Ethereum Institutional Thesis: A Store of Value with Cash Flow
In this report, we offer a variety of institutional frameworks to analyze ETH, alongside BTC, as a part of a diversified crypto portfolio. Bitcoin has transcended into the mainstream, accelerated by the acceptance of spot BTC ETFs. ETH, while more complex, has unique use cases that could position it as a premier crypto asset alongside BTC.
Vivek Raman
Key Takeaway #1
The Ethereum network creates a value proposition that is differentiated from (and potentially superior to) most traditional investment assets.
Key Takeaway #2
In this report, we dive into eight key institutional theses about the Ethereum network and ETH, its native asset.
Key Takeaway #3
Ether (ETH), the native currency of the Ethereum ecosystem, creates a way to both transact in this digital economy as well as capture upside in its network growth.
Key Takeaway #4
Ethereum extended Bitcoin’s technology to create a digital economy - a globally accessible App Store. Moreover, ETH is both the underlying currency and captures value as the Ethereum network grows - giving ETH a unique store of value proposition that is differentiated from BTC.
In this report, we dive into eight key institutional theses about the Ethereum network and ETH, its native asset:
1. Ethereum has one of the strongest monetary policies of any major crypto asset.
2. Ethereum’s native staking yield makes it a differentiated store of value.
3. Ethereum’s Proof of Stake mechanism offers a more economical value capture mechanism than Bitcoin’s Proof of Work.
4. Ethereum’s Proof of Stake mechanism is potentially more secure than Proof of Work.
5. Ethereum is a global ledger for the tokenization and ownership of real-world assets - including institutional stablecoins.
6. Ethereum is public infrastructure for the banking system to integrate.
7. Ethereum’s stable and secure Layer 1 enables a Cambrian explosion of fast, customizable Layer 2 ecosystems.
8. ETH is becoming a store of value for the digital economy - but with cash flow.
We conclude with near-term catalysts and the road ahead for the Ethereum ecosystem.
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The Ethereum network creates a value proposition that is differentiated from (and potentially superior to) most traditional investment assets:
Ethereum offers a way for a global audience - from individuals to financial institutions to nation states - to own and participate in the growing digital economy.
The Internet was the last platform that had such potential for societal impact. Today, the Internet is ubiquitous: it is integrated into most devices around us - from phones to laptops to watches to cars - and provides a global platform for creating and consuming digital content.
Ethereum represents a digital platform with the potential scope of the Internet itself, with two improvements: (1) it embeds a digital asset (ETH) as a store of value and money into the network, and (2) it provides an innovation platform (like the App Store) for creating and consuming content, as well as allowing users to own their digital content on the Ethereum blockchain.
As our lives become increasingly digital and more commerce takes place online, the Ethereum ecosystem is providing a digital economy to facilitate this transition.
Ether (ETH), the native currency of the Ethereum ecosystem, creates a way to both transact in this digital economy as well as capture upside in its network growth.
There had not been a way to “invest” in the early infrastructure growth of the Internet (until the app layer, e.g. FAANG stocks, flourished). Owning ETH provides investors a way to share in the upside of the entire Ethereum network - its infrastructure, its apps, and its user growth.
Bitcoin revolutionized the financial world by creating a digital, globally accessible version of gold. Bitcoin’s functionality ends there - it is simplistic by design (which is a feature, not a bug).
Ethereum extended Bitcoin’s technology to create a digital economy - a globally accessible App Store. Moreover, ETH is both the underlying currency and captures value as the Ethereum network grows - giving ETH a unique store of value proposition that is differentiated from BTC.
Where Bitcoin is easily understood due to its simplicity, Ethereum is more multi-faceted. However, Ethereum’s value proposition is potentially broader than that of Bitcoin, and as an investment vehicle could complement BTC as part of a balanced digital asset portfolio.
Ethereum Institutional Theses
In this report, we dive into eight key institutional theses about the Ethereum network and ETH, its native asset:
1. Ethereum has one of the strongest monetary policies of any major crypto asset.
2. Ethereum’s native staking yield makes it a differentiated store of value.
3. Ethereum’s Proof of Stake mechanism offers a more economical value capture mechanism than Bitcoin’s Proof of Work.
4. Ethereum’s Proof of Stake mechanism is potentially more secure than Proof of Work.
5. Ethereum is a global ledger for the tokenization and ownership of real-world assets - including institutional stablecoins.
6. Ethereum is public infrastructure for the banking system to integrate.
7. Ethereum’s stable and secure Layer 1 enables a Cambrian explosion of fast, customizable Layer 2 ecosystems.
8. ETH is becoming a store of value for the digital economy - but with cash flow.
We conclude with near-term catalysts and the road ahead for the Ethereum ecosystem.
Prologue: Why Blockchains Need Crypto
What differentiates a blockchain from a database?
A database stores historical information - transactions, data, etc. - in one central place and is typically controlled by one entity.
A blockchain also stores historical information, but is not controlled by one entity. Instead, a blockchain consists of a globally distributed set of computers (called nodes) working independently to verify all transactions and data stored on the chain.
As a result, although a database will almost always be faster and cheaper than a blockchain, a blockchain’s distributed set of nodes provides additional security and resilience. No individual or central entity can control a globally distributed blockchain, which makes it an ideal ledger of record for valuable assets.
A common follow-up question since the birth of Bitcoin has been: why not pursue the benefits of “blockchain technology” without “crypto”? The reason is that both technologies are intrinsically interconnected.
Blockchains, like all economic systems, rely on incentives. All of a blockchain’s nodes (miners/validators) need to be incentivized to independently and honestly verify the blockchain’s history and transactions. Therefore, every blockchain network requires a native crypto asset with its own monetary policy. This native crypto asset is issued programmatically by the blockchain to pay its miners/validators.
Without a native asset within a blockchain ecosystem to pay a distributed set of miners/validators, there is no incentive to validate a blockchain and the blockchain system would not be secure. In other words, if a blockchain does not have a strong underlying crypto asset, then a database will always be better.
The greater the value of a blockchain’s native crypto asset, the more incentive there is for miners/validators to perform work and receive the underlying tokens. Most blockchain ecosystems have weak monetary policies - they use high inflation of their crypto assets to pay validators, which depresses the underlying value of the token.
There are two main blockchain ecosystems with native crypto assets that have strong monetary policies: Bitcoin and Ethereum.
Ethereum: Strong Monetary Policy
We have noted that most blockchain ecosystems rely on token inflation to pay miners (under Proof of Work) or validators (under Proof of Stake) to verify and secure the underlying blockchains. Issuance via inflation is a “necessary evil” to ensure that enough tokens can be produced to fairly compensate a blockchain’s nodes for their work in keeping the blockchain secure.
Ethereum, under its previous Proof of Work mechanism, had issued 2 ETH per block to miners. Average block time was ~13.3 seconds, meaning that ~13,500 ETH were issued every day to miners. This translated to a gross inflation of ~4.1%.
In contrast, the Bitcoin network (since the last halving) issued ~900 BTC per day to miners, resulting in gross inflation of ~1.7%. The next halving will occur around April 2024, resulting in a reduction in issuance to ~450 BTC / day, or gross inflation of ~0.85%.
So why does ETH have the one of the strongest monetary policies in crypto? The answer is twofold. First, for both BTC and ETH, in addition to the block issuance, the aggregate transaction fees from users using the chain are also paid to miners/validators. Unlike Bitcoin, whose primary use case is to store value, the Ethereum network is flourishing as a hub for digital economic activity. Decentralized finance, NFT marketplaces, social media, gaming ecosystems, and more all have emerged as use cases for Ethereum. As a result, ETH fees skyrocketed from 2020 onward, resulting in miners earning very high rewards: 4.1% inflation plus elevated transaction fees, arguably resulting in miner overpayment. However, the Ethereum community arrived at a solution after years of discussion.
In August 2021, the Ethereum network upgraded to enact EIP-1559 (Ethereum Improvement Proposal #1559). This upgrade enabled a change through which ~80% of Ethereum fees would be “burned,” or programmatically destroyed from circulation, rather than going to miners.
This change resulted in a much more robust and self-correcting monetary policy: when economic activity is high, the fee burn would be high, potentially resulting in more ETH burned than issued (deflation). When economic activity is low, the fee burn would be low, resulting in inflation.
Note: this mechanism is ironically similar to a “programmatic Federal Reserve,” which raises rates (resulting in deflationary pressure) during strong economic times and lowers rates (resulting in inflationary pressure) during weak economic times.
