Immutable Tokens & DeFi
The second most popular cryptocurrency today is Ethereum, a public decentralized application blockchain network (aka smart contract platform.) Decentralized applications replace trusted institutions and intermediaries with software. Software developers can build a variety of decentralized web or mobile applications (dApps) using the Ethereum blockchain network as a database that enables financial value and immutable data to be used in new and innovative ways. The most common use case is to create immutable tokens on the platform. The most active category of application development is known as decentralized finance (DeFi).
Organizations in DeFi have built and are building products and services on Ethereum that allow users to make payments, tokenize assets, raise money, programmatically move financial value for business transactions as well as recreate financial instruments and services that traditional institutions such as those on Wall Street and banks have normally provided. Ethereum developers are also building decentralized web (Web 3.0) applications that could complement or even recreate a new more secure Internet infrastructure. Although Ethereum is the market leader in the decentralized application space, there are many more platforms that are vying for dominance compared to the money-alternative category that Bitcoin and Litecoin fall under. Let’s take a deeper look at Ethereum.
Vitalik Buterin spearheaded the Ethereum project in late 2013 after realizing the incredible difficulties trying to help build tokenized assets on top of Bitcoin software during his work on the Colored Coins project. Vitalik believed that it would be better to have a blockchain that was the foundational layer of new protocols and applications, didn’t require keeping track of the entire history of transactions for efficiency and came with a built-in programming language to make it more flexible. Vitalik gave one of his first presentations about Ethereum during a Bitcoin conference in early 2014. Gavin Wood later became the CTO and wrote the Ethereum Yellow Paper that provided technical specifications for the Ethereum software.
Vitalik and the rest of the founders created a Swiss non-profit foundation and raised roughly $18 million in Bitcoin between July and August 2014. For the next year, developers built the software for the official launch in July 2015. 72 million Ethereum (ETH) coins were distributed to contributors, investors and founders.
After launch, ETH prices hovered below $1 for many months before in Jan 2016 prices gradually started moving up to over $10 in Jan 2017 and then peaked over $1,300 in late 2017.
In April & May of 2016 one of the first crowdfunding projects for a decentralized venture capital fund called the DAO raised roughly 11.5 million ETH ($150 million) or 14% of all ETH available at the time from 11,000 investors. However a major hack occurred on the DAO smart contract that compromised 3.6 million ETH and after intense debate the Ethereum community created a hard fork to update the software and allow users to recover their ETH. Some developers who felt the decision to change the software would hurt Ethereum’s reputation for immutability kept the software unchanged and created a new network called Ethereum Classic.
ICOs & Token Sales
Tokenization became one of the first major use cases for Ethereum especially for fundraising and token sales/ICOs during the 2017 cryptocurrency boom. Many believed that token sales were a path towards democratizing capital and disrupting venture capital. It allowed anyone around the world to both invest in or raise money in a trusted way. Unfortunately the token sale boom created a mania and an extreme overvaluation of experimental projects that also attracted opportunists taking advantage of unsophisticated investors. Eventually token sales have slowed to a trickle as regulators started to challenge their legality and as cryptocurrency market prices have turned down. Billions were raised on the Ethereum platform, some of the most notable being the following by size:
- $4 billion – EOS
- $148 million – Bancor
- $109 million – Status
- $144 million – Polkadot
- $77 million – WAX
- $55 million – Nexo
- $51 million – Kyber Networks
- $43 million – Orchid Protocol
- $38 million – Origin Protocol
- $36 million – BAT
- $36 million – Civic
Although token sales may make a comeback, the regulatory environment makes it far more difficult for any organization to raise as much money as easily as before.
Decentralized Finance (DeFi)
Currently the most active applications on Ethereum are DeFi protocols. DeFi applications and protocols typically remove the trusted financial institutions and replace them with software. Cryptocurrency, especially Bitcoin, is used as a new money. Therefore it is natural to have new applications that build around this new foundational money.
One of the most popular use cases in Defi is using tokens on Ethereum for fiat-backed stablecoins. These stablecoins are tokens that have the same qualities as a cryptocurrency except they are priced as US dollars and are backed and redeemable by real fiat dollars held in a legal trust in a bank. Tether’s USDT is the most popular stablecoin, followed by Coinbase’s USDC, Paxos PAX and TrustToken’s TUSD. Another kind of stablecoin is MakerDAO’s DAI, also valued at roughly a dollar, but is backed by more than a dollar’s worth of ETH collateral at any given time. (As of 5/17/20) MakerDAO, a virtual organization made up of its users and governs the DAI stablecoin, has a market capitalization of over $280 million. (As of 5/17/20) A total of about $3.7 billion worth of stablecoin token value is held on the Ethereum network.
