The purpose of this state of the union is the criticize aspects of the Ethereum project and bring awareness to fixable issues while combating general ignorance of cryptocurrencies and the blockchain.
Ethereum is a cryptocurrency network which offers a new currency “Ether” to rival Bitcoin and national currencies like the US Dollar. Having the same blockchain-based roots as Bitcoin it functions the same as that family and requires differentiating qualities to stand out, and those differentiating qualities are very expansive and have single-handedly ushered in entirely new industries and work for governments.
Ethereum is the “world computer”, and is also the backbone of a new “decentralized finance” (“DeFi”) ecosystem. It is important to know that these things have very little to do with its native currency “Ether”. Many people wish to prosper from the success or proliferation of the Ethereum platform by purchasing Ether, hoping that more people want to use Ether and will buy Ether from them at a higher price. This is not the way to profit from — or voice an opinion about — the Ethereum platform. Ether is all but useless in the expanded feature set and merely needed to help keep the Ethereum network to be tamper-resistant, it can be ignored. Given the public interest in imagining that Ether’s demand is significantly affected by the use of the Ethereum network, we can revisit this next year to see if the dialogue has changed.
“DeFi” cannot exist without the “world computer”, so let's break down the world computer feature first.
Everything wrong with Ethereum in 2019.
Ethereum is the “world computer”, and it is powered by a gas called Ether. To use the world computer, you must submit Ether to fuel any computations. These are two innovations combined: the first is that a network of individual computers all store the same outcomes of an instruction, and there is a market price for doing so.
Humans act like a world computer when they tell the time. Almost all people have a set of rules and protocols they use to look at an analog clock they own and come to the same result on what time of day it is. Without telepathy or any other kind of networking, humans know what time it is. The goal of Ethereum is to give computers the same capability for more complex calculations, while also keeping a record that all computers, in fact, did come up with the same result. Obviously, humans telling the time would have slight deviations in what time they think it is, and in a similar people-driven system we would have to take the average answer in a record. We would furthermore begin deferring to certain people that have more specific technology for telling time. Computers, of course, are always exact — or at least will compute the product of unchanging inputs the same every time — so then the point of this network would be to merely ensure that one computer was not introducing bad data and getting that recorded. In the movie Minority Report, three telepathic humans “pre-cogs” were working in unison to determine whether a crime was about to happen, allowing law enforcement to arrest people that did nothing wrong yet. The plot twist was that one of the “pre-cogs” was introducing false future events, and they made a whole movie about it. The Ethereum network prevents bad computations from gaining consensus, records what the consensus was, and makes that record tamper-proof. So instead of trusting Microsoft, or your local government, to keep a record in perpetuity, the Ethereum network does it instead.
What’s wrong? Actually, this part works extremely well. The outstanding issues are how many computations can happen at once, and how many results can be stored. In 2019, there are already several other networks with their own cryptocurrency that do the same thing, but faster, cheaper and for larger more complex calculations — so better. They all introduce different compromises on security to do so, but perhaps the market can simply bear that. Perhaps, Microsoft or your local government simply doesn’t require a completely tamper-resistant blockchain network in order to be a $1 Trillion company or maintain the trust of the people.
The World Computer allows people to run “decentralized applications” or “dApps”, pronounced de-apps (or dapp). This is nomenclature and pronunciation not settled yet, just like how people used to write E-Mail before the concept remained in the lexicon as email. dApps save developers time and resources by offloading a lot of a business or service onto the public utility of the Ethereum network. There are games like Cryptokitties where the digital collectibles are enforced by actual scarcity instead of a game developer’s promise, and there market intelligence services like Pareto Network where market-moving information can be submitted anonymously and paid for transparently. One common subset of these dApps are Decentralized Finance or “DeFi” services.
The Decentralized Finance ecosystem is big already. These all aim to offer faster financial services that are not encumbered by regional limitations. These are borderless, global and egalitarian versions of financial services.