Since the implementation of EIP-1559 in August 2021, Ethereum’s net issuance dropped ~100bps from ~4.1% to ~3.14%. More importantly, EIP-1559 tied the value of ETH to the underlying economic activity on the Ethereum blockchain. More activity in the Ethereum ecosystem would directly translate to more ETH burned, adding deflationary pressure that could support ETH’s value.
However, 3.14% inflation is still higher than that of Bitcoin. The second Ethereum upgrade that led to a stronger, more self-sufficient monetary policy was the transition from Proof of Work to Proof of Stake via the Merge on September 15, 2022. We will address the advantages of Proof of Stake in later sections, but from an economic standpoint, the Ethereum network was able to reduce its gross inflation by ~80%, from 13,500 ETH / day to miners under Proof of Work to ~2,700 ETH / day to validators under Proof of Stake.
Moreover, we need to include the effect of EIP-1559. If we integrate the average fee burn since the transition to Proof of Stake in 2022, it turns out that more ETH has been burned than issued, resulting in net deflation of ~0.21% since the Merge!
The monetary policy of a blockchain network’s crypto asset is critical to the long-term sustainability of the network. Bitcoin addresses monetary policy via programmatic halvings. Every 4 years, the amount of BTC issued is reduced by 50%, resulting in decreasing inflation over time and an asymptotic climb toward a terminal max supply of 21 million BTC. BTC inflation is currently ~1.7% and it will drop to ~0.85% in April, giving Bitcoin a sound monetary policy.
With EIP-1559 and the transition to Proof of Stake, Ethereum’s monetary policy has differentiated itself from that of Bitcoin. Ethereum, a chain which continues to have consistently high economic activity (and therefore, fee revenue), has ongoing organic deflationary pressure from the fee burn (instead of issuance halvings like for Bitcoin).
Adding in the efficiencies of Proof of Stake resulting in lower issuance, Ethereum’s monetary policy is currently deflationary, and in most cases will continue to be lower than Bitcoin inflation - positioning ETH as a potentially superior monetary asset and a contender for pristine store of value. This case is further bolstered by ETH’s staking yield, a native source of cash flow from Proof of Stake.
Source: ultrasound.money
Ethereum: A Native Source of Yield
With the spectacular launch of the BTC ETFs, Bitcoin has arguably crossed the rubicon into an institutional-grade store of value. Bitcoin has carved out its spot in the crypto space as “digital gold.”
Ethereum has a more robust, less inflationary monetary policy than BTC. After the transition to Proof of Stake, ETH also has a native staking yield, making ETH a differentiated “digital gold”: a store of value with cash flow.
In the previous section, we highlighted the effect on gross issuance after the Merge, when ETH transitioned from Proof of Work (~13,500 ETH issued to miners per day) to Proof of Stake (~2,700 ETH issued to validators per day). However, we did not address why such a drastic reduction in issuance is possible.
Why is Proof of Stake able to operate on such lower issuance, with arguably higher economic security (addressed in the next section)? The reason: the cost for a validator to operate in a Proof of Stake network is lower than the cost for a miner to operate in a Proof of Work network. While BTC miners require specialized hardware, infrastructure for the hardware, and large quantities of electricity to power their mining operations, ETH validators can operate on consumer-grade laptops with an Internet connection. This necessitates lower issuance needed to compensate stakers than miners.
While the benefits of Proof of Stake are many, one key result is that ETH validators receive issuance from the Ethereum protocol in the form of a “staking yield.” In exchange for “pledging” 32 ETH as collateral (or fractions of that if using a liquid staking mechanism), each validator receives cash flows from issuance (and transaction fees). This is a potential reason to hold ETH as part of a portfolio in addition to BTC; ETH holders can stake (with virtually zero operational costs) and receive a staking yield, while BTC requires expensive mining infrastructure setup to receive block rewards.
The ETH staking yield is a function of two main variables. The first is the total amount of ETH staked; more staked ETH means lower yield for each staker, so that the entire network is not incentivized to stake. The second is the fee revenue from transaction activity on the Ethereum network. Even after EIP-1559, which resulted in ~80% of transaction fees being burned, the remaining ~20% bolsters the ETH staking yield for validators.
The figure below depicts approximate ETH staking yields across different amounts of ETH staked and different annualized fees. The addition of underlying cash flow (without compromising the integrity of ETH’s monetary policy and maintaining low-to-deflationary issuance) bolsters the case for ETH as a store of value asset that is differentiated from BTC.
Sources: X.com, BitOoda estimates
Ethereum: Proof of Stake is Economical
Both Ethereum and Bitcoin started as Proof of Work networks. There is an underlying benefit to Proof of Work: due to the high cost of running a mining operation, miners typically need to sell more of the underlying block rewards than stakers, since stakers have near-zero operational costs and therefore less need to sell. As a result, Proof of Work can lead to broader distribution of tokens, while Proof of Stake can lead to a concentration of holdings.
Ethereum had the benefit of starting as a Proof of Work network, which allowed it to achieve a wider distribution of tokens, and then switching to a Proof of Stake mechanism after ~8 years. Bitcoin will likely remain the only major Proof of Work crypto asset going forward and has a robust mining ecosystem securing the network. However, it is worth noting why Proof of Stake is more economical and sustainable over the long-term and institutions may want diversified exposure to both types of crypto assets.
The advantages of Proof of Stake are (1) lower cost, which leads to (2) lower issuance. The costs of Proof of Work are the cost to acquire mining equipment, the associated infrastructure (land, buildings, cooling, security, etc.), and the electricity required to power the mining operation. These costs are non-trivial, requiring substantial block rewards to fund operations. Conversely, an Ethereum Proof of Stake validator requires a consumer laptop and an Internet connection, which is operationally trivial. While the barrier of entry to be a validator used to be 32 ETH, staking is now possible in smaller denominations via liquid staking.
This allows Ethereum’s monetary policy to be “Minimum Viable Issuance,” or an issuance of the minimum amount of ETH needed to provide validators with a yield (yield matrix is in the previous section). When Minimum Viable Issuance is coupled with the fee burn (via EIP-1559 which distributes ~20% of fees to validators while burning the rest), this results in a net deflationary pressure to counteract issuance inflation.
A common criticism of Ethereum is that the monetary policy looks malleable vs Bitcoin’s simpler monetary policy of issuance halvings every 4 years, which results in declining inflation and an ultimate supply cap of 21 million. This is a fair point, given that BTC nodes have never changed Bitcoin’s monetary policy to date.
First, it is important to note that BTC and ETH governance operate similarly. Just like software upgrades accepted by the network’s nodes can change the Ethereum blockchain, the exact same governance and upgrade process exists for Bitcoin (and we have seen many key upgrades - like SegWit and Taproot - showing that Bitcoin is indeed malleable). If needed, Bitcoin can change its monetary policy and introduce tail inflation. Nevertheless, although Ethereum has changed monetary policy to include EIP-1559, reduce block rewards, and transition from Proof of Work to Proof of Stake, each of these changes has resulted in a reduction in inflation and an ultimate path toward monetary policy ossification, like Bitcoin has achieved.
Second, even in a “worst case” monetary policy situation for ETH (80+% of the network staked and zero transaction fees, both of which are extreme assumptions), ETH issuance is relatively low. The net issuance table below shows that with 100 million staked ETH and zero fees, inflation would be ~1.5%. As ETH fees increase, net issuance drops and ultimately becomes deflationary.
Sources: X.com, BitOoda estimates
We established above that a native crypto asset is essential to a robust blockchain, and if the underlying crypto asset has strong monetary policies, it can achieve store of value status. Bitcoin has become institutional grade and will be a premier portfolio asset. Ethereum’s lower issuance (and organic deflation) should arguably position ETH as the premier Proof of Stake asset and a diversified complement to BTC.
To summarize: running Ethereum’s Proof of Stake network is relatively economical due to lower issuance, lower operating costs, and higher economic security, which we explore next.
Ethereum: Proof of Stake is Secure
In addition to providing a native yield and being more economically efficient, there is a third benefit to Proof of Stake: Proof of Stake (under Ethereum) achieves high economic security.
Arguably, the entire point of a blockchain is security. All the “crypto-native” terms, such as “decentralization” and “censorship resistance” can be rolled up into one overarching use case - the blockchain is a secure ledger where anyone can store assets without needing to worry about a central point of failure. If security were not prioritized, then there is no point to blockchains, as traditional databases are faster and cheaper.
