Alex B joins me on the show to talk about why Ethereum is predictably on a path to centralisation. How does Bitcoin contrast in terms of and long term possibilities?

We chat:

• MEV
• Can MEV be stopped?
• MEV and staking derivatives interaction
• Ethereum as the Myspace 
• Ethereum cannot be ultra sound money
• Problems with utility tokens

Alex links:

• Twitter:  @bergealex4 
• Twitter Thread: Holy **** is Ethereum broken. 

Sponsors: 

• Swan Bitcoin
• Hodl Hodl Lend
• Compass Mining
• Unchained Capital (code LIVERA)
• CypherSafe (code LIVERA)
• CoinKite.com (code LIVERA)

Stephan Livera links:

• Show notes and website
• Follow me on Twitter @stephanlivera
• Subscribe to the podcast
• Patreon @stephanlivera

Podcast Transcript:

Stephan Livera:

Alex, welcome to the show,

Alex B:

Hey Stephan. Happy to be here. Excited to do this.

Stephan Livera:

Yeah. So Alex, I’ve been following you online for a while. I know you’ve been around the Bitcoin space, commentating on things and writing as well and tweeting about, out about things. Do you want to just give a bit of a background for listeners who don’t know you?

Alex B:

Sure. Yeah, I’ve been pretty involved. I would say I guess I started my journey around 2013. Got pretty active on the related social medias and forums. I guess Bitcoin talk and reddit early on, which eventually actually led me to all of it, obviously all of that ramped up as the sort of block size debate started picking up. That’s when I started getting very, very active and that actually eventually led me to an opportunity in the industry as the official troll for hire at Blockstream. So I had a bit of a short stint there, but I think it was very productive, did a lot of good in terms of helping with the community effort with regards to the block size debate and all that then sort of producing documentation and some write-ups about the entire debate.

Alex B:

So that was definitely interesting. After that I had a bit of a hiatus for a couple of years, the 2017 sort of bubble came along that allowed me to kick back a little bit and I started getting a little more active again, I guess last year COVID and all that. We’re all kind of stuck into in front of our computer with nothing much to do, but start shit posting again. So here I am, I got involved again with the industry with company I’ll keep private, but yeah, it’s good to be here interesting times. I mean, obviously with all that’s happening, the way the growth the industry has been growing. Very exciting. Yeah.

Stephan Livera:

Yeah. And I’m curious would you put yourself in the Bitcoin maxi camp, or kind of where are you situated?

Alex B:

Yeah, definitely Bitcoin maxi camp. I tend to have a more I think a bit of a more open mind than others. I actually believe, and this is what led me to some of the stuff that we’re talking about today is like, if we’re going to be a sort of commenting and or even debating with other parts of the ecosystem, I think we owe it to ourselves to have a better understanding. I think of some of the other shitcoins that are around at least to the extent that they may have claim to some of the properties that Bitcoin has. So we’ve seen that with ethereum sort of switching the narratives to clear ultrasound money. And so there are a lot of people that are, trying to refrain from entertaining, these debates.

Alex B:

They make the argument of course, that Bitcoin and ether aren’t competing, which I think is fair. Ultimately, I do believe that as well, but unfortunately they’re sort of trying to hijack the narrative that the Bitcoin has built. And so the new people that are coming into the ecosystem I think are owed some kind of explanation as to how both systems differ. And if we’re going to get into that, and if we’re going to come across as sort of rational observers, you want to have a decent grasp of what’s happening on the other side of the field and be able to put forward better arguments. So here I am. Yes.

Stephan Livera:

Yeah. Great. So yeah, today we’re going to chat a little bit about why there are certain centralizing tendencies inside Ethereum. So maybe you want to just give us a bit of a high level overview. What’s your thinking here?

Alex B:

I guess it all began with that massive Twitter thread that I put up. I mean, it’s been a couple of months now, I guess, and I don’t know exactly how I came around to this writeup. I think I had followed this idea of the staking derivatives particularly the Lido implementation. And I had a sneaking suspicion that this was going to have a massive impact on the dynamics and sort of the incentives around the proof of stake proposition that Ethereum has. And then I encountered, or at least started digging in a little deeper into the whole MEV thing as this was becoming a pretty hot topic in the Ethereum community. And I what I found was I think pretty ugly to say the least and I also also realized that some of the concepts behind it.

Alex B:

And this was sort of validated by me putting this thread out. Is there not a lot of people in the Ethereum ecosystem that are actually aware of what’s going on here. I mean, obviously the more technical circles are keenly aware of it to the extent that they’ve fully recognized it as a challenge. And some of them are actually pretty worried about it, but outside of these circles, although it’s been talked about on some podcasts that people have been putting out some articles on it. It seems very clear to me after putting out that thread, that the larger ecosystem really did not fully recognize the challenges that this whole, this entire concept brought about. So I ended up just browsing through Twitter, digging through a couple of threads and sort of highlighting what were those dynamics and how that could eventually play out.

Alex B:

And I ended up realizing that the combination of staking, the combination of those derivatives and the combination of of MEV led to a pretty grim sort of centralized forces that it seems to me will be dictating the future in Ethereum in some ways. And so I thought that was worthy to share. And given the reactions, this one’s gotten almost 2 million prints now, it’s still running. People are still re-tweeting it nowadays. I mean, I’ve had, now, I don’t know that I’m an ethereum influencer now, but like I have had so many people — probably 4,000 more followers just from that tweet alone. And a lot of them were actually seems like, or at least seems to be ethereum followers. So it’s, although I’m a maxi, it seems that people start valuing my opinion on those things. Not that I’m some kind of expert, but I guess it’s worthy to you know, bring some balance.

Stephan Livera:

somebody’sYeah. So let’s break that down. You mentioned three main ideas, which I think maybe it would be good to explain what those are, and then we can dive a little bit further into those. So you mentioned — let’s call it the interaction between three different things that are all combined in a way of centralization. So you mentioned staking, you mentioned also liquid staking or the staking derivatives, perhaps, and also finally the MEV concept. So could you just give, for people who don’t know what this is like if they just have only ever used Bitcoin, they’d never heard anything about proof of stake. What are these ideas, the staking liquid, staking and MEV?

Alex B:

Sure. Maybe we can start with MEV.

Stephan Livera:

Yeah.

Alex B:

So MEV stands originally for miner extracted value. They’ve flipped the term a little bit for it to mean sort of maximally, extracted value or maximal extractable value. and people that are within Bitcoin only might not be too familiar because the fact of the matter is there’s not many MEV opportunities within Bitcoin. I mean, the opportunities are essentially arbitrage opportunities that are offered mainly because of the nature of these smart contracts in the system, the EVM type such as Ethereum, or really any platform that offers large scale smart contracts, decentralize exchanges and whatnot. And the nature of it basically is this is made possible because some entities have the opportunity to order transactions in a way that will allow for them to essentially front run other participants in the ecosystem.

Alex B:

So obviously if you’ve got a decentralized exchange, then if you’re able to place and given the transparency of these network, you’re able to sort of observe and monitor any transactions that are going through these systems. And if you find an arbitrage opportunity that will allow you to capture a certain amount of value, then if you sit in a place where, as a miner, obviously, or anyone that’s willing to outbid the other participants and get your transaction in a block and confirmed before the other, and you’re able to capture that value sometimes to the detriment of the other participants. I think there’s some arguments that some, some of the MEV is actually positive. It makes the markets more efficient. And I believe that that’s a reasonable argument, but there are also some other concepts such as sandwich attack, for example, that directly target users of these decentralized exchange, for example, and essentially create a situation where they’re a victim of slippage.

