In a recent interview with DrWealth, I highlighted an issue I had with the term “cryptocurrencies”. I feel that by painting all crypto as currencies, there was no way for traditional investors to grasp the idea that crypto could be valued. It has become such a deep-seated idea in traditional investors’ minds that they dismiss crypto out of hand without doing more research.
I hope to slowly chip away at this bias by talking about crypto assets that are beyond simple currencies / store of value. This means not talking much about Bitcoin at all and focusing on programmable blockchains, namely Ethereum. Programmable blockchains like Ethereum form the basic underlying infrastructure that enables decentralised applications (DApps). The most successful DApp to date is decentralised finance (DeFi).
Before we can talk about DApps like DeFi, investors first need to understand, at least on a conceptual level, what Ethereum truly is.
This article tries not to focus on the underlying technologies of blockchain and Ethereum as it can be quite technical. Feel free to research more to convince yourself on how Bitcoin and Ethereum works and how the underlying technologies secure the network.
Disclaimer: I invest and use in some of the protocols mentioned in this article. Mentioning these protocols does not constitute my endorsement of the protocol or financial advice. Please always do your own due diligence, especially in a very speculative field like crypto and DeFi.
What is Ethereum?
To understand Ethereum, let’s talk a bit about Bitcoin.
Bitcoin is essentially a distributed network of computers that work in tandem to maintain a distributed ledger (blockchain). A bundle of technologies and cryptography enables all parties involved to trust the ledger. The ledger only records transactions and movements of BTC from address to address, with no additional functionality.
As such, Bitcoin can only function as a currency or store of value as the only thing you can do with it is transfer it from wallet A to B.
Expanding on Bitcoin’s design
Ethereum builds on top of this concept by allowing people to write code and create smart contracts / DApps. This extends Ethereum’s native asset ether, ETH, beyond what BTC can be used for.
- You can use it for paying other people like BTC
- You can use it to pay for using digital services provided by DApps. This comes in the form of transaction fees, also known as gas fees on Ethereum.
- You can invest in digital assets by swapping ETH for them.
Don’t understand? Perhaps the following analogy helps.
Imagine Ethereum as a giant IPhone the size of Earth. The Ethereum network provides all the components and infrastructure for this giant IPhone to work. DApps add functionality to this giant IPhone like Apps in the App Store. Anybody can create a DApp on Ethereum, much like how anybody can create a App in the App Store. ETH pays for using or investing in these DApps instead of cash.
This is why Ethereum is sometimes called the “world computer”. A global network providing the infrastructure and computing power to run DApps.
Ethereum enables new economies
The result is Ethereum is its own global marketplace and economy for digital assets and services. This economy has its own monetary policy with ETH as its base currency. Each DApp can also have its own micro economy that plugs into the overall Ethereum economy.
Why each DApp creates its own micro economy is because in a decentralised world, you need to assume that participants are rational and will not provide anything for free. Tokens are useful in measuring the utility of the DApp and incentivise participants.
Each DApp can have its own native token. On Ethereum, these are usually ERC-20 standard tokens.
Depending on each DApp’s token design (also known as tokenomics), the native token provides some form of utility or measure of value to the micro economy. Tokenomics is also how you incentivise participants to act in a manner favourable to the DApp, while also punishing bad behaviour. This is also what drives value to the native token.
Tokenomics is a giant topic on its own and deserves to have its own separate discussion in future articles.
Interesting applications on Ethereum
Decentralised Finance (DeFi)
DeFi is probably the killer app on Ethereum, with most of Ethereum network’s transaction volume coming from DeFi DApps. I’ve been giving readers a taster of what is possible in DeFi in my DrWealth interview and earlier articles. Some functions I’ve shared in the past include:
- Lending and Borrowing: Compound and Aave
- Asset swaps: Uniswap, SushiSwap, Balancer and Curve
- Options contracts and Derivatives: Opyn, Hegic and Synthetix
- Smart Contract Insurance: Nexus Mutual and Cover Protocol
While these applications seem quite usual when compared to traditional finance, the reality is that the sky is the limit on the type of DeFi applications we can potentially see in the next decade. Blockchain technology enables unprecedented transparency, access and interoperability in the financial ecosystem, something traditional finance has never solved / wanted to solve.
A recent example of this inefficiency in traditional finance is how Gamestop shorts were allowed to short more than 100% of GME’s float. If everyone was aware of how much GME’s float was sold short at any given moment in time, brokers would have disallowed the trade. Blockchain technology usage would have avoided this.
At the minimum, I expect DeFi to be much more efficient and transparent than traditional finance. For the more imaginative, it may enable financial applications that we have not seen or experienced before.
Future articles will discuss more about DeFi.
Gaming and Collectibles (NFTs)
Something worth mentioning is the presence of the ERC-721 token standard. It enables Non-Fungible Tokens (NFTs) trading on Ethereum. Each individual NFT is unique (thus non-fungible), which allows tokenisation and trading of unique assets.
Examples of assets that are “NFT-like” in the real world include art, collectibles like Pokemon cards and even real estate, assuming each property is unique. Imagine tokenising these assets digitally on the blockchain and traded freely.
Currently, NFT adoption and implementation has been quite nascent, with implementations mainly related to digital art and collectibles.
The only NFT application that has significant development is in gaming, where digital gaming assets are tokenised as NFTs to be traded by players. 2 examples of crypto gaming applications include:
- Axie Infinity – A Pokemon inspired kingdom-building pet battle game.
- Enjin – A platform for creating crypto based games. A notable partnership is with Microsoft, who is trying to bring crypto gaming to Minecraft, a popular world building game.
Personally, I feel that current implementations of NFTs still need work. However, it is an area that has great design space and potential for the right application.
Future development (ETH 2.0)
The last thing I think investors should be aware of is the ETH 2.0 roadmap. Ethereum is currently undergoing a migration process from Ethereum 1.0 to Ethereum 2.0. The reason for transition is, in my opinion, largely due to 2 things:
- Transition from energy expensive Proof-of-Work (PoW) consensus to a more eco-friendly Proof-of-Stake (PoS) consensus. Just know that PoS uses less energy and tries to address enviromentalists’ criticism of crypto mining’s carbon footprint.
- Address scalability issues in Ethereum. Ethereum 2.0 improves Ethereum’s throughput (number of transactions per second) among other things.
The launch phase has 3 – 4 phases and will take about 18 months. The transition process has begun in November 2020 with the launch of the Beacon Chain (Phase 0).
I’ve mentioned in an earlier portfolio update that you can stake your ETH in the Beacon Chain and earn yield on your ETH. Here’s a guide to how to do it.
Programmable blockchains like Ethereum create and enable digital marketplaces and new economies. This marketplace enable the creation of applications known as DApps, which provide various digital services and assets to use and invest in. Currently, the main DApps for Ethereum fall within the DeFi sector, with other interesting applications like gaming and NFTs yet to be fully explored.
I hope this article helps you understand that the native assets of programmable blockchains like Ethereum are not mere stores of value / currency. While they serve as the base currency of new digital economies, they also serve as the gateway to digital assets and services.
Assets that can generate cashflows and as result, can be valued.