Bitcoin has built an enormous moat around security. There is a global network of miners that form a giant Proof of Work network running continuously to produce blocks and distribute block rewards. This is a beautiful globally defensible security mechanism that no crypto asset will replicate.
Ethereum’s Proof of Stake network eliminates the hardware, infrastructure, and electricity footprint of Proof of Work and secures the network via an economic moat consisting of ETH staked by validators, who are able to continuously verify transactions and collect block rewards. If these validators act maliciously, their stake (32 ETH per validator) is slashed, resulting in economic loss and incentivizing them to act honestly.
What could break the security of Bitcoin’s Proof of Work network? That could occur if 51% of the Bitcoin network’s computational power for mining (also known as hashrate) is amassed by one malicious actor.
What could break the security of Ethereum’s Proof of Stake network? If 34% of the total staked ETH securing the Ethereum network is amassed by one player. (Note: the actual number to truly compromise the Ethereum blockchain is 67%, since Ethereum can recover from a 34% attack, but we will use 34% to be conservative.)
We turn to a recent paper by Lucas Nuzzi, Kyle Waters, and Matias Andrade (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4727999) to examine the Total Cost to Attack (TCA) 51% and 34% of each network respectively. The methodologies are described in detail in the paper; attacking the Bitcoin network would require an attacker to purchase enough ASICs to control 51% of the network hashrate and pay for the electricity and infrastructure costs to deploy them. The TCA ranges from $5bn to $22bn to perform a 51% attack.
The cost to attack Ethereum is a simpler calculation; an attacker would need to purchase 34% of the outstanding staked ETH and stake it (which would take months, given there is an entry queue to stake and an exit queue to unstake). At the snapshot date of the paper (12/31/23), this would cost an attacker $34bn (and double that if the attacker wanted to perform a 67% attack).
The attack surface is, of course, more nuanced than comparing dollar values. Although the dollar value required to attack Ethereum is larger than attacking Bitcoin, Bitcoin attackers would be heavily constrained by the ability to buy (or manufacture) enough ASICs to control 51% of the network hashrate, rendering such an attack practically infeasible. A much more doable attack would be taking control of existing mining pools, given that miners have tangible footprints (electricity, real estate, and hardware).
In contrast, Ethereum attackers would need to acquire 34% of the staked ETH supply, which would potentially drive up the price of ETH and make it even more costly to attack. A more doable attack would be taking control of existing validators until an attacker has 34% of the stake. However, an Ethereum validator has a much smaller footprint than a Bitcoin miner - an ETH validator can run on a consumer-grade laptop, making it more difficult to control individual nodes. Ethereum’s security under Proof of Stake is arguably further bolstered by the ease of access to running a profitable ETH validator vs the high barrier to entry to run a profitable BTC miner. Both assets have impressive infrastructure (BTC) or economic (ETH) moats that make attacks very low probability. There are additional differentiated benefits to Proof of Stake outlined in a research post by Vitalik Buterin: https://vitalik.eth.limo/general/2020/11/06/pos2020.html.
One final note: because Ethereum’s Proof of Stake is designed so validators can run on consumer grade laptops, Ethereum has a lower environmental / electricity footprint. This is not meant to be a criticism of Bitcoin’s Proof of Work; in fact, many BTC miners act as load balancers in areas with volatile power grids. In other words, BTC mining is arguably accretive to the environment and much of the BTC mining infrastructure relies on green energy. However, the argument comes back to security. A BTC miner with a power, infrastructure, and real estate footprint has more of an attack surface than an ETH validator, and over time, ETH validators can be more geographically decentralized (and therefore offer differentiated security) from BTC miners.
Ethereum: Ledger for Tokenization and Ownership
We have gone into detail on Ethereum’s strengths as a digital store of value under a Proof of Stake regime, which results in a staking yield, economic security, and one of the strongest monetary policies in the crypto space.
However, the Ethereum network is more than just ETH as its native store-of-value asset. At the start of this report, we referred to Ethereum as a digital economy that provides an innovation platform (like the App Store) for creating, consuming, and owning digital content.
ETH, as an asset, needs to act as a money and store of value in order to effectively secure the entire Ethereum ecosystem. However, the applications and use cases of the Ethereum network are the real upside for consumer adoption and for technological innovation. Leading VC firms like a16z have even referred to the digital economies running on blockchains as “web3,” referring to a fundamental upgrade to the existing Internet.
So what is the killer application for the Ethereum ecosystem? It is a globally secure ledger for tokenization and ownership of assets.
The world is undeniably becoming increasingly digital. Smartphones accelerated this trend. Social media and remote work poured fuel on the fire. The rise of AI and introduction of consumer-grade AR/VR hardware (like the Apple Vision Pro) make it all but inevitable that more and more of our lives will be spent in the digital realm, with commerce, social interactions, jobs, marketplaces, and the broader economy needing more digital infrastructure.
However, the digital world has many of the same issues as the physical world. How will “digital property rights” be enforced? Who owns and makes money from digital content? Is our money safe on the Internet? Right now, these problems are solved via central databases whereby the gatekeepers are the FAANG companies and fintechs/banks. This model has been effective from a convenience standpoint, especially in the US, where we have the world’s strongest property rights.
However, an increasingly digital economy in which commerce and interactions take place across geographies necessitates the existence of a global property rights system for digital assets. Luckily, this is the ultimate use case for blockchains. A blockchain has one real advantage over a database: it has a moat of economic security without having a single point of failure. Hence, assets stored in a blockchain’s ledger have strong global property rights. As a cherry on top, these assets can be programmed using “smart contracts,” meaning that traditional jobs of record keeping, escrow, settlement, and more, can be programmed directly into digital assets.
In the end, all assets, whether physical or digital, should be tokenized (digitally represented on a blockchain), which allows for a globally accessible ledger of ownership for all assets. Physical assets, like real estate deeds, as well as digital assets, such as digital content and currencies and art, can all be represented on a blockchain. And this is the revolutionary innovation that is bringing institutional players into the blockchain space.
Jenny Johnson, CEO of Franklin Templeton, has a trademark talking point: “Bitcoin is the greatest distraction from the greatest disruption that is coming to financial services.” The disruption she is referring to is tokenization; she refers to blockchain’s use cases as (1) a general ledger / source of truth, (2) a payments method with smart contracts, and (3) a venue for tokenization, or “securitization done on steroids.”
If the global economy is becoming more digital, blockchains represent the natural evolution for record keeping and programmability of those assets. And to close the loop, tokenized assets are only as safe as the blockchain on which they are issued. The most secure, global, programmable smart contract platform that is primed for the tokenization boom is none other than the Ethereum blockchain.
Ethereum: Public Infrastructure for the Banking System
While at an abstract level, tokenization seems idealistically correct, it will realistically take time for all assets to be tokenized and represented digitally on a blockchain. For example, putting real estate on a blockchain would require physical property rights (existing legal systems) to expand in framework to include digital “deeds.” In reality, it will take years for existing regulatory frameworks to be rewritten to include digital property rights. In the near term, the first industry that can adopt tokenization with the lowest barrier to entry is the financial sector.
Tokenization has several obvious benefits: instant settlement, programmable assets, lower costs of asset ownership and transfer, and fewer middlemen. However, what is the most tangible example of product-market fit that is ready for tokenization today? The answer is the US Dollar.
Stablecoins, or tokens pegged to the US Dollar, have emerged as one of the most applicable use cases for blockchains. The top 2 stablecoins comprise nearly $130bn of market cap, indicating clear demand for US Dollar-pegged stores of value in digital economies on blockchains. While some crypto natives will denominate assets in ETH or BTC, there is a vast demand from consumers for native stable currency that tracks the value of the dollar.
This results in a very complementary use case for Ethereum as public infrastructure for the existing banking system. Rather than replacing banks - which is the zero-sum thinking of just a few crypto zealots - Ethereum provides a digital “back office,” with a programmatic settlement and record keeping infrastructure layer that banks can easily integrate into their operations. Since Ethereum is a public layer, these different “back office” systems can interoperate, reducing friction and costs across the financial system.
It is important to note that blockchain innovation is a positive sum game. Ethereum complements the existing financial system - it does not compete with it. Bank adoption of stablecoins into their infrastructure could result in payments and transfers that are faster, cheaper, and 24/7, with automated accounting and instant on-chain settlement.