Alex B:

Whereas the sandwich attack would basically be that an immediate extractor targets, a user that wants to make a certain transaction on these decentralized exchange. Initially front runs their transaction so that the price of the asset that the users willing to buy goes up because the MEV extractor transaction goes in before his then the user obviously ends up paying higher price for the transaction that he was originally willing to make. On the other side of that, it could very well be that the people that initially bumped the price of that transaction by front running him is actually the one that is selling him back the token at a higher price capturing that inefficiency in the market. And because of that, you also have this dynamic or the people that are being front run sometimes there’s this dire sort of concept in Ethereum where unfortunately, if your transaction doesn’t go through, you end up paying fees, nonetheless.

Alex B:

And so, I mean, given the state of fees in Ethereum at the moment, which can be pretty high, especially on one, doing those sort of swap exchanges regularly from $50 to $200 then people are victims of failed transactions. People are paying 50 to hundreds of dollars for transactions that aren’t going through specifically because they’re being targeted by these sort of MEV opportunists. So that’s, I guess the basis of MEV, it’s a pretty, pretty, pretty interesting issue. It is one that has effectively no limit in the way that it can be gamed, because the more applications that are brought about on Ethereum, the more different games and systems that are being developed, then arises more opportunities for MEV. And it’s not very clear that there’s really a solution for that. And so, yeah, I think that’s, yeah…

Stephan Livera:

I see. So I guess maybe it sounds as you were explaining it there, it sounds similar to what people might’ve seen, that the whole flash boys story, or the whole idea of those like people who set up their trading, right. Really close to a stock exchange, and they try to front run the incoming orders and they try to basically beat, sort of profit off of that. It almost seems like an Ethereum version of that and like the certain tendencies that have been created by these opportunities, because now everyone is trying to go for some MEV. So let’s talk a little bit about why it’s not possible for them. Like, is it possible for this to be fixed?

Alex B:

It’s a sort of I think that’s one of the biggest questions that Ethereum is facing at the moment. And if you actually read some of the work of some of the people that are most involved in at least this so to your comment they’re fully aware that there are parallels here to the extent that they’ve the biggest sort of piece of research that’s been done on MEV in the Ethereum ecosystem has been released on their white paper that they call a flash boys or — anyway, I guess the ultimate, what came out of it was this concept of flash bots, which is one of the solution that they’ve brought forward. And it is a solution that allows for people to essentially bypass the public blockchain, the public mempool of Ethereum. And that came about because as these MEV opportunities started to arise and mostly they did when DeFi started really picking up steam back in, I guess last year, then what happened is you had these people that started spotting those opportunities and started writing bots that would essentially try and outbid each other for those those front running those arbitrage opportunities.

Alex B:

And what this essentially created is really an absolute bidding war on ethereum where the networks started getting very quickly full capacity, the fees started ramping up because those bots would obviously broadcast their transaction and consistently outbid each other. And so flash bots was created to sort of work around that by creating this new auction system for MEV products, MEV extractors to essentially bundle transactions and propose them directly to the miners, essentially off chain. So they’ve created this network they’ve created this sort of off-chain mempool, if you will, that allows people to, it allows these extractors to share the, their transactions they’re bought in one little transaction and bid for them without essentially filling up the Ethereum blockchain with those transactions and incidentally you know, raise the fees.

Alex B:

It has achieved probably to a certain extent the purpose that it was designed to. So it’s definitely at least for awhile decreased the fees and the activity of these spots on the public Ethereum chain, but that does not without consequences because obviously now what you’re left with and this flash bot idea, this sort of flashbot protocol, if you will, has been adopted widely by pretty much all of the Ethereum miners. I think last time I checked there was like an 85% uptake. It could very well be a hundred percent uptake at this point. And obviously the danger here is you’ve got a very permissioned network. So to be able to participate into the flash bot network or protocol, if you will, it is completely permissioned. And it is also a an obvious sort of central of failure.

Alex B:

I mean, this whole thing is ultimately hosted probably on the AWS servers. And so you have this parallel sort of mempool. That’s running on Ethereum, that’s managing a significant amount of the Ethereum current sort of transaction economy, but that is fully controlled by a certain group of individuals. Obviously they’ll say like their incentive is for that network to keep running and be running in this sort of in a way that’s beneficial to the Ethereum ecosystem. But it’ll be interesting to see how that scale that scales in the future. Now, obviously they’ve came up and they’re still working on other potential solution to MEV. There’s been talk of trying to make that network a little less permissioned and integrating it with, for example, Intel SGX secure enclave. So as to make it a little more, I believe so is to make it a little more difficult for people to gain that network so that there would be sort of be a cost of attack is my understanding.

Alex B:

And while that might be a sort of viable solution, you also have a problem where, I mean, it seems to me like it’s the long running story with Ethereum is that they put forward solution sometimes in the haste because they uncover a problem that needs fixing now. And by putting together that solution, they don’t fully understand or study or care about the long-term incentives or the long-term consequences of these solutions. And by implementing those, then later down the road, they realize that they’ve only created more problems. I think generally the consensus within the Ethereum community, or at least some of the, some of its leading researchers is that MEV is something that will be present, possibly forever. There’s no sort of catchall solution to it. So this is definitely something that they don’t have to deal with foreseeable future. Yeah.

Stephan Livera:

Then I guess, is the argument essentially then that it causes this centralized, like, I guess, bringing it back to what’s the problem, right. So I think centralization of the cryptocurrency is obviously an issue. And I think maybe this is a good point here just to kind of spell out in 2017, there were big debates being had about Bitcoin and whether there would be centralization pressure, it might be, you could spell out some of those even some of the different arguments I heard were for example, that miner, the additional latency caused by larger blocks would cause miners to have a centralizing pressure because they might want to be in the same location, which again, is another centralizing force. Did you want to elaborate on any of those ideas in the Bitcoin context for say 2017 before we then compare it back to what’s going on in Ethereum?

Alex B:

Yeah, so that was definitely, obviously one of the concerns back then there was a lot of work that was done in sort of trying to reduce that latency and Bitcoin also had, it’s sort of also had for a while it’s sort of parallel broadcasting network for blocks, although the transaction broadcasting was still done on chain at the L1 level, but certainly yes, as, as blocks would have increased in size, then it would have created this issue where less well-connected miners could have had their blocks orphaned because of the lack of better connectivity. And so it would obviously favor larger pools. And so it would ultimately lead to consolidation of this hashing power, the obvious sort of other danger there was that by creating a lot of these larger blocks, you would make it sort of resource intensive for validating nodes for the individual that are running the validating nodes and thereby again, sort of compounding the centralization by making it more and more difficult.

Alex B:

Obviously, I guess the small blockers won that debate. And we’re well past that nowadays. I think it’s pretty well recognized that the way we’re able to scale is through layers. The situation is, although not entirely dissimilar certainly different in terms of how these all, how MEV and the staking derivatives thing would play out. So maybe to introduce the staking derivatives idea, if you want me to go there, is so obviously with ethereum considering, or considering [inaudible] actively moving towards the proof of stake implementation. It’s not clear exactly when they’ll get there. It seems like it’s getting pushed back every other month, but that’s ultimately their target. And the idea originally with staking is that you would it would require a sort of minimal capital amount of 32 Ethereum for an individual to be able to stake and by staking, what we mean is that you essentially lock up quote, unquote, your capital into this contract that allows you to affect what they’re trying to do is replicate the concept of proof of work really, but using capital rather than proof of work, energy expenditure.

