Bankless: The Era of the Ethereum Empire is Coming

Original Author: David Hoffman

Compiled by: Katie, Odaily Planet Daily

The crypto space is filled with internal struggles.

From the beginning, competition has characterized this industry, rather than the "collaboration" envisioned by idealists. The top-ranked crypto assets possess "blockchain superpowers": liquidity brings liquidity, capital generates capital, and network effects create network effects. Winning public chains can capture all of the above elements and easily maintain their leading position.

In this article, let’s revisit the fundamental principles of blockchain, understand what the "blockchain empire model" is, and how investors can leverage this to navigate the extremely complex L1 valuation process. Ultimately, you will realize that the Ethereum empire is on the horizon.

1: The Key to Winning L1

There is enough space in the crypto realm to "make the pie bigger," as we are still in the early stages of the long growth phase of Crypto. At the onset of the industry explosion, the space was vast, accommodating many public chains, and it seemed that the ecosystem could support an unlimited number of L1s, but this is just an illusion. In reality, if an L1 does not compete for the top position, it will be dominated by other L1s.

Liquidity brings liquidity. Capital generates capital. Network effects create network effects. Winning public chains will capture all liquidity + capital + network effects.

The battle for currency is a daily occurrence in the crypto industry. "Currency premium" is the most scarce resource in cryptocurrencies. This is what every blockchain desires but not all can possess. Bitcoin holds the majority, Ethereum has some, while other public chains only get a little soup. The so-called "more monks than porridge" describes the current state of currency premium (detailed in the fourth part).

2: Fighting for "Fiat Capability"

The same competition occurs at the national level. When your currency is the global reserve currency, you possess the most powerful asset in the world: the ability to print any currency you need. When the whole world uses your money, you are the top player. Any country can print money, but without global demand to support it, it may quickly fall into high inflation.

When you have the world's number one currency, global demand for your assets greatly mitigates the negative impact of currency issuance. Due to the "petrodollar system," any new supply of dollars is immediately absorbed by global trade. However, wasteful spending and corruption have also weakened confidence in the dollar. Tokens based on decentralized blockchain networks are catching up to a good era—leaping to the status of global reserve currency.

3: The Value Cycle of Chains is Similar to Nations

Countries with the world’s reserve currency also possess the most powerful military forces. Military power ensures currency value by controlling global trade (the global economy uses its money).

This power is in a positive feedback loop: once a country becomes the world’s number one, maintaining the cost of its military becomes cheaper due to its control over the world reserve currency; the value of the primary reserve currency further subsidizes military costs, which in turn reinforces the value of the currency.

Back to the Crypto world:

• The military of a nation = blockchain security;

• Bitcoin's army = miners, PoW erects a wall of electricity around the Bitcoin economy, and anyone with weak energy cannot penetrate Bitcoin's PoW force field;

• Ethereum's army = holders, PoS erects a wall of capital around the Ethereum economy, and anyone with less capital than required cannot penetrate Ethereum's protective wall.

Every chain has security cost expenditures. The sustainability of a blockchain is achieved by optimizing the amount of currency issued for producing security. The prices of BTC and ETH are important factors affecting the security costs of these ecosystems. If the asset value of a chain increases tenfold, the security budget will also increase tenfold accordingly. A tenfold price increase also means that the system can achieve ten times the level of security with the same issuance.

4: Currency Premium is Linked to Security Issues

As the price of BTC rises, its hash rate supply will also increase. As the price of ETH rises, interest in investing in Ethereum will also increase.

The issuance rules of Bitcoin are difficult to reprogram, so the rise in Bitcoin's value will increase its security cost expenditures (at least until its block reward subsidies run out), which may lead to overspending on security costs.

In contrast, Ethereum is more flexible in issuance. As the price of ETH rises, the block rewards for ETH decrease:

• Block 0 - Block 4369999: 5 ETH;

• Block 4370000 - Block 7280000: 3 ETH (adjusted in 2017 through EIP-649);

• From Block 7280000 to now: 2 ETH (adjusted in 2018 through EIP-1234).

In 2021, EIP-1559 began to burn excess ETH. By the end of 2022, after Ethereum upgraded to PoS, issuance will further decrease by 90%.

The security philosophy of Ethereum is to issue the least amount of ETH necessary to achieve the required security.

To draw a parallel with nations: how do we optimize our military for maximum safety at the least cost? The answer is to reduce the number of tanks and increase the number of drones.

The reduction in ETH issuance makes ETH scarcer, increasing its value in the secondary market. Higher prices in the secondary market enhance Ethereum's security, creating a positive feedback loop that achieves higher security with less issuance.

This is the currency premium.

5: What About L2? Can It Also Establish an Empire Model?

Ethereum's modular design structure allows for infinite scalability. Ethereum does not attempt to host a decentralized economy on a single (main) chain but instead serves as a settlement layer for other chains. This is like the United States having the strongest military power, ensuring and promoting global trade among nations as long as they adopt the dollar. Ethereum now possesses the highest security, and transactions of ETH on L1 can secure and facilitate transactions between L2s.

The strength of the dollar does not come from the domestic production of the U.S. economy but from the external demand for dollars from countries wanting to participate in global trade. The U.S. does not control the economies of Germany, France, Argentina, etc., but it still captures the advantages of these economies. To trade with other countries, these nations must convert their GDP into dollar demand for imports and exports.

Similarly, Ethereum does not control the economies of L2 blockchains. Each L2 has complete sovereignty over its economy. However, when it comes to transferring GDP from one Rollup to another, L2 must consume ETH to conduct L1 transactions. Integrating thousands of transactions into L1 transactions is the way for economic activities on L2 to achieve interoperability with other parts of the Ethereum ecosystem.

The beauty of Ethereum's modular design is that you can add (essentially) unlimited L2s on top of it, making Ethereum as L1 the most fundamental scalable blockchain design, evolving from a nation into an empire.

The cost of developing new L2s on Ethereum is nearly zero. This is akin to an empire that can easily showcase its economic influence in new territories or foreign lands whenever necessary. Each additional L2 increases Ethereum's net GDP, allowing Ethereum to freely increase L2s based on market demand.

All roads lead to Ethereum, increasing the value of ETH.

6: Ethereum's L1 and L2 are Like the U.S. Federal and State Governments

The modular structure of Ethereum's L1/L2 simulates the federal/state structure of the United States. The center is simple, while the periphery is complex.

The U.S. federal government is L1. It establishes the "laws" that all states (L2) must adhere to. These laws are designed to promote interoperability among states. It provides trust for effective interstate trade.

Ideally, the federal government only needs to provide a minimum set of rules and regulations. All other laws and rules can be left for the states (L2) to decide for themselves.

The same pattern exists in Ethereum.

The EVM on Ethereum L1 coordinates the economic resources between L2s as a set of rules. This common standard helps L2s share the economic benefits of each other's growth.

Sharing the same L1 protocol transforms each independent chain from opposition into a united front. Due to the interoperability provided by the underlying L1, the success of one L2 Rollup on Ethereum positively impacts other Ethereum L2 Rollups and will become a "joint advantage."

The brilliance of the L2/state rights model is that each L2/state can decide what is most effective for itself.

Currently, the "states" of Ethereum's "federal" structure include:

• Optimistic Rollups: such as Optimism or Arbitrum;

• Zk-Rollup L2 solutions: such as zkSync or Starknet;

• Ethereum L2 scalability solutions like Immutable X;

• Centralized ledgers like Coinbase or Wells Fargo;

• Consortium chains like Hyperledger…

Building L2s on Ethereum is unrestricted, as long as they comply with EVM interoperability standards. "The simplicity of the center" maximizes "the expression of the periphery." It allows everyone to build what they want, fostering creativity.

7: We Have Choices in the Face of L2

The L1/L2 structure (federal/state structure) is a mechanism for individual empowerment.

If the state government charges you more in taxes than the services they provide, the solution might be: move to another state. States must compete with each other to satisfy voters and retain their residency rights. States that perform better in this regard will gain more economic resources and population.

The same situation will arise in L2.

Has the fee for your commonly used L2 increased? Has it invested enough in infrastructure, is it keeping pace with innovation, or is it lagging behind? If L2 does not meet your requirements, you can switch to another. L2s will compete for users and locked value, and this competition is beneficial for users.

8: The Ethereum Empire

Ethereum is a modern example of a global coordination model. Over time, Ethereum's basic structure resembles that of the United States—maintaining its status by ensuring global trade is denominated in dollars.

The Ethereum empire will solidify itself in two ways:

• New L2s are created and added to the ecosystem, such as Ethereum-native Rollups (Arbitrum, Optimism, zkSync) leaving the crowded central empire to establish new sub-territories outside the main castle;

• Other lower-security L1s join to become new L2s of Ethereum.

These new branches of Ethereum can self-manage and generate their own economies. However, after a few blocks, they will bundle their overall economic activities and transact with L1. In exchange for processing transactions, ETH taxes are levied, granting L2 the security power of Ethereum L1.

Copycat L1s can issue more tokens compared to Ethereum, allowing them to pay lower security costs. But if they want to stop currency inflation, they can always choose to accept Ethereum's protection.

9: Let the Data Speak, Comparing Different L1s

Ethereum currently provides $45 million in security assurance costs to its network daily.

Bitcoin's current inflation rate is only 1.7%, yet it can provide $40 million in security assurance costs daily. So from a security efficiency perspective, Bitcoin is 2.7 times more efficient than Ethereum.

Solana has an inflation rate of 7%, while its daily security expenditure is only $11 million. Ethereum's security efficiency is 7.17 times that of Solana.

Avalanche has an inflation rate of 5.5%, with daily security costs reaching $5.7 million. Ethereum's security efficiency is 10.4 times that of Avalanche.

This is still before Ethereum switches to PoS (Solana and Avalanche are already PoS). In the future, ETH's issuance will decrease by 90%, while strengthening its security mechanisms.

10: The Competing Chains Falling into the "Currency Premium" Trap

Avalanche and Solana both tout themselves as low-fee L1s, but this forces them to issue more tokens to pay for security costs. Solana and Avalanche indeed have much higher throughput than Ethereum. They generate more total block space to accommodate more data. If you have more block space, you must increase security expenditures to protect the additional space.

The larger the territory, the more military forces are needed to guard it. Expanding a vast kingdom is like enlarging the territorial scope, rather than letting people leave the kingdom to build scattered small outposts.

To outperform Ethereum in performance, copycat L1s have increased L1 throughput and lowered gas fees. The long-term currency premium consequences for these L1s could be disastrous. This design choice creates high issuance while limiting fee collection. This stifles the currency premium, serving as a trap for scaling.

In contrast, Ethereum's scalability on its L2s generates higher L1 fees while minimizing the need to issue ETH.

Issuing less while charging more. This is how to create a currency premium.

Since issuance has been minimized, the burn fees from EIP-1559 capture the economic energy of the Ethereum ecosystem and inject it into the value of ETH (by making it scarcer). The rising value of ETH requires less issuance to pay for security. This reduction in issuance increases the scarcity of ETH, enhances its value, and further reduces the need for issuance. This is the positive feedback loop of currency premium.

Other chains attempting to scale on L1 have a negative feedback loop. Scaled L1s require high issuance and cannot achieve meaningful fee income. This forces supply inflation, reducing their scarcity and putting downward pressure on the currency. It cannot subsidize issuance with fees, as this contradicts the purpose of these competing chains. With increasing issuance, currency devaluation (due to inflation) triggers further issuance demand.

The battlefield for the top L1 always favors those who can issue the least amount of currency to achieve the greatest security. If you create a sense of security, you can have everything (users and funds). If security is expensive for you, then your options are limited.

11: Competing Chains, Better Align with Ethereum~

On April 13, insiders indicated that one of Arbitrum, Optimism, zkSync, or Starknet might issue tokens next month.

Optimism and Arbitrum, as operational L2s, do not need to issue tokens economically. They generate income by selling blocks, and each time they conduct an L1 transaction, they pay a small "tax" to the Ethereum economy.

Avalanche, Solana, Terra, and essentially all blockchains where "security efficiency is not dominant" have a flaw. The longer they allow inflation, the worse the problem becomes. In the future, by becoming Ethereum L2s, their token issuance flaws could drop to 0, yielding immediate benefits and potentially increasing throughput.

The community of competing chains has described me as an "ETH maximalist." In fact, it is the maximization of decentralization that enables this blockchain empire model to exist. Ethereum's commitment to L1 decentralization and limited block space encourages a vibrant and rich L2 ecosystem.

Ultimately, you will find that all roads lead to Rome, and all public chains lead to Ethereum.