Stablecoins can be a net positive for the US economy. As the US continues to issue debt, stablecoin issuers have ended up being one of the main purchasers of treasuries. The figure below shows that stablecoins were the ~16th largest sovereign holder of US treasuries and will likely be an ongoing buyer as the stablecoin market grows. Stablecoins are therefore additive by creating a new buyer of government debt.
Returning to the financial sector, banks are already exploring blockchain integration. The benefits are clear: cheaper, faster settlement of money with a built-in accounting ledger that can streamline back office functions and increase profit margins. However, much of this exploration has been happening on private blockchains which the banks themselves operate.
Private blockchains sound like an ideal solution for banks, but ultimately represent closed systems controlled by central entities. And as we alluded to in the beginning of this report, the most efficient closed system controlled by one entity is a database; there is no need for a blockchain if it is not used as public infrastructure. After all, the Internet only blossomed after the initial notion of private “Intranets” was replaced by a public, globally accessible Internet protocol. The financial system will ultimately need to integrate a public blockchain into their infrastructure to capture the full benefits of a global settlement layer.
The main pushbacks on bank adoption of public blockchains (apart from needing regulatory clarity) are that secure, public blockchains are (1) slow and (2) fully transparent and compromise user privacy. Banks undoubtedly need both speed and privacy to operate with their enormous user bases at a global scale. Ethereum’s design consists of a layered, or modular architecture, which solves both speed and privacy while remaining the safest, most secure global public blockchain for banks to integrate. We will address Ethereum’s modular design in the final section of this report.
To come full circle, we will conclude this report at the same place we started in the prologue: databases vs blockchains.
Global blockchains have only one advantage over databases: their distributed set of individual nodes, validators, and/or miners can provide greater security, reliability, and resilience than a centralized database. But this advantage comes at a (literal) cost: blockchains are more expensive and slower than databases.
And in fact, the more “decentralized” (globally accessible for a diverse set of participants to run nodes/validators) and secure a blockchain is, the slower and more expensive the blockchain will be for everyday transactions. This phenomenon is described as the “blockchain scalability trilemma,” diagrammed below:
This trilemma exists due to the architecture of blockchains, which need a globally distributed set of computers (nodes) working to validate and verify the blockchain’s transactions and history. As a result, when choosing a blockchain design, we can only pick one side of the triangle above:
-A blockchain can be scalable and secure, but not decentralized. In that case, it may just be better to use a centralized database with a trusted operator. Decentralization, or the accessibility of any individual to run a node / validator / miner, is what gives a blockchain its unique security and resilience.
-A blockchain can be scalable and decentralized, but not secure, which makes it a poor use case for high value assets and transactions.
-Or, a blockchain can be decentralized and secure at the cost of scalability. This means the blockchain will be reliable, secure, and stable, but slow and expensive relative to databases. This is the path chosen by Ethereum and Bitcoin.
However, banks, companies, and other regulated entities cannot use a slow, expensive blockchain as core infrastructure, which is one reason that blockchain adoption has not reached an inflection point. But what if there was a solution to the blockchain trilemma?
One key conclusion we made in the “Proof of Stake is More Secure’ section is that the entire point of a blockchain is security. And security is achieved in two ways: (1) having a prohibitively high economic cost to attack the chain, and (2) having a robust, geographically distributed set of lightweight nodes securing the chain, which makes it decentralized and therefore not controllable by one entity or oligopoly. Only Ethereum and Bitcoin achieve both criteria, and they do so by keeping their base layer – or Layer 1 (L1) – very simple, resulting in slower speeds and higher fees.
So how do we solve the blockchain trilemma and introduce scalability to a stable, secure, but slow L1 if we can’t increase throughput at L1 itself? We can build additional smart contract layers on top of the base layer. The Ethereum blockchain, unlike the Bitcoin blockchain, was designed for programmable smart contracts from the start - meaning that smart contract layers built on top of Ethereum can inherit the full security of Ethereum while being optimized for speed and scale. These smart contract layers are called rollups, or L2s.
The technical architecture of the L2 ecosystem is vast and will be explored in subsequent reports. However, it is important to understand why Ethereum has a rollup-centric, or L2-centric roadmap: while Ethereum L1 has been optimized for security and decentralization, L2s can be fully customizable while inheriting Ethereum’s security.
This means that the design space for L2s is infinite. There is no such thing as a “one size fits all” blockchain. Companies, countries, and other users will want to customize their blockchain ecosystems, and as different regulatory frameworks emerge, blockchains will likely need to integrate regulatory changes to be compliant. For example, coming back to the financial sector: banks will need fast, private L2s with integrated user KYC. While this design cannot be programmed into Ethereum L1, it is possible on a bank-built L2. If real estate transactions move onto blockchain rails, they will likely need to be reversible in the case of legal proceedings (e.g., an erroneous title). Ethereum L1 transactions are immutable and cannot be reversed, but this additional functionality could be programmed into a real estate L2. There will be social media L2s, gaming L2s, commerce L2s, and more - which will have cheaper, faster, and potentially private transactions while inheriting the security of Ethereum. And because all L2s “settle” transactions on Ethereum, they will be able to interoperate with each other, effectively building an “Ethereum Trade Network.”
L2s are the answer to the scalability trilemma, and are how Ethereum scales to billions of users without becoming a centralized database like today’s web2 architecture. And to come full circle,
L2s themselves pay fees to the Ethereum L1 to settle transactions on the blockchain; these fees accrue value to ETH, strengthening the economic security of Ethereum while cementing ETH as the canonical store of value across the L2 ecosystem.
Ethereum: A Store of Value with Cash Flow
In this paper, we explored several institutional theses on the Ethereum network and its native crypto asset, ETH:
1. Ethereum’s lower Proof of Stake inflation, coupled with its deflationary fee burn, gives it the best monetary policy of all crypto assets (alongside BTC).
2. Ethereum’s has a native staking yield that increases with higher economic activity in the Ethereum ecosystem - across L1 and the ETH L2s.
3. Ethereum’s Proof of Stake is relatively inexpensive, allowing for lower issuance, lower infrastructure requirements, and a negligible environmental footprint.
4. Ethereum’s Proof of Stake mechanism creates a strong economic security barrier, resulting in a complement to Bitcoin’s Proof of Work mining ecosystem.
5. Ethereum’s biggest upside is being the most stable, secure global ledger for tokenization of all assets, with institutional USD-pegged stablecoins being the first major use case.
6. Ethereum provides a public infrastructure layer that the financial sector can integrate to streamline operations, cut costs, and increase efficiency.
7. Ethereum’s decentralized, stable L1 architecture unlocks a fully modular architecture with customizable, fast, cheap L2s.
These properties make ETH a unique asset: a store of value with excellent monetary policy that produces cash flow from the underlying Ethereum economy. As activity in the Ethereum ecosystem increases with more users, more applications, and more L2s, the cash flow profile of ETH becomes stronger while ETH becomes more valuable collateral used to secure the blockchain.
While we do not attempt to fundamentally model a valuation for ETH, we can look at Ethereum as a global, permissionless “App Store” (similar to Apple) and as a store of value (similar to gold) - both of which command trillions in market value.
While Bitcoin was first in establishing blockchain as a new asset class. Ethereum built upon Bitcoin’s vision, adding a productive economy and a platform for digital innovation secured by ETH: a digital store of value with cash flow.
Appendix: Ethereum - The Road Ahead
What are the near-term catalysts for the Ethereum ecosystem?
In this report, we offered a variety of institutional frameworks to analyze ETH, alongside BTC, as a part of a diversified crypto portfolio. Bitcoin has transcended into the mainstream, accelerated by the acceptance of spot BTC ETFs. ETH, while more complex, has unique use cases that could position it as a premier crypto asset alongside BTC.
We will conclude with a roadmap of near-term catalysts that could further increase the spotlight on the Ethereum ecosystem.
-EIP 4844 - On March 13, 2024, the next Ethereum hard fork will implement EIP 4844, an upgrade that will ultimately reduce L2 transaction costs by an order of magnitude, greatly enhancing the accessibility of the Ethereum ecosystem.
-Proliferation of L2s - EIP-4844, coupled with a boom in the L2 design space, is resulting in heated competition between Ethereum L2s: Coinbase’s Base, Optimism, Arbitrum, Polygon, Starkware, Blast, and others. In this competition, the consumer is the ultimate winner as L2s take the mantle as the business development arms for Ethereum.
