Unchained - Is ETH on Its Way to Becoming Ultra-Sound Money? Yes, Says Justin Drake - Ep.262

Starting point is 00:00:00 Hi, everyone. Welcome to Unchained, your No Hype resource for all things crypto. I'm your host, Laura Shin, a journalist with over two decades of experience. I started covering crypto six years ago and as a senior editor at Forbes was the first mainstream media reporter to cover cryptocurrency full-time. This is the August 10th, 2021 episode of Unchained. My book The Cryptopians, Idealism, Greed, Lies, and the making of the first big cryptocurrency craze is available for pre-order on Amazon, Barnes Noble, Bookshop.org, or any of your other favorite bookstores. Go to Bitley slash Cryptopians. That's B-I-T-L-Y-S-C-R-Y-P-T-O-P-I-N-S. TASOS is smart money. That's redefining what it means to hold an exchange value in a digitally connected world. Discover how people are reimagining the world around you on Tazos. The Crypto.com app lets you buy, earn, and spend crypto all in one place. earn up to 8.5% interest on your Bitcoin and 14% interest on your stable coins, paid weekly. Download the crypto.com app and get $25 with the code Laura.

Starting point is 00:01:09 The link is in the description. Today's guest is Justin Drake, researcher at the Ethereum Foundation. Welcome, Justin. Hi there. Thanks for having me, Laura. So we're here to discuss Eith as ultrasoned money. But before we dive into all that, why do we start? start with you giving your background and telling us what you do at the Atheon Foundation now, because I think it informs our discussion about the idea of ethos ultrasound money.

Starting point is 00:01:38 Sure. So I've been at the Aferm Foundation officially since December 2017. And also explain how you got into crypto before that. So I got into crypto in late 2013. It was the bubble all the way up to $1,000 for Bitcoin. And I fell down the rabbit hole pretty quickly. I started the Cambridge Bitcoin Meetam group in the UK. And then I started operating a Bitcoin ATM. And then I started a company that was trying to make OpenBazaar, which is a peer-to-peer marketplace built all the top of Bitcoin easy to use.

Starting point is 00:02:18 And then my startup didn't do so well. OpenBazaar also didn't do so well. when I left my startup, basically I was looking for open problems in the space. And I was especially interested in Ethereum. And Vitalik gave this presentation on what's called the data availability problem. So I spent some time thinking about this problem for a couple weeks. And I had some ideas that seemingly no one else had in the space. So I emailed Vitalik with my ideas.

Starting point is 00:02:48 And he liked my ideas. And we had this kind of long email thread. And kind of a few weeks later, he hired me and I joined the Affirm Foundation. So that was in December 2017. So I've been at the Ephraim Foundation for a bit over three and a half years. And I guess my role has evolved as Ethereum 2 has evolved because I've been focused on Ethereum 2. So when I joined, there were very, very few people working on Ethereum 2. It was actually quite shocking how few people, I thought, you know, this is this multi-year-old.

Starting point is 00:03:23 billion dollar project, you know, looking to make this huge upgrades. Surely they must have like a massive team. It turned out it was like a handful of people. And so I joined in Dan and basically working on pretty blue sky kind of design questions, like how are we going to design sharding? You know, I started focusing on sharding. And then as time went on, you know, we went from research to spec design. So the Firm Foundation, part of what we do is, producing the spec for the Ethereum protocol that then gets implemented by various teams around the world. This is a very unique kind of model where there's a decoupling of the protocol and the spec versus the implementation. And I guess now that a lot of the research has been done,

Starting point is 00:04:13 you know, my role has shifted a little bit. So for example, I've helped hiring. So we're hiring. we've hired actually some security researchers because one of the things we want to do soon is the merge, basically securing Ethereum purely with proof of stake, no more proof of work. And so we want to make sure that the proof of stake foundational layer, which is called the beacon chain, is as robust as possible. So we really want to have this very strong before the merge. Another thing that we're doing, and this is kind of a general theme, is that as blockchain has become more and more sophisticated, they rely more and more on the cryptography. And so we're building in-house within the EEF, a relatively large team of cryptographic experts helping us with all sorts of

Starting point is 00:05:02 primitives that will be part of the Ethereum consensus, the layer one. My role in the last few months has changed yet again. Now I'm kind of at the meme layer, what we call layer zero, the kind of under layer one, like the people, you know, being navigating this new space for me, which is very interesting, through the ultrasound money. Oh, interesting. Okay, so there are so many things that we'll dive into based on what you talked about, but just to mention for people some of the terms that you named there, the merges where Ethereum 1 apps move over to this beacon chain, which is the beginning of this new

Starting point is 00:05:47 Ethereum 2.0, the proof of stake network. And so we'll talk about that more in a second. But first, let's talk about the most recent news. So we're recording on Friday, August 6th. And on Thursday, Ethereum underwent a major hard fork, which implemented Ethereum Improvement Proposal 1559. And that essentially changes the monetary policy of Ethereum pretty significantly. So tell us what EIP-1559 does. Ethereum 1559 does a lot. And one of the original motivations was around user experience to improve the user experience. And one of the main things there is that right now when you want to use Ethereum, you don't know how much you need to pay.