Here are a list of other DeFi applications and a short description:
Compound – enables users to borrow and lend ETH, DAI and other coins to earn interest conveniently.
dYdX – has the same borrowing & lending feature as Compound, but also enables users to trade ETH with leverage.
Synthetix – works similar to MakerDAO, except instead of just a US dollar stablecoin, the application enables users to create a variety of derivative assets including foreign currencies (USD, AUD, CHF, JPY, EUR, and GBP), Gold, Silver and other cryptocurrencies like Bitcoin. [Note: Derivatives are assets based on another underlying asset]
DigixDAO – a gold-backed stablecoin similar to fiat-backed stablecoins, but backed by actual gold in a vault.
Augur – a decentralized predictions market platform that allows people to bet on event outcomes such as the US Presidential election
Aave – open infrastructure for decentralized fiannce
Lastly another group of common applications and protocols are decentralized exchanges (DEX) that enables trading of ETH and other tokens without a custodian or intermediary. The following are DEX protocol tokens by market capitalization (As of 5/17/20):
Non-Fungible Tokens (NFTs)
Another growing category of applications revolve around collectibles called Non-Fungible Tokens (NFTs). These are similar to token assets that can be transferred and exchanged, except each token is unique like a collectible. Thus these tokens are popular for in-game items and collectibles for video games, virtual or VR sim games, digital art or virtual real estate games. NFTs can also be used to represent ownership or title to real property like real estate as well as domain names and event tickets. Ethereum’s technology has a strong emphasis on immutability so the network is well-suited to hold high-valued NFTs. The Open Sea website is an extensive resource on NFTs.
Here are a few NFT projects:
CryptoKitties – game that allows players to purchase, collect, breed and sell virtual cats. The game went viral when it first launched in late 2017.
Decentraland – a 3D virtual world where you can build, explore, play games and hang out with others.
Gods Unchained – a digital trading card game where you can trade cards you purchase or earn for real-world currency.
Ethereum Foundation, Consensys and Enterprise Ethereum Alliance
The Ethereum Foundation (EF) is the main organization that funds research and development for the Ethereum software and tools as well as support the community. They have budgeted $30 million in funding for the 2019/2020 year. It currently holds over $100 million in ETH and likely has another $100 million in cash from selling 70,000 ETH near all-time highs in 2017.
Here is an example of new projects EF supported in 2019 exclusive of recurring projects:
The funding includes the next generation Ethereum 2.0 platform, Layer 2 solutions, developer tools, privacy & cryptography projects as well as community support that includes hackathon sponsorships.
Consensys is the largest Ethereum tech company that focuses on helping enterprises use Ethereum technology as well as help launch Ethereum startups. Based on the latest content of the Consensys website, the company seems to be focusing on traditional financial as well as DeFi applications. Joe Lubin, one of the Ethereum founders, funds most of the operations. Consensys currently has roughly 800 employees down from over 1000 as its cash burn rate was $100 million and was actively looking for outside funding in 2019. Consensys backed ICO projects including Gnosis, Grid+, Airswap and Civil media. Consensys is also behind Metamask one of the most popular ethereum wallets as well as Infura, an infrastructure provider that maintains a full node on behalf of developers and provides an easy-to-use API. The company recently restructured into two, one as a software development company and the other a venture capital company.
The Enterprise Ethereum Alliance (EEA) is the bridge for Ethereum technology to be used in industry. The EEA’s goal is to create open-source standards, bridge the public Ethereum network with private-permissioned chains and promote global interoperability. Members also have working groups in various industries as well as a technical and legal working group. By May 2017, the nonprofit organization had 116 enterprise members—including ConsenSys, CME Group, Cornell University’s research group, Toyota Research Institute, Samsung SDS, Microsoft, Intel, J. P. Morgan, Cooley LLP, Merck KGaA, DTCC, Deloitte, Accenture, Banco Santander, BNY Mellon, ING, and National Bank of Canada.