Alex B:

And so by staking, by allocating your capital to those staking contracts, then you get the opportunity to validate those blocks, those transactions on the network. And of course, because of that year, you earn a reward, the reward being the issuance and the fees that come from the transaction activity on the network. Now this obviously created this situation where it obviously becomes a little bit prohibitive staking to be done if you absolutely need 32 ETH, which is what by a hundred thousand dollars at this point in time. And so people came up with ideas to sort of democratize, I guess the staking activity. And one of these ideas are just staking pools. Staking pools are the first order solution where just as with mining pools in a certain way, whatever amount of ETH you have available for staking, you contribute to essentially a pool of funds.

Alex B:

And this pool of funds is sort of maintained by an infrastructure solution that runs their own validators. And so they’ll use whatever ETH you have available for you to be able to participate in this activity, but people obviously, ethereum being ethereum, people quickly wanted to see if they could come up with a sort of more, again, quote unquote, decentralized solution to this. And I think last, I mean, it’s probably been a work in progress for a couple of years, but what they came what they came up with is this idea of this decentralized staking protocol. So you actually have a contract that effectively does the same thing that a, I guess, a centralized staking pool would do. And so then they collect your material into this contract and they allow for anyone to be staking. Probably the most important or popular implementation of this.

Alex B:

And Ethereum is the LIDO protocol. And so the LIDO protocol, as in, on one hand, yes, this the staking contract that people can contribute to, but they also are governed by the LIDO DAO, the LIDO decentralized autonomous organization, the LIDO DAO has their own token, which is used for governance purpose which allows the participants of this LIDO ecosystem to sort of vote on proposals. But most importantly, the LIDO sort of governance organization is the one to say to effectively select who are the validators that are sort of allowed to use the capital that is staked to the LIDO contract and distribute that for staking. So there are several validators right now, not clear exactly what the amount is, but certainly half a dozen that are but they’re effectively handpicked by this DAO organization. Obviously we’ll get into how this becomes a very challenging going forward.

Alex B:

But this is generally the idea, right, is that you allow for the democratization of staking by enabling anyone in the ethereum ecosystem to be able to do this. Now, one of the other innovations that they’ve brought about is this idea of the staking derivatives and the staking derivatives is a game changer, really, in terms of the security infrastructure and the security dynamics of Ethereum. Because the initial idea with staking is that you would freeze up your capital and this material that is staked into validating contracts obviously cannot be used for other purposes. It is quote unquote dead capital. And so they quickly realized though that if you have this contract, then you can use the Ethereum that is staked into this contract and issue a one off or one derivatives. So they have this wrap token that whoever deposits into the LIDO contract gets in return one, they call it STE. And so this unlocks the liquidity, obviously this allows for people to not only participate in the staking, but then get a token in return that they can use to gamble away and use for all DeFi purposes so as to try and compound the yield that they’re getting.

Stephan Livera:

So it’s almost like they want to, it’s like having your cake and eating it too. And because the craze is all about yield and defies just it’s like Fiat degenerate gambling, but just put into the crypto world. that’s like a weird way that this whole thing is growing, isn’t it?

Alex B:

It is. And I think, well, from my reading, I think a lot of people sort of anticipated those contracts, those taking derivatives to come along. It seems pretty clear to me that from day one, probably at least the smartest people in the room, sort of realized that there were very real challenges to this because in a certain way there’s been this talk of, there’s always been this talk with proof of stake or this sort of ‘nothing at stake’ issue. And this really reintroduces this I mean, thinking derivatives really reintroduces this problem where it really brings down the actual costs of staking on the system to the extent that they are potentially effectively negligible. And so a lot of the security design that was put into proof of stake, a lot of the sort of economic, I think, reasoning that was done initially always sort of accounted for the fact, or always sort of made the assumption that only a certain proportion of people in the Ethereum ecosystem would be willing to stake because obviously because it freezes up their capital.

Alex B:

So you have this narrative that like all this only as strongest bulls will be staking and what not. And this sort of really flips the script on it’s head where you’ve created this opportunity for practically every single person, every single Ethereum token owner to be staking. And I think it’s not well understood what the full outcome of this are from sort of a game theoretical standpoint. But I guess ultimately this realization, I guess, this combination of the staking derivatives incentive, this dynamic and what I had previously also observed in the MEV sort of challenge really sort of reinforced my belief that it was inevitable. It seems to me that proof of stake could potentially even be more centralizing than even some of it its strongest opponent would have anticipated, and we can go into how exactly that would play out.

Stephan Livera:

So yes, a proof of stake could be even more centralizing than its strongest opponent may have argued. So what are, I guess some of the consequences of that staking centralization?

Alex B:

There are a lot. Obviously there are a lot. And so maybe before we go into exactly how or the consequences of it. I think it’s worth highlighting again, how these two concepts sort of compound the interaction aspect. Exactly. And so starting with MEV, the problem with MEV is that it is a very, very, very specialized activity. I’ve explained I’ve sort of laid out the case before that as more applications come around in the Ethereum ecosystem, there’s always new MEV opportunities that are being created. And for someone to stay on top of these MEV opportunities, it is a full-time job. It is an activity that requires deep knowledge of the Ethereum protocol in a way that very, very, very few people in the ethereum ecosystem actually have. And so I think I put this quote in the original thread where it was an excerpt of a comment that Vitalik made on an article on medium that sort of decried or at least complained about the sort of MEV situation.

Alex B:

And I mean, maybe to quote him, but Vitalik himself said, I mean, the extraction is naturally a highly economies of scale and centralization pro activity. And it involves writing and constantly maintaining advanced software. It’s arguably even more, a high fixed cost than mining itself and definitely more so than proof of stake. So obviously given that fact and given that MEV ultimately nowadays is what makes the difference between a usually profitable Ethereum miner and a less so profitable one. And so the actors that are, will become experts at MEV, and that will have the resources to constantly reinvest into this MEV activity will ultimately come out on top. And that will be even more true. And so one of my reasoning is that will be even more true in a proof of stake ecosystem.

Alex B:

And one of the reason why that is, so is that the larger your stake is in ethereum, the more opportunity you have to be able to capture this MEV there’s this sort of variance concept where the larger obviously the larger miners have an opportunity to create more blocks. There’s this sort of randomized within proof of stake. There’s this sort of randomized selection of validators that are adding blocks to the chain. Obviously, if you have more stake, then you’re more likely to get picked, and then you’re more likely to capture more MEV and also within proof of stake when they actually delegate the, at the stage when they actually delegate the block producers within a certain round, if you will, there’s not only one validator that’s selected, there’s a couple of validators that are picked within a certain round.

Alex B:

And if you actually, if there’s relations between those validators, there is opportunity for them. There’s this sort of opportunity that’s created within proof of stake for them. That’s not present within the current proof of work ecosystem that allows for them to coordinate around sort of MEV opportunities that can be executed across different blocks. And it really, so it really introduces a sort of a new, not necessarily attack vector. I guess some people wouldn’t be happy for me to call it that way, but certainly a ultimately a way for larger centralized validators that are able to coordinate between each other to capture more MEV than their counterpart. And that is especially true within a staking derivatives environment.

Stephan Livera:

Let me just try and explain that to make sure I’ve understood that. So the idea is there’s this MEV, so this idea that by a block producer or miner selectively reordering transactions, they could potentially benefit themselves, by also concurrently going and doing trades on some of these quote unquote decentralized exchanges that allow them to frontrun the ethereum transaction user at that point. And so what you’re saying is also that given the way the system is set up, it’s very possible, and maybe we could argue even probable that those block producers might then start collaborating with each other to start doing multi block MEV opportunities or taking advantage of those. Correct?

