Exploring the Ethereum ecosystem
Ether is enabling a vibrant and open financial system as evidenced by the rise of DeFi, stablecoins, and wrapped tokens
I recently helped write and research an article for Coinbase Learn called Rise of the Ethereum economy. Here’s a personal and expanded version of the main article.
What is Ethereum, the second largest crypto by market cap after Bitcoin? This past year, both Bitcoin and Ethereum have gained mainstream, institutional, and global interest. Or as Morgan Stanley Chief Global Strategist recently noted “cryptocurrencies are rapidly gaining popular support as alternatives to gold (a store of value) and the dollar (as a means of payment).” While Bitcoin has gained support as a store of value, Ethereum has enabled new means of payment upon a vibrant and open financial system.
While the price of BTC has appreciated by ~550% from the start of 2020 until today, ETH has appreciated by more than 700%. With a market capitalization of $176B today, the value of Ethereum surpasses major banks such as Morgan Stanley and fintech such as Square. Yet Ethereum is more than a bank or payments network. Ethereum is a transparent and global protocol that “can be used to codify, decentralize, secure and trade just about anything.” Consider the rapid rise of the Ethereum economy over the past year.
Upon Ethereum, innovations such as decentralized finance (a.k.a. DeFi), stablecoins (a.k.a. cryptodollars), and tokenized Bitcoin have gained significant value. As research published by the St. Louis Federal Reserve recently explained:
“DeFi offers exciting opportunities and has the potential to create a truly open, transparent, and immutable financial infrastructure… For example, one can buy U.S. dollar (USD)-pegged assets (so-called stablecoins) on decentralized exchanges, move these assets to an equally decentralized lending platform to earn interest, and subsequently add the interest-bearing instruments to a decentralized liquidity pool or an on-chain investment fund.”
Decentralized finance, stablecoins, and the Reddit revolution
The open-source software behind Ethereum potentially makes it more transparent, transferrable and trustworthy while faith in legacy systems is at an all-time low. In the wake of February 2021’s memestock saga on Reddit Mark Cuban explained his belief that blockchain will make “markets much more efficient, transparent and available to the small investor.” Further, Cuban cited DeFi as an industry with great potential and that he holds DeFi tokens such as Sushi and Aave (examples of a decentralized exchange and lending platform respectively).
Of the major decentralized exchanges, Uniswap currently processes the greatest volume of tokens followed by Sushiswap and Curve. Since it launched in May 2020, Uniswap has enabled over $100 billion worth of trading volume.
In parallel, the rate of U.S. dollars being issued upon Ethereum has been growing substantially.
While USDT is the dominant stablecoin currently, an increasing proportion of other stablecoins such as USDC have been gaining market share. USDC is backed by and has the familiarity of dollars while leveraging some of Ethereum’s most powerful properties:
- Open, global, and accessible to anyone on the Internet, 24/7/365.
- Fast, programmable, and secure to transmit.
Anyone, anywhere (such as the 1.7 billion people estimated to be without a bank account) being able to send or receive dollars in such a way is a remarkable innovation. As a result, Ethereum has driven record global search interest as of January 2021.
As another indicator of rising mainstream interest, Ethereum and crypto subreddits have gained record numbers of new subscribers in recent days.
Reddit itself, one of the most popular social media platforms in the world, recently partnered with the Ethereum Foundation to bring “the value and independence of blockchain technology to our communities and millions of redditors.” In a stream with U.S. representative Alexandra Ocasio-Cortez, Reddit co-founder Alexis Ohanian explained how “No one’s gonna wake up in a week and be like let’s all go back to how it was. The collective public cannot unsee this, and so I think that there’s going to be more and more energy to find decentralized solutions. There is so much energy to rally behind something that isn’t capable of having the game rigged.”
Ethereum is not only capturing the attention of the revolutionary public, however. It is also capturing the attention of commercial institutions and even central banks.
Research published by the Federal Reserve from December 2020 explains how “Several years ago, innovation in financial markets began to generate discussion of digital tokens and tokenization of financial assets” while illustrating “a possible future state where financial instruments could be turned into digital objects and transferred in real time across the globe without financial intermediaries.” The Fed also notes how “Current concepts of tokens and tokenization likely originate from their usage in the context of Ethereum, a large public blockchain that offers a robust programming capability…”
Institutional adoption and the future of money
Catalyzed by crypto, global central banks are now actively researching and implementing digital currency initiatives. Or as Bloomberg reported, “With modern technology and even the coronavirus facilitating a global shift toward cashless economies, and alternative concepts such as Bitcoin taking hold, monetary policy makers are acting to ensure they don’t fall behind.”