-ETH ETF Potential - While the potential approval of a spot ETH ETF is uncertain, the overwhelming success of the spot BTC ETFs has created anticipation around ETH. While the launch of the ETH Futures ETF was underwhelming, the spot ETH ETF could be a major catalyst.
-Eigenlayer - At a high level, Eigenlayer uses the economic moat of staked ETH to bootstrap security for new blockchain infrastructure. New L2s, new price oracles, new bridges, and more can be built using Eigenlayer, which creates a “restaking” layer that increases utility - and risk - for staked ETH.
-AI and Ethereum - As content becomes increasingly digital, AI is resulting in the proliferation of fake, untrustworthy content. Blockchains, which enforce digital property rights and authenticity, are the natural counterweight to AI. The intersection of blockchain and AI is at its infancy but will likely be a key area of innovation going forward. Ethereum, as the most secure smart contract blockchain, could complement the AI boom as a ledger to prove authenticity of content. Additionally, as autonomous AI agents perform more day-to-day tasks, ETH and stablecoins could become programmable “AI money.”
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The Ethereum network creates a value proposition that is differentiated from (and potentially superior to) most traditional investment assets:
Ethereum offers a way for a global audience - from individuals to financial institutions to nation states - to own and participate in the growing digital economy.
The Internet was the last platform that had such potential for societal impact. Today, the Internet is ubiquitous: it is integrated into most devices around us - from phones to laptops to watches to cars - and provides a global platform for creating and consuming digital content.
Ethereum represents a digital platform with the potential scope of the Internet itself, with two improvements: (1) it embeds a digital asset (ETH) as a store of value and money into the network, and (2) it provides an innovation platform (like the App Store) for creating and consuming content, as well as allowing users to own their digital content on the Ethereum blockchain.
As our lives become increasingly digital and more commerce takes place online, the Ethereum ecosystem is providing a digital economy to facilitate this transition.
Ether (ETH), the native currency of the Ethereum ecosystem, creates a way to both transact in this digital economy as well as capture upside in its network growth.
There had not been a way to “invest” in the early infrastructure growth of the Internet (until the app layer, e.g. FAANG stocks, flourished). Owning ETH provides investors a way to share in the upside of the entire Ethereum network - its infrastructure, its apps, and its user growth.
Bitcoin revolutionized the financial world by creating a digital, globally accessible version of gold. Bitcoin’s functionality ends there - it is simplistic by design (which is a feature, not a bug).
Ethereum extended Bitcoin’s technology to create a digital economy - a globally accessible App Store. Moreover, ETH is both the underlying currency and captures value as the Ethereum network grows - giving ETH a unique store of value proposition that is differentiated from BTC.
Where Bitcoin is easily understood due to its simplicity, Ethereum is more multi-faceted. However, Ethereum’s value proposition is potentially broader than that of Bitcoin, and as an investment vehicle could complement BTC as part of a balanced digital asset portfolio.
Ethereum Institutional Theses
In this report, we dive into eight key institutional theses about the Ethereum network and ETH, its native asset:
1. Ethereum has one of the strongest monetary policies of any major crypto asset.
2. Ethereum’s native staking yield makes it a differentiated store of value.
3. Ethereum’s Proof of Stake mechanism offers a more economical value capture mechanism than Bitcoin’s Proof of Work.
4. Ethereum’s Proof of Stake mechanism is potentially more secure than Proof of Work.
5. Ethereum is a global ledger for the tokenization and ownership of real-world assets - including institutional stablecoins.
6. Ethereum is public infrastructure for the banking system to integrate.
7. Ethereum’s stable and secure Layer 1 enables a Cambrian explosion of fast, customizable Layer 2 ecosystems.
8. ETH is becoming a store of value for the digital economy - but with cash flow.
We conclude with near-term catalysts and the road ahead for the Ethereum ecosystem.
Prologue: Why Blockchains Need Crypto
What differentiates a blockchain from a database?
A database stores historical information - transactions, data, etc. - in one central place and is typically controlled by one entity.
A blockchain also stores historical information, but is not controlled by one entity. Instead, a blockchain consists of a globally distributed set of computers (called nodes) working independently to verify all transactions and data stored on the chain.
As a result, although a database will almost always be faster and cheaper than a blockchain, a blockchain’s distributed set of nodes provides additional security and resilience. No individual or central entity can control a globally distributed blockchain, which makes it an ideal ledger of record for valuable assets.
A common follow-up question since the birth of Bitcoin has been: why not pursue the benefits of “blockchain technology” without “crypto”? The reason is that both technologies are intrinsically interconnected.
Blockchains, like all economic systems, rely on incentives. All of a blockchain’s nodes (miners/validators) need to be incentivized to independently and honestly verify the blockchain’s history and transactions. Therefore, every blockchain network requires a native crypto asset with its own monetary policy. This native crypto asset is issued programmatically by the blockchain to pay its miners/validators.
Without a native asset within a blockchain ecosystem to pay a distributed set of miners/validators, there is no incentive to validate a blockchain and the blockchain system would not be secure. In other words, if a blockchain does not have a strong underlying crypto asset, then a database will always be better.
The greater the value of a blockchain’s native crypto asset, the more incentive there is for miners/validators to perform work and receive the underlying tokens. Most blockchain ecosystems have weak monetary policies - they use high inflation of their crypto assets to pay validators, which depresses the underlying value of the token.
There are two main blockchain ecosystems with native crypto assets that have strong monetary policies: Bitcoin and Ethereum.
Ethereum: Strong Monetary Policy
We have noted that most blockchain ecosystems rely on token inflation to pay miners (under Proof of Work) or validators (under Proof of Stake) to verify and secure the underlying blockchains. Issuance via inflation is a “necessary evil” to ensure that enough tokens can be produced to fairly compensate a blockchain’s nodes for their work in keeping the blockchain secure.
Ethereum, under its previous Proof of Work mechanism, had issued 2 ETH per block to miners. Average block time was ~13.3 seconds, meaning that ~13,500 ETH were issued every day to miners. This translated to a gross inflation of ~4.1%.
In contrast, the Bitcoin network (since the last halving) issued ~900 BTC per day to miners, resulting in gross inflation of ~1.7%. The next halving will occur around April 2024, resulting in a reduction in issuance to ~450 BTC / day, or gross inflation of ~0.85%.
So why does ETH have the one of the strongest monetary policies in crypto? The answer is twofold. First, for both BTC and ETH, in addition to the block issuance, the aggregate transaction fees from users using the chain are also paid to miners/validators. Unlike Bitcoin, whose primary use case is to store value, the Ethereum network is flourishing as a hub for digital economic activity. Decentralized finance, NFT marketplaces, social media, gaming ecosystems, and more all have emerged as use cases for Ethereum. As a result, ETH fees skyrocketed from 2020 onward, resulting in miners earning very high rewards: 4.1% inflation plus elevated transaction fees, arguably resulting in miner overpayment. However, the Ethereum community arrived at a solution after years of discussion.
In August 2021, the Ethereum network upgraded to enact EIP-1559 (Ethereum Improvement Proposal #1559). This upgrade enabled a change through which ~80% of Ethereum fees would be “burned,” or programmatically destroyed from circulation, rather than going to miners.
This change resulted in a much more robust and self-correcting monetary policy: when economic activity is high, the fee burn would be high, potentially resulting in more ETH burned than issued (deflation). When economic activity is low, the fee burn would be low, resulting in inflation.
Note: this mechanism is ironically similar to a “programmatic Federal Reserve,” which raises rates (resulting in deflationary pressure) during strong economic times and lowers rates (resulting in inflationary pressure) during weak economic times.
Since the implementation of EIP-1559 in August 2021, Ethereum’s net issuance dropped ~100bps from ~4.1% to ~3.14%. More importantly, EIP-1559 tied the value of ETH to the underlying economic activity on the Ethereum blockchain. More activity in the Ethereum ecosystem would directly translate to more ETH burned, adding deflationary pressure that could support ETH’s value.
However, 3.14% inflation is still higher than that of Bitcoin. The second Ethereum upgrade that led to a stronger, more self-sufficient monetary policy was the transition from Proof of Work to Proof of Stake via the Merge on September 15, 2022. We will address the advantages of Proof of Stake in later sections, but from an economic standpoint, the Ethereum network was able to reduce its gross inflation by ~80%, from 13,500 ETH / day to miners under Proof of Work to ~2,700 ETH / day to validators under Proof of Stake.
Moreover, we need to include the effect of EIP-1559. If we integrate the average fee burn since the transition to Proof of Stake in 2022, it turns out that more ETH has been burned than issued, resulting in net deflation of ~0.21% since the Merge!