Starting point is 00:06:34 So there's basically two options. Option number one is you underpay in terms of the gas price and your transaction doesn't get included on chain or it doesn't get included on chain when you want it. It becomes pending for a period of time that you don't want. Option number two is that you overpay and then you basically end up wasting some money, putting your transactions on chain. So one of the benefits of EIP 1559 is that users will know 99% of the time what fee to pay, and if they pay that, they will just get included on chain. So it's a much better user experience.

Starting point is 00:07:10 EIP159 also improves security. And this is a bit of a subtle thing, but it turns out that transaction fees, so-called MEV, are the fuel for reorgs. If you have a transaction fee which goes in the block, another miner could go and take that transaction fee and put it in another in his block as opposed to that other miners block. And so one of the things that EAP-1559 does is that it, it reduces the value that can be extracted by miners or by validators, simply by burning some of the transaction fees that would otherwise potentially be used as fuel for reorgs. And then this final aspect, which you mentioned, which is the monetary policy aspect, is that we don't want to be overpaying for security.

Starting point is 00:08:09 So when you look at the fuel for the security engine, if you will, so the consensus engine, which could be proof of work or proof of stake, is fueled by one issuance and number two by transaction fees. And what we've done in Ethereum is that we've set the issuance to be large enough such that alone they are sufficient to secure the blockchain. And so anything above the issuance is kind of overspending for security. And so the idea here is that instead of overspending for security, let's destroy the EIF, thereby reducing the EF supply, basically strengthening the monetary properties of EF.

Starting point is 00:08:59 And so in a way, the goals of EIP-1559 were to, create more efficiency, both from a user standpoint in terms of paying fees and then also from a security standpoint. And so, you know, why does that matter necessarily for the security of Ethereum just to make it more efficient? You know, what is the problem with maybe like overpaying for security or I don't know were there ever times when Ethereum was underpaying for it or just kind of describe for me how security worked prior to EIP 1559? Right. So what we're actually doing with EIP159 is actually reducing the security in a way. And the reason is that we're reducing the security budget that would go to minors.

Starting point is 00:09:48 So the amount of revenue that miners will be receiving will be reduced. And that will most likely reduce the hash rate. In terms of what we're trying to achieve here is two things. One is guaranteed security. And the way that we achieve guaranteed security is using issuance, right? Issuance is the best form of fuel for security because it's 100% predictable. It's non-volatile. You know, you can just set it to be exactly the same amount for every single block.

Starting point is 00:10:21 And it cannot be stolen, right? The issuance in a given block can't be kind of stolen by the next miner in the same way the transaction fees could. If there is a transaction, which is worth a million dollars, that transaction could be included in Block A or it could be included in Block B, and that it really affects the game theory. So that's the first thing we want to achieve. We want to achieve guaranteed security with issuance.

Starting point is 00:10:50 And now that we have that, we want to achieve economic efficiency in the sense that we don't want to be wastefully paying for security. If we don't have to expand the security budget, let's not do it. It's just wasting money. So instead, what we do is that we capture the value from the transactional utility of Ethereum in terms of transaction fees. And this is done through the burning of transaction fees.

Starting point is 00:11:18 And that, as I mentioned, is going to provide a deflationary pressure on the EF supply. It's going to be reducing the total amount of EF in circulation. thereby improving the monetary qualities of ether. All right. So this leads us to the main topic for today, which is this idea that ETH could be turning into what people in the Ethereum ecosystem are calling ultrasound money. So what were the characteristics of ETH as money before the upgrade? And what would you say they are now?

Starting point is 00:11:56 And why would you call that ultrasound money? Right. I mean, one of the things that's kind of useful is to understand what is money, right? So money for me is a money candidate with monetary premium. Okay, so what is the money candidate and what is monetary premium? A money candidate is an asset which has various characteristics, which means that it could potentially be used at money. It's durable, it's divisible, it's fundable, it's transmissible, blah, blah, blah.