The value of dollars settled on Ethereum has begun to rival that of major commercial payment systems such as Zelle and Paypal, although it is still far from central bank payment systems such as Fedwire.
Last year, the volume of USD payments processed by Ethereum neared that of Paypal and surpassed that of Zelle, a payments network run by a network of major U.S. banks. Paypal has also recently enabled ETH trading for its U.S. user base, is enabling its funding for its 29-million merchant network, and is planning to extend functionality for its 325-million international user base. In a 2021 earning call, the Paypal CEO explained:
“We all know the current financial system is antiquated, and we can envision a future where transactions are completed in seconds, not days; a future where transactions should be less expensive to complete; and a future that enables all people to be part of the digital economy, not just the affluent. We are significantly investing in our new crypto, blockchain, and digital currencies business unit in order to help shape this more inclusive future.”
Paypal is not the only institution interested in the future of crypto-money. In July 2020, Visa proclaimed how “Today, fiat-backed digital currencies, commonly referred to as ‘stablecoins,’ have emerged as a promising new payment innovation, combining the benefits of digital currencies with the stability of existing currencies like the US dollar. It’s a concept that is gaining traction beyond fintechs, and now includes financial institutions and central banks.”
And in December 2020, Visa announced that it is connecting its global payments network of 60 million merchants to the U.S. Dollar Coin (USDC) developed by Centre primarily on the ethereum blockchain. Further, rival Mastercard said it expects to bring stablecoins onto its payment network.
Institutional investors seem to be beginning to take an interest in Ethereum. The Grayscale Ethereum Trust, a way to gain Ethereum exposure via traditional brokerages, has grown substantially over the past year. Three million ETH are held in the trust as of February 2021 at a value of greater than $5 billion.
Ethereum has also been increasingly referenced by corporations in regulatory filings since 2016.
In other indications of institutional interest, CME futures, another vehicle for institutional Ethereum exposure, recently went live and traded over $33 million on its first day. And One River Asset Management in December 2020 revealed commitments that would “bring its holdings of Bitcoin and Ether to about $1 billion as of early 2021.”
As both Bitcoin and Ethereum gain momentum, their networks are becoming symbiotic. Like dollars, Bitcoin can also be tokenized on Ethereum.
A wave of innovation, unique risks, and potential solutions
As outlined by the St. Louis Federal Reserve research cited above, “DeFi has unleashed a wave of innovation…. While this technology has great potential, there are certain risks involved…
Smart contracts can have security issues that may allow for unintended usage and scalability issues limit the number of users. Moreover, the term “decentralized” is deceptive in some cases. Many protocols and applications use external data sources and special admin keys to manage the system, conduct smart contract upgrades, or even perform emergency shutdowns.
While this does not necessarily constitute a problem, users should be aware that, in many cases, there is much trust involved. However, if these issues can be solved, DeFi may lead to a paradigm shift in the financial industry and potentially contribute toward a more robust, open, and transparent financial infrastructure.”
Especially contrary to the democratic potential of Ethereum is that as demand rises, its network has become more expensive to use. As of February 2021 it costs ~$10 to send a transaction.
As Ethereum network congestion increases however, solutions are on the horizon. In August 2020, 22 developer teams submitted Ethereum scaling proposals to Reddit. Projects such as Optimism and rollups can potentially help Ethereum scale to process hundreds of thousands of transactions per second, although each solution presents unique challenges.
ETH 2.0 is also on the horizon, which intends to fundamentally solve Ethereum scaling. As of February 2021, over 3 million ETH are staked in the ETH 2.0 contract.
Ethereum and crypto’s core innovation is its open source network. In near real-time, one can visualize and audit billions of dollars worth of value transferring globally. This network can be accessed independently, or via great data providers such as CoinMetrics and Dune Analytics (which source much of the data referenced above).
Any research and opinions presented in the article above do not necessarily reflect that of my employer. For this and everything else you read on the Internet, do your own research and form your own opinions.