The monetary policy of a blockchain network’s crypto asset is critical to the long-term sustainability of the network. Bitcoin addresses monetary policy via programmatic halvings. Every 4 years, the amount of BTC issued is reduced by 50%, resulting in decreasing inflation over time and an asymptotic climb toward a terminal max supply of 21 million BTC. BTC inflation is currently ~1.7% and it will drop to ~0.85% in April, giving Bitcoin a sound monetary policy.
With EIP-1559 and the transition to Proof of Stake, Ethereum’s monetary policy has differentiated itself from that of Bitcoin. Ethereum, a chain which continues to have consistently high economic activity (and therefore, fee revenue), has ongoing organic deflationary pressure from the fee burn (instead of issuance halvings like for Bitcoin).
Adding in the efficiencies of Proof of Stake resulting in lower issuance, Ethereum’s monetary policy is currently deflationary, and in most cases will continue to be lower than Bitcoin inflation - positioning ETH as a potentially superior monetary asset and a contender for pristine store of value. This case is further bolstered by ETH’s staking yield, a native source of cash flow from Proof of Stake.
Source: ultrasound.money
Ethereum: A Native Source of Yield
With the spectacular launch of the BTC ETFs, Bitcoin has arguably crossed the rubicon into an institutional-grade store of value. Bitcoin has carved out its spot in the crypto space as “digital gold.”
Ethereum has a more robust, less inflationary monetary policy than BTC. After the transition to Proof of Stake, ETH also has a native staking yield, making ETH a differentiated “digital gold”: a store of value with cash flow.
In the previous section, we highlighted the effect on gross issuance after the Merge, when ETH transitioned from Proof of Work (~13,500 ETH issued to miners per day) to Proof of Stake (~2,700 ETH issued to validators per day). However, we did not address why such a drastic reduction in issuance is possible.
Why is Proof of Stake able to operate on such lower issuance, with arguably higher economic security (addressed in the next section)? The reason: the cost for a validator to operate in a Proof of Stake network is lower than the cost for a miner to operate in a Proof of Work network. While BTC miners require specialized hardware, infrastructure for the hardware, and large quantities of electricity to power their mining operations, ETH validators can operate on consumer-grade laptops with an Internet connection. This necessitates lower issuance needed to compensate stakers than miners.
While the benefits of Proof of Stake are many, one key result is that ETH validators receive issuance from the Ethereum protocol in the form of a “staking yield.” In exchange for “pledging” 32 ETH as collateral (or fractions of that if using a liquid staking mechanism), each validator receives cash flows from issuance (and transaction fees). This is a potential reason to hold ETH as part of a portfolio in addition to BTC; ETH holders can stake (with virtually zero operational costs) and receive a staking yield, while BTC requires expensive mining infrastructure setup to receive block rewards.
The ETH staking yield is a function of two main variables. The first is the total amount of ETH staked; more staked ETH means lower yield for each staker, so that the entire network is not incentivized to stake. The second is the fee revenue from transaction activity on the Ethereum network. Even after EIP-1559, which resulted in ~80% of transaction fees being burned, the remaining ~20% bolsters the ETH staking yield for validators.
The figure below depicts approximate ETH staking yields across different amounts of ETH staked and different annualized fees. The addition of underlying cash flow (without compromising the integrity of ETH’s monetary policy and maintaining low-to-deflationary issuance) bolsters the case for ETH as a store of value asset that is differentiated from BTC.
Sources: X.com, BitOoda estimates
Ethereum: Proof of Stake is Economical
Both Ethereum and Bitcoin started as Proof of Work networks. There is an underlying benefit to Proof of Work: due to the high cost of running a mining operation, miners typically need to sell more of the underlying block rewards than stakers, since stakers have near-zero operational costs and therefore less need to sell. As a result, Proof of Work can lead to broader distribution of tokens, while Proof of Stake can lead to a concentration of holdings.
Ethereum had the benefit of starting as a Proof of Work network, which allowed it to achieve a wider distribution of tokens, and then switching to a Proof of Stake mechanism after ~8 years. Bitcoin will likely remain the only major Proof of Work crypto asset going forward and has a robust mining ecosystem securing the network. However, it is worth noting why Proof of Stake is more economical and sustainable over the long-term and institutions may want diversified exposure to both types of crypto assets.
The advantages of Proof of Stake are (1) lower cost, which leads to (2) lower issuance. The costs of Proof of Work are the cost to acquire mining equipment, the associated infrastructure (land, buildings, cooling, security, etc.), and the electricity required to power the mining operation. These costs are non-trivial, requiring substantial block rewards to fund operations. Conversely, an Ethereum Proof of Stake validator requires a consumer laptop and an Internet connection, which is operationally trivial. While the barrier of entry to be a validator used to be 32 ETH, staking is now possible in smaller denominations via liquid staking.
This allows Ethereum’s monetary policy to be “Minimum Viable Issuance,” or an issuance of the minimum amount of ETH needed to provide validators with a yield (yield matrix is in the previous section). When Minimum Viable Issuance is coupled with the fee burn (via EIP-1559 which distributes ~20% of fees to validators while burning the rest), this results in a net deflationary pressure to counteract issuance inflation.
A common criticism of Ethereum is that the monetary policy looks malleable vs Bitcoin’s simpler monetary policy of issuance halvings every 4 years, which results in declining inflation and an ultimate supply cap of 21 million. This is a fair point, given that BTC nodes have never changed Bitcoin’s monetary policy to date.
First, it is important to note that BTC and ETH governance operate similarly. Just like software upgrades accepted by the network’s nodes can change the Ethereum blockchain, the exact same governance and upgrade process exists for Bitcoin (and we have seen many key upgrades - like SegWit and Taproot - showing that Bitcoin is indeed malleable). If needed, Bitcoin can change its monetary policy and introduce tail inflation. Nevertheless, although Ethereum has changed monetary policy to include EIP-1559, reduce block rewards, and transition from Proof of Work to Proof of Stake, each of these changes has resulted in a reduction in inflation and an ultimate path toward monetary policy ossification, like Bitcoin has achieved.
Second, even in a “worst case” monetary policy situation for ETH (80+% of the network staked and zero transaction fees, both of which are extreme assumptions), ETH issuance is relatively low. The net issuance table below shows that with 100 million staked ETH and zero fees, inflation would be ~1.5%. As ETH fees increase, net issuance drops and ultimately becomes deflationary.
Sources: X.com, BitOoda estimates
We established above that a native crypto asset is essential to a robust blockchain, and if the underlying crypto asset has strong monetary policies, it can achieve store of value status. Bitcoin has become institutional grade and will be a premier portfolio asset. Ethereum’s lower issuance (and organic deflation) should arguably position ETH as the premier Proof of Stake asset and a diversified complement to BTC.
To summarize: running Ethereum’s Proof of Stake network is relatively economical due to lower issuance, lower operating costs, and higher economic security, which we explore next.
Ethereum: Proof of Stake is Secure
In addition to providing a native yield and being more economically efficient, there is a third benefit to Proof of Stake: Proof of Stake (under Ethereum) achieves high economic security.
Arguably, the entire point of a blockchain is security. All the “crypto-native” terms, such as “decentralization” and “censorship resistance” can be rolled up into one overarching use case - the blockchain is a secure ledger where anyone can store assets without needing to worry about a central point of failure. If security were not prioritized, then there is no point to blockchains, as traditional databases are faster and cheaper.
Bitcoin has built an enormous moat around security. There is a global network of miners that form a giant Proof of Work network running continuously to produce blocks and distribute block rewards. This is a beautiful globally defensible security mechanism that no crypto asset will replicate.
Ethereum’s Proof of Stake network eliminates the hardware, infrastructure, and electricity footprint of Proof of Work and secures the network via an economic moat consisting of ETH staked by validators, who are able to continuously verify transactions and collect block rewards. If these validators act maliciously, their stake (32 ETH per validator) is slashed, resulting in economic loss and incentivizing them to act honestly.
What could break the security of Bitcoin’s Proof of Work network? That could occur if 51% of the Bitcoin network’s computational power for mining (also known as hashrate) is amassed by one malicious actor.
What could break the security of Ethereum’s Proof of Stake network? If 34% of the total staked ETH securing the Ethereum network is amassed by one player. (Note: the actual number to truly compromise the Ethereum blockchain is 67%, since Ethereum can recover from a 34% attack, but we will use 34% to be conservative.)
