Ethereum and the New Era of the Internet Part II

✨ Hi, I’m Sara Tortoli and this is the July edition of The Plunge Club, a monthly newsletter dedicated to product and human tinkering.

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This is the third issue of the “🕳 🐇 Down the rabbit hole” series, in which I deep dive into different topics. This rabbit hole is dedicated to Ethereum and the Internet. If you have no idea why those two things are connected, and why Ethereum could mean a new era for the Internet, this article is for you.

This is part II of a two-part edition.

Part I focused on the Internet and its evolution, what’s Ethereum and why it could be the herald of a new era for the Internet. It explored what is the impact for the Web as we know it and possibly on some of our favorite apps.

In Part II, we will focus on the economic value of Ethereum, its coin Ether as the Internet native payment system, and the current use cases. Finally, we take a look at what the future looks like, including risks and adoption.

🛑 Important: this article is not in any form or shape financial advice. Always do your own research. A good place to start, it’s from the resources I used to prepare for this article. You can find the links with all the references at the end. 🛑

Where we left off: Etherum as the new Internet

In part I of the "Ethereum and the New Era of the Internet", I have described how Ethereum, the “world’s programmable blockchain”, is the prime candidate upon which Web 3.0 is currently built. Web 3.0 is a decentralized internet that is community-first rather than company-first.

This is because Web 3.0 is hosted on all the computers of the network, rather than in a centralized server/cloud. It’s an Internet that cannot be owned.

Could you imagine Facebook paying its users, while at the same time being unable to leverage your data to benefit advertisers? This is exactly what would happen with a decentralized version of Facebook (spoiler alert, there are already some decentralized alternatives available, which I will cover in a separate issue).

But how can we shift from the current model of the Internet towards this new distributed, more equitable future? What does it mean for Ethereum and how does it affect its value? In Part II, we explore the answers to these questions.

Solving the “original sin of the Internet”

To understand the economic revolution of Web 3.0 and why the current system works the way it does, we need to look again at the history of the Internet. In the early days, no one could figure out a way to make payments through the browser and build economics directly into the protocol. Back then, big companies like Netscape and Microsoft, all tried and failed.

This is because Web 1.0, with its shared protocols (TCP/IP, HTTP, SMTP, etc.), while producing immeasurable amounts of value, failed to capture it. Web 1.0 lacked the technical foundation because of its stateless nature, due to the simplistic architecture of its protocols. To put it in another way, Web 1.0 is an Internet that has no memory. If you ever had the chance to watch the Disney movie Looking for Nemo, the Internet is like the character Dory, that suffers from short-term memory loss.

From a user’s perspective, this would be like using the Internet for the first time every time you connect to the Internet. Imagine the hassle of having to submit your user information and download all your favorite apps every time you open your phone. While we eventually overcame the short-term memory issue of the Internet, with the implementation of cookies and with companies acting as centralized service providers that hold user states on their own servers; there is one additional consequence that could not be solved until recently.

To ensure any type of transaction, you needed to bring in intermediaries that instead could execute, register and store those transactions.

Marc Andreessen, the co-founder of Netscape, calls this “the original sin of the Internet”. In a podcast I heard recently (and linked in the resources at the end of the article), he tells the story of how in the ‘90s he and his team tried to work with banks and credit cards companies to devise Internet payments. It is no secret that banks have problems catching up with technologies today, let alone back in the early ‘90s. Not only they didn’t show much interest, but they also didn’t have the people with the right competency to understand this new technology.

This is why Web 2.0 is advertisement-based. The consequences of not being able to figure out how to monetize directly on the Internet, made it so that its main revenue generation came from advertising. This in turn has many subtle implications.

Because the advertisers are the one paying, all the apps and websites that we see are designed to lock in users and to make us buy more of the products that they are advertising. If you are a product manager, you know this perfectly well. All our metrics are designed to measure some level or other of addictiveness and we have grown very sophisticated in the way we advertise and use users’ personal information to sell more. For all intents and purposes, we users often end up being the actual product.

When Bitcoin was created in 2009, it introduced a revolution. Suddenly it was possible to make secure payments towards complete strangers without any third parties to guarantee the transaction (if you want to know exactly how I have written about it here). This opened the way to a new era of the Internet, as it allowed Ethereum to create its own native digital payment system, that does not rely on any institution and can monetize the network.

Enter Ether, the first Web 3.0 native money

Ethereum has made it possible to solve the “Internet's original sin”, meaning it found a way to natively monetize the web. It has done so by creating its own digital currency, called Ether (shortened ETH). Ether is a coin much like Bitcoin, and it is currently used for:

• Paying for all the transactions that happen on the Ethereum network (known as gas fees)

• A commodity that you can trade and use as collateral, for example in the DeFi space

• A store of value

• Soon it will be used for the governance and the security of the network, once we transition from Proof of Work to Proof of Stake (more on this later)

Having an Internet with its own native money has two major implications.

• First, we can move away from the advertising-based monetization model. As you now have to pay small fees to perform transactions that happen in Web 3.0, there is no need to leverage personal data to advertisers to generate revenues. More, it is not even possible (or at least not as easy) anymore, as data are spread across the network instead of being centralized and are encrypted.