Alex B:

That is correct. And obviously the obvious argument, at least from ethereum proponent would be, well, this would be detrimental to the system. This would you know potentially bring the value of the asset down. if people if you know, the validators do perform those kinds of activities in a way that’s too malicious. But I think there’s a, there’s a very fine line between sort of the profit incentive that is made available by these opportunities and the way or at least to the extent to which the sort of ecosystem — the ethereum ecosystem is willing to tolerate it. And it’s been increasingly blurry. And there’s a lot of debates between some people in that ecosystem as to whether or not even just something like flash bots is actually beneficial or detrimental to the ecosystem.

Alex B:

But yeah, I mean, overall, the underlying bottom line is that the larger validator you are, the more stake you have within the proof of stake, the more MEV opportunities you capture, especially if you’re sort of able to coordinate or collaborate, or if your staking infrastructure is created in partnership with you know, people that are very close to the protocol. And that’s what we’re seeing play out with LIDO, for example, LIDO, for example, one of the main components of the LIDO protocol is Paradigm. Paradigm is pretty well known, at least within the Ethereum ecosystem. They’re not as active in Bitcoin, although they do to their credit, I believe sponsor a couple of Bitcoin developers. But all that to say is paradigm actually bought 10% stake into the LIDO DAO and paradigm has hired has within its team.

Alex B:

You know, some of the most proficient ethereum developers, some of the people that are closest to the core protocol. And so this allows them, the ability to have a very deep understanding of MEV and the opportunities that might arise. And so you have you know, this introduces to proof of stake, a sort of a dynamic where you’re not only concerned with your staking infrastructure and maintaining those computers on top of which the staking contract run but you need to spend capital on this expertise of MEV. And obviously this capital might not be available to everyone, but the scarcity is very much in the resources that are available to people that are actually able to write an execute the code that can capture this MEV. So that’s the centralization dynamic for MEV.

Alex B:

And then the relationship that this has with staking derivatives is basically that by allowing for a staking derivatives contract to be issued in exchange for staking ethereum, you create a network effect, create an liquidity network effect. And so it is not beneficial for people that are interested in those staking derivatives to be using the relatives for different providers. Obviously, if you have — or maybe to, just to jump back a little bit, like how does the staking ecosystem looks like nowadays? Well, to be perfectly fair, LIDO itself, the protocol is still a small fraction of the Ethereum that’s currently staked into sort of this the beacon chain they call is this sort of pre-merged proof of stake contract. So it’s still a very small fraction. It is the fastest growing pool of funds for ethereum.

Alex B:

I believe that I’ve read that in less 30 days, 50% of the ETH that were staked into this beacon chain were actually staked into the LIDO protocol. And, but nevertheless right now probably the most significant entities are exchanges. Kraken does a lot of staking. They have a significant portion and if Kraken were to offer their own staking derivatives then there’s this situation obviously where the staking derivatives from LIDO and the staking derivatives from Kraken, they’re not tangible. And so no one is better off by using those different derivatives. These revenues are essentially becoming the money that is available within the economy for Ethereum. So obviously liquidity begets liquidity. And so there’s this very, very, very strong network effect, incentive playing out. And if that holds true, and if the LIDO protocol through their proficiency and their expertise in being able to to capture the MEV, become the sort of de facto staking protocol for Ethereum, then there’s very little reason for anyone that’s willing to stake to use anything other than LIDO.

Alex B:

And so it is my feeling that this sort of growth in LIDO and for people that are holding LIDO token, that’s probably very bullish. But there’s, it seems to me like there’s this very, very strong incentive for people that are interested in or all the capital that is available for staking to effectively converge with time into the LIDO contract, because it has all the benefits of staking. It has all the benefits of sort of ecosystem integration, where they have you know, they allow you to use your ledger to be able to stake. They have all these integrations with all of the DeFi applications. But ultimately their biggest value proposition is the liquidity that is created by their staking derivatives.

Stephan Livera:

Yeah, interesting stuff. And so it’s like, it reminds me of how our friends, Marty and Matt, over at rabbit hole recap often talk about the centralizing pressure that proof of stake has even in the exchanges, because the exchanges might be holding lots of coins and giving incentives to their customers to leave their coins on the exchange. So that exchange’s staking does better. And so in what you’re outlining here is like that on steroids, right. Because it’s that another level, because now it’s staking derivatives, which causes even more of a centralization pressure. So, yeah. would you say that’s an accurate summary then, or..?

Alex B:

Definitely. And I think originally that was one of the concern, right. And that’s how people were seeing the proof of stake centralization playing out is obviously you’ve got these massive amounts of ETH on centralized exchanges, and they’re able to sort of offer that yield to their customer without their customer having to do much of anything. And it’s not obvious at least that some of the Capital will necessarily leave those exchanges, but I feel it feels to me like the incentives are very much there for them to do so. and obviously these exchanges, one of their biggest downside is that they’re not able to offer. They’re certainly able to offer sort of a similar derivative in the sense that they can allow at least even just within their own exchange for people to have that collateral in the staking in the same contract.

Alex B:

But potentially offer that derivative product on exchange. They could also have their own on chain token. But obviously it’s not as quote unquote trustless as the staking derivatives that’s offered by a on chain contract such as such as LIDO something else also. That’s that’s very interesting and sort of it just, it really just dawned on me in the last couple of days, that compounds the centralization, that fact is that you have I think it’s always been very known that this notion that the largest holders of this staking ecosystem you know, this sort of rich get richer effect where they only have to sit on their coins and then they continue to earn that yield without having to do much of anything that’s actually compounded by offering that derivatives, because then you unlock the capital that was originally set to be sort of dead capital.

Alex B:

And you allow those people to use that capital and go back to the DeFi ecosystem and potentially lend that capital on things like compound which is a DeFi app. and obviously the more capital you have available to lend the more profit, the more yield you earn and like, and so by the same effect, the more that profit you get, the more you can reinvest into staking, the larger your share of the pie grows. And so, yeah, it’s a very, very, very, I mean, it’ll be interesting to see how it plays out. I can’t claim that I predict the future, but I think there’s a strong case to make that ultimately this all converges into a lot of the capital being, and this is not only my opinion. Funny enough, the people at Paradigm have actually put up a blog post in last few months that outline this sort of decentralized staking protocol infrastructure.

Alex B:

And they make the exact same case. They make the exact same case that there’s network effect at play that could very well lead to up to almost a hundred percent of the Ethereum being staked within the LIDO contract. And it make that case, I think without, at least in this article without fully sort of acknowledging and knowledging these sort of systemic risks that this introduces. And one of the ones that I think they’re aware of, they’re definitely aware of it because they’ve just put forth a couple of weeks back and you article claiming how they would address this problem. And the problem is that if you have a majority of the stake that is allocated to the LIDO contract, then the people that own the actual DAO token, the LIDO governance token are effectively the ones that are handpicking the validators for the entire Ethereum ecosystem, right?

Alex B:

That is a massive problem because this introduces even regulatory risk because some of the owners of this DAO contract are public facing entities. And so by voting, using their capital they’re able to decide who gets to potentially ultimately validate the Ethereum chain. And so to be fair, again, they have acknowledged that risk they claim to have a plan to sort of to sort of diminish this control that the DAO would have on the validator selection they claim that they will use on chain metrics to create a reputation system across the validators that will then sort of make it almost permissionless I think if it works out, it’s a pretty decent idea, but from my perspective, it’s not within the incentives of the DAO token holders to enable that because if you create such a permissionless system, then the actual DAO loses all of its purpose because the governance, ultimately of that protocol, the value that is it is essentially this curation of the validators.

Alex B:

But then when you put this curation out of the hands of the DAO token, what’s the value there? Why would the validators, this group of validators decide that hey, we don’t want to pay any more fees to the DAO? Why would we share our revenue of the pie with people that are effectively providing almost no value at all? And so they might, and given obviously that these smart contracts are all public, anyone can copy and paste them. You know, you’ve seen that with uni swap and with the sushi centralized exchanges, why would the validators decide? We don’t need the DAO anymore. That’s switched to a new protocol and then we’ll implement this sort of permissionless curation system. And then all of the DAO token holders are, are left with nothing with something that’s worth nothing. So it’s not clear to me that it’s incentives compatible.

