Ethereum - A lot to explore
Here is a beginner's overview into what is broadly happening in the world of Ethereum.
Image source: https://imgur.com/gallery/eYiGy
Most people have heard of at least two crypto currencies - Bitcoin and Ethereum.
Although both are blockchain based protocols, Bitcoin is the OG and came before Ethereum.
But what makes Ethereum much more interesting is its
1) Ability to provide scarcity to any digital asset
Bitcoin has built its narrative of doing one thing really well - being a store of value. It achieved this by solving the ‘double spend problem’. In other words you cannot send someone something digitally and also keep it yourself. Bitcoin was the first to solve this problem.
However, with Bitcoin, this is only true if you are sending bitcoins; the Bitcoin protocol only provides scarcity to bitcoins, nothing else.
On the other hand - Ethereum has the capability of providing this scarcity to any digital asset.
2) High programmability
In addition to that Bitcoin has very little programmability, whereas Ethereum has the ability to execute smart contracts. These smart contracts are basically If-Then instructions in code.
Modern programming languages are often benchmarked as being Turing Complete or Turing Incomplete - it is a measure of the level of complexity that the language is capable of handling.
The scripting language used in Bitcoin is intentionally designed as Turing Incomplete because it serves its purpose and increased complexity would potentially introduce problems.
Ethereum, on the other hand, is built as a Turing Complete blockchain. This is important because it needs to understand the agreements which make up smart contracts. By being Turing Complete, Ethereum has the capability to understand and implement any future agreement, even those that have not been thought of yet. In other words, Ethereum’s Turing Completeness means that it is able to use its code base to perform virtually any task, as long as it has the correct instructions, enough time and processing power.
An oft-used analogy is that if Bitcoin is a calculator, Ethereum is a computer.
What this translates to in the real world - a rich ecosystem of applications.
Let’s dive in - left to right. Also in my mind the degree of ease of broad based consumer adoption drops from left to right.
1) Non-fungible Tokens (NFT)
So this happened mid way last year
Yep - Visa bought a NFT. A CryptoPunk to be more precise. They spent about US$150,000.
As you can see from the tweet, the rationale is to add to their collection of ‘historic commerce artifacts’
Perhaps then the first application to try and understand is the one driven by the Eth protocol’s ability to provide scarcity to any digital asset.
An NFT is a type of digital token which is unique and scarce. An NFT is essentially a unique proof of ownership of something, usually a digital asset. NFTs are digital versions of physical collector’s items and no two NFTs are the same.
As you can also see from the tweet - CryptoPunks are collectible characters on the Eth blockchain of which there are, and will only ever be 10,000!
Ofcourse you are wondering where you can get one for yourself. There are a few marketplaces - but one of the biggest ones is called OpenSea.
Here’s a look at their monthly volumes
So for context OpenSea did about $5bn trading volume in the month Jan 2022.
For comparison Etsy - the American e-commerce platform with a market cap of $18Bn - did trading volume of $3.8bn in Q4 of 2021.
So in other words Open Sea did more volume in one month than Etsy did in 3 months!
Here are the top 5 NFTs by value traded on OpenSea. Note the last column specifies the scarcity aspect showing the cap on the number of NFTs
So what does all of this lead to?
Chris Cantino of Color Capital has a great thread on how companies can use NFTs for marketing and community building.
Summary of his views (examples are mine)
Companies pivot digital strategy to turn audiences into communities, giving them space to interact: financial and social capital, education and place where they belong.
Brands could either partner with existing communities or create their own
One example of leveraging the power of existing communities is what Visa did
Another path is for brands to tokenize access. Allowing exclusive access to products and content
They could also democratise decision making among token holders which moves the needle from “I love this business” to “I am a participant in the business”
An example of the above is the Paris St Germain Fan token. Fans of the club who hold the token can vote on nominal matters like motivational messages in team change rooms. Interestingly, Messi’s transfer fee also included some component in these Fan tokens
2) Gaming
Okay so moving onto the next application - Gaming
Have heard about the Sydney based crypto company called ZedRun?
Zed.Run features horses in neon harnesses that exist as tradeable nonfungible tokens (NFTs) on Polygon, the Ethereum sidechain, and compete against one another in virtual races.
Zed.Run racehorses have sold for as much as US$125,000 in Ethereum, with about $43 million in total sales
How does it work?