In many cultures, there is a tendency for the people to wish that some people can’t access the financial system. In some cases, they link prosperity with morality, they imagine that because someone does not comply with their imagined social contract, that they should not be allowed to consolidate capital. The capital itself can’t differentiate and it is a stretch of the imagination to consider these things related but the effects can be real. Private businesses offering financial services arbitrarily cancel relationships with customers. In other cases, this is translated to using the power of the state to prevent certain groups of people from accessing the financial system. In the United States, access to credit for buying a home — the “American dream” a meme which briefly enraptured the hearts and minds of many during the last century — was not a dream widely available to people of non-European and especially African descent until the late 20th century. Centuries after landowners and speculators had carved out industries and directed generational wealth. In many other markets, no matter how nuanced the circumstances are which led to the outcome, you see people shut out of wealth-generating system and global capital markets. Societies prosper from economic growth and the productivity of all participants. DeFi destroys the ability for some participants to limit the productivity of others through private businesses or the state. Outside of the DeFi and blockchain ecosystem, people and regulators actually view the “unbanked” as victims which need to become banked. The unbanked are still more numerous and this technology allows them to leapfrog the whole concept of a bank while having access to sophisticated financial products for investors.
It no longer matters that a host nation has declared that all occupants of a dependent state to be terrorists with no recognized national identity and deciding that they don’t deserve access to banking, let alone credit and investment opportunities. It no longer needs a diplomatic resolution as the state’s role in this has been completely disintermediated all while DeFi businesses/services have no ability to distinguish the attributes of a human participant. It doesn’t matter if that’s controversial in 2019, the only thing that matters is recognizing that the state’s monopoly on gatekeeping finance is gone. It has evaporated along with the human element and has been replaced with the autonomous Ethereum network which simply doesn’t care about the power consolidations humans seek to impose on others. An ephemeral machine has bestowed a public resource on this planet that doesn’t care about this planet’s history, reminiscent of the aether state machine and element Plato described 2,300 years ago. Using energy and resources to perpetuate financial exclusion only accelerate the growth of DeFi services and destabilize the centralized incumbent’s budget (and laughable, divide the very people that the government derives its power from, keep it up ya’ll), and in 2019 it is already far more than just marginalized persons using these services.
DeFi services offer insurance, stock exchanges, banking like services and much more. But it still might not be clear why, until you look at the commonalities amongst this wide range of services. A business that offers a DeFi service never takes custody of your money. When you use a stock exchange or bank, you deposit money with that company. You have to trust the company and trust the governing regulations to ensure the company doesn’t just take your money. And sometimes you still wind up disappointed! You find out you can’t withdraw your money or use your money, or you find out that you can’t use the service any longer because the company canceled its relationship with you. On the flip side, the company itself has to spend lots of money on compliance with banking regulations, investor regulations, consumer protection regulations and more, which means expensive lawyers and personnel, usually all triggered by the fact that they accept deposits or take custody of customer’s money. When a DeFi company is able to offer the exact same service without taking custody of your money, they are exempt from many regulations, and you also don’t need to worry about the business taking your money. DeFi services also have a shorter time to market because they don’t have to apply for regulatory approval, they don’t have to worry about local regulations and can immediately service the whole planet. Other times, a DeFi company’s regulatory exemption comes from there being no-known human to sanction. A government would need to take down the whole Ethereum network to prevent a non-compliant/unlicensed DeFi service from being inaccessible, and the Ethereum network itself makes that an expensive and profitable proposition to attempt.
