The Ethereum Empire Era is Coming

The crypto space is rife with internal struggles.

Competition has characterized this industry from the beginning, not the “collaboration” envisioned by idealists. The top crypto assets by market capitalization have “blockchain superpowers”: liquidity brings liquidity, capital generates capital, and network effects generate network effects. The winning public chain can capture all of the above elements and easily maintain the top position.

In this article, let us look back at the basic principles of blockchain, understand what is the "blockchain empire model", and how investors can use this to navigate the extremely complex L1 valuation process. In the end, you will realize that the Ethereum empire is coming.

L1's key to success

There is enough space in the crypto space to “expand the pie” because we are still in the early stages of Crypto’s long growth phase. At the beginning of the industry’s outbreak, the space was large and there were many public chains. It seemed that the L1s that the ecosystem could carry were unlimited, but this was just an illusion. In fact, if L1 does not compete for the first place, it will be dominated by other L1s.

Liquidity begets liquidity. Capital begets capital. Network effects beget network effects. The winning public chain will capture all liquidity + capital + network effects.

Currency wars are a daily occurrence in the crypto industry. “Currency premium” is the scarcest resource in cryptocurrencies. It is something that every blockchain wants, but not all of them have. Bitcoin has the majority, Ethereum has some, and other public chains only get a little bit. The so-called “too many monks, too little porridge” is the current situation of currency premium (detailed in Part 4).

Fighting for “Cash Power”

The same competition happens at the national level. When your currency is the global reserve currency, you have the most powerful asset in the world: the ability to print any money you want. When the whole world uses your money, you are number one. Any country can print money, but if it is not backed by global demand, it may quickly fall into high inflation.

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

The value of the chain is circulating like a country

The country that owns the world's reserve currency also owns the world's most powerful military. The military ensures the value of the currency (and the global economy that uses its money) by controlling global trade.

This power is in a positive feedback loop: once the world's number one country, it becomes cheaper to maintain a military due to control of the world's reserve currency; the value of the leading reserve currency further subsidizes military costs, which in turn reinforces the value of the currency.

Back to the Crypto world:

The country’s army = blockchain security;

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

Ethereum’s army = coin holders. PoS has erected a capital wall around the Ethereum economy. Anyone with less capital than required cannot penetrate Ethereum’s protective wall.

Every chain has security expenses. The sustainability of a blockchain is achieved by optimizing the amount of currency issued to produce security. The price of BTC and ETH is an important factor affecting the security costs of these ecosystems. If the value of a chain's assets increases 10 times, the security budget will also increase 10 times accordingly. The 10 times higher price also means that the system can obtain 10 times the security level with the same issuance.

Currency premium is linked to security issues

As the price of BTC increases, its hashrate supply will also increase. As the price of ETH increases, people’s interest in investing in Ethereum will also increase.

Bitcoin's issuance rules are difficult to reprogram, so an increase in the value of Bitcoin will increase Bitcoin's security costs (at least until its block reward subsidy runs out), which may lead to overspending on security costs.

In contrast, Ethereum is more flexible in terms of issuance. As the price of ETH rises, the block reward issuance of ETH decreases:

Block 0 - Block 4369999: 5 ETH;

Block 4.37 million - Block 7.28 million: 3 ETH (2017, adjusted through EIP-649);

Block 7.28 million to date: 2 ETH (2018, adjusted through EIP-1234).

In 2021, EIP-1559 began to recycle excess ETH through burning. By the end of 2022, after Ethereum is upgraded to PoS, the issuance will be further reduced by 90%.

Ethereum's security philosophy is to issue the minimum amount of ETH to achieve the required security.

Let’s use the national analogy again: How do we optimize our military to achieve maximum security at the lowest cost? The answer is to have fewer tanks and more drones.

The reduction in ETH issuance makes ETH more scarce, increasing its value on the secondary market. Higher prices on the secondary market increase the security of Ethereum, creating a positive feedback loop that achieves higher security with less issuance.

This is the monetary premium.

What about L2? Can it also build an empire mode?

Ethereum's modular design structure allows it to be infinitely scalable. Rather than trying to host a decentralized economy on a single (main) chain, Ethereum becomes a settlement layer for other chains. This is like the United States having the most powerful military to protect and facilitate global trade between countries as long as they adopt the US dollar. Ethereum now has the highest security, and ETH transactions on L1 can protect and facilitate transactions between L2.

The strength of the dollar does not come from the domestically produced portion of the U.S. economy, but rather from external demand for dollars from countries in order to participate in global trade. The U.S. does not control the economies of countries like Germany, France, Argentina, etc., but it still captures the strength of these economies. In order to trade with other countries, these countries must convert their GDP into demand for dollars to import and export.

Likewise, Ethereum does not control the economies of L2 blockchains. Each L2 has complete sovereignty over its own economy. But when it comes to exporting GDP from one Rollup to another, L2 must consume ETH to conduct L1 transactions. Integrating tens of thousands of transactions into L1 transactions is how economic activity on L2 interoperates with the rest 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 an L1 the most fundamental scalable blockchain design, enabling it to grow from a country to an empire.

The cost of developing a new L2 on Ethereum is close to zero. This is equivalent to an empire that can easily demonstrate economic influence in new territories or foreign countries whenever it needs to. Each additional L2 will increase Ethereum's net GDP, and Ethereum is free to add L2s based on market demand.

All roads leading to Ethereum increase the value of ETH.

Ethereum’s L1 and L2 are the federal and state

The L1/L2 structure of modular Ethereum simulates the federal/state structure of the United States. The center is simple and the edges are complex.

