The Breakdown - With EIP 1559, Has ETH Become Ultra Sound Money?

Episode Date: August 6, 2021

On today’s episode of “The Breakdown,” host NLW discusses: Proposed amendments to the infrastructure bill Notable EIP 1559 changes “Ultra-sound” money meme explained Amendment proposals came from a variety of political figures, including Sen. Ted Cruz’s bid to scrap the crypto provision altogether. A more realistic option, however, came from Sens. Wyden, Toomey and Lummis, who chose to insert a definition excluding non-custodial intermediaries. In the main discussion, the London hard fork to Ethereum took place early this morning. The changes aimed to improve the user experience on the network and included the introduction of a maximum bidding tip, increased block size in times of high demand and the change to burn the base fee. The base fee burning modification has sparked conversation about a potentially powerful side effect. In new EIP-1559 transactions, the protocol will burn the ETH used for to pay the base fee. If more ETH is burned this way than is issued, it will make ETH deflationary.  If bitcoin’s fixed supply constitutes “sound money,” does ether’s declining supply “ultra-sound?” Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW The Breakdown is written, produced by and features NLW, with editing by Rob Mitchell and additional production support by Eleanor Pahl. Adam B. Levine is our executive producer and our theme music is “Countdown” by Neon Beach. The music you heard today behind our sponsor is “Only in Time” by Abloom. Image credit: Zoltan Tasi/Unsplash modified by CoinDesk, modified by CoinDesk.

I think it's important to point out that sound money, as a concept applied to Bitcoin, really has at least two dimensions. The first is this element of fixed supply. Obviously, it's absolutely essential. But the second is that it has a programmatic money supply that is not tamperable with by humans. The two key dimensions of people's belief in that inviolable monetary policy are, one, the true absence of a founder as a force in the protocol,

and two, a track record of conservativeism and non-interference. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by NIDIG

and produced and distributed by CoinDesk. What's going on, guys? It is Thursday, August 5th, and today we are talking about EIP 1559 and whether it turns a thing. Ethereum, ether specifically into ultrassound money. First, however, let's do an update on the infrastructure bill.

Where we left off yesterday was that a group of Republican and Democratic senators were coming together to author an amendment to the crypto tax reporting provision. The goal of the amendment would be to specifically exclude non-custodial actors like miners from the new IRS definition of broker as applied to the crypto industry. It's short, so I want to read the whole thing, but before we do, I should also note that Senator Ted Cruz also offered an amendment. His amendment would scrap the provision entirely, which, while I think crypto would love to see, most didn't find especially politically viable, hence us focusing on the widened Toomey Lummis Amendment. Here's the amendment as written.

Purpose. To revise the rule of construction with respect to information reporting for brokers and digital assets and for other purposes. On page 2437 strike lines 9 through 21 and insert the following. Definition of broker. Nothing in this section or the amendments made by this section shall be construed to create any inference that a person described in section 6045C1D of the Internal Revenue Code of 1986 as added by this section includes any person solely engaged in the business of A, validating distributed ledger transactions. B, selling hardware or software for which the sole function is to permit a person to control private keys, which are used for accessing digital assets on a distributed ledger, or C, developing digital assets or their corresponding protocols

for use by other persons, provided that such other persons are not customers of the person developing such assets or protocols. So basically, this is explicitly excluding validators, hardware and software developers, miners, etc. Now, obviously, this is huge progress. The Blockchain Association issued a letter with more than 100 signatories, urging majority leader Chuck Schumer and minority leader Mitch McConnell to support the amendment. On top of this, there's a major campaign in the crypto industry to light up the phones of senators in support of the amendment. Just one platform helping route those calls fight for the future had logged 5,000 calls within a few short hours. Pat Toomey tweeted of the amendment, quote,

While Congress works to better understand and legislate on issues surrounding the development and transaction of cryptocurrencies, it should be wary of imposing burdensome regulations that may stifle innovation. By clarifying the definition of broker, our amendment will ensure non-financial intermediaries like miners, network validators, and other service providers are not subject to the reporting requirements specified in the bipartisan infrastructure package. So, a couple interesting points of contention in political intrigue. First, there is a question about whether this specific language sufficiently excludes the Lightning network or not. Here's the way that Niraj from Coin Center put it last night. Quote, Lightning went from

definitely included to arguably not included. The amendment gives us space to advocate for Lightning to be spelled out where previously there was none. Unfortunately, it's not going to get better than this tonight. For what it's worth, I think the odds of a lightning node being considered a broker and practice are vanishingly small. End quote. Still, I think it's a concern enough that it's worth keeping an eye on. But here's something even more intriguing that has to do with the politics behind this whole thing. Politico this morning has a piece on the amendment called cryptocurrency tax changes spark clash between White House and a key Democratic senator, to which of course they're referring to Senator Ron Wyden, the Senate finance chair. In discussing the Tumi-Lummis-Widen