What do DeFi services let you trade and invest in if Ether is the only native currency and it is just gas? Well, being the hottest asset issuance platform on the market, Ethereum users have made digital representations of real-world assets, along with new digital-only assets, on the Ethereum network. There are even competing versions of US dollars tradable one-to-one for actual US dollars. The Ethereum community and developers actively work on a variety of standards and protocols for the world computer to recognize and compute with. These are called ERC “Ethereum Request for Comments” and EIP “Ethereum Improvement Protocols”. The most monumental one of these has been ERC20, which refers to fungible digital assets. It simply means it is the 20th proposal put up for comments on Ethereum. (More technically, it doesn’t mean 20th consecutive, the just the one happened to be labeled #20.) Companies launching ERC20 assets or “tokens” have pioneered revenue models that have shaken up incumbents and gotten the attention of regulators worldwide. Earning billions of dollars since 2017. DeFi services allow people to invest in and manage risk with ERC20 assets. ERC20 as a concept has entered the lexicon as an adjective meaning “fungible digital asset”, even though the standard itself has already become antiquated in favor of ERC777, ERC1404 for securities and many others. On other blockchains, such as Tron, their token standard is called TRC20 even though it wasn’t the 20th of anything. It is just recognizable for fungible digital assets. This phrasing is something to revisit next year, to see if it remains in the collective conscious or has been replaced with something else.
Decentralized exchanges are a hit, but are actually beginning to voluntarily comply with regulations since they are not leveraging the most decentralized operations and can be sanctioned. Instead many exchanges are now starting to focus on the “non-custodial” aspect of their service, instead of the “there’s no business owner to throw in jail” aspect. Let’s see how this evolves over the next year, the regulators have been taking a collaborative approach since it is probably clear that if they did aggressively sanction, it will just make the technology evolve faster and take away their power forever.
DeFi is an interesting growth market, but many of the dApps do not have much use due to the niche and complexity of the user experience. Other faster, cheaper successors to Ethereum also offer parallel or competing versions of DeFi offerings. Finally, if they do have much use then they risk congesting the Ethereum network for other transactions and computations by using too much gas. Remember, Ether is gas.
Ether is Gas
Ether is the cryptocurrency for the Ethereum network and is also a base unit. There are many denominations of Ether, which are difficult to remember. “Gwei” is a popular sub-unit of Ether.
The only native use of Ether is as payment to the Ethereum computers to make your punch-card level calculations and store the result forever. The participating computers do not really have a choice in the matter, so it is more appropriately like gas to make as many calculations as you can before the computers run out of fuel. It is a provisioning system.
Since it is very complex and counterintuitive to use the computational aspects, so people just use Ether as a payment system. People trade Ether back and forth for goods and services, as a replacement for national currencies like the US dollar. People own Ether and use it to invest in projects which will eventually earn them more Ether. In this regard, it is no different than how people use Bitcoin, and Ether transactions are way faster.
Given this common use case of payments, when people refer to Ethereum, they are referring to the cryptocurrency Ether. Nobody says Ether. They might say “eth” for short, pronounced “EETH” like “TEETH” without the “T”, for example, “I sent 5 eth”. Given that so many things are priced in denominations of Eth, some people may adopt the terminology from the bitcoin community with an adjective and say “this cost 500 eth sats”. Instead of using terms for Ether denominations like “500 gwei”, people more often use satoshis or sats from the pre-existing Bitcoin economy.
Except, there is way more Ether on the market than needed, ever. Anyone expressing their enthusiasm in the Ethereum ecosystem by purchasing Ether may be in for a world of hurt. This is quantifiable by looking at a full block: at time of writing blocks have a gas limit of 8,000,000 gas, and the average gas price is 6 gwei. This means a miner found the privilege of creating that block to be added to the blockchain and included the optimum number of unconfirmed transactions that were waiting to be included in a new block. The optimum number of transactions means determining the most Ether which can be earned from the transaction fees that users added to their transaction — in order to be included in a block faster. This miner earned .13 Ether from all of these transactions. They earned 2 Ether for creating the block, and .13 Ether from the transactions. It would take 15 blocks to actually use that 2 Ether as gas, while 30 more Ether would have been created in the process. It is impossible for Ether to be a scarce resource. Even DeFi applications that use Ether as collateral only make a small dent, as they accept other digital assets as collateral too. A cartel is necessary to keep Ether valuable enough for the miners to remain incentivized to function at all. (Miners have costs and typically liquidate their earnings for cash, adding to the selling pressure of any Proof of Work cryptocurrency).
Developers have also noticed that the Ethereum network doesn’t actually need Ether as gas either! There are proposals via EIP to standardize how miners can accept assets besides Ether as payment!
