(Any views expressed in the below are the personal views of the author and should not form the basis for making investment decisions, nor be construed as a recommendation or advice to engage in investment transactions.)
“I must not fear.
Fear is the mind-killer.
Fear is the little-death that brings total obliteration.
I will face my fear.
I will permit it to pass over me and through me.
And when it has gone past I will turn the inner eye to see its path.
Where the fear has gone there will be nothing. Only I will remain.“
– Paul Atreides, Dune
I love sci-fi novels. At any given time, I am reading at least one sci-fi novel. Dune, by Frank Herbert, is the single best sci-fi novel ever written. The full six book series is quite good, but the quality tapers off after the first book. The best sci-fi book series is The Three-Body Problem trilogy by Liu Cixin. It is just astoundingly well written; I wish my Mandarin was better so I could read it in Chinese rather than an English translation. If you like sci-fi this shit is the TRUTH. I’m also super pumped for the upcoming Foundation TV series. Asimov is a gangster.
Us traders and investors are simple creatures driven by fear and greed. While greed goads humans into doing many incredible things, the fear of loss trumps all. Daniel Kahneman has a great body of work describing how humans’ decisions are not as rational as classical economists believe. In particular, monetary loss afflicts greater damage on our psyche than monetary gain. As we venture deeper into this epic crypto bull market, an evaluation of what scares us is essential because one or more of these narratives could supplant the desire of punters to keep BTFD.
The Flippening
A few weeks back, I got a message from Su Zhu of Three Arrows out of the blue. He asked me what I thought the probability was that the Ether market cap would surpass Bitcoin’s during this bull run. I replied 0%, and then asked his opinion. He hit back with 50%. Raoul Pal’s May 2021 edition of the Global Macro Investor dropped shortly afterwards. Contained, in the always amazing report, was a snippet of a lengthy report by Nikhil Shamapant on why Ether could reach $150,000 by Jan 2023. After reading the report, I sent Su another message updating my probability of the flippening occurring to 30%.
There is a subsect of the Bitcoin community that has night tremors rooted in the fear that Ether will one day overtake their beloved currency, featuring images of Apostle Buterin and Lord Lubin. I don’t get the tribalism, but check out Crypto Twitter for some epic Bitcoin vs. Ether rants. The Bitcoin maximalists believe that Bitcoin is the one true monetary god in the crypto firmament. Everything else is at best a supporting deity, at worst pure evil.
On the other end of the spectrum are mETH heads who believe that Ether can be both the hardest form of crypto money and the world’s best decentralised computer. To them, after ETH 2.0 launches and the switch from Proof-of-Work to a Proof-of-Stake consensus algorithm is completed— currently slated for later this year— then Ether’s market cap will quickly eclipse Bitcoin’s.
I try to eradicate dogma from my thinking as much as I can lest I become married to a way of thinking that will become outdated as time marches forward. I, as all humans, will fail in this endeavour, but hopefully I reduce future losses by reminding myself I can only predict the probability outcomes and act accordingly. The dogma surrounding Bitcoin and Ether must be stripped down to what the actual fundamental vision is for each crypto. Then we can build back up to the current state of affairs and evaluate whether the narrative fundamentally makes sense.
What is Bitcoin / Ether?
The best forms of money have no industrial use case. Fiat currencies are very useful for commerce because they are intrinsically worthless. The demand to use a particular fiat is completely tied to the usefulness of its network. The network in this case is the number of domestic and or international trading counterparties that will accept a particular fiat currency in exchange for goods and/or labour.
The reason why commodity forms of money are not great for everyday use is that they have a value tied to some real-world use case. A barrel of oil is a terrible currency. Oil would have two sources of demand affecting its price vs. labour and goods. The first would be the demand function from energy consumers. The second would be the demand function as a medium of exchange. How do I price my labour in terms of a barrel of oil? I must impute a value based on oil’s usefulness to my daily energy needs, and what I think other people believe it’s value is vs. the good or service I’m trading. It gets quite complicated as the number of economic actors grows, and the supply and monetary velocity of oil contains interdependent vectors.
The number one mission of Ether is to power the world’s largest decentralised computer. Ether is valuable because the Ethereum network is the most used smart contract protocol. It has the most developers, the most Dapps, and the largest Total Value Locked (TVL). Ether is the commodity that is spent to pay for gas so that you may use the Ethereum decentralised computer.
Ether’s use case is not purely monetary. The best example of this is the DAO hack. For those of you not around in 2016, here is a very very abridged sequence of events that led to a decision to hard-fork the Ethereum network in order to save investors in the DAO.