Stephan Livera:

Yeah. So fundamentally then it just points towards more and more centralization in the ethereum system. And so if the Ethereum validators end up being handpicked, what are the consequences of this?

Alex B:

Yeah, well, obviously at face value, some of the consequences are pretty obvious you have this organization, like I said, that it effectively devolves ethereum into what’s essentially called a sort of DPOS system, a delegated proof of stake system, a delegated, meaning that those who hold the coin actually gets to vote on who is validating the chain. We have some experience with these DPOS system. They’re not very decentralized. The target that is put on the token holders is a lot more obvious and a lot more pervasive than they are within a sort of or at least at least the current sort of proof of stake implementation of ethereum. And one of the danger, one of the main danger probably is that this very strong potentially challenges the claims of ethereum with regards to their monetary policy.

Stephan Livera:

So it’s not ultrasound money?

Alex B:

Well, I mean, exactly, they already have this history of switching their monetary policy around in different ways. Now their claim is that they always have targeted a sort of more deflationary issuance. They have this concept that they call it the minimum viable issuance, which is very hand-wavy implementation of something that has actual, no inputs. It cannot be codified. It’s something very, very vague. But obviously there are target and the narrative that they wanted to entertain is that you will end up with a system that’s deflationary. And their argument lately has been that this — it has been that this EIP 1559 that has been introduced is the last change they’ll make is probably the argument is that the monetary policy with ethereum will calcify after this because we have all the tools that are needed for us to probably go into the long term and have an incentive compatible monetary system.

Alex B:

The problems that I see with that, obviously, if you concentrate the validators set, especially if you allow for most people, potentially a hundred percent of the people in Ethereum to be able to to validate, the more people that are validating the less stake they act, the less issuance, less rewards each individual player actually is rewarded with. And so you could come to a point in that sort of dynamic down the road where the validators aren’t too happy anymore with their rewards. They might get to claim that the issuance is not enough for them to be incentivized, to actually you know, stake. They probably are earning more stake within potentially DeFi activity. And so they will say, well we’re in this, a consequences of LIDO set of validators, that potentially is very centralized.

Alex B:

We’ll say, Hey guys, we’ve got to flip the monetary terms around a little bit, but let’s increase that by a couple percentage point, like, what’s the big deal, right? You’re going to incentivize us to continue staking and everyone will be happy. And if the history of Ethereum is to be trusted, I guess it’s not clear that by the time this happened and the scale at which ethereum community will be, it’s not clear that everyone will sort of raise up and work against that because there’s a very real danger that you’re effectively raising up against the overlords of the system by the time the validators become that big, especially if it’s concentrated against such a small set of validators, or even just a single protocol, it becomes a very risky business to say, like a, just F off like you’re not going to get what you want.

Alex B:

Because then you know, then they might decide the validators might decide, okay, well, we’re not going to get the issuance change, but then watch for your MEV watch for your transactions. You know, like we’re going to be doing like we had previously sort of avoided doing detrimental MEV activities, but we need more revenue. So now we’re going to do whatever we need to get those revenues. So it’s a challenge. And also like one of the things that the validators do, one of the things that is an obvious downside to Ethereum, that’s always been very clear to me is that the miners of Ethereum actually control the block size they get what they call the gas limit is effectively decided by the miners. Historically it’s been something that was done in coordination with the Ethereum foundation, the ethereum core devs would say like, okay, we feel that it’s safe to increase the block size a little bit, and the miners would be compliant and say, okay, let’s do that.

Alex B:

But then if you and to my knowledge, this is not going to change with proof of stake. And so obviously if you have, again, this usually centralized entity that control the block size is like what’s to stop them from increasing, increasing and increasing the gas limit, thereby not only concentrating the validators set, but also it’s important to remember that although there are valid these validators within Ethereum, there’s also supposed to be this sort of dynamic, this balance of power, where you also have the Ethereum nodes, the validating nodes, the ones that supposedly everyone is able to run. Obviously we all know that that’s a big challenge within Ethereum itself already at this point. And, but down the road you know, the validators are giving the opportunity to blur — to sort of diminish this balance of power and concentrate their control even more by slowly pushing out at the edge, the validators set. So that I mean, down the line, who knows, maybe there’ll be the only ones like the validators themselves will be the only one able to run the Ethereum nodes at which point there’s effectively no distribution of power, but this, you have this one single entity that controls all the rules within Ethereum.

Stephan Livera:

Yeah. it just seems to me like it’s recreating the world, it’s just recreating all the problems that we don’t like about Fiat. And that’s just, well, I mean, look, the ETH huffers might have some counter-argument here, so, but fine, whatever. And now one other idea as well, so related to this centralization idea, what about in the case of some big failure, if there were to be some big systemic failure or some kind of network split, could you elaborate a little bit on that and what the centralization of Ethereum might mean for that?

Alex B:

I think that’s one of the biggest downside of proof of stake. And it’s funny this topic of this topic came up last night. So Dennis Porter had a bit of a debate with David Hoffman from bankless, from the bankless podcast. And this exact conversation came along and it was a little astounding to hear David’s reply and effectively for proof of stake, there’s no answer because if you dig a little bit into this entire concept, if you dig a little bit into the proof of stake implementation, it’s sort of — they refer to it as weak subjectivity. So it doesn’t actually secure the past. It only really secures the present. And so at a certain point in time, if the network forks and especially if the network splits the longer the networks split, the harder it is for the network participant to be able to ascertain exactly which chain is the valid one.

Alex B:

And so by that effect, if ever this happens. And obviously it’s also David’s answer to that. Basically yesterday was, well, the community will just get together and we’ll make a decision as to which chain is the valid one. Well, first off, obviously, if you’re going to do that, you need to be validating the chain. You need to be actively running a node, which might get further and further, more difficult down the line with Ethereum. But also like, and I guess this is one of the answer that comes along every time that an issue was brought is brought up with Ethereum is the community. We’ll figure it out. Everyone is working within Ethereum’s best interests. And so it’s participants will figure it out. And it’s very obvious to someone that sort of studied the systems and actually understand why they were created in the first place.

Alex B:

Is that because the concept of community does not scale, you cannot reach. There becomes a certain point in time where the community becomes too big. It’s like saying if the internet breaks well the community is going to figure it out who exactly is who is the internet community here? Like, it will start losing value sorry, it will start losing, losing sense in the future, it is already sort of it’s already happening you know, even within the Bitcoin ecosystem, like you have different, different factions, people are getting interested or excited about certain projects. People, some people are not, and that’s good, that’s healthy, that’s decentralization playing out, but decentralization ultimately brings about an inability to coordinate. And so obviously then what happens if something, if a split happens within proof of stake? Well, since there’s no sort of objective measure of that you have with proof of work with the weight of the chain, if there’s no objective measure of what is the valid, which one is the valid chain then it all comes down to a sort of popularity contest because who holds the most ETH gets to decide who are the biggest validators.

Alex B:

Again, they get to decide which one is the valid chain. And it doesn’t matter if it isn’t basically, if they’re the provider of all the infrastructure you really have no choice, but to play along with them, because otherwise you’re left with a chain that has very little security or very little actual capital dedicated to them. So that’s a major concern. I don’t know how to get around this one. I think, it will become increasingly obvious that the community answer is not going to cut it. And so, yeah,

Stephan Livera:

Yeah, especially if there’s competing interests, because there might be people like, supposedly for Ethereum it’s going to be the whole smart contracting, so on, and there would be people on different sides of the arguments saying, Hey, I’ve lost this much money. And the other one would be saying, no, I’m going to lose all this money. And then it’s going to be like, well, who’s interest do we protect, does the community decide? And then it just, what are they even protecting at the end of the day?