• Second, Ethereum has managed to create a parallel and completely independent financial system, with the creation of Defi and the possibility to issue other coins built on top of the Ethereum network.

But why should we buy Ether and where does its value come from?

Why is Ethereum valuable?

The value of Ethereum can be assessed by taking into account two factors: the tokenomics of its coin, Ether, and the value of the blockchain Ethereum itself, as measured by network growth and use cases built on it.

The tokenomics of Ether currently works very similarly to Bitcoin. Ethereum in fact uses the same Proof of Work system. Miners who successfully create a block are currently rewarded with 2 freshly-minted ETH, plus all the transaction fees within the block. These fees, known as gas fees, incur every time there is a transaction on the Ethereum network, from buying ETH and sending it to your wallet, to minting NFTs. Contrary to Bitcoin however, ETH does not have a max supply and new ETH can be minted indefinitely. This of course impacts ETH price, because the more the network grows, the more ETH will be minted to power transactions, making ETH an inflationary asset.

However, things are about to change (maybe) this week, with the go live of EIP-1559.

EIP-1559 is a proposal that changes how the gas fees auction market works and it is supposed to go live on August 4th. It will see the implementation of a standardized base fee and an optional tip that can be paid to speed up transactions. 70% of the base fee will be burned on each transaction, while the miners keep the remaining 30% plus any voluntary tip. This means that if the network demand is high enough, EIP-1559 will make ETH a deflationary asset. While Bitcoin has a fixed supply, ETH will reduce its circulating supply as the network grows.

Quoting Vitalik Buterin in a recent interview: “if fix supply is sound money, then if you have a decreasing supply, does it make us ultrasound money?”

Speaking the growth of the network, the demand for the coin Ether is inextricably tied to the use of its blockchain, Ethereum. The more Ethereum the blockchain is used, the more the ecosystem grows, the more Ether is needed to pay for transactions.

According to the fat-thin protocol theory made popular by Joel Monegro, contrary to Web 2.0, where value is captured by the application layer and the protocol layer was free for everyone to exploit, in Web 3.0 the value is instead captured by the protocol layers that powers the entire system (Ethereum in this case), whereas the remaining value is distributed in the application layer.

To properly assess the Ethereum value, we need therefore to understand the value of its network. The more the network grows and uses Ethereum as its underlying protocol, the more Ethereum becomes valuable.

Currently, the use cases that are increasing the Ethereum network are:

• NFT

• Stable coins

• Dapps

• Defi

The booming Ethereum Network

While media have toned down on news regarding crazy NFT sales, the NFT market is anything but dead. In fact, as of the first half of 2021, the total NFT transactions are worth $2.5 bln. If this sounds impressive, perhaps even more impressive is the current value locked in Defi, which amounts to a staggering $119 bln as of today, the vast majority of which is powered by the Ethereum network.

If you couple this with the fact that almost all stablecoins available are issued in the Ethereum network, including the most popular by market cap such as Tether, USDC, and BUSD, and that the Dapp market is booming, with startups replicating the most popular apps on Ethereum, it comes as no surprise that Ether trading volume is higher than that of Bitcoin in 2021. According to a recent report from Coinbase, the total exchange volume has shot up 1,461% to $1.4 trillion and this is mainly driven by the massive growth of decentralized finance, which is also drawing the interest of traditional institutions.

While Bitcoin use cases are mostly limited to record its own transactions, Ethereum seems to be keeping its promise to power a new Internet.

Is it really as good as it seems?

Not quite. At present, Ethereum has also its fair share of shortcomings, the majority of which are structural. One of the greatest criticism towards Ethereum is related to the slowness of its network. For comparison, Ethereum can handle 15 transactions per second, against VISA’s 24,000 transactions per second.

This limited capacity to perform transactions creates congestion in the network, causing gas fees to shoot up and driving people to seek out other solutions to complete transactions and avoid expensive gas fees, like the Binance Smart Chain or Polygon, Ethereum layer 2 scaling solution.

This in turn affects the value of ETH and drives its price down.

The Ethereum foundation however has been working to overcome these limitations with a series of network upgrades, known collectively as Ethereum 2.0. Without diving into the technical details, Eth 2.0 will allow staking and the transition from a Proof of Work system to a Proof of Stake system (an event known as “The Merge”). This will speed up transactions and facilitate the governance of the ecosystem, without sacrificing (too much) its security. Network scalability, and therefore the ability to grow and implement more future use cases, will be further ensured by the addition of parallel chains (known as Shard Chains), alongside the main one, where to process transactions, which has the benefit to speed up and decongest the network. Together, the Merge and the implementation of Shard Chains, alongside EIP 1559, are supposed to solve the Ethereum scalability issue and increase the value of the entire network.

However, there is the concrete risk that this might never happen, that Ethereum never gets to upgrade its network because it cannot complete the development from a technical point of view, or because of some changes in governance that might lead to adverse hard forks and prevent the implementation. It is also worth noting that both the Merge and Sharding have been postponed several times, with the first set to go live at the end of 2021 and the second at some point in 2022. Until both are in place, Ethereum will be cursed with its slowness, preventing it from reaching the scalability it needs to power Web 3.0 to its full potential.

