How to Value Ethereum Today: DeFi, The Protocol Sink Thesis and Beyond

NBX Editorial
Oct 1, 2020 · 10 min read


It’s the network that for most of its history, has sat just behind Bitcoin in value and yet newcomers and even seasoned crypto participants still have a hard time putting a finger on exactly where its value comes from.

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Source: Coinmarketcap

The fact is, however, Ethereum and by extension Ether, are both as easy to understand as any “platform,” like Ebay, Alibaba, Airbnb, or even Youtube.

All of these businesses are connectors that bring buyers and sellers together across different contexts. From their outset, these platforms were revolutionary because they gave people all over the world a new way to buy and sell just about anything, including information itself.

Since the launch of Bitcoin, the crypto space has represented the next logical iteration of platform, starting with giving everyone a new way to use and own money and extending to the current DeFi movement.


Under the DeFi or decentralized finance movement’s umbrella, now anyone can truly buy, sell, and trade anything valuable at any time, anywhere.

While DeFi began with Bitcoin(making you the bank for the first time), it really took flight this year on the Ethereum network, due to innovations in smart contracts and token standards. What it aims to do is make it truly easy for anyone to access any sort of financial service anywhere, while never losing ownership of the assets they’re trading, or “HODLing.”

Since DeFi(on Ethereum) has now boomed to just under $11 billion in value, it holds just over 10% of the Ethereum network’s total market cap.

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Source: DeFi Pulse

Despite its recent, meteoric rise, for the Ethereum-based DeFi movement, it’s early yet and for the most part, a heavy amount of speculation continues to cloud the fundamentals, leaving investors still questioning where Ether comes into play. Through applying a theoretical framework to the Ethereum network and Ether, it’s easier to answer that question.

The Protocol Sink Thesis

Perhaps the leading framework for understanding how to value both Ether and the Ethereum network is the Protocol Sink Thesis, as introduced by the Bankless community.

Before exploring this thesis, it’s important to be familiar with the ideas that serve as its foundation.

First, the internet today benefits a small number of platform creators above all other businesses and the average user. Google and Facebook, alone, for example, continue to capture the majority of the web’s digital advertising revenue. This amounts to hundreds of billions of dollars that come from selling the average internet user’s personal data to a horde of third parties in grey markets where the user’s never paid at all during the process.

Second, all traditional(non-blockchain) internet services can lock out any user at any time because they’re centralized, i.e., controlled by one group and located in one easily, physically identifiable location. Due to these facts, they can theoretically decide to go offline or be forced to go offline at any time.

Lastly, they’re biased by default. Since all traditional platforms are run by centralized entities(traditional companies), they abide by the views of those entities and restrict users who don’t. Accordingly, any platform that lives on the non-blockchain internet is never “for everyone.”

Enter the Protocol Sink Thesis

This is where the idea of “a Protocol Sink,” i.e., the “Protocol Sink Thesis” comes in.

At its core, it assumes that Ethereum can fix the above issues through making platform businesses, including their hosting, as much of a global public good as Bitcoin is. By definition, a global public good is something that is freely available for anyone to access (use) anywhere in the world without restriction, like water or air.

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Image Credit to Spencer Selover via Pexels

If we then imagine Ethereum as a global public good, it’s best to elaborate on that idea by thinking of it as a “new foundation for the internet” just as Bitcoin is a “new foundation for money.”

Taking that, we can then call DeFi’s leading projects like MakerDAO (a decentralized lending provider or blockchain-based lender) the new, fully decentralized banks and think of Ether as then being a settlement asset for those banks.

Here, by settlement asset, we mean the thing of value that is used to close transactions that are made by or on Ethereum-based services. This idea works out despite the fact that most of these services depend on their own ERC-20 tokens or Ethereum-based cryptocurrencies that live in smart contracts.

The reason why is simple.

For the transactions that are made in any service or application (DApp) to be considered legitimate, they need to be eventually settled in Ether. This can be done at the end of a group of transactions, which are then batched into one by the service itself or on an individual basis.

It’s this fact that makes up the center of the Protocol Sink thesis.

While all sorts of services can be built upon the Ethereum blockchain, then upon each other, final settlement can only be done in Ether. In other words, at some point, all Ethereum services have to send Ether transactions to pay to keep themselves running. Due to this, any growth on top of the network always sinks down to its foundation, where the most value ends up being accrued over the long-term.

What this entire theory assumes is that while Ether may not be growing as explosively as the DeFi movement right now, it will experience progressively more explosive price growth as time goes on.

Ethereum only wins if ETH is Money?: Debunking Ether’s Bear Cases

Standing in the way of both the Protocol Sink Thesis and all other positive or bull cases for Ethereum(and Ether) are three main critiques, which Ryan Sean Adams explains well in a guest post for the popular DeFi-focused newsletter, “The Defiant.”

In a nutshell, the heart of all arguments against Ether and its network being valuable are that Ether is too volatile(its price moves too frequently), its supply isn’t fixed, and that it can never retain any reasonable value as a result. Since most of you are likely already familiar with the fact that Bitcoin’s supply is limited to 21 million bitcoins by its code, we’ll start with the second case against Ether.

Is it, as its detractors claim, truly just an asset that’s doomed to continuous inflation over time?

In short, no. The main issue with Ether is that many investors, even a large number who may now be considered experienced, aren’t familiar with how its supply is limited. While the Bitcoin network is coded to only ever release 21 million bitcoins, Ether’s supply is limited, also on the code-level, by a percentage-based issuance rate.

As Adams points out in his guest post, “Ether’s issuance rate is now 4.6% and has only decreased over time.”

In case you don’t already know, this is a yearly measure, and Adams’ statement is proven by history. To date, Ether’s supply has never increased and according to the Ethereum development community, it never will “unless the security of the network is at risk.” At face value, this means that as long as Ether stays above a certain value which we can think of as the minimum value to keep miners incentivized to secure the network, then its issuance can continue to decrease.

While none of the above proves that Ether’s supply is fixed by a number of coins, it does prove that it is a deflationary asset that can’t just be wantonly printed by anyone at any time. Lending credence to this is the fact that changing anything about this cryptocurrency’s issuance would require achieving majority consensus from all sorts of groups in the Ethereum community beyond developers alone.

In the end, it is still viable to refrain from calling Ether a digitally scarce asset, but it isn’t viable to call it “inflationary” or “worthless.”

When you become more familiar with the history of Ether’s volatility, the argument for it being a deflationary asset is easier to get behind. In the last two years (September 30 2018–2020), Ether’s had an average volatility of just over 23%. If we directly compare that to the average volatility of the US Dollar to Euro exchange pair over the same time period, which was 0.005%, then it’s easy to argue that Ether isn’t money.

What if, however, it never was meant to be money and instead, should be treated as something else entirely?

One way of doing so would be to take the Protocol Sink Thesis into account and call it a “global public good.” As previously mentioned, a global public good is a term that can be applied to anything of value that can’t be changed based on any regulations and can be accessed by anyone in any locale, at any time.

Because the Ethereum network is decentralized and Ether is what acts as the initial point of access, both would seem to be global public goods.

Working with that term, it could then be argued that the value of a global public good such as Ether can be determined by thinking of Ethereum as the future home for platform businesses and Ether as the settlement asset for those businesses. Here, by settlement asset, we mean the thing of value a business uses to pay for its continued hosting on the Ethereum network. So, in effect, it’s also possible to think of Ethereum as the future of web hosting as well, since it allows for any sort of service to be hosted in a decentralized fashion.

Where then, does any of this leave us related to Ether as a deflationary asset and the effect of its volatility on that?

Generally, it all comes down to network effects.

It’s easy to see that Ethereum’s a platform.

Therefore, just as with a simple site like Ebay, a simple rule of thumb could be used to speak to Ethereum and Ether’s future values.

The more valuable services the Ethereum network provides, the more users will come to it. In turn, the more users it amasses, the more that Ethereum-based services will be used. As Ethereum-based services grow in usage, Ether could grow in value as a settlement asset since history (the ICO boom and the DeFi boom in particular) has shown this to be the case. Working in favor of this argument is the previously discussed fact that Ether’s value needs to grow with the network’s usage so that miners are continuously incentivized to keep Ethereum secure. Additionally and perhaps just as importantly, if this proves to be the case, then Ether will remain deflationary and as less Ether are left available, it’s reasonable to think that their value will rise as demand increases.

As with any theory or model, this is far from perfect since cryptocurrencies have consistently shown tendencies to work against any framework that professionals try to place on them. Still, with Ethereum in particular, network effects has generally shown the most promise over time since Ethereum is a platform and Ether’s price has grown the most as Ethereum services have.

If network effects fail to scale Ethereum (including its market cap and Ether’s price), then it‘s reasonable to conclude that platform economics have failed the network altogether.

Bringing it all Together

So, what further conclusions can be drawn from the above discussion?

First, both DeFi and the idea of a “protocol sink” are truly theses instead of time-tested Ethereum valuation models. That means, by definition that their central ideas need to be observed over time in practice to see if they actually pan out. Next, in doing so, it’s likely best to apply as many other theories/theses/frameworks as possible in order to have a balanced approach to valuing Ethereum(and Ether). Whatever the case, any attempt to do so will still be an untested approach since the Ethereum network has only really made a strong case for its staying power in the past two years.

Last but not least, from the outset, even the creators of the Ethereum network made nothing close to a promise on Ether having any specific sort of value. Nonetheless, since Ethereum is clearly a platform and Ether is clearly its primary medium of exchange, the protocol sink thesis, together with platform economics, appear to work as the most viable valuation framework to date.

All in all, this discussion was only the tip of the iceberg.

In future posts, we’ll analyze Ether and Ethereum’s values on a deeper level, starting with the Gas system and its relationship to the Protocol Sink Thesis. For now, however, we hope you feel more comfortable in beginning to create your own case for Ethereum and Ether’s value.

Before using the above information, remember that none of our posts should be considered direct financial advice, they should be taken as educational articles, which present leading ideas in an easily accessible format. In other words, at NBX, we’re committed to breaking down the most important and interesting parts of the crypto space so you don’t have to.

If that interests you, follow this blog and check out our Knowledge Base on our site as well, which has the same goal. All in all, widespread education is key to a “tokenized future” and at NBX, we’re dedicated to being at the forefront of that future.

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Disclaimer: Content provided does not constitute financial advice.

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