Nobody needs a speculative amount of Ether. Even the most sophisticated developers of Ethereum only need a fraction of a fraction of an Eth, solely as inventory to pay for their computations.
In 2019, even hedge funds express their love for Ethereum via excess speculative purchases of Ether, this expression of interest seems to be devoid of economic reality and is just waiting for a greater fool simply because there have been greater fools in the past, as Ether traded for 800% greater prices several years ago. Let’s revisit this next year. There are even Crypto Index funds that merely invest in holdings of the top 5, 10 or 20 largest cryptocurrencies, hoping they eventually go up in price. Ether fluctuates quite heavily but the fundamental economics alone does not support it, only speculative mania — which has historically been a profitable strategy completely divorced from the economic realities, but as the markets mature the realities would be expected to become more important.
Ether as a Necessity
Ethereum’s tamper-resistant security model does depend on miners — people running computers to find transactions — in exchange for finding transactions they earn newly created Ether and they also earn the Ether transaction fee paid by users making transactions. The price of Ether needs to be worth enough to keep miners interested and also too expensive for a malicious miner — the bad “pre-cog” from Minority Report — from introducing incorrect data. As long as 51% of the miners are telling the truth, then the system works flawlessly (see “51% attack”). This is the same as other “proof of work” blockchain networks.
Ethereum still has a stretch goal of transitioning to “proof of stake” (PoS) instead of “proof of work”. It hasn’t because Proof of Stake is not a proven security model, but Proof of Work has known limitations in speed and scalability. This has been a known problem and conundrum since the beginning of Ethereum back in 2014 when Vitalik Buterin launched it. Half a decade later it looks more like Vitalik Buterin is a one-hit-wonder and has no solution. That’s fine, it is just that he can’t admit it since it's not fine to so many people who have put their confidence in the viability of Ethereum within Vitalik. The truth is that Ethereum will function fine either way, if you accept that Ether is not scarce, is not inherently valuable, and has little reason for supply shocks to make it more valuable. The Ethereum Foundation and some DeFi projects do aim to create circumstances that ensure the scarcity of Ether simply to entertain speculators and people with large holdings of Ether, including themselves. Like OPEC. Remember, Ether is gas.
Scaling and Future Growth
Ethereum main network is a victim of its own success, potentially. If any of the DeFi applications or if any of the games gain traction, the Ethereum network is debilitated until the user experience gets so bad that the DeFi application or game stops being played. More practically, it means there will be many transactions ahead of yours and you can skip the line by paying more gas. It self regulates by becoming expensive. The last time this self-regulation happened in late 2017, many of the computers simply couldn’t identify transactions fast enough so the transactions simply got dropped and never recorded. This was a horrible user experience because it wasn’t clear what was happening. Hopefully, the Ethereum software itself has improved since then to handle the load better.
This known problem is why Proof of Stake was considered in 2014, and perpetually delayed because proof of stake and security is an oxymoron and the secure version has not been invented yet. Transactions can be more numerous in proof of stake networks, than on proof of work networks.
But more recently, different experiments have been tried with competitors, one which has stuck around is called Delegated Proof of Stake or DPoS. Basically, the people elect representatives because the security model of direct representation breaks down across a large geographical region. Where have I heard this before? All of the competitors such as EOS, Tron, Binance Chain, and even Libra are using DPoS, with the representatives being called “Validators”. So now instead of needing a majority of mining computers around the world agreeing on a single source of truth, you only need 10 or 20 or 100 non-mining computers agreeing on a single source of truth. This means they can reach consensus much faster for much cheaper, and subsequently do much more complex calculations. Basically larger files (transactions and blocks) are transmitted between a small and known number of computers with fast internet connections, instead of an unknown number of computers worldwide with unstable internet connections. The downside? Tamper resistance is lost. In fact, on the EOS blockchain, it is called a feature that it is not tamper-resistant! The EOS validators reverse transactions in an opaque process, and they attempt to recreate arbitration and court tribunals to add confidence in their system to create some semblance of the rule of law. Governments can also easily get involved in that process. A government we might not agree with. This is the compromise. Ethereum is still the most efficient world computer with natural consensus, all other systems attempting to be more efficient have had to compromise on security, so it is, therefore, interesting to see how Ethereum tries to improve its bandwidth.