The US federal government is L1. It determines the "laws" that all states (L2) abide by. These laws are meant to facilitate interoperability between states. It provides the trust for efficient interstate commerce.

Ideally, the federal government would only need to provide the minimum necessary rules and regulations. All other laws and regulations could be left to the states (L2) to decide.

The same pattern exists in Ethereum.

The EVM on Ethereum L1 acts as a law to coordinate economic resources between L2. This common standard helps L2 share the economic benefits of each other's growth.

Sharing the same L1 protocol allows each independent chain to go from opposition to a united front. Due to the interoperability provided by the underlying L1, the success of a certain L2 Rollup on Ethereum has a positive impact on other Ethereum L2 Rollups and will become a "joint advantage."

The beauty of the L2/states rights model is that each L2/state can decide what works best for them.

Currently, the “states” of the Ethereum “federation” include:

Optimistic Rollup: 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…

There is no limit to building L2 on Ethereum, as long as the EVM interoperability standards are followed. "Simplicity at the center" maximizes "expression at the edge". Let everyone build what they want and inspire creativity.

Facing L2, we have a choice

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

If your state is charging you more in taxes than they provide in services, the solution may be to move to another state. States must compete with each other to keep voters happy and retain their residency. States that do better in this regard will receive more economic resources and more people.

The same situation occurs in L2.

Is the L2 you use charging more? Is it investing enough in infrastructure, is it keeping up with the pace of innovation, or is it lagging behind? If the L2 doesn’t meet your requirements, you can switch to another one. L2s will compete with each other for users and locked volume, and this competition is good for users.

Ethereum Empire

Ethereum is a modern example of a global coordination model. Over time, the underlying structure of Ethereum will be like the United States - maintaining its position by ensuring that global trade is denominated in dollars.

The Ethereum empire will consolidate itself in two ways:

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

Other L1s with lower security join to become Ethereum’s new L2.

These new forks of Ethereum can govern themselves and generate their own economies. But after every few blocks, they tie up their overall economic activity and transact with L1. In exchange for an ETH tax on processing transactions, the security powers of Ethereum L1 are delegated to L2.

The copycat L1s can issue more coins than Ethereum, which allows them to pay lower security fees. But if they want to stop currency inflation, they can always choose to accept Ethereum's protection.

Let the data speak for itself and compare different L1

Ethereum currently provides $45 million in security fees to its network every day.

BTC's current inflation rate is only 1.7%, but it can provide $40 million in security costs every day. So from the perspective of security efficiency, Bitcoin is 2.7 times that of Ethereum.

Solana’s inflation rate is 7%, and its daily security expenditure is only $11 million. Ethereum’s security efficiency is 7.17 times that of Solana.

AVAX’s inflation rate is 5.5%, and daily security fees reach $5.7 million. Ethereum’s security efficiency is 10.4 times higher than Avalanche.

This was before Ethereum switched to PoS (Solana and Avalanche are already PoS). In the future, ETH issuance will drop by 90% while strengthening its security mechanisms.

Competitive chains that fall into the "currency premium" trap

Both Avalanche and Solana tout themselves as low-fee L1s, but this forces them to issue more tokens to pay for security. Solana and Avalanche also do have much higher throughput than Ethereum. They generate more total block space to carry more data. If you have more block space, you have to increase security spending to protect the extra space.

The larger the territory, the more troops you need to guard it. Expanding a large kingdom is like expanding the territory, rather than having people leave the kingdom to build small dependencies here and there.

In order to outperform Ethereum, alt L1s increase L1 throughput and reduce gas fees. The consequences could be disastrous for the long-term monetary premium of these L1s. This design choice creates high issuance while also limiting fee collection. This kills the monetary premium and is a trap for expansion.

In contrast, Ethereum’s scalability on its L2 generates higher L1 fees while minimizing the need to issue ETH.

Issue less and charge more. That's how you create a monetary premium.

Since issuance is already 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 more scarce). The value of ETH rises, and less ETH needs to be issued to pay for security. This reduction in issuance increases the scarcity of ETH, increasing its value and further reducing the need for issuance. This is a positive feedback loop of monetary premium.

Other chains attempting to scale on L1 have a negative feedback loop. Scaling L1s require high issuance, which does not generate meaningful fee income. This forces supply inflation, reducing its scarcity, and puts downward pressure on the currency. It cannot subsidize issuance with fees, as this defeats the purpose of these competing chains. With more and more issuance, the currency’s devaluation (due to inflation) triggers the need for further issuance.

The battle for first place in L1 always tends to be who can issue the least currency to achieve the greatest security. If you create security, you can have everything (users and funds). If security is expensive to you, then your options are limited.

Competitive chains, join Ethereum as soon as possible~

On April 13, people familiar with the matter said that one of Arbitrum, Optimism, zkSync and Starknet may issue tokens next month.

As L2s already in operation, Optimism and Arbitrum do not need to issue coins from an economic point of view. They generate income by selling blocks, and then they pay a small "tax" to the Ethereum economy every time an L1 transaction is made.

Avalanche, Solana, Terra, and basically all blockchains where “security and efficiency are not dominant” have a vulnerability. The longer they allow inflation, the worse the problem will be. In the future, by becoming Ethereum L2, their token issuance vulnerability may drop to 0, bringing immediate benefits and even increased throughput.

People in the altchain community describe me as an “ETH maximalist.” In fact, it is decentralized maximalism that allows this blockchain empire model to exist. Ethereum’s commitment to L1 decentralization and limited blockspace encourages a vibrant and rich L2 ecosystem.

In the end, you will find that all roads lead to Rome, and all public chains lead to Ethereum.