The main programming language used to build applications on Ethereum is called Solidity. The software programs that developers create are known as smart contracts, a term first used by Nick Szabo to describe the formalization of a contractual relationship involving property using software or hardware. Smart contracts is now a term more broadly used to describe any application that formalizes relationships of value or immutable data between users on the blockchain. Although Solidity is a fairly easy language to get started with, it’s very difficult to build complex applications securely with it. There has been an extensive history of hacking incidents on Ethereum including the major DAO hack of 3.5 million ETH (~$50 million at the time).
Ethereum like Bitcoin currently uses proof-of-work mining (POW) to secure the network. The block times on Ethereum are 15 seconds instead of 10 minutes for Bitcoin. Ethereum uses a hashing algorithm called Ethash that makes it difficult for manufacturers to build specialized machines (ie. ASICs) to mine. From the beginning, Vitalik planned to move Ethereum away from POW to a proof-of-stake (POS) network as soon as the core developers settled on a secure POS consensus architecture. Developers added a difficulty ‘time bomb’ to the software so that at a certain point in time in the future mining would get increasingly difficult and the Ethereum network could shift incentives so the transition to POS would happen much more smoothly. However developers had to delay activating this difficulty ‘time bomb’ in Feb 2019.
Ethereum uses Patricia Merkle trees to maintain cryptographic proof of the state of both user & smart contract accounts. Both the historical state of each account and in a smart contract are cryptographically verifiable using local machines. Users can remain confident about the rigid immutability of the network without having to trust third parties. Hence as Szabo describes, Ethereum like Bitcoin can be considered socially scalable.
Ethereum calculates transaction fees called ‘gas’ based on computational complexity, bandwidth and storage needs.
Here are a couple other technologies that complement the blockchain network:
Ethereum Name Service (ENS) – Using NFT technology, ENS enables wallets and applications to use human-readable names. The difficulty with creating a new domain system are trademark issues, the process of distributing high-value names as well as user adoption.
Swarm is an alternative decentralized storage solution to the popular IPFS and future Filecoin network. The differences from the main Swarm author is described here: https://github.com/ethersphere/swarm/wiki/IPFS-&-SWARM
Ethereum’s roadmap includes a plan to transition the network gradually into a more modern version of Ethereum called Eth 2.0 that is more scalable and performant than the original. The main idea is to start with a proof-of-stake Beacon chain on top of Eth 1.0 that coordinates future Ethereum subnetworks called shards that run in parallel and could eventually interoperate. These shards would be individual blockchains like Ethereum, but each could have it’s own use case so it would not congest the main network. Eth 2.0 includes implementing eWASM, a Webassembly virtual machine that will execute smart contracts written in C++ or Rust instead of Solidity.
Ethereum - Strengths
The primary strength of Ethereum is that its tech architecture is highly regarded in the industry. Ethereum has similar immutability characteristics to Bitcoin and thus more ‘socially scalable’. Hence DeFi and NFT applications that require strong immutability find Ethereum a strong foundation to build on. Large institutions like JP Morgan & Toyota Research Institute, Samsung SDS, Microsoft, Intel are among many industry giants that have been using private versions of the software as part of the EEA so the trust and brand awareness within industry is very high.
The Ethereum ecosystem attracts by far the most developers in the cryptocurrency and blockchain space. An estimated 250,000 – 350,000 people have downloaded developer tools and there are currently over 1,200 monthly active Ethereum developers that make up roughly 20% of the entire blockchain ecosystem. Note, Bitcoin only has about 300 monthly active developers, but Ethereum has an inherent advantage because it’s a general purpose blockchain platform with a multitude of projects that build on it compared to Bitcoin that is simply a money transfer system.
Ethereum (ETH) is the second most liquid cryptocurrency and is second only to Bitcoin in exchange listings. The 24hr-volume of ETH on exchanges is roughly half that of Bitcoin.
Ethereum also has some of the most valuable application projects building on top of it. The following are the market capitalizations of the Top Projects built on Ethereum (as of 5/17/20):
- MakerDAO – $286 million
- 0x – $242 million
- Augur – $141 million
- Kyber Networks – $114 million
- OmiseGo – $144 million
- Numeraire – $125 million
- Status – $107 million
- Synthetix – $81 million
- Matic – $70 million
- Aave – $68 million
Most of the top projects are in DeFi. Omisego is a retail payments network in SE Asia. Status is a private mobile messaging application project and Matic is a layer 2 scaling solution based on a technology called plasma.