Alex B:

Exactly. And I think it’s interesting that you bring to bring up this argument, because, or from my perspective, we’re seeing that split already sort of occurring in the Ethereum community where they’ve introduced this sound money narrative, this ultrasound money narrative, because they see how well it’s working for Bitcoin, the number go up, that’s working well. But in the other hand, you’ve got this dynamic right now where the actual original utility use case of Ethereum the ability for people to perform economic activity on the chain, through whatever dApp, DeFi app or whatever it is, it’s become challenged or challenging because of the fees on the network. Obviously they’ll claim that they have a solution to the, to the fees and network, but you’re seeing this divergence already from people that are just interested in minting, those NFTs trading, those NFTs around using those DeFi applications speculating in such a way that it is becoming uneconomical to do so on the Ethereum chain.

Alex B:

And so that is why you’re seeing this emergence of these alternative layer ones, Binance Smart Chain, Solana, polkadot, and all of that. And so you have this divergence in interest within the Ethereum community, [inaudible] of the sound money proponent, and for the sound money proponents to be correct, for the claim to be validated, you sort of need high fees. They really want higher fees because the higher fees they have the more Ethereum gets burned. And so the more deflationary it becomes. But then on the other hand, you’ve got these other guys that just want to be able to transact for as little fees as possible. They want their activity to be as efficient as possible. And so they’ll gladly move their activity across different chains if it allows them to do that. And so, like you said, down the line, competing interests, what happens is if there’s a fork, it’s not clear that everyone will sort of reconcile together. So you might be left with ultimately two different chains.

Stephan Livera:

Yeah. And that’s not a winning outcome for them. And potentially, like, I think you were touching on this before that it might be painting a regulatory target on the back of Ethereum companies and Ethereum entities as well.

Alex B:

Definitely. I think there’s a lot of ways you can conceive how this could happen. I think one of the obvious ways. And I’m not one for supporting regulators to to attack these networks because you don’t want to play favorites. Obviously if they start being adversarial towards one network, nothing stepping down from being adversarial towards Bitcoin, but the target is just there for Ethereum. And it’s increasingly the case. If you consider the DAO organization because it’s very clear to me that the DAO token is obviously a security — it is inarguably a security. It is something that allows a claim on future rewards that is offered by I mean, it is offered by a ultimately in the beginning centralized team. Of course now that’s the whole idea they sort of distribute this token within the ecosystem and then they get to claim that, oh, well it’s a centralized, there’s no centralized.

Alex B:

Sure. So it’s not really a security. I don’t think that’s a very convincing arguments for the regulators, but ultimately even if it’s not a matter of securities, you expose through these organizations, through those validators the validators in Ethereum, these are keys. This is capital that’s held on servers that needs to be online a hundred percent of the time, 24/7, because if there is any downtime to their activity, there’s immediate repercussions for them. They get there’s this concept of slashing. If you’re a validator and you go offline, and somehow that has an effect on the network while then you get to pay for that. So they need, so obviously then this entire infrastructure, it becomes a little hard to be able to manage that without putting a regulatory target on your back.

Alex B:

The ideal, some people will say that it’s the same for mining, obviously, mining being large operations, they’re subject to a sort of government enforcement. We’ve seen that work with China, and it’s going to be interesting to see how exactly it plays out. But the one major difference really is that with mining or the government might come along and say, okay, well, you’ve got to burn your mining facility down. I’m sorry. There’s nothing we can do. Ultimately. Yeah, obviously the miners, this exact miner is affected potentially the security to a certain extent of the network is affected. But ultimately all other miners will come up to pick up the slack. The problem with the Ethereum staking nodes is that you hold the private keys there and if this gets compromised. And that’s why some of the arguments about potential proof of attacks from the validators, the argument is always that, well like miners, they don’t have the incentive to attack the network. And so they’ll play along and they’ll be nice to everyone. But the problem is that if you paint the regulatory or sort of adversarial target on your Ethereum staking notes, well, if someone comes along, not only can they burn down your infrastructure, they can actually steal they can actually compromise your private key at which point they control directly the capital. And again, they can sit on that capital perpetually sort of reinforcing their control over ethereum.

Stephan Livera:

Yeah. That’s, it’s pretty concerning stuff. Well, it should be very concerning. So for any ETH person or proponent and so I think to contrast with Bitcoin as well, because obviously this is a Bitcoin show, and I think the idea is to give people some context or give them some ideas on what are the differences there to understand how is Bitcoin structured differently? So maybe one area would be to contrast with Bitcoin miners. And so obviously Bitcoin is openly a proof of work system. Do you want to outline any differences there?

Alex B:

Yeah. Well, there are very major differences and this comes back to what I just said is there’s this notion of and especially true what you said, the exact same thing earlier, especially true with staking derivatives, where there’s kind of a free lunch dynamic playing out with staking where you know, you capture this capital overtime, you might already have this capital from ICO days. Like how much percentage of the Ethereum that’s been allocated to certain entities that they’ve been sitting on since essentially the ICO and not only probably have they been sitting on them, but then this was essentially free capital for them to down the line leverage during the ICO boom, the DeFi boom. So obviously you have this concentration of this concern about the concentration of capital. And what happens is that the way staking is designed is obviously that you have no expenditure to maintain that validating infrastructure.

Alex B:

You sit on your capital again, increasingly too, with the derivatives, you sit on your capital and you earn more rewards. It’s a bit of a cantillon effect at play really. And something that Bitcoiners will be obviously very familiar with, but like you said, it really creates a very strong parallel between Ethereum, as it is designed to turn into and Fiat’s system. And the obvious difference as you point out is the permissionless aspect of the proof of work. We’ve seen that throughout its history the biggest miners at a certain point in time. If you if you look at the ecosystem four years afterward in the future, they might not even exist anymore. They like there was this entity back in 2013 or something like GHash, they control it to a point almost 51% of the actual ashing power.

Alex B:

And you look at it, you look at it today. There’s no Ghash on the network anymore. And I mean, you had bitmain for like very long period of Bitcoin history been made through the Ant pool. They control a significant stake in the mining infrastructure while who’s the leading miner. Nowadays the leading mining pool is probably moving. It’s a little volatile obviously, but recently Foundry the mining initiative from DCG, from Barry Silbert. Actually it became probably the first mining pool the first American mining pool in Bitcoin history to actually hold the number one place. So it’s a very competitive environment and it’s increasingly the case given, and it will actually become increasingly the case in the future when margins will probably go down nowadays, miners are increasing are enjoying a very, very, very preferential sort of dynamic that’s especially true because of what happened with the mining shutdown in China, where the difficulty went down so much the existing miners, the margins are ridiculous.

Alex B:

It’s not going to say the same for a long time down the road is mining further and further professionalizes the margin will be razor thin. And then so it becomes a game of, who’s got the cheapest power, who’s got the, who’s got the lowest CapEx. Who’s got the most efficient machines? And so it’s a situation that’s always in flux. And so you never have this one miner that will have a stake on the network that they can never — where no one can replace them. So I mean, to me, it’s a very massive it’s a very beneficial aspect of proof of work. It’s actually how it thrives toward further and further decentralization is it becomes this very capitalistic system where people have to become specialized, they have to continue to expand capital to be able to stay in this game and earn the rewards of Bitcoin mining.