Since Ethereum mainnet’s transition from proof of work to proof of stake has been delayed for 5 years in a row, and basically indefinitely, Lord Vitalik et al have suggested Eth 2.0, the “beacon chain” which basically is a separate blockchain operating as a sidechain. If you can’t reasonably transition to Proof of Stake, why not launch a separate blockchain which is! This means an alternate chain of records where users can offload some computations in order to keep the main Ethereum chain less congested. Since the market has shown it can bear having faster, weaker security models and has the confidence to build billion-dollar businesses on top of them, the Ethereum network can also create these options for users.
There have been several scaling proposals for Ethereum which include a mixture of sidechains and shards. The beacon chain seems to be the latest and also most serious of these proposals. But does anyone remember Plasma? In 2017 Vitalik was promoting Plasma as the sharding and scaling solution for Ethereum. Sharing just means that small non-infinite blockchains are stored amongst relevant computers, with only the results of multiple records stored on the main infinite blockchain by all the world computers sometime in the future. So let’s revisit this next year.
Ethereum was inspired by Bitcoin but has separate evolution than Bitcoin. Vitalik Buterin tried to contribute to Bitcoin and was pushed away by Bitcoin developers of the time period. His approach was to make a blockchain network that could handle complex computations, instead of just payments. The complex computations he needed were to be able to issue assets, which Ethereum has become the market leader in, where Bitcoin has stagnated in.
There are other blockchain networks that evolved from Bitcoin. And Blockchain networks evolved from Ethereum. These two do not share a common ancestor.
Aside from competitor blockchains such as Tron being available. There are also permissioned blockchains used by Fortune 500 enterprises who are actively developing the Ethereum ecosystem in their own ways.
Typically, these systems do not use gas at all and have their own consensus models, which so far seems to work for JP Morgan and accounting firms.
The user experience of Ethereum is pretty bad. That’s saying a lot since it is probably the best in the blockchain and distributed ledger sector. What happens is that Ethereum applications can do A LOT, but the visual interfaces to help people do those things practically do not exist.
The bare minimum that a digital currency system needs is an application that lets people send and receive the digital currency. Ethereum has these and they are called wallets. Cryptocurrency enthusiasts and speculators look for these for any cryptocurrency they trade, in this case, they see the price of Ether moving and they want an Ethereum wallet. But when you want to interact with the DeFi ecosystem, only a few wallets do this, and you typically sacrifice conveniences and familiarity to use those wallets. All of the wallet applications change over time as well, just like any software that tries to improve itself and its userbase.
This makes things confusing.
When you want to go beyond sending Ether back and forth, graduating to using an ERC20 token like PARETO you’ll find that many wallets do not show that you even have a balance of ERC20 tokens. Your whole portfolio, invisible! The most secure way to store your Ethereum assets is using a hardware wallet such as the Ledger Nano X which comes with its own software called Ledger Live. The ERC20 standard was first proposed in November 2015, developers started creating assets for their businesses and selling them in the beginning of 2017, the ERC20 standard was ratified in late 2017. The Ledger Live wallet began letting people see, and transfer, their ERC20 assets in September 2019. 🤦🏽♂️ Four years after the initial proposal, two years after ratification. This means during the infamous periods of speculative demand during 2017 and 2018, almost nobody was able to securely trade their Ethereum assets. It is easy to say that you missed the boat but think about what that boat really looked like at the time: a rickety raft on the high seas. It is more likely your portfolio would have been obliterated by a mistake or by a hacker during the infamous 2017 bull markets than you actually profiting from the speculative furor.