We turn to a recent paper by Lucas Nuzzi, Kyle Waters, and Matias Andrade (https://papers.ssrn.com/sol3/papers.cfm?abstract_id=4727999) to examine the Total Cost to Attack (TCA) 51% and 34% of each network respectively. The methodologies are described in detail in the paper; attacking the Bitcoin network would require an attacker to purchase enough ASICs to control 51% of the network hashrate and pay for the electricity and infrastructure costs to deploy them. The TCA ranges from $5bn to $22bn to perform a 51% attack.
The cost to attack Ethereum is a simpler calculation; an attacker would need to purchase 34% of the outstanding staked ETH and stake it (which would take months, given there is an entry queue to stake and an exit queue to unstake). At the snapshot date of the paper (12/31/23), this would cost an attacker $34bn (and double that if the attacker wanted to perform a 67% attack).
The attack surface is, of course, more nuanced than comparing dollar values. Although the dollar value required to attack Ethereum is larger than attacking Bitcoin, Bitcoin attackers would be heavily constrained by the ability to buy (or manufacture) enough ASICs to control 51% of the network hashrate, rendering such an attack practically infeasible. A much more doable attack would be taking control of existing mining pools, given that miners have tangible footprints (electricity, real estate, and hardware).
In contrast, Ethereum attackers would need to acquire 34% of the staked ETH supply, which would potentially drive up the price of ETH and make it even more costly to attack. A more doable attack would be taking control of existing validators until an attacker has 34% of the stake. However, an Ethereum validator has a much smaller footprint than a Bitcoin miner - an ETH validator can run on a consumer-grade laptop, making it more difficult to control individual nodes. Ethereum’s security under Proof of Stake is arguably further bolstered by the ease of access to running a profitable ETH validator vs the high barrier to entry to run a profitable BTC miner. Both assets have impressive infrastructure (BTC) or economic (ETH) moats that make attacks very low probability. There are additional differentiated benefits to Proof of Stake outlined in a research post by Vitalik Buterin: https://vitalik.eth.limo/general/2020/11/06/pos2020.html.
One final note: because Ethereum’s Proof of Stake is designed so validators can run on consumer grade laptops, Ethereum has a lower environmental / electricity footprint. This is not meant to be a criticism of Bitcoin’s Proof of Work; in fact, many BTC miners act as load balancers in areas with volatile power grids. In other words, BTC mining is arguably accretive to the environment and much of the BTC mining infrastructure relies on green energy. However, the argument comes back to security. A BTC miner with a power, infrastructure, and real estate footprint has more of an attack surface than an ETH validator, and over time, ETH validators can be more geographically decentralized (and therefore offer differentiated security) from BTC miners.
Ethereum: Ledger for Tokenization and Ownership
We have gone into detail on Ethereum’s strengths as a digital store of value under a Proof of Stake regime, which results in a staking yield, economic security, and one of the strongest monetary policies in the crypto space.
However, the Ethereum network is more than just ETH as its native store-of-value asset. At the start of this report, we referred to Ethereum as a digital economy that provides an innovation platform (like the App Store) for creating, consuming, and owning digital content.
ETH, as an asset, needs to act as a money and store of value in order to effectively secure the entire Ethereum ecosystem. However, the applications and use cases of the Ethereum network are the real upside for consumer adoption and for technological innovation. Leading VC firms like a16z have even referred to the digital economies running on blockchains as “web3,” referring to a fundamental upgrade to the existing Internet.
So what is the killer application for the Ethereum ecosystem? It is a globally secure ledger for tokenization and ownership of assets.
The world is undeniably becoming increasingly digital. Smartphones accelerated this trend. Social media and remote work poured fuel on the fire. The rise of AI and introduction of consumer-grade AR/VR hardware (like the Apple Vision Pro) make it all but inevitable that more and more of our lives will be spent in the digital realm, with commerce, social interactions, jobs, marketplaces, and the broader economy needing more digital infrastructure.
However, the digital world has many of the same issues as the physical world. How will “digital property rights” be enforced? Who owns and makes money from digital content? Is our money safe on the Internet? Right now, these problems are solved via central databases whereby the gatekeepers are the FAANG companies and fintechs/banks. This model has been effective from a convenience standpoint, especially in the US, where we have the world’s strongest property rights.
However, an increasingly digital economy in which commerce and interactions take place across geographies necessitates the existence of a global property rights system for digital assets. Luckily, this is the ultimate use case for blockchains. A blockchain has one real advantage over a database: it has a moat of economic security without having a single point of failure. Hence, assets stored in a blockchain’s ledger have strong global property rights. As a cherry on top, these assets can be programmed using “smart contracts,” meaning that traditional jobs of record keeping, escrow, settlement, and more, can be programmed directly into digital assets.
In the end, all assets, whether physical or digital, should be tokenized (digitally represented on a blockchain), which allows for a globally accessible ledger of ownership for all assets. Physical assets, like real estate deeds, as well as digital assets, such as digital content and currencies and art, can all be represented on a blockchain. And this is the revolutionary innovation that is bringing institutional players into the blockchain space.
Jenny Johnson, CEO of Franklin Templeton, has a trademark talking point: “Bitcoin is the greatest distraction from the greatest disruption that is coming to financial services.” The disruption she is referring to is tokenization; she refers to blockchain’s use cases as (1) a general ledger / source of truth, (2) a payments method with smart contracts, and (3) a venue for tokenization, or “securitization done on steroids.”
If the global economy is becoming more digital, blockchains represent the natural evolution for record keeping and programmability of those assets. And to close the loop, tokenized assets are only as safe as the blockchain on which they are issued. The most secure, global, programmable smart contract platform that is primed for the tokenization boom is none other than the Ethereum blockchain.
Ethereum: Public Infrastructure for the Banking System
While at an abstract level, tokenization seems idealistically correct, it will realistically take time for all assets to be tokenized and represented digitally on a blockchain. For example, putting real estate on a blockchain would require physical property rights (existing legal systems) to expand in framework to include digital “deeds.” In reality, it will take years for existing regulatory frameworks to be rewritten to include digital property rights. In the near term, the first industry that can adopt tokenization with the lowest barrier to entry is the financial sector.
Tokenization has several obvious benefits: instant settlement, programmable assets, lower costs of asset ownership and transfer, and fewer middlemen. However, what is the most tangible example of product-market fit that is ready for tokenization today? The answer is the US Dollar.
Stablecoins, or tokens pegged to the US Dollar, have emerged as one of the most applicable use cases for blockchains. The top 2 stablecoins comprise nearly $130bn of market cap, indicating clear demand for US Dollar-pegged stores of value in digital economies on blockchains. While some crypto natives will denominate assets in ETH or BTC, there is a vast demand from consumers for native stable currency that tracks the value of the dollar.
This results in a very complementary use case for Ethereum as public infrastructure for the existing banking system. Rather than replacing banks - which is the zero-sum thinking of just a few crypto zealots - Ethereum provides a digital “back office,” with a programmatic settlement and record keeping infrastructure layer that banks can easily integrate into their operations. Since Ethereum is a public layer, these different “back office” systems can interoperate, reducing friction and costs across the financial system.
It is important to note that blockchain innovation is a positive sum game. Ethereum complements the existing financial system - it does not compete with it. Bank adoption of stablecoins into their infrastructure could result in payments and transfers that are faster, cheaper, and 24/7, with automated accounting and instant on-chain settlement.
Stablecoins can be a net positive for the US economy. As the US continues to issue debt, stablecoin issuers have ended up being one of the main purchasers of treasuries. The figure below shows that stablecoins were the ~16th largest sovereign holder of US treasuries and will likely be an ongoing buyer as the stablecoin market grows. Stablecoins are therefore additive by creating a new buyer of government debt.
Returning to the financial sector, banks are already exploring blockchain integration. The benefits are clear: cheaper, faster settlement of money with a built-in accounting ledger that can streamline back office functions and increase profit margins. However, much of this exploration has been happening on private blockchains which the banks themselves operate.
Private blockchains sound like an ideal solution for banks, but ultimately represent closed systems controlled by central entities. And as we alluded to in the beginning of this report, the most efficient closed system controlled by one entity is a database; there is no need for a blockchain if it is not used as public infrastructure. After all, the Internet only blossomed after the initial notion of private “Intranets” was replaced by a public, globally accessible Internet protocol. The financial system will ultimately need to integrate a public blockchain into their infrastructure to capture the full benefits of a global settlement layer.