Stephan Livera:

Yeah. Excellent points all there. Essentially it’s know, Bitcoin mining is a hyper competitive environment you need to be, and it’s constantly changing. And as you were saying, it’s constant expenditure, right? So capital expenditure and operating expenditure, because you’re buying new machines, you’re paying for power, you’re paying for Rackspace, you’re paying to to get all of the things done, to get maintenance, all of these aspects, it just requires constant expenditure and there’s constant competition happening. So that element is further decentralizing over time compared to with Ethereum, which is further centralizing over time. And then even with Bitcoin being formed with that 21 million from the start aspects, I think that’s also an important point that people may be taking that a little bit for granted in this conversation and just thinking, oh, well, see ultrasound money. I’ll just make this money that’s going down to try and — but ultimately the point is that you’re not changing it. Like Bitcoin exactly is not going to change.

Alex B:

Exactly. I think this point cannot be emphasized enough and I’ve actually lately been sort of trying to introduce this different framing with regards to Bitcoin’s distribution, because I think it’s very valuable in terms of contrasting it with ethereum’s monetary policy. And the idea is that Bitcoin does not really have a monetary policy. Bitcoin was built with a distribution schedule. Satoshi decided there’s going to be it’s a first, it’s more of a, like a first principle design [inaudible] where Satoshi decides that there will be a hard cap decides how many coins there will be in in Bitcoin throughout its history and then builds a distribution curve around that. And it’s very important because it’s sort of to me, it’s sort of really defeats the argument that a lot of people in Ethereum make “Ah well Bitcoin has this monetary policy.”

Alex B:

You know, it’s not guaranteed that in the future it’ll work because what if the fee revenue is not too high, the fee revenue being sort of an uncertainty then it’s likely that Bitcoin changes its monetary policy to adjust potentially more inflation, but really that’s a non-starter, like I said, it’s a first principle design that Bitcoin was built with a hard cap. And the assumption is made that Bitcoin, if Bitcoin is to succeed, it will obviously as the standard for transfer of value across the world, generate a ginormous amount of fees for miners to be incentivized to secure network. And if those fees are not enough, if miners aren’t incentivized, it is not a reflection of the security model. It would simply be a reflection of Bitcoin failing to monetize. And so the assumption that somehow there’s a flaw in the security model in the fee based security model is wrong.

Alex B:

It is only true if you assume that Bitcoin fails and if Bitcoin fails, it’s not because it’s because as a store of value, it has failed to build a network effect and to monetize into the real world. So you have this fee-based market mechanism. There’s no right amount of security and that’s another major misconception that people always make to me. You cannot say whether or not Bitcoin has got too much security or not enough security. It has just as much security as the market is willing to pay for if the market doesn’t value Bitcoin, to the extent of the hashing power that is active on the network, the value of the asset will go down. The miners will be disincentivized. They’ll have to turn off their machine, or people will be paying less fees.

Alex B:

So it’s not a problem. Like, again, it comes back to the argument, if there is low fees on the Bitcoin network and the miners, aren’t incentivized to mine, that’s because ultimately there’s low demand for Bitcoin. That’s where it ends. And so to contrast that with Ethereum, rather than having this distribution schedule in Bitcoin where there’s a very strong commitment made to distribute the monetary asset within the ecosystem and then let the market figure it out. Well with Ethereum, like you said, they’ve made this sort of commitment to a policy and policies are not set in stone. Policies will depend on inputs, outputs from the system. And it seems, I mean, it’s a bit bewildering to me. Whenever you hear most of Ethereum proponents really talk about this is that it it’s very much a Fiat mindset it’s total keynesian arguments really that are being made, where they will adjust according to what the result of their experiment is.

Alex B:

And again, they make the argument, well if it doesn’t work, the community will figure it out. But the whole point of Bitcoin, the whole point while we have this system is that we want to remove the human element from this conversation because the human element has failed us repeatedly through history. And so it doesn’t matter that they claim that the current policy that they have is deflationary because they’ve created this opening for them to be able to change it down the line. And if it can be changed once, it can be changed, it can be changed twice and more and more and more. And the point I want make also, and I think it’s, I think people might understand it better also, or at least to bring it back to Bitcoin. There’s this notion that’s always talked about what if Bitcoin was built with a 1% sort of emission schedule and eventual 1% inflation schedule, would it be as sound money as it is without the without the hard cap that it has today?

Alex B:

And a lot of people make the argument? Well, it doesn’t matter. As long as the rules are set from the beginning, if it’s 1%, 5%, whatever the market will decide, whether it accepts this proposition and as long as it stays set, and there’s no historical precedent of it changing, then it will remain the same. I reject this notion very strongly. And the difference between zero and 1% or half a percent is all the difference in the world because the 1% introduces a monetary policy, right? The 1% says that we cannot rely on market functions to be able to value the asset and the demand for the transaction on the network to be able to secure it. So by introducing this monetary policy, then you open the Pandora’s box for it to be able to you create a sort of schelling point where it becomes easy to open an argument against well down the line where people might feel okay, well it turns out 1% is not enough. We have an inflation rate, so might as well play around with it, you know? So I think it was a non-starter from the beginning. I think Satoshi very much understood that notion. And that’s why the hard cap is fundamental to the design of Bitcoin. I believe it would not have garnered the adoption that it has up to this day without the hard cap.

Stephan Livera:

Yeah. Really interesting stuff. And I think it’s like that discovery of the number zero, and I think Breedlove has written about this. It’s kind of like this idea that even in maths, people weren’t necessarily like, it was like an interesting article that he wrote about the discovery of the number zero. And I think that’s very related to the point that you’re making. And so I guess summarizing things in terms of what’s the future looking like for Ethereum and it’s centralization, what do you see for that?

Alex B:

Well, one thing I see that people, or Bitcoiners won’t really be happy about this. I expect Ethereum to stick around for awhile. Because the way it’s designed is sort of this same a bit perverse design that the Fiat system is built right where that it’s fundamentally flawed, but it takes a while for these incentives to ultimately play out. But what I see as the real danger, and I think we’ve discussed that and we were seeing that emerge, and I’m also observing people that are usually like the flag bearers of ethereum. Some of the influencers within the Ethereum are starting to have this sort of sneaking suspicion that they’ve put themselves, between a rock and a hard place where, like I said, either they entertain the store of value narrative, but if they fail to do that, and ultimately I think we agree that they will fail to do that.

Alex B:

I don’t think the market ultimately will buy this argument. They might sort of be able to entertain it for a while, but by having so much of these fees being burned so much of the Ethereum being burned. So from a supply perspective, it’s absolutely possible that for at least a short amount of time the supply the becomes constrained and the number goes up and then they can play along with that narrative. But the issue is that if they actually, so if they fail to establish sound money narrative, all they’re left with is the utility narrative. All they’re left with is the application layer narrative and the application layer narrative is a death sentence because the application layer narrative is a technology narrative. And so when people used to say in the past that Bitcoin is the MySpace of money, I mean, we all know why that’s wrong, but if ethereum on the other hand, it’s funny.

Alex B:

I think you had that I think you had who was it? I think it was Paul Tudor Jones that was on Bloomberg or who’s the one that anyways, one of the major sort of TradFi investor that actually owns Bitcoin was making the exact same argument is that actually Ethereum might just be the Myspace of its ecosystem. Because if you’re hanging on to technology as your only value proposition, then that’s a very, very sort of weak grounding because as we all know technology is improving it’s iterating every single day. And so you already have the Solana’s of this world. You already have the Binance chain. Now people might say, well, Binance chain, obviously, very, very centralized. so potentially not a viable competitor to Ethereum, same could be said about Solana, but who knows how, who knows sorry.