amendment, Politico writes, quote, echoing concerns from the cryptocurrency industry, these senators say the legislation's definition of who counts as a broker and therefore subject to the new rules is overly broad and will sweep in too many unintended targets. They want to amend the legislation to specifically exclude people like software developers. But the administration, which has advised the larger bipartisan group of lawmakers who put together the infrastructure plan, calls that bunk. It believes the industry is using scare tactics to try to water down the requirements, a senior administration official said speaking on condition of anonymity, and the administration believes the proposed changes are significant enough to put a dent in the 28 billion budget

forecasters anticipate the provisions raising for the $550 billion infrastructure plan. So according to this piece, the administration is taking the same weird line that Rob Portman, the Republican author of the provision, took, which is that of course they don't have the intent of going after those actors, but let us write it really broadly. Here's another quote from the piece. The administration which worked behind the scenes with lawmakers on the provision in question scoffs. It says people like minors are minor players in the cryptocurrency economy, the official said, and it has no intention of pressing people for information they could not possibly have. The amendment will needlessly tie Treasury's hands when it comes time to develop regulations

spelling out the details of how the rules would work, the person said. This to me is so, so suspect. This one. morning, the Joint Committee on Taxation said that the revenue would be reduced by $5.17 billion if the amendment passed. So here's the big fucking question. If for days, Rob Portman has said that these miners, devs, and validators weren't the intended target, a position that this scoffing anonymous White House source reiterates, but now we have an amendment that's only purpose is to say officially, these are not the targets of this plan. How could there possibly be a $5 billion gap? It sounds to me like the Joint Committee on Taxation was intending to include these actors to the tune of $5 billion, which is shady.

As always, I will continue to share this story as it develops, and wow, what an interesting dimension to it. The breakdown is sponsored by Nidig, the institutional-grade platform for Bitcoin. As longtime listeners know, Nidig is a major force in the Bitcoin space, and they're now making it possible for thousands of banks who have trusted relationships. relationships with hundreds of millions of customers to offer Bitcoin. That mainstream access is critical for all of us, and you can learn more about it at nydig.com slash nLW. That's nydig.com forward slash nLW. Now let's flip to the big crypto industry happening of the day, Ethereum's London upgrade, which includes the implementation of EIP-1559. I think where this intersects with the

interest of the average breakdown listener is about the macro narrative and if and how this changes where Ethereum fits in that macro narrative and two large-scale institutional investors. That said, I think it's also important to cover at least some of the basics and the technical specifics, so a big shout out to Anthony Sassano's Daily Gway and Zero X nadir who I cribbed much of this from. EIP 1559 was first proposed in April 2019 and is now going live with Ethereum's London upgrade. The changes made by EIP-159 are largely about the user experience of the Ethereum network. It changes how transaction fees are determined as well as how the network operates in times of high demand.

Ethereum currently uses a first-price auction model. In other words, users that bid more are more likely to have their transactions included first. This creates an incentive to overbid to ward off fluctuations in demand. In this current model, there is a base fee, which is a minimum fee set by the protocol, and the priority fee or tip. Currently, if a user overpays, that overpayment goes to minors. In the new EIP 1559 model, there is still a base fee. That's the portion set by the protocol, but then users also set a max fee and the priority fee or tip. If the max fee exceeds what is needed for the transaction to be processed by the market, they pay only the base fee and their tip,

but get refunded the difference between that and their max fee. So imagine if you were trying to buy a ticket board Jeff Bezos spaceship and the minimum bid was 10k. Your priority bid was 5K over that for a total of 15K, but you were willing to pay up to 25K. Now let's say that the price necessary to secure a spot was 20K, more than the 15K you wanted to pay, but less than the 25k you were willing to pay. In this new model, you'd be refunded the difference between the winning bid of 20k and the max bit of 25K. Effectively, the key thing to know here is that the overpayment goes back to the bidder to the user rather than to the miners. This is meant to better align the incentives of miners with the rest of the community. Now, there's another dimension to EIP 1559, which is an approach to

temporarily increasing block size in times of high demand. The goal, again, is to improve the user experience by smoothing out transaction prices. Now, that's sort of out of the technical scope for this podcast, but I wanted to at least mention it. Still, the change that has created the most chatter is the burning of the base fee. As mentioned above, in an EIP 1559 transaction, there is a base fee, a priority fee or tip, and a max fee. The base fee, again, set by the protocol, and the logic of having it burned rather than go to the miners is that if the base fee did go to the miners, it would create an incentive for them to keep that fee high. Now, here's the thing that has a lot of people chattering about this. What happens if the ETH burned as part of the base fee are greater than the

issuance of ETH. ETH would then, by definition, become deflationary, right? And this is where the ultrasound money meme was born. The idea behind that meme is that if Bitcoin's issuance reduction, leading ultimately to a fixed total supply is sound money, ETH's overall supply reduction over time leading to a supply that is declining, would make it even sounder money, or so the argument goes. So let's discuss this specifically, and then let's discuss ETH in the macro context more broadly. First, a lot of the Ethereum community that I most respect, even those who are excited about these deflationary changes, are quick to point out that, one, the fee burns do not necessarily mean that more ETH will be burned than is issued right away. Folks have created models to show what the average base fee would have to be, both in the current proof of work design and in the anticipated ETH2 proof of stake design for the burn to be higher than issuance. reason to reinforce that is to point out that the core of the proposal is really intended to improve

