The Past is Not the Future
There’s a tendency in crypto to over index on the past. This is frustrating, and ironic. The whole point of Nakamoto’s amalgamation of ideas was to to invent something new. Before Bitcoin, there was no known way to secure a permissionless system where nodes were free to come and go. Also before Bitcoin, there was no censorship-resistant global payment system or successful digital currency whose supply was managed by a protocol. Bitcoin was, and is, a true original.
This hasn’t stopped people from trying to classify it — or value it — using old ideas and weak analogs. To them, Bitcoin is just a form of hard money, or a commodity, or a NASDAQ proxy, or
“digital gold.” But gold doesn’t have a payment system, commodities don’t have explicit network effects, and the stocks that trade on the NASDAQ are corporations run by people, as opposed to a protocol run by code. I understand why people find comfort in these comparisons, new things are hard to classify. But one shouldn’t take them too far.
For example, back in the 2017–2018 era, when Bitcoin was widely considered a commodity, there was a movement to value Bitcoin based on the cost of mining. Doing so was promoted by everyone from Wall Street analysts to the then chair of the CFTC. But it was a bad idea. Cost of production is relevant for physical commodities like oil and gold because supply is price elastic in the long run. When oil prices crash, producers with a high cost of production shut down their wells, helping the market stabilize. But the supply of Bitcoin is inelastic of price (or anything else) thanks to the difficulty adjustment. Even if the majority of miners turn off their ASICs or go out of business, the supply of Bitcoin would stay the same (outside of two weeks). Bitcoin’s supply is only impacted by the 4 year halving cycle. No commodity offers anything like this
Today, people prefer to call Bitcoin money. But this too doesn’t tell us much. The history of money is more varied than people think, and the more you study it, the more exceptions you’ll find to whatever rubric is used to classify it today. Indeed, the type of fiat money people accept as “normal” today was unfathomable to most experts a few generations ago. That’s not to say Bitcoin isn’t money. But calling it that doesn’t really prove anything.
Also today, a lot of people love talking about general purpose layer-1 blockchains like Ethereum in terms reserved for corporations providing a service. And, since the value of corporations can be valued by discounting cash flows, so can a native coin like Ether. But ETH is not equity issued by a corporation at the discretion of management, it’s a cryptocurrency issued (or burned) by a fairly decentralized protocol. It has multiple uses (fees, staking, collateral) and is ownable, transferable, composable, and auditable in ways equity is not. Furthermore, Ethereum (the chain) is unlike any other network or platform that has ever come before it. It does things that no legacy payment, settlement, compute, or data transfer protocol does. To analyze it the same way one would a platform managed by a corporation — by measuring current value accrual, projecting it forward, and discounting with some interest rate — is the height of hubris.
It’s also ignorant of history, even recent history. Just this past weekend, I heard two otherwise respectable crypto experts analogize Ethereum to Amazon. One referred to the rollup scaling strategy as “Amazon allowing third-party sellers on its platform but not charging them.” Another responded to my complaint that the people who describe ETH’s recent price weakness to poor fundamentals never address XRP (a strong coin that has none) by tweeting “…Imagine Bezos on an earnings call going “ya GME/AMC stock ripped without earnings, so we don’t need to make $$ either now””.
Funnily enough in the late 90s, after it had become clear that ecommerce would be a big deal, but before Amazon had established itself a juggernaut, the company was famous for not making money. It had plenty of revenue but no profits, because leadership had decided to sell many products at cost to change consumer behavior, take market share from incumbents, and fend off future competition.
Loads of smart people thought this was a poor strategy, because that’s not how corporations behaved. The widely respected Barron’s investment magazine, which was Wall Street gospel back then, ran a covery story on how Amazon was bound to go bankrupt, because older retailers running a traditional playbook made more money.
To Bezos’ credit, he didn’t fall into the trap of backwards thinking. He understood that the web and ecommerce were different and played a long game that eventually resulted in a trillion-dollar company.
Misapplying the past to the future also applied to early evaluators of Google. Most people don’t realize this, but before Google, search in of itself wasn’t considered a valuable business. Google’s competitors were portal sites that tried to make money doing other things. One of them even turned down the opportunity to buy Google for $750,000. Remarkably, this all happened after Google search had become a proven success. But the backwards looking models many applied to it didn’t let them see the future potential.
Today, Ethereum is pursuing a similar strategy as that of Amazon. It’s underpricing rollup data and settlement in order to enhance overall network effects. Layer-1 fees are down while L2s like Base are generating hefty profits. This dichotomy is sort of the point. The more profitable one rollup is for the issuer, the more rollups we’ll have. And the more L2s derive security (and bridge assets from) Ethereum, the more irreplaceable the L1 will be.
There will soon be hundreds of L2s, some of which may be managed by the world’s largest chat, payments, gaming, and financial firms. All will have to pay something to the L1, for proofs or maybe data. Some will allow close to trustless bridging from other L2s. Many will alow users to “defect” to Ethereum if they are unhappy. All will accrue some value back to Ethereum, the platform, and ETH the asset. How much? I have no idea. But the claim that the L2s and dApps will siphon most of the value away from Ethereum itself is nonsensical to me. It won’t work from a security standpoint, and is just the latest iteration of the dumbest idea in crypto, one that was falsely applied to Bitcoin for years: ““Blockchain, not ETH.”
That’s not to say the original fat protocol thesis was correct or the ETH will capture most of the value. There’s a wold in which Ethereum is worth two trillion dollars and the assets and activity that happen on top of it are worth twenty trillion, or two hundred trillion, in aggregate. But importantly, in this structure, every single dApp and L2 will be more replaceable than Ethereum. That’s how network effects perpetuate.
Whatever the ratio of value accrual to ETH vs l2s or dApps will end up as is indeterminate today because there is so much that we don’t know, including what the blockchains (L1s or L2s) of tomorrow will actually look like, how much economic security will be needed, and how the market will value different types of blockspace offering different amounts of decentralization. It also remains uncertain that Ethereum becomes the go to global settlement layer, though it’s currently in the lead, and is the only L1 pursuing what I consider a viable scaling strategy. All the other L1s that are doing everything on a single layer will eventually learn that socialism doesn’t work, for an economy or a cryptoeconomy.
Once we have some clarity on these variables then smart people will formalize them into some kind of valuation rubric. But the value creation will happen first, and those who get caught up cramming new things into old models will be caught off sides. After all, the first joint stock companies could not be valued in ways invented for land, and options couldn’t be valued using formulas meant for equities, and Amazon and Google turned out to be very different businesses from Barnes & Noble and NBC.