It’s also important to have strong immutability for tokens. Tokenization & fundraising was Ethereum’s killer application in 2016/17 before the regulatory bodies started to crack down on token sales. Many projects have released their tokens using the Ethereum network. For example these are the projects that have tokens on Ethereum:
- Tether (est 40% of supply – $8.9 billion market cap)
- Chainlink – $1.3B market capitalization
- USDC – $726 million
- FTX – $301 million
- BAT – $305 million
FTX is another cryptocurrency derivatives exchange. BAT is the token for Brave, a fast growing ad-free web browser that allows content creators to earn and ad networks to give financial rewards for user attention.
Other notable projects in the virtual organization category include:
Ethereum - Challenges
There are many challenges facing the Ethereum network, many of which are broader blockchain problems that need to be solved before blockchain technology gets mainstream adoption. Usability is a general problem that even Bitcoin faces. However because Bitcoin is a high-powered settlement layer and store of value there is less of a need for it to be usable for retail users. Institutions can just pay more for Bitcoin custodial solutions and insurance so private key management is less of an obstacle. Because Ethereum is designed for applications, usability becomes far more important. Currently most Ethereum applications are too difficult to use. Account addresses are long hexadecimal strings that will deter average users and naming systems such as ENS are not common yet. Most people will forget private key seed phrases and good recovery systems are also not standard. Signing and confirming each smart contract transaction is tedious. Paying gas fees for every transaction can be costly and creates more friction for the average user. If developers decide to cover the fees for users it could become cost prohibitive to use, especially as more applications use the network and the higher the ETH token prices become. Also despite having talented developers, the pace of ETH core software development is generally slow because there is a culture of decentralized decision-making.
Ethereum has much faster confirmation times than Bitcoin, but still much slower than the traditional web applications most people use. Ethereum has scalability problems and is already at its limits as tokens such as Tether become more active on the network. At times during the token sale/ICO boom in 2017, there was significant congestion on the network that led to very high transaction fees and network stalls. CryptoKitties, a very popular collectible game project launched on Ethereum in Oct 2017 and congested the network.
Finally although many projects use the Ethereum network, there are very few applications with a significant number of active users. Even the popular DeFi applications have only hundreds of daily active users and perhaps some are in the low thousands daily on a good day.
The Ethereum token does not have the same unique qualities Bitcoin has as a money. Because Ethereum has a multitude of use cases there will be more price instability in the token so it would be less suitable as money just as Facebook stock would be unsuitable. Money would also likely have to have a ‘fair’ distribution. 65% of the Ethereum supply was distributed to early founders, investors and developers. Hence Ethereum can be considered more of a decentralized company or organization that can achieve higher market capitalizations as more successful applications are built on top of its network.
Ethereum has by far the largest number of cryptocurrency advocates and open-source developers and the Ethereum Foundation has a significant war chest to provide support. The dedication and loyalty in the ecosystem go a long way. Many in the developer community are young and highly talented and have a hardened resolve in building on top of complex technology. The technology is robust, but blockchain technology needs significant enhancements and perhaps several breakthroughs for mainstream adoption.
Performance, scalability and usability remain the most difficult challenges for Ethereum. Even if there was a wildly popular application built on Ethereum it would likely congest the network and not be able to scale. Application developers may also want to customize the infrastructure to suit their own needs and may not remain on the Ethereum network unless switching costs and the network effect on the platform is too great. Hence value may eventually concentrate on the application layer rather than the infrastructure layer contrary to the ‘fat protocol thesis’ proposed by many others. Competition is fierce in the smart contract space. There are public blockchain networks such as EOS, AVAX, Cosmos, Algorand, Hedera, Tezos, Tron, Cardano, Neo, Rootstock and Ethereum Classic as well as major social network companies with mainstream user bases such as Facebook, Wechat, Line, Telegram, KaKao that could gain the dominant market share of users.
The key to Ethereum’s success may be in DeFi and NFTs, where Ethereum’s reputation for strong immutability can give users more confidence. Ethereum 2.0 is an opportunity for a fresh restart. Core Ethereum developers and advocates can lead the ecosystem of dedicated followers on to a more modern network that incorporates the latest innovations in this fast-changing industry to compete with the many other newer public blockchains.
If you live in the US or Europe here are a couple good ways to buy Ethereum:
1) Coinbase is a reputable Silicon Valley based firm backed by major venture capital companies:
You can also use Coinbase to buy if you’re from: Canada, Mexico, Australia, Chile, Singapore
3) You can use another reputable exchange Binance almost anywhere in the world outside the US.