The main pushbacks on bank adoption of public blockchains (apart from needing regulatory clarity) are that secure, public blockchains are (1) slow and (2) fully transparent and compromise user privacy. Banks undoubtedly need both speed and privacy to operate with their enormous user bases at a global scale. Ethereum’s design consists of a layered, or modular architecture, which solves both speed and privacy while remaining the safest, most secure global public blockchain for banks to integrate. We will address Ethereum’s modular design in the final section of this report.
To come full circle, we will conclude this report at the same place we started in the prologue: databases vs blockchains.
Global blockchains have only one advantage over databases: their distributed set of individual nodes, validators, and/or miners can provide greater security, reliability, and resilience than a centralized database. But this advantage comes at a (literal) cost: blockchains are more expensive and slower than databases.
And in fact, the more “decentralized” (globally accessible for a diverse set of participants to run nodes/validators) and secure a blockchain is, the slower and more expensive the blockchain will be for everyday transactions. This phenomenon is described as the “blockchain scalability trilemma,” diagrammed below:
This trilemma exists due to the architecture of blockchains, which need a globally distributed set of computers (nodes) working to validate and verify the blockchain’s transactions and history. As a result, when choosing a blockchain design, we can only pick one side of the triangle above:
-A blockchain can be scalable and secure, but not decentralized. In that case, it may just be better to use a centralized database with a trusted operator. Decentralization, or the accessibility of any individual to run a node / validator / miner, is what gives a blockchain its unique security and resilience.
-A blockchain can be scalable and decentralized, but not secure, which makes it a poor use case for high value assets and transactions.
-Or, a blockchain can be decentralized and secure at the cost of scalability. This means the blockchain will be reliable, secure, and stable, but slow and expensive relative to databases. This is the path chosen by Ethereum and Bitcoin.
However, banks, companies, and other regulated entities cannot use a slow, expensive blockchain as core infrastructure, which is one reason that blockchain adoption has not reached an inflection point. But what if there was a solution to the blockchain trilemma?
One key conclusion we made in the “Proof of Stake is More Secure’ section is that the entire point of a blockchain is security. And security is achieved in two ways: (1) having a prohibitively high economic cost to attack the chain, and (2) having a robust, geographically distributed set of lightweight nodes securing the chain, which makes it decentralized and therefore not controllable by one entity or oligopoly. Only Ethereum and Bitcoin achieve both criteria, and they do so by keeping their base layer – or Layer 1 (L1) – very simple, resulting in slower speeds and higher fees.
So how do we solve the blockchain trilemma and introduce scalability to a stable, secure, but slow L1 if we can’t increase throughput at L1 itself? We can build additional smart contract layers on top of the base layer. The Ethereum blockchain, unlike the Bitcoin blockchain, was designed for programmable smart contracts from the start - meaning that smart contract layers built on top of Ethereum can inherit the full security of Ethereum while being optimized for speed and scale. These smart contract layers are called rollups, or L2s.
The technical architecture of the L2 ecosystem is vast and will be explored in subsequent reports. However, it is important to understand why Ethereum has a rollup-centric, or L2-centric roadmap: while Ethereum L1 has been optimized for security and decentralization, L2s can be fully customizable while inheriting Ethereum’s security.
This means that the design space for L2s is infinite. There is no such thing as a “one size fits all” blockchain. Companies, countries, and other users will want to customize their blockchain ecosystems, and as different regulatory frameworks emerge, blockchains will likely need to integrate regulatory changes to be compliant. For example, coming back to the financial sector: banks will need fast, private L2s with integrated user KYC. While this design cannot be programmed into Ethereum L1, it is possible on a bank-built L2. If real estate transactions move onto blockchain rails, they will likely need to be reversible in the case of legal proceedings (e.g., an erroneous title). Ethereum L1 transactions are immutable and cannot be reversed, but this additional functionality could be programmed into a real estate L2. There will be social media L2s, gaming L2s, commerce L2s, and more - which will have cheaper, faster, and potentially private transactions while inheriting the security of Ethereum. And because all L2s “settle” transactions on Ethereum, they will be able to interoperate with each other, effectively building an “Ethereum Trade Network.”
L2s are the answer to the scalability trilemma, and are how Ethereum scales to billions of users without becoming a centralized database like today’s web2 architecture. And to come full circle,
L2s themselves pay fees to the Ethereum L1 to settle transactions on the blockchain; these fees accrue value to ETH, strengthening the economic security of Ethereum while cementing ETH as the canonical store of value across the L2 ecosystem.
Ethereum: A Store of Value with Cash Flow
In this paper, we explored several institutional theses on the Ethereum network and its native crypto asset, ETH:
1. Ethereum’s lower Proof of Stake inflation, coupled with its deflationary fee burn, gives it the best monetary policy of all crypto assets (alongside BTC).
2. Ethereum’s has a native staking yield that increases with higher economic activity in the Ethereum ecosystem - across L1 and the ETH L2s.
3. Ethereum’s Proof of Stake is relatively inexpensive, allowing for lower issuance, lower infrastructure requirements, and a negligible environmental footprint.
4. Ethereum’s Proof of Stake mechanism creates a strong economic security barrier, resulting in a complement to Bitcoin’s Proof of Work mining ecosystem.
5. Ethereum’s biggest upside is being the most stable, secure global ledger for tokenization of all assets, with institutional USD-pegged stablecoins being the first major use case.
6. Ethereum provides a public infrastructure layer that the financial sector can integrate to streamline operations, cut costs, and increase efficiency.
7. Ethereum’s decentralized, stable L1 architecture unlocks a fully modular architecture with customizable, fast, cheap L2s.
These properties make ETH a unique asset: a store of value with excellent monetary policy that produces cash flow from the underlying Ethereum economy. As activity in the Ethereum ecosystem increases with more users, more applications, and more L2s, the cash flow profile of ETH becomes stronger while ETH becomes more valuable collateral used to secure the blockchain.
While we do not attempt to fundamentally model a valuation for ETH, we can look at Ethereum as a global, permissionless “App Store” (similar to Apple) and as a store of value (similar to gold) - both of which command trillions in market value.
While Bitcoin was first in establishing blockchain as a new asset class. Ethereum built upon Bitcoin’s vision, adding a productive economy and a platform for digital innovation secured by ETH: a digital store of value with cash flow.
Appendix: Ethereum - The Road Ahead
What are the near-term catalysts for the Ethereum ecosystem?
In this report, we offered a variety of institutional frameworks to analyze ETH, alongside BTC, as a part of a diversified crypto portfolio. Bitcoin has transcended into the mainstream, accelerated by the acceptance of spot BTC ETFs. ETH, while more complex, has unique use cases that could position it as a premier crypto asset alongside BTC.
We will conclude with a roadmap of near-term catalysts that could further increase the spotlight on the Ethereum ecosystem.
-EIP 4844 - On March 13, 2024, the next Ethereum hard fork will implement EIP 4844, an upgrade that will ultimately reduce L2 transaction costs by an order of magnitude, greatly enhancing the accessibility of the Ethereum ecosystem.
-Proliferation of L2s - EIP-4844, coupled with a boom in the L2 design space, is resulting in heated competition between Ethereum L2s: Coinbase’s Base, Optimism, Arbitrum, Polygon, Starkware, Blast, and others. In this competition, the consumer is the ultimate winner as L2s take the mantle as the business development arms for Ethereum.
-ETH ETF Potential - While the potential approval of a spot ETH ETF is uncertain, the overwhelming success of the spot BTC ETFs has created anticipation around ETH. While the launch of the ETH Futures ETF was underwhelming, the spot ETH ETF could be a major catalyst.
-Eigenlayer - At a high level, Eigenlayer uses the economic moat of staked ETH to bootstrap security for new blockchain infrastructure. New L2s, new price oracles, new bridges, and more can be built using Eigenlayer, which creates a “restaking” layer that increases utility - and risk - for staked ETH.
-AI and Ethereum - As content becomes increasingly digital, AI is resulting in the proliferation of fake, untrustworthy content. Blockchains, which enforce digital property rights and authenticity, are the natural counterweight to AI. The intersection of blockchain and AI is at its infancy but will likely be a key area of innovation going forward. Ethereum, as the most secure smart contract blockchain, could complement the AI boom as a ledger to prove authenticity of content. Additionally, as autonomous AI agents perform more day-to-day tasks, ETH and stablecoins could become programmable “AI money.”
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