Alex B:

It was Druckenmiller that made the exact same analogy to… Anyways. And so there will be better, better technology for the DeFi applications that will come along. There will be better technology for the NFTs obligation though will come along. And so this will inevitably dilute the market cap of Ethereum, because if they don’t monetize, if the monetary premium is removed from their value proposition, then it’s who gets the best [inaudible]. And as we all know, it’s pretty much impossible to hold that lead forever. And if you create a precedent where you lose that lead, then you create a precedent where people will not be willing to invest. You know, it’s the, it’s the flippening argument. and the Ethereum people think that flipping argument would be good for them, but obviously the obvious response to that is that if Bitcoin could be flippened and so can Ethereum, and at this point who will be willing to trust their money into any of these systems, because they might always be at risk of being flippened.

Alex B:

And then you’ve got this sort of musical chair around where who’s the last that will be left holding the bags. You know, it’s not a very favorable scenario, especially if tech is your only value proposition. So ultimately I see that as how it plays out. I think Ethereum stays around for a while, I think it enjoys some temporary success for probably several years. I mean, success in terms of like money being tossed around and sort of I mean, they’re enjoying the same in a way they’re enjoying the same byproducts of the fiat system that as Bitcoin is where there’s so much liquidity around. So why wouldn’t you you know, buy a picture of a rock for $500,000 for you to be able to flip it to someone else for a million dollars, but when ultimately I think when that liquidity dries up, that’s, when Ethereum will be on very, very shaky grounds.

Stephan Livera:

Yeah. Really interesting way to summarize it, because I’m thinking now back to some of the early writings of the Nakamoto Institute, where the boys there were writing articles like app coins are snake oil, or pointing out the problems of utility tokens. And as you were rightly saying, if Ethereum doesn’t have a chance at winning the store of value, quote unquote, I mean, that’s what kind of the VC shitcoiner people say, oh, that’s store of value, but really it’s just money. Right? We’re just trying to create money, like reliable, open money. Anyone can run a node, anyone can use Bitcoin, anyone can validate the full 21 million coins. Like that’s really what is that’s the Bitcoin project. And of course there are different ways you can use Bitcoin, but that’s the broad idea of Bitcoin where there’s 21 million.

Stephan Livera:

And as we, as we’re saying, it’s a distribution schedule, whereas with Ethereum, they can change that money supply. So it’s not that they’re just not going to win. They’re never going to win that. They’re never going to become that. And then if they’re just trying to be a utility, well, there’s a lot of already well-documented and known problems with utility coins because somebody else can just go and make a technology that does it cheaper, or does it more centralized and faster or better, or some different new way. So there’s really a lot of problems there in that way. And I love the Ethereum is the MySpace. I actually, while we’re here as well. I’m curious, do you have any thoughts on I think what I believe is the OG critique of proof of stake, which is the nothing at stake paper. And I believe it was Andrew Poelstra who wrote that in. I want to say 2014. Do you have any thoughts on that or do you think how well do you think that paper holds up now?

Alex B:

To my knowledge, I’d have to revisit, I haven’t read that one in a while, to my knowledge, it doesn’t hold up as well. For the fact that it didn’t account back then for the sort of implementation of slashing that Ethereum is with, like it didn’t account for the proof of stake implementation that Ethereum is now proposing. So there’s still, I believe some value to it and I’d encourage anyone to read it because it certainly gives a sort of very intelligent perspective on the challenges of proof of stake. But I think some of the arguments break down a little bit, especially when it comes to how Andrew proposes that there is not necessarily a cost to attacking the system. It’s not clear that like, what ethereum has come up with is a perfect solution for it, but it’s a different sort of scenario. So I don’t know that we can evaluate it under the same lens.

Stephan Livera:

Gotcha. And I mean, in fairness, it is what seven years old or something like that now. So that was quite a while back. But I think the arguments that you’ve presented today certainly make a lot of sense to me around centralization pressure that is simply there in Ethereum. So did you have any, I guess, final comments you wanted to make on this whole topic?

Alex B:

I mean, ultimately I think I’ve said all that needed to be said. What I would want to say is that I would encourage, and this is what I said in the very beginning is I would encourage people to start. And if you’re going to get into these conversations, I think you owe it to yourself to get a little more knowledge about exactly how these systems are designed. I mean, you might think that it’s not worth your time, which is perfectly fair. I would encourage anyone that’s working on anything productive or within the Bitcoin ecosystem. And that’s just not, that’s not just like shitposting on Twitter. Like I am every day to not bother with that continue doing what you’re doing. You’re doing well, continue writing code. We don’t need you. I’ll, handle the arguments on Twitter, but for anyone else that sort of gets into these conversations, I’m afraid that a lot of times we end up looking a little bit silly than the Bitcoiners.

Alex B:

And I mean, there’s a, there’s a guy called Eric Wall on Twitter. This Norwegian guy. I think he often makes the argument, sorry, he’s made the argument in the past that a lot of Ethereum people actually probably know more about or understand more about Bitcoin, better than Bitcoiners give them credit for. And the same is not true. A lot of people especially unfortunately like from this sort of last batch of Bitcoiners, they’ve been ingrained in with this idea that Ethereum is evil, but they actually understand none of it. And so when they come around to discussing it there especially if there’s an audience there’s people that are new to this ecosystem that ended up over hearing those conversations from my perspective. And if I was that person, I would think that Ethereum’s definitely got something going for itself, because the arguments that I’m hearing from the average Bitcoin on clubhouse, not very convincing sometimes pretty embarrassing.

Alex B:

So again, if you’re going to sort of critique those systems, you really should just dive a little more deeper into them so that you can actually have an intelligent conversation. I mean, I’ve been getting into arguments lately with people in the Bitcoin and Bitcoin maxis, because I think there’s some value to the NFT idea. I think 99%, 99.9% of it at the moment is completely speculative. It’s a bubble it’ll pop, and also it’s worth pointing out NFTs ultimately is not a moat for Ethereum and people associate it with Ethereum so much that they don’t think for themselves and use sort of a rational mindset where they evaluate the idea on its own without you know, immediately saying, oh, well, it’s from Ethereum. It’s full of shit. There’s no interest here personally.

Alex B:

I think some of it is pretty tenable. But then I’m always, like I said, I’m always faced with these conversations of people just being blind for no reason that they’ve been, it’s sort of this conditioning that we’ve created throughout the years with people that are new to this ecosystem, this sort of toxic maximalism, and I’m all for toxic maximalism, but I’m also all for critical thinking. I need people to not trust the Oracles and not trust me or someone else to tell them, like, this thing is bad. Don’t believe in it. Don’t trust it. No, you need to come to these conclusions on your own. You need to think for yourself. and so whenever you encounter a subject like this, yeah. Just bring some rational thinking to the table, you’ll be better off for it. Everyone will be better off and your audience if there is any will benefit.

Stephan Livera:

Yeah. So I think, and for, look for listeners out there who just think, look, all I care about is sound money. That’s fine. Then just don’t worry about anything else. Just focus just on Bitcoin. And then I think maybe one of the lessons of this episode might just be that here are some ways to think about them all like an intelligent critique, basically. So if you’re going to be talking about Ethereum and maybe if you can offer a more intelligent critique, that’s probably the better way to go about it. So that’s probably a good spot to finish here, Alex, where can people find you online if they want to follow you or see your work?

Alex B:

Twitter is the place where I’m most active. So you can find me at @bergealex4 I’m always happy to chat with you. You’ll see. I’m pretty active. I mean, I’ll have some comments, some tweets that will rub people the wrong way, but that’s the nature of this ecosystem.

Stephan Livera:

Fantastic. Well, thank you, Alex. It’s been a pleasure chatting with you today.

Alex B:

Same thanks. Thanks for the time. It was very, very, very interesting chat. Have a good one.