The good news is that wallets are mostly compatible with each other. Although your hardware wallet’s official application was unnecessarily handicapped, you could use your hardware wallet with Metamask or MyEtherWallet or other services, where you could see your ERC20 balances for years. In comparison, assets issued on Bitcoin have the possibility of being deleted and erased permanently when you use a wallet that isn’t configured correctly. There isn’t a real concern about this happening on Ethereum (unless someone went out of their way to make a malicious system).
Viewing the history of transactions on Ethereum Block Explorers is tricky. They try to show the chain of transaction but there are just too many types of transactions and computations to show on the Ethereum network for a single account/address.
Etherscan is a block explorer that shows the history of transactions in the most comprehensive way. It primarily tries to separate transactions by asset type: plain transactions of Ether from one person to another, transactions of Ether from a smart contract to the person, transactions of ERC20 tokens, and transactions of ERC721 tokens (non-fungible tokens, or collectibles). It doesn’t seem to have a way to consolidate all of these categories into a single list.
In areas where Etherscan falls apart, other companies have started their own block explorers. They often excel at one thing, revealing records that occurred in an intuitive way, but never being complete enough to show all records in an intuitive way.
There seem to be some paid offerings that excel here. Let’s revisit this next year.
So you want to be an online or in-person merchant that accepts Ether or Ether based Dollar assets while following the best practices and having a good user experience using readily available open source code? Tough luck! You have to use a payment processor bound by the same banking regulations that burden more familiar non-cryptocurrency offerings. Let’s also revisit this next year.
Bitcoin steals the thunder in prompting governments for regulatory clarity of it, and regulatory approval of financial products based around Bitcoin. The $150 Billion market cap helps here. Ethereum’s second place $18 Billion market cap has resulted in ambiguity. There are no Ethereum futures contracts to manage the future price of ether gas. There are no Ethereum ETFs on the stock markets. We can barely get a view from the SEC that Ether is not a security (Directors and Commissioners comments have so far not been the view of the SEC itself), or a view from the CFTC that Ether is a commodity given its similarities to gas. CFTC has claimed Bitcoin is a commodity.
Ethereum has prompted a response from governments on the topics of the assets issued using the Ethereum platform. ERC20 is back in view again as it has accelerated securities law policy and custody policy. This has been interesting, to say the least, but unresolved in many circumstances in jurisdictions that matter. This has raised the cost of doing business to be greater than incumbent financial services even though the technology itself lowers the costs to be a small fraction of incumbent financial services. Legal tweaks will change this and there are bills in committee in US Congress such as the Token Taxonomy Act which has so far stalled with a small trickle of co-sponsors. Let’s revisit this next year closer to the end of the congressional session.
The bad thing here is that there simply isn’t that much to write about yet. There are several ERC and EIP proposals that aim to adapt the Ethereum asset issuance technology to public and private sector regulations, and there are proposed laws around the world that would update the regulations themselves to make this less necessary and also unnecessary. This is all happening while DeFi services grow in ways that make it impossible for regulators to enforce any of their existing laws.
So, a long way to go! The great thing about permissionless technology is that you don’t need permission to contribute either! I identify these problems and help move things forward where they are broken, both personally and through my companies Blockology (Blockchain Development Company d/b/a Blockology) where we build and advise companies in the distributed ledger and blockchain space, Pareto Network where we trade information using blockchain technology, and others I advise. You can too! Addressing these problems makes all of my companies more viable and useful to a broader community! Reach out if you need guidance navigating the crypto space!
The private industry spends an inordinate amount of resources looking for specialists and marginalizing people with deep capabilities across a wide spectrum, but Ethereum, Blockchain, and Crypto space rewards generalists as far as they can apply themselves. This parallel economy is the true land of opportunity, and I hope it is clear where you can push it forward.
That’s a wrap everyone! In future series, I plan to highlight the state of the crypto space as a whole, and other crypto networks like Monero, be sure to read my other state of the union on Bitcoin. We have to revisit this once per year to see if anything has improved!
If you like this post, hit the 👏 button as MANY TIMES as it lets you and feel free to mention incorrect or debatable aspects in the comment section.