Even if Ethereum is successful in implementing Eth 2.0, there is one additional element to take into account.

At the beginning of the article, I have mentioned that Ethereum is the prime candidate upon which Web 3.0 is built today. Note that I didn’t say it was the only candidate. In fact, Ethereum has plenty of competition. From Cardano, Polkadot, EOS, or even Algorand and Solana, many other blockchains threaten Ethereum's current #1 spot.

Some of these blockchains, like Cardano and Polkadot, look particularly promising. Although their development is much behind that of Ethereum, in fact, they still have to launch, both these layer 1 solutions have been created by two former Ethereum co-founders, Charles Hoskinson and Dr. Gavin Wood respectively. Because they built Ethereum, both of them know very intimately its weaknesses and breaking points and have gone on to create their blockchain projects in a way that addresses these weaknesses, while preserving its strengths.

What does the future look like? How we can think of the New Era of the Internet

Part I of this series started with a question:

While it’s not possible to know that for sure, today Ethereum gives us a chance to find an answer to this question.

As this new era approaches, with its risks and upsides, how much is it worth to own a piece of it? What does it mean the transition to Web 3.0?

If we were to make a comparison between Web 2.0 and 3.0 in political terms, Web 2.0 would be a benevolent dictatorship and Web 3.0 a democracy. This is also reflected in the way they are governed: in Web 2.0 companies make decisions for thousands of users, whereas in Web 3.0 decisions are made by open communities.

However, the adoption of Web 3.0 will be neither fast nor clean.

As Dr. Gavin Woods put it: “With entrenched interests controlling much of our digital lifestyles, and interests often aligned between lawmakers, government, and technology monopolists, some jurisdictions may even attempt to make components of the new web illegal. Web 3.0 will engender a new global digital economy, creating new business models and markets to go with them, busting platform monopolies like Google and Facebook, and giving rise to vast levels of bottom-up innovation. Cheap government attacks on our privacy and liberty like widespread data trawling, censorship, and propaganda, will become more difficult.”

According to Chris Dixon however:

“Decentralized networks can win the third era of the internet for the same reason they won the first era: by winning the hearts and minds of entrepreneurs and developers.An illustrative analogy is the rivalry in the 2000s between Wikipedia and its centralized competitors like Encarta. If you compared the two products in the early 2000s, Encarta was a far better product, with better topic coverage and higher accuracy. But Wikipedia improved at a much faster rate, because it had an active community of volunteer contributors who were attracted to its decentralized, community-governed ethos. By 2005, Wikipedia was the most popular reference site on the internet. Encarta was shut down in 2009. The lesson is that when you compare centralized and decentralized systems you need to consider them dynamically, as processes, instead of statically, as rigid products. Centralized systems often start out fully baked, but only get better at the rate at which employees at the sponsoring company improve them. Decentralized systems start out half-baked but, under the right conditions, grow exponentially as they attract new contributors. This is further amplified by the incentives of the associated token, which — as we’ve seen with Bitcoin and Ethereum — can supercharge the rate at which crypto communities develop”

This is what is currently happening on Ethereum. Ethereum is today the backbone of Web 3.0, and besides its intrinsic value, it powers movements towards building digital economies that are own and operated by communities rather than companies.

This value is then captured and distributed through tokens which users can hold almost from inception, without having to wait for a company to get listed on stock exchanges or for intermediaries to act as custodians. By holding these tokens, it’s possible to own pieces of the future Internet.

Whether this future is likely to happen or not, is what we are all called to decide.

👉 📚 All materials and references I used for this article can be found here

The “Now” section

🎧 What I am listening: the episode of Acquired, dedicated to Ethereum. It covers in-depth Ethereum history, value, and use cases. As with all Acquired episodes, it is both highly researched and entertaining, an excellent starting point for anyone who wants to dip their toes in this world.

📚 What I am reading: I recently started A Million Miles and a Thousand Years by Donald Miller. This book is a punch in the stomach, a reminder that we often lead ourselves astray in the pursue of meaningless achievements. Here is my favorite quote so far:

“If you watched a movie about a guy who wanted a Volvo and worked for years to get it, you wouldn’t cry at the end when he drove off the lot, testing the windshield wipers. You wouldn’t tell your friends you saw a beautiful movie or go home and put a record on to think about the story you’d seen. The truth is, you wouldn’t remember that movie a week later, except you’d feel robbed and want your money back. Nobody cries at the end of a movie about a guy who wants a Volvo. But we spend years actually living those stories, and expect our lives to feel meaningful. The truth is, if what we choose to do with our lives won’t make a story meaningful, it won’t make a life meaningful either.”

🥁 What I am doing: July has been a month of deep changes and healing of old wounds. Keeping up with the story metaphor, I am scared and excited at the same time of writing a new chapter.

🧐 Question I am asking myself:

What are the ingredients of a meaningful story?