Finally, MassMutual, the insurance company, has recently allocated $100M to Bitcoin; while this represents a very small amount of their total float, it is a sign of growing comfort with crypto, and supports the idea that the risk-reward tradeoff of a small BTC allocation is increasingly attractive (some have even suggested it’s risky not to have a tiny BTC allocation).
 Satoshi Nakamoto, “Bitcoin: A Peer-to-Peer Electronic Cash System”
 This is not a new idea; many Bitcoiners have used this language before, including Michael Arrington in his Nakamoto article.
 For the most comprehensive and insightful explanation of today’s global macroeconomic paradigm, characterized by the petrodollar system, look no further than Lyn Alden’s “The Fraying of the US Global Currency Reserve System.”
 Paul Tudor Jones on CNBC
 I’ve mentioned this “set of technologies” before, and while the purpose of this post is not to burrow into technical subject matter, it’s important to understand that Bitcoin is the product of an amalgamation of technologies and research representing an impressive academic pedigree stretching back to at least the 1980s. As Naranayan and Clark describe in “Bitcoin’s Academic Pedigree,” Satoshi Nakamoto’s innovation was to combine several key ideas, such as linked timestamping in a ledger, merkle trees, public key cryptography, and Proof of Work to form the permissionless blockchain-based currency system we now call Bitcoin.
 For a real deep dive on the emergence of the internet, I highly recommend M. Mitchell Waldrop’s The Dream Machine.
 See, for example, this 2015 video from the Ethereum Foundation.
 Balaji Srinivasan on Messari, “Crypto Theses for 2021 with Balaji Srinivasan”
 EIP-1559 is interesting and consequential enough to deserve its own post, and I will not delve into it here. Thankfully, several others have written extensively about it before; I recommend Deribit Insights’ analysis for an objective view.
 Sourced from Nathan Tankus in “Payment Systems: Monetary Policy 101”, which I highly recommend reading in full, if only for the amusing yet enlightening parable Nate uses to describe the importance of payment systems (and interrelated balance sheets — read: ledgers) in the economy.
 Balaji Srinivasan on Messari, “Crypto Theses for 2021 with Balaji Srinivasan”
 See Ethhub.io for explainers and further resources on each of these topics.
 From the Uncommon Core podcast, “#13: Light and Su Zhu on the Art of Trading”. It’s worth also noting that Light asserts that research has “failed”; it hasn’t failed — there’s a wealth of it; it may iterate on previous concepts, but that’s a positive, rather than a negative, development. I should note that despite my disagreement on some assertions in this section, I highly recommend the podcast and this episode in particular.
 This is at least true of the version of the white paper stored on the Ethereum Foundation site.
 This last point is particularly interesting, as it contrasts with Bitcoin’s model, where issuance eventually goes to zero and miners (and hence network security) must rely exclusively on transaction fees. This, in the context where Bitcoin is primarily a Store of Value asset (ie. few transactions), seems to me to be one of the more credible critiques of Bitcoin in the long-term.
 Al Rappaport and Michael Mauboussin, Expectations Investing
 Joel Monegro, “Fat Protocols”
 Jake Brukhman, “Fat protocols are not an investment thesis”
 Taylor Pearson, “Will Cryptocurrency Protocols Be Fat or Thin?”
 See Ben Thompson, “Stripe: Platform of Platforms”
 These examples are by no means exhaustive, but are a great starting point. There are other interesting examples in the DeFi space, such as Aave, Snythetix, UMA protocol, etc.
 For the uninitiated, using any of these DeFi protocols will first require setting up an Ethereum wallet. The most popular of these wallets is called MetaMask, and functions as both a browser extension and mobile app. Once set up, this wallet will serve as your account and gateway to any protocol or application built on Ethereum.
 Nic Carter, “Bitcoin at 12”
 Vitalik Buterin, “Ethereum White Paper”