First you buy a virtual horse with prices in the range of $250 - $1200. (prices represented in dollars - but you would need Ethereum to actually buy the horses)
Owning a horse then lets players pay $5 to $25 or so as an entry fee for a race, where they have the chance to split a 95 per cent of a pot of around $200 or so. Nearly US$10 million has been won.
Winners are determined by each racehorse’s unique assets and racetrack conditions. So there’s skill involved in learning about the horse and being tactical about what races to enter.
What’s the vision?
“Our vision for the future is to build a creator economy within the ZED RUN metaverse where players can work in professions such as stable owner, race track owner, breeder, accessory designer and more. We are also working to partner closely with brands to produce immersive sponsorship experiences, such as our recent collaborations with The Preakness, Stella Artois and Atari” Chris Laurent, CEO at Virtually Human Studio
What’s the potential?
Currently there are about 100-200 horseraces per day globally.
But unlike the real-life counterparts - Zed Run’s racehorses are not bound by limitations of the physical world.
They already do 1,600 races per day!
And Mike Tyson had bought one
Another example is a game called Axie Infinity
Axie Infinity is a Pokémon-inspired universe where anyone can earn tokens through skilled gameplay and contributions to the ecosystem. Players can battle, collect, raise, and build a land-based kingdom for their pets (called Axies).
The interesting thing about both these games is their different business model
Most of the modern successful games like Fortnite, Pokemon Go, PubG are Free-to-play games. In other words the game makers give the full game to players for free and make money by selling virtual in-game items like skins and emotes. But the players have no income stream from the games.
Blockchain games like Zed and Axie operate on Play to Earn model.
Here’s a paragraph from Axie whitepaper
The key difference between Axie and a traditional game is that Blockchain economic design is used to reward our players for their contributions to the ecosystem. This new model of gaming has been dubbed "play to earn".
So unlike a traditional game there is an upfront investment in blockchain games. But while in a traditional game you essentially rent the avatar or skin - in the blockchain game like Zed or Axie - you own the horse or Axie - which can be traded / sold for Eth.
Axie has attracted thousands of players from developing countries in the pursuit of a new income stream during the Covid pandemic. Many of these players are fathers, aunts, and even grandparents who have never used Blockchain technology before!
These games are creating new jobs / employment opportunities for people - and that’s mindblowing!
3) Ethereum Name Service (ENS)
The third application is ENS.
Before you delve into ENS. Its worth revising what is DNS or Domain Name System.
The Domain Name System (DNS) is the phonebook of the Internet. Humans access information online through domain names, like nytimes.com or espn.com. Web browsers interact through Internet Protocol (IP) addresses. DNS translates domain names to IP addresses so browsers can load Internet resources.
So instead of having to remember and type out IP addresses which look like 192.168.1.1, or more complex newer alphanumeric IP addresses such as 2400:cb00:2048:1::c629:d7a2 - we simply type amazon.com
Now this is what crypto wallet addresses look like “0x3Cc52a6E7238cd13ab34dc86B7B18d2a8778DA1Z”.
You see where this is going?
Going to borrow from Villa Staylight
Ethereum Name Service (ENS) makes crypto addresses human readable. Just as DNS converts internet IP addresses into web addresses, ENS converts 64 character crypto addresses to readable addresses ending with “.eth”
Just as you can register on Gmail and get an email id which is a universal identifier, simple to use and share with anyone. You can register for a id on the ENS
Why would you want to do that?
Let’s say you’re Bryan Smith. You are a content creator with a global following. How do you receive money? You could have a Patreon, but that’s only for recurring payments. You could include your PayPal for tipping. But PayPal is not a global standard. Unlike universal protocols like email, payment apps are fragmented by geography. In the US people use PayPal, Venmo, and Square Cash. In China it’s AliPay and WeChat Pay. In Latin America it’s Samsung Pay and Mercado Pago. Almost none of these services are interoperable. Just as you can register bryan.smith@mail.com and get on one universal email standard, you can register bryansmith.eth and get on one universal internet money standard. By including bryansmith.eth on his website and business card, you can receive bitcoin, ethereum, and other crypto currencies from anyone in the world. A transfer costs less than $1 using Litecoin and settles in minutes. ENS makes crypto addresses memorable and readable. It makes internet money transmission as universal and dependable as email.
Guess who has got one already :)
And I am not alone
So these first three applications i.e. NFTs, Gaming and ENS are primarily driven by the scarcity creation quality of Ethereum. These three applications are also much easier to grasp and adopt by the broader consumer group as compared to the next two.