Starting point is 00:12:28 So if you look, for example, at a capital, a cow that will never be money, right? Because it's not easily divisible. You know, the head is not equivalent to the tail. And, you know, it's not durable and it's not transmissible easily. On the other hand, if you take an asset like, you know, salt, for example, that was using money as money or gold or Bitcoin, they have all these basic properties. But it's not sufficient to be a money candidate. You know, you can look at all the coins on coin market cap.

Starting point is 00:12:55 Most of them are not money. And the reason is that they haven't really achieved. monetary premium. Now, what is monetary premium? It's this idea that the asset, the money candidate, has value beyond its raw utilitarian value. And maybe a good way to illustrate that is gold. If you look at gold, which has a market cap of $12 trillion, it has kind of utilitarian value as an industrial metal. So, for example, gold is used in every single iPhone. And people have estimated that the utilitarian value of gold is roughly a trillion dollars. And so there's this extra $11 trillion, which is, you know, monetary premium because, you know,

Starting point is 00:13:41 central banks will keep gold and involved and all sorts of reasons around money. And so monetary premium is really kind of this magic meme power where somehow society agrees that this one asset is special in some way. and we're going to endow it some special value. And, you know, various assets have achieved this idea of having monetary premium, one of which is gold, another one, for example, is Bitcoin. And Ether as well, arguably, has monetary premium. Now, in terms of how Ether is actually used as money, today,

Starting point is 00:14:17 it's mostly used as money as a collateral money. So what does that mean? It means that if as a programmable asset can be, placed as collateral, for example, in a small contract. And this collateral can be used to fuel DFI. So right now there's about 10 million EF that is placed as collateral in DFI. And so this money is, this EF is used as money in the context of DFI. There's actually a second way that EF is used as money also as collateral, but here it's

Starting point is 00:14:52 at layer one, not layer two, is with staking. So there's about 6.5 million EFI. which is used as collateral money in the context of staking. If is also used as money in the sense that it's used to pay for transaction fees. Now, this aspect of money in a way is relatively weak because it doesn't improve scarcity. If you used if you used EF a week ago to pay for transaction fees, then this EF will go to the miners and basically just be circulating EF is kind of a closed system. Whereas now, whenever you're going to spend EF, it's very similar to gasoline.

Starting point is 00:15:34 You're just going to burn it and it's going to be destroyed. And you're kind of improving the scarcity of the thing. And so that's kind of a way in which EIP-1559 improves the monetary qualities of EIF. Yeah, and it does so in a way where the value of Ethereum, contains within it the amount of usage it's getting. So the more popular Ethereum is, then essentially the more ETH that will be burn, which should then make ETH the asset more valuable. So in that regard, like it, yeah, it kind of captures that.

Starting point is 00:16:11 Then for this term, ultrasound money, how would you say that that description now applies to, or will eventually apply to ETH, I guess, once all these changes are implemented for now EIP-1559 and then later eventually the merge. Right. So I guess before talking about ultrasound money is maybe good to understand what is sound money. So the word sound money actually comes from silver and gold. And the reason is that there was this thing called the ping test, which was kind of a sound-based test to determine if a coin was a real silver or real gold. So what you do is that you put the coin on your finger like this, and then you take another coin, and then you tap it and go, ding!

Starting point is 00:16:58 And there was this characteristic ding that, you know, silver coins and gold coins had, and you could use that to check if they were real. Now, this is kind of a metaphor for something kind of deeper, which is this idea that sound money is a money that cannot be the based. And here, you know, we're using these metal-based monies in comparison, for example, to Fiat money. So in Fiat money, you know, you have a central entity who could arbitrarily debase the money. And what does depase mean? It means just arbitrarily inflating the supply, increasing the supply. With these metal-based monies, you have this idea of a capped supply. And that's very powerful because you're protected against debasing.

Starting point is 00:17:47 I guess ultrasound money takes this no debasing idea to kind of the next level where I guess the opposite of debasing might be rebasing. So it's not only preventing kind of the debasing, but it's allowing the rebasing of the money is kind of strengthening over time with this idea that not only do we have a supply cap, but we actually have a decreasing supply over time. because as you said, the transactional utility of Ethereum is being captured by this fee burn. And if the transactional utility is greater than the security budget that we're expending, then the supply decreases. And just to give you an order of magnitude, in the first 24 hours since EIP 1559 was launched,

Starting point is 00:18:36 we've had 4.6,000 if burnt, and that's the equivalent of roughly $7 million. