Dialogue with Vitalik: In the future, cryptocurrencies will fluctuate like gold or the stock market

Original title: Interview: Vitalik Buterin, creator of Ethereum

Compiled by: Yangz, DeFi Road

As we speak, Ethereum, which powers most smart contracts and other complex structures and products in the Crypto world, is undergoing an epochal transition. In a process called "merge" scheduled to be completed in two weeks, Ethereum is switching the way it verifies transactions from proof-of-work to proof-of-stake. This will allow it to significantly reduce energy use and carbon emissions.

In the following interview, I discussed with Vitalik topics such as proof of work and proof of stake, the recent crash of the Crypto market, the security of cryptocurrencies, decentralized governance, "startup society", and more.

NS: So, I guess we should start with some current events. In recent months, almost all coins have crashed pretty hard. Why do you think this happened? And does this have any impact on the long-term future of the crypto/blockchain ecosystem?

VB: I’m actually surprised that this crash didn’t happen sooner. Usually, crypto market bubbles last for about 6-9 months after exceeding the previous top, and then fall rapidly. This time, the bull run lasted for almost a year and a half. People seem to have adjusted to this mentality that higher prices are the new normal. I always knew that the bull run would eventually end and we would fall, but I just didn’t know when. Today, people seem to be reading too much into the ultimate cyclical dynamics that cryptocurrencies have always existed and may continue to exist for a long time. When prices are rising, many people say this is the new model and the future, and when prices are falling, people say it is doomed and fundamentally flawed. The reality is always a more complex picture between the two extremes.

I do think that price drops have the benefit of revealing problems that have been there from the beginning. Unsustainable business models tend to succeed in good times because everything is going up, so so is the money people have at their disposal, so things can be temporarily propped up by a constant influx of new money. But during crashes, as we saw with Terra, that model no longer works. This is most true in extreme cases like high leverage and Ponzi schemes (2017 veterans will remember “BIT-CONNE-EE-ECT!!!”), but it’s also true in more subtle ways, like protocol development being easy to sustain in a bull market, but often hard for newly expanded teams to sustain financially when prices crash. I can’t think of a good solution to these dynamics, other than my usual advice that people should remember the history of the space and take the long view.

NS: Great talk. Now, I want to get to the interesting technical stuff… but first, let’s talk a little more about the financial side of things. With Bitcoin — the most widely held and traded cryptocurrency — we’ve seen this cycle where there are repetitive, fairly regular bubbles and busts, but each boom has lower percentage returns than the one before it. To me, this looks like an adoption curve — as more and more people hold some cryptocurrency, the financial gains from new users get smaller and smaller. Are we going to reach a stage where Bitcoin adoption saturates and the returns fall to gold-like levels?

VB: I definitely think that in the medium-term future cryptocurrencies will stabilize and only fluctuate like gold or the stock market. The main question is at what level will the price stabilize. In my opinion, a lot of the volatility in the early days was related to existential uncertainty: in 2011, when Bitcoin fell from $31 to $2 in six months, people really didn’t know if Bitcoin was just a one-time fad and would collapse forever. In 2014, this uncertainty was less than before, but it was still there. Then after 2017, the uncertainty shifted to whether it would gain the level of mainstream legitimacy needed to support higher price levels, and this is still roughly where we are in 2022, although we have come a long way. These existential questions will gradually be resolved over time. If in 2040, cryptocurrencies have already robustly entered several niche markets: it replaced the store of value part of gold, became a kind of "Linux of finance", an always-available alternative financial layer, and eventually became the backend for really important things, but did not completely replace the mainstream, then the chances that it will disappear in 2042 or that it will completely take over the world will be much smaller, and individual events will have less impact on this possibility.

To put it mathematically, the price of cryptocurrencies is stuck in a bounded range (between 0 and the price of all wealth in the world), and cryptocurrencies can only remain highly volatile within this range until repeatedly buying high and selling low becomes an arbitrage strategy that is almost mathematically certain to win.

NS: Separately, estimates of Bitcoin’s energy usage suggest that the network’s energy consumption is fairly closely tied to Bitcoin’s price. This isn’t true for stocks, houses, or gold — none of these other assets require an increase in energy usage to support a higher price. Will this depress Bitcoin’s price in the long term?

VB: I generally view the interaction of the demand and supply curves for Bitcoin and the question of how supply is generated as two separate issues. The difficulty adjustment ensures that the number of Bitcoins minted is fixed on a schedule. Today it's 6.25 every 10 minutes, starting around 2024 it's 3.125 every 10 minutes, and so on. This schedule remains the same regardless of total mining power or price. So from an economic point of view it doesn't matter whether the protocol distributes these coins to miners, core developers, or not. That's why I don't agree with the view that mining is somehow supporting the value of Bitcoin.

A consensus system that consumes a lot of electricity unnecessarily is not only bad for the environment, but it also requires the issuance of hundreds of thousands of BTC or ETH every year. Eventually, of course, issuance will decrease to near zero, at which point this will no longer be an issue, but then Bitcoin will start dealing with another problem: how to ensure it remains secure…

And these security motivations are also a really important driving force behind Ethereum's move to proof of stake.

NS: Let's talk about these security issues. A lot of people seem to assume that if a token is called a "cryptocurrency," then the protocol governing the transfer and ownership of that token must be secure. But from your last answer, it seems like you're more concerned about security, at least when it comes to Bitcoin. Can you explain that?

VB: Efficiency and security are not independent issues. The question is always: how much security can you buy with a dollar per year? If the security of a system is too low, you can increase security at the cost of minting more coins, at which point you regain security by sacrificing efficiency. I mentioned some deep economic reasons in this post about why proof of stake can buy about 20 times more security for the same cost. Basically, participating as a miner in proof of work has a medium ongoing cost and a medium entry cost, but being a validator in proof of stake has a low ongoing cost and a high entry cost. It turns out that your security is only as good as the entry cost, because that is the cost of attack that the attacker has to pay. Therefore, you want your consensus system to have a low ongoing cost and a high entry cost, and PoS is excellent at this. In addition, the two also differ in the options for responding to attacks: in PoW, you can only respond by changing the PoW algorithm, which will burn all existing mining hardware, whether good or bad, but in PoS, you can have the protocol only burn the attacker's assets, so even if the attacker pays a lot, the ecosystem can recover quickly.

In the case of Bitcoin, I am concerned for two reasons. First, in the long run, Bitcoin's security will come entirely from fees, and Bitcoin has simply not succeeded in getting the fee levels needed to secure what could be a multi-trillion dollar system. Bitcoin's fees are around $300,000 per day and have not really grown over the past five years. Ethereum has been far more successful in this regard because the Ethereum blockchain is designed in a much better way to support usage and adoption. Second, proof of work provides far less security per dollar of transaction fees than proof of stake, and it seems unfeasible for Bitcoin to migrate away from proof of work. What does the future look like when there is $5 trillion in Bitcoin but it only takes $5 billion to attack the chain? Of course, if Bitcoin were to be attacked, I'd hope that the political will would soon emerge to move to at least hybrid proof of stake, but I'd expect it to be a painful transition.

NS: Anyway, your argument about the security per dollar provided by proof of stake is perfectly valid; Bitcoin’s high energy cost is actually a high security cost. But let’s talk about the politics that make Bitcoiners reluctant to accept any alternative to the proof of work system. Does the idea of ​​proof of stake allow large stakeholders to modify the network protocol to their own advantage at the expense of small network users? Is it true that proof of work creates a large class of miners who have an incentive to protect their ongoing revenues even if those revenues represent an ongoing cost to users?

VB: There are several arguments in favor of proof of work. The strongest argument, in my opinion, is the “costless simulation” problem. Basically, the idea is that in a proof of stake chain, an attacker can get access to the owners of the coins at some point in time many years ago, buy their old keys for a very low price (because the coins were later transferred to addresses controlled by different keys), and use these coins to create a different chain that forks from that point. A node that only knows the rules of the protocol, connecting to the network from scratch, will not be able to distinguish between the actual chain and this simulated chain provided by the attacker. In PoW, on the other hand, creating such a simulated alternate chain requires redoing an equal amount of proof of work.

In PoS, this problem is solved by adding a weak subjectivity period: nodes are required to connect to the mainnet once in a while (e.g. once a month), and nodes syncing for the first time may need to ask some source they trust (doesn’t need to be centralized, can be a friend) what is the valid chain. Stakers are required to keep their tokens locked up during this time, and if someone sees that a staker is supporting two conflicting chains, then they can send a transaction that “slashes” them, burning most or all of their funds. In this model, this makes perfect sense. However, PoW supporters are not happy with weak subjectivity periods; they prefer a purist approach, where you should need nothing but the rules of the protocol.

My take on their argument is that I don't think the purist approach would really work in practice. You need trusted sources to give you the protocol rules, especially given that you occasionally get software updates to make them more efficient or fix bugs. And I think the attacks that the purists fear are unrealistic: you'd have to convince a whole bunch of people that everyone who says they saw some recent block hash is wrong, and some other hash that no one except the attacker has ever seen is correct. Once you start looking into the details, that doesn't seem very feasible.

There are also people who try to claim that PoS allows large stakeholders to control the protocol, but I think these arguments are completely wrong. They are based on the false notion that PoW and PoS are governance mechanisms, when in fact they are consensus mechanisms. All they do is help the network agree on the correct chain. A block that violates the rules of the protocol (for example, if it attempts to mint more coins than the protocol rules allow) will not be accepted by the network, no matter how many miners or administrators support it. Governance is a completely separate process that involves users freely choosing to download software, as well as BIPs and EIPs and all the core developers talking and other bureaucracies to coordinate which changes are proposed. Interestingly, Bitcoiners (who tend to be the most supportive of PoW) should understand this very well, because the Bitcoin Civil War in 2017 demonstrated very well that miners are quite powerless in the governance process. In PoS, the situation is exactly the same; minters do not choose the rules, they just enforce them and help order transactions.

One possible argument is that PoS has stronger centralization pressures than PoW because the digital nature of stake makes it easier to centralize, or because optimal PoW mining involves exploiting local, limited-scale opportunities to get cheap electricity. These are definitely things I worry about, though I think people overstate them. In particular, Ethereum Proof of Stake today does not yet have the ability to withdraw your ETH. This creates pressure to join a pool, because if you stake in a pool, whenever you want to get your money back you can just sell your share to someone else, so pools offer a big competitive advantage in accessing liquidity. But this will no longer be true when deposits are enabled next year. Another problem with staking today is that pool stakers can’t easily switch pools (or switch to solo staking) due to the same lack of withdrawal capabilities, but next year they can. As for the decentralization of mining, let me just say that I’m skeptical that these highly decentralized small-scale mining opportunities are that meaningful. Mining is a highly industrialized activity, and the big mining farms outside the US (~35% of global hash power) seem to have close ties to various governments, so the future of PoW’s censorship resistance story is highly contingent. The highly democratized early proof-of-work era was nice, and it went a long way toward making cryptocurrency ownership more equal, but it’s not sustainable, and it’s not coming back.

NS: Let’s talk about governance. To me, governance has always seemed like the most promising and interesting thing about blockchain technology — it’s a potential way to sidestep the cumbersome process of setting up a business and create fluid, ad hoc economic collaboration, especially across international borders. I’m a big fan of the sci-fi novel Rainbows End, where much of the economy is based on this kind of collaboration. But in practice, there seem to be a lot of problems with the way people have tried to achieve this so far — in fact, you have a series of blog posts criticizing rigid blockchain governance systems that try to remove all human judgment and trust from the equation. Can you briefly talk about your own ideas about how blockchain governance should work?

VB: One reason blockchains are interesting is that they share many properties with many things we are already familiar with, but are not exactly like any of them. Like a company, a blockchain has a token that you can buy in the hope that it will go up. But unlike a company, a blockchain is more like a country and does not rely on external institutions to resolve internal disputes. Instead, the blockchain is its own adjudicative "root"; you could even say it attempts to be a "sovereign state" (of course, blockchains are not truly independent of existing nation-state infrastructure, but let's be honest, most nation-states are not truly independent either). Like democratic countries aspire to be, blockchains are highly open and transparent, and anyone can verify that the rules are being followed. Blockchains often generate things that look like religions, inspiring the kind of enduring and devout fervor among their followers, but they usually have more complex economic components than religion. A blockchain is like an open-source software project, both in its egalitarian ideals and, more importantly, in the freedom to fork: if the “official” version of the protocol goes astray and violates what some in the community consider to be their core values, they can coordinate around their own chain, split off from there and continue on, and then they can contest legitimacy with the original version in the court of public opinion. But blockchains are not quite like open-source software projects: in blockchains, there are billions of dollars of capital at stake, and the cost of a split going wrong is much higher. If the cost of forking becomes too high, as some believe it will, its role in governance becomes more like a nuclear deterrent than a routine part of the process that is intended to actually happen.

All of this means that blockchains are not only a powerful fundamental substrate that can be used to host the governance logic of other applications, but also a complex thing that itself requires a new and different form of governance. We have seen various forms of "constitutional crises" emerge in both Bitcoin and Ethereum, most notably the Ethereum DAO fork and the Bitcoin blocksize debate. In both cases, there were groups on both sides with strongly different beliefs about what values ​​the project should embody, and both cases were ultimately resolved in chain splits. Interestingly, both Bitcoin and Ethereum have eschewed formal governance; there is no specific person or council or voting mechanism with an established legal right to decide which protocol changes become official. There is an All Core Devs call in blockchain, but even there, the rules for what constitutes a sufficient dissenting opinion are not clearly defined, and for anything truly controversial, the core developers tend to step back and listen to the community.

Of course, people often say that this quasi-anarchic design looks ugly, and that it needs to be replaced by a more "proper" formal system. But they almost never succeed. In my opinion, there is actually a lot of wisdom in our current "tyranny of structurelessness". In particular, it captures the idea very well that a relatively small group of core developers should be able to independently decide on detailed technical decisions that don't really affect the core vision, but for some philosophically major events, such as a hard fork to save the coin, or switching to proof of stake, you need to go deeper.

Governance of applications on blockchains is a different challenge. Here, there’s also a disagreement about how “forkable” an application is: is it like ENS, where if governance breaks down, you can fork it with different rules and convince all the infrastructure to move to that fork, or is it like the DAI stablecoin, where you simply can’t safely fork DAI without forking everything else because of your reliance on reserves of other assets like ETH? If an application is forkable, that’s great; it gives you extra support that you can leverage (like Hive does). If an application is unforkable, then you really need some fully formalized and trusted governance.

For a long time, my main opinion on this topic has been that the current popular token-driven governance technology, where governance is done by voting by token holders, is broken, and we need to move to something better, specifically something less "financialized". Token-driven governance naturally favors the wealthy, and there are various long-term ways that it can be easily subverted. In one of my articles last year, I described an example of a smart contract that would automatically allow token holders to accept bribes in a very friendly way to vote in a specific way from the highest bidder:

This will turn every governance decision into an auction, resulting in only the wealthiest participants having a say. In the best case, this will lead to ruthless profit maximization, and in the worst case, it will lead to high-velocity exploitation followed by a rapid collapse of the project.

My preferred alternative to token holder governance is some form of multi-stakeholder governance that attempts to formally represent people, not just tokens. Optimism does this through the concept of “citizenship”, which is designed to be assigned to contributors and participants in the ecosystem and is intentionally non-transferable. But we are still in the very early stages of figuring out how this stuff works.

NS: Let’s talk more about the alternative forms of human organization that blockchains might enable. I really enjoyed your insightful review of Balaji Srinivasan’s The Network State. Are there any promising attempts so far to create a “startup society” with crypto as a component?

VB: I think one reason this hasn’t really happened yet is that there’s a fundamental difference between a blockchain ecosystem and a full-blown entrepreneurial society. A blockchain ecosystem survives economically by convincing a lot of people to participate in it, or at best indirectly. You only need a handful of core developers, and even they don’t need to make big personal sacrifices. They can just live in a “normal” city forever, and generally look like any other job. But an entrepreneurial society, on the other hand, is much deeper. You need people to take the risk of moving to a specific place, and probably an unconventional one, that comes with big disadvantages that can only be overcome by the virtues created by the community itself. Balaji is right that it takes a deep moral narrative to get people to do something like this.

I think crypto does have deep moral narratives, and they were very important in the ecosystem in 2009-2014, when people didn’t even know if crypto would survive, there were almost no offline crypto social circles, and even legal issues were uncertain. The concept of crypto as a continuation of the larger web libertarian movement, the spiritual successor to PGP, BitTorrent, Tor, Assange, Snowden, etc., was very strong, and these strong ideals served as the ideological and moral glue that allowed people to make huge sacrifices and risks for the industry. More recently, the industry has matured, and with this maturity has come a certain amount of dilution. This dilution is conducive to mainstream adoption, and in fact, newer blockchain projects often intentionally downplay their weirdness to achieve the goal of mass adoption. NFTs are broadening the appeal of cryptocurrencies to groups further away from the original user base.

But at this point, this growth also makes existing blockchains too “thin” to be a good network state. Ethereum has so many different user communities, many of which are deeply divided from each other (there are certainly “woke” and “anti-woke” Ethereum, for example, not to mention international divisions). Just like we have seen recently with communities uniting to prevent on-chain censorship, there is a strong, overriding point of consensus around protecting the integrity and operation of the chain, but these are not strong enough to form a state.

Furthermore, intentional attempts to form crypto-native communities have so far failed. The problem I see is that they all basically use some form of "low taxes" as their primary pitch, and while low taxes are a benefit from a personal perspective, they are a poor filter if your goal is to attract genuinely interesting people. When low taxes are the main reason for coming to a community, then that community is really boring and sucks. Network effects are about quality, not just quantity. I do think there is room for some startup societies right now; there are a lot of people who need a physical community that is oriented around specific values, providing an outlet to express those values ​​constructively, and not just through zero-sum Twitter wars, combined with a pragmatic need to escape the high cost of living in the United States, and the growing, not just theoretical, authoritarianism in many other large countries. But the projects I've seen so far haven't done a very good job.

A key point about this answer is that much of it is about culture; whether we have on-chain land registries, smart contract title, Harberger taxes, or anything else is secondary. I think the startup community should experiment with very different ideas than what we’re used to. For example, I would try not to emphasize absolute ownership of specific plots of land, houses, and apartments, but rather emphasize economic alignment with communities through things like city tokens. But I think the value of innovations like these is more in the long term, and that alone is not enough to attract people in the short term. In the beginning, the alignment with cryptocurrencies and blockchain technology will be mostly symbolic, and over time it will evolve into something more practical.

NS: Another question: In that article, you disagree with Balaji’s emphasis on the importance of a single core leader to the online startup community. Do you think your role as the founder and “face” of Ethereum is overemphasized by the media and crypto enthusiasts?

VB: My hope from the beginning was that Ethereum would grow into something where my influence would gradually decrease as so many other amazing voices started to grow and express themselves. I think that’s been happening over the last two years! In 2015, I was basically doing 80% of Ethereum “research”, and I even did a chunk of Python coding. In 2017, I was doing much less coding, but I was probably doing 70% research. By 2020, I’m probably only doing a third of research, and very little programming. But I’m still doing most of the “high-level theory”. But over the last two years, my work on high-level theory has also slowly, definitely decreased. We have a lot of great new Ethereum influencers, like Polynya, who has been doing a lot of thought leadership around layer-2 scalability. The Flashbots team has been responsible for leading the whole area of ​​MEV research. People like Barry Whitehat and Brian Gu have taken on the mantle of zero-knowledge proof technology, and Justin and Dankrad, who were originally hired as researchers, have also been increasingly asserting themselves as thought leaders.

This is a great thing! I don’t think the public realizes this yet, but I expect that over time, they will.

NS: OK, as always, last question: Which of the current projects you’re working on are you most excited about?

VB: I would say that what excites me most is not any single project, but rather the entire ecosystem of many interesting ideas. This is true on a technical level, with Ethereum approaching its merger, and huge improvements in blockchain scalability, usability, and privacy coming soon. It is also true on a social and political level, with many ideas about decentralized organizations, radical economic and democratic mechanisms, internet communities, and more maturing simultaneously. On the cutting edge away from crypto, advances in biotechnology and artificial intelligence are amazing—some might say, in the latter case, maybe a little too amazing. We are starting to get a sense of what 21st century politics and technology will look like, and how each of the pieces we are working on will fit into that picture. In 2022, Crypto finally feels useful; many mainstream organizations and even governments are using it as a way to send and receive payments, and I feel like other applications will soon follow. The future is still uncertain, but we have more ideas about how this will all play out than we did before.