From here on its the programmability / smart contract characteristic of Ethereum which results in creation of the app ecosystem.
4) Decentralised Automonous Organisations (DAO)
What is a DAO?
Here is a summary from Packy Mccormick
A DAO is “decentralized” in that it runs on a blockchain and gives decision-making power to stakeholders instead of executives or board members, and “autonomous” in that it uses smart contracts, which are essentially applications or programs that run on a publicly accessible blockchain and trigger an action if certain conditions are met, without the need for human intervention.
A good example is an entity called Maker DAO - which is often referred as the reserve bank of the DeFi world.
Maker DAO operates using a stablecoin called DAI.
A stablecoin is a currency pegged to other assets. In most cases the other asset is the US dollar.
So basically 1 Dai = 1 USD
Matt Levine explains the basic premise
Here is the basic story of stablecoins. It is very useful, for people who trade crypto, to have a cryptocurrency worth $1. In many respects you live your life denominated in dollars, so you want a supply of dollars (as opposed to volatile assets like Bitcoin, etc.). But in many other respects you live your life on the blockchain, so you want your money to be on the blockchain (as opposed to in a bank account in the U.S. payments system). A cryptocurrency worth a dollar solves both these problems: It is worth a dollar, but it can be traded on the blockchain, transferred between crypto exchanges, held in a crypto wallet, and generally used as a cryptocurrency without interacting with the U.S. banking system.
Okay okay, so how does this Bank work?
An investor comes into Maker DAO for a loan. He (yep, usually he) has some collateral he’s happy to keep locked in a vault. Right now, that collateral is usually a crypto asset like Ethereum. For every $100 worth of crypto assets, Maker is typically prepared to lend $66 – the gap adding a buffer of protection against a possible fall in the value of the collateral. Maker accepts the collateral and advances a loan, which it does by issuing its Dai money.
So you give Maker DAO $100 worth of ETH as collateral and walk away with $66 in DAI.
And remember 1 Dai = 1 USD.
Maker DAO charges the borrower a interest. Its called a ‘Stability fee’.
You could also simply deposit your ETH in Maker DAO and get paid a ‘Dai Savings Rate’
All sounds very familiar?
Here’s where it gets interesting. Remember that Maker DAO has very low operating costs. So
most of the revenue flows through to operating profit.
This means that the protocols are capable of offering high rates to depositors - much higher than traditional banks.
Finally, lets not forget that it is a DAO.
The “shareholders” of the DAO are basically the holders of a token called MKR.
Profits are returned to holders via a buyback mechanism. Rather than being reinvested back in the business or returned to owners via dividend, surplus profits are used to buy MKR tokens in the market, which are then cancelled
Of course, a DAO can be created with any specific purpose. The above example related to a bank.
Finally we come to the umbrella term - DeFi
5) Decentralised Finance (DeFi)
Okay, so what is DeFi?
Decentralised finance (or DeFi) is an emerging ecosystem of applications seeking to rebuild financial services from the ground up. Easy!
You must be thinking - why fix something which works. Well here are a few drawbacks of centralised financial systems from Marc Rubenstein
The system limits access. Around 1.7 billion people around the world remain unbanked; they don’t have access to the financial system.
The system can be expensive, partly because of the legacy infrastructure it’s built on; remittance fees of 5-7% for example seem high when information can be moved around the world much more cheaply.
There’s a lack of interoperability between financial institutions globally. Many fintech companies have emerged to solve this problem – companies like Plaid, which allows customers to transfer financial information between providers; and dLocal, which allows multinational companies to take payment from customers in emerging markets using their own niche payment systems.
Here’s a snapshot of the DeFi landscape
The column on left broadly covers the key areas of operation. As you can see most of them are basically traditional world finance functions ported over to work on the blockchain in a trustless and permissionless manner.
Roughly 80% of DeFi occurs on the Ethereum blockchain and uses ETH as the reserve asset.
Ethereum - Value layer of the internet
To recap, What makes Ethereum really amazing
1) Ability to provide scarcity to any digital asset
2) High programmability
And here’s David Hoffman on the potential role for Ethereum
Ethereum exists as a new layer on the internet. It uses the communication protocols below it to create a new network that defines how digital value is managed. Ethereum is the value-layer of the internet.
And that’s that! Long story short :)
Cheers,
Guru