- A project called The DAO launched in an attempt to be the first real decentralised autonomous organisation running an Ethereum protocol VC fund.
- Users staked ETH into the DAO smart contract, and in return they could vote on how the pooled funds would be invested into promising projects.
- The DAO attracted approx. $150m worth of ETH at the time, which made it one of the largest crowdfunding campaigns in human history.
- A bug in the smart contract allowed an entity to drain the funds from the DAO. I object to calling this hacking; the contract performed as written. The problem was that the DAO creators did not fully understand how their smart contract would perform in the wild.
- The Ethereum community loosely –led by Vitalik– had a very stark choice to make:
- Allow the DAO funds to be drained, but uphold the immutability of the blockchain. This would have made Ether more akin to a hard monetary instrument, but given the nascent stage of the Dapp ecosystem in 2016, it would have dented the enthusiasm of investors to participate in future DeFi projects because of the losses they sustained.
- Push for the miners to accept a hard-fork which would roll back the Ethereum blockchain to before the DAO was exploited and allow investors to recover their ETH. This makes Ether a poor monetary instrument because history can be re-written under duress, but it would give confidence to investors to continue experimenting with DeFi applications.
- Allow the DAO funds to be drained, but uphold the immutability of the blockchain. This would have made Ether more akin to a hard monetary instrument, but given the nascent stage of the Dapp ecosystem in 2016, it would have dented the enthusiasm of investors to participate in future DeFi projects because of the losses they sustained.
- The community, true to the actual mission, chose advancing Ethereum’s position as a decentralised computer over being a true monetary instrument.
- This decision upset a lot of community members who valued immutability above all else, so after the hard-fork they continued mining the original chain but changed the name to Ethereum Classic (ETC). It has the same community commitment to acting like hard money as Bitcoin, and the same smart contract logic of Ethereum.
My religion is the market, and over the 5 years, it decreed that ETH shall be worth 30x MORE than ETC. The market values the focus of Ethereum on being the best smart contract protocol over it attempting to be a form of hard crypto money good collateral as well. Serving two masters is impossible.
When in doubt, the Ethereum community will always elevate the needs of the decentralised computer over the needs of being a true hard monetary instrument. As we look towards the future of ETH 2.0, there is a budding narrative that Ether could be both the hardest form of crypto money AND the best decentralised computer. #REF!
Ether Inflation Schedule
EIP-1559, if approved, will substantially alter the inflation schedule of Ether. Essentially, instead of Ether moving from users to miners in the form of network gas usage fees, there will be a base fee that is burned, and a tip that goes to the miners. There are estimates that up to 70% of gas spent on a transaction could be burned. In my piece “Yes … I Read the Whitepaper” I talked about the potential massive growth in Ether gas fees if DeFi can replace even a fraction of CeFi.
If the amount of gas fees exponentially increases alongside usage, and these fees are burned, then very quickly the inflation schedule will become deflationary. The supply of Ether will decline in Ether terms as the platform becomes more useful. If we are underestimating the impact of DeFi on human economic interactions, there is a future where there isn’t enough Ether supply to allow the system to function.
The retort to that is that an extremely high price of ETH solves that supply issue. But it does not, there is no magic ETH in the ground that can be exploited if the marginal mining profits expand enough. The network will not produce enough ETH, via block rewards, to satisfy its use in the attainment of the Ethereum mission.
At this point, the network’s economics fails. The price is high, and HODLers are popping Ace of Spades, but it’s a short walk to the poor house if the DeFi apps that require fuel cannot obtain it at ANY COST. Given what we know about how the community responds to existential threats to accomplishing its mission (see: the DAO hack), do you expect them to sit by and watch the network kill itself due to a flawed inflation schedule? If you hard-forked once, you can hard-fork again. The deflationary issuance and gas burn schedule will be sacrificed so that Dapps can be used at the volumes necessary to power the decentralised computer.
Therefore, those who bet that this current EIP-1559 inflation schedule will never change, need to review the protocol’s history. A prime driver of the Flippening bull case is that the exponential rise of DeFi-necessitated on-chain transactions, which causes more fees to be spent then burned, lowering supply and pamping the price.
If we really reach a $150,000 ETH price, and the network is disintermediating the parasitic CeFi regime, the mere suggestion that the protocol must change its emission schedule in order to continue cracking CeFi skulls will send the price careening towards the bottom of the Mariana Trench. This failure to understand the implications of a deflationary emission schedule on the currency that powers the underlying technology whose usefulness underpins the price could prove fatal. Ether cannot ever be the hardest form of crypto money while achieving its real mission to power the world’s decentralised computer.
However, this does not mean that Ether’s market cap cannot eclipse Bitcoin’s. It just means that it will be much harder to achieve because Ether does not get to have its cake and eat it too.
Money is less valuable than Tech
The global reserve currency is the most valuable because it has the largest network of actors who will accept it in return for goods and labour. Currently that is the USD. An approximation of the value of the currency is M0, or the amount of base money in circulation. Currently USD M0 is $5.8 trillion.
The combined value of the FAANGs (Facebook, Apple, Amazon, Netflix, and Google) is $6.36 trillion. The USD is just pure money that rides on the US financial system’s network. It is not more valuable than companies that provide actual goods and services priced in USD units.
Holders of USD don’t cry like babies on social media because companies that sell their products denominated in USD are worth more than the USD. So why are Bitcoin maxis so threatened by the inevitability that other cryptos that have an industrial use case will be worth more than Bitcoin? The feeling doesn’t seem to be mutual – many of the most successful alt-coins raised their initial funding in Bitcoin.
Bitcoin is no less intrinsically useful as the hardest form of crypto collateral if its crypto market cap dominance is significantly lower than it is currently. Holders of Bitcoin must believe that at the base of any crypto enabled economy lies Bitcoin collateral. They should strive to support that mission, because in doing so it further entrenches Bitcoin’s role as the base of the Exter crypto pyramid.
The Spectre of Sir Thomas Gresham
Fiat and gold require living breathing humans to exchange them for other forms of money, goods, and or services. These traditional forms of money rely on a network of humans. As long as there are humans the network can function.
While Bitcoin is the hardest money ever created, it requires— in addition to humans— a cadre of self-interested miners to expend real-world energy to upkeep the network. Miners are only rewarded with Bitcoin. Should the Bitcoin vs. energy exchange rate falter for any variety of reasons, the miners won’t mine, and the network disappears. Poof — begone, Bitcoin.
The higher the velocity of Bitcoin transactions, the more on-chain fees generated. These fees, in addition to block rewards, allow miners to purchase energy in order to upkeep the network. We all know that the block reward seigniorage will decline approx. every 4 years until ceasing all together by 2140. Thankfully the number of on-chain transactions are up and to the right bigly. But as the culture of purchasing paper Bitcoin derivatives grows and OG’s continue HODLing, the bite of Gresham’s law looms large in the not-so-distant future.
Bad money is spent, e.g. USD and other fiats; good money is hoarded, e.g. Bitcoin. This is Gresham’s law. However, while hoarding gold does not diminish its value, in extremis hoarding Bitcoin in the future without using it in any fashion will destroy the economics of the network which gives Bitcoin its value— because after block rewards end, miners will only be paid in transaction fees, and if there are no transactions, there are no fees, and no incentive for miners to maintain the network.
Not Your Keys, Not Your Coins
Most new entrants to our pond want an easy way to acquire Bitcoin vs. fiat risk. That is, they believe Bitcoin Number Go Up, but have zero interest in becoming their own financial institution. They want the 1-800 number to call when they forget their password, and a human to complain to when things don’t go as planned. Service providers are happy to sell paper Bitcoin derivatives that provide exposure to the asset, while dealing with all the pesky blockchain issues for a fee.
Judging by the asset gathering success of Grayscale’s GBTC, Coinshare’s XBT Provider, and other paper derivatives, the average investor just wants price risk. My close friends who all actively trade also use these products because they are easy, and they are fully cognisant that the true revolutionary aspects of the Bitcoin blockchain are completely lost when you don’t custody your own coins. But that is irrelevant because they covet an inflation hedge more than a new financial ecosystem.
A bunch of Bitcoin sitting in custodial accounts that are not used in commerce, or as collateral in a new digital financial economy act as a potential drag on the profitability of miners in the long run. The other drag is those who fully buy into the “be your own bank” ethos but would rather spend fiat for life’s necessities than their precious Bitcoin. If both ends of the belief system are resolute, growth in on-chain transaction volume will moderate and/or outright decline.
No Chips
Due to the persistent shortage of semiconductor chips needed to build new mining machines, the large profit margins of mining farms at these high Bitcoin vs. energy prices will continue. Even if you have the money to purchase machines, there are just not enough for sale to dramatically increase the network hash rate.
As a reminder, the real exchange rate that matters is Bitcoin vs. energy. Fiat will come and go, but miners must purchase electricity somehow with the Bitcoin earned to sustain their operations. The residual Bitcoin remaining after such purchases is their profit. 1 USD can buy 1 kWh or 1,000 kWh; however, 1 kWh is always 1 kWh.
The current crop of large mining farms don’t need transaction volume to dramatically increase in order to afford their ongoing CAPEX. They are printing so much money even with 2nd generation mining rigs, that it is irrelevant whether Bitcoin is used in actual commerce.
Farm-to-Table
When primary, intermediate, and final goods are all priced in Bitcoin, credit in Bitcoin terms can be extended to all steps of the value chain. A truly Bitcoin economy allows for uncollateralised loans in Bitcoin terms. When / if this future arrives, on-chain transaction volumes will skyrocket.
Farm-to-Table Bitcoin use is the salve to soothe the persistent itch of Gresham’s law. We have time to rectify the rational but destructive impulse to purchase paper Bitcoin derivatives and hoard physical coins.
Dog Money
The most awesome force in the universe is the power of the collective human imagination. Every single non-natural physical object we interact with began in the imagination of one or more individual humans. Everything begins as make believe and then transitions into physical reality.
The value systems that underpin our collective delusions are guarded fiercely. We only need to document the millions that have died over the millennia of human civilisation due to differences in opinion regarding political systems and religion. It is not a surprise that when it comes to the realm of monetary systems, people take their beliefs quite seriously. They should, as your monetary belief system can be the difference between a life of leisure and one of senseless toil.
Humans intrinsically know that money is pure fiction. Therefore, when you challenge their belief system with an alternate story, they can become hostile. The best way to elicit a response is through the use of humour.
The most talented comedians take our most cherished beliefs as a society and show logical fallacies using the arc of humour. If you can’t take a joke, then you might want to meditate for a while on why you are so insecure in your beliefs. Maybe it is because you know deep down that they are complete bullshit.
Dogecoin infuriates both the traditional financial mandarins and the crypto cowboys. It is magic internet money with no pretence about its lack of technological innovation. It’s a cute dog displayed on a computer screen. Jackson Palmer, the founder of Dogecoin, famously rage quit Doge a few years back highlighting that he believed that it was ridiculous that this obvious joke of a crypto currency still had value.
It is only fitting that one of humanity’s best salesmen of all time, Elon Musk, used the Dogecoin foil to elucidate the absurdity of our current monetary regime. Elon’s company Tesla is worth more than most car companies combined while producing 1 / 60th the number of cars. It is unabashedly pure hype. Elon creates more shareholder value through his Twitter megaphone than delivering safe, fast, and environmentally sustainable electric vehicles.
Love him or hate him, he is the poster boy for Number Go Up! The joke of Dogecoin has produced many basement dweller millionaires. How infuriating that must be to the traditional financial gatekeepers who pontificate about value and growth investing on television while barely managing to generate single digit percent returns in an era when global central banks have expanded their balance sheet at 15% CAGR since the 2008 GFC. The joke’s on you.
The joke is also on crypto acolytes who preach a techno decentralised utopia. Their dogma is also threatened by dog money. How can this technologically deficient protocol be in the top ten? What does this say about the value system of their peers? They lament that Dogecoin “makes us look bad”, and “makes crypto look unprofessional”. If professional means wearing a suit and tie or a black pencil skirt while earning substandard returns, give me dog money. You too are trading magic internet money, and pushing electrons across a computer screen while waxing philosophical. Maybe you just want your Number Go Up token to be touted by Lord Elon on Saturday Night Live.
Crypto has nothing to fear from Doge. It instead should be used as a foil to show the emperor has no clothes. Money is a mental abstraction. The sooner gen pop realises that everything is make-believe, the sooner they can make the leap from physical government issued bank notes, to a purely digital decentralised currency. They are both equally as fake. Which piece of fiction can preserve your purchasing power in the face of rising energy, food, and housing costs? Which piece of fiction is inclusive rather than exclusive? Which piece of fiction can you participate in the development of?
Dogecoin is a blessing. Long live cute dog money!
I Will Face My Fear
It is very simple— I am afraid that global central banks will slow the growth of their balance sheets. Absent that, there is no reason why any crypto should be worth multiples of what it is today. When the price of money is no longer distorted, traditional cash flow analysis will become relevant again.
The various fears I spoke about during this essay are idiosyncratic to particular cryptos. The asset class as a whole, just like equities, real estate, and commodities will continue to grow as more money is printed. Understand your fear, and choose an appropriate ecosystem to hide your wealth from the ravages of inflation. As Chuck Prince, the former head of Citigroup, once said, “When the music stops, in terms of liquidity, things will be complicated,” Prince said. “But as long as the music is playing, you’ve got to get up and dance.” Don’t be afraid to get out on the dance floor, anybody can do the crypto electric slide