the experience of paying for transactions, with this burn being a side effect. That said, as many on Twitter pointed out this morning, at Ethereum Block 12,965,263, more ETH was burnt than was issued. As many put it, the first deflationary block in history. Still, I think it's important to point out that sound money, as a concept applied to Bitcoin, really has at least two dimensions. The first is this element of fixed supply. Obviously, it's absolutely essential. But the second is that it has a programmatic money supply that is not tamperable with by humans. The two key dimensions of people's belief in that inviolable monetary policy are, one, the true absence of a founder as a force in the protocol, and two, a track record of conservatism and non-interference. To the

extent then that one wants to entertain the meme of ultrasound money. Even if you give ETH high marks around a new deflationary supply, or at least a supply trending that way. I think many people will have questions around this second part. ETH's monetary policy was never prioritized to be inviolable in the same way that Bitcoin's was. This is what has allowed it to change. But the change itself in some ways undermines the confidence that it won't change again. On the leadership front, I will note that I believe strongly that Vitalik exerts less influence now in Ethereum than at basically any point in the past.

However, even his intentional withdrawal points to how fundamentally unique Satoshi's vanishing was. At any point, Vitalik could decide to try to exert more influence. Over time, his ability to do so would of course diminish, but there likely would always be a pretty big block, pun intended, ready to support him. So what's the point of pointing all this out? Is it to crap all over the ultrasound money meme is just some cringe Twitter artifact? No. I will let you make your own judgments about memes.

it is instead to try to draw contrast about what might make macro players care about one crypto asset versus another. I have felt and continued to feel that the credibility of Bitcoin as an antidote to human monetary policy remains unlike anything before or since. And to be clear, I think that the 21 million hard cap is the great expression of that inviolability, but that what matters is the contrast between human-made monetary policy and math-made monetary policy. The people who care about such things as their chief and primary concern will continue to prioritize Bitcoin. There is also the whole other dimension of things that people prioritize around Bitcoin, i.e. censorship resistance and what true decentralization looks like, but I'm not even going into that now. I'm just

focusing on the sound money side of the argument. However, now let's ask a different question. Will a deflationary eath supply make ETH more appealing to some parts of the market? And the answer here is almost certainly yes. There are many people who currently interact with Ethereum for reasons other than its monetary policy, who will still find this new deflationary supply pressure even more of an inducement to hold ETH. My argument is that this set will likely not be folks who poke their heads into crypto looking for the hardest asset. Instead, it will be people who have come to Ethereum for other reasons. For example, the dynamism of its developer community, which is what VCs always call out, or those focused on NFTs for which ETH functions in many

cases as the unit of account, or those interacting with Ethereum-powered DeFi applications. These folks already have different interests and different weightings of tradeoffs, but by simple laws of supply and demand, the overall supply of the base asset decreasing over time is likely to make it more appealing. Now, there are counter-arguments to all of this. There are many who argue that a restricted supply makes a currency ill-suited to be the base of a complete financial ecosystem like Ethereum is trying to build. These are the same folks, however, that argue vociferously for the contemporary fiat-based

system in the macro world, so their arguments are unlikely to hold much water with the crypto crowd. Ultimately, my perspective in this industry has always been that maybe the most important thing any person needs to align themselves around is objectives and tradeoffs. Is creating the soundest money possible the objective? Is censorship resistance the objective? Is creating the building blocks for developers to reimagine old systems the objective? Is it speed? Is it security? Is it durability? There are no right answers a priori. There are right answers based on what one is trying to achieve. I will also say this, though. The cool thing, also a challenging thing about decentralized protocols, is that the answer to what one is trying to achieve can be fiercely different among different groups

even who are focused on the same asset. The arguments around objectives and tradeoffs often represent some of the most important forging moments in the life of protocols. See, for example, the block size wars in Bitcoin. So, is ETH now ultrasound money? Simply put, I have a hard time believing that the folks who prioritize sound money, hard money, are going to abandon Bitcoin for ETH because of these changes. The burden of proof on human involvement in monetary policy is too high, and the ICO that launched ETH is, to them, an original sin that can't be expunged. The flip side is that for people who are already invested in or interested in the Ethereum ecosystem for other reasons, this could certainly increase the appeal of holding that base asset.

On top of that, I do think it's worth exploring the potential impact among institutional investors. There are some institutional investors that have a highly ideological thesis, but there are far more who like making money. I think for that set, it is totally plausible that we'll start to see more arguments for sound money baskets and other such Wall Street-style instruments that group these things together. Their argument might be that it's sound enough relative to engorged government balance sheets, plus it has some other things going on, so why not? Either way, so far, the market likes it.

EIP 1559 is trending on Twitter, ETH is up 6% in the last 24 hours, although I do think that the short-term impact of big changes like this tends to be overestimated. But either way, there you have it. Apologies to the partisans on both sides for a sort of avowedly apolitical take. But now, let me know what you think. Hit me up on Twitter, on YouTube. I appreciate you listening, as always. And until tomorrow, be safe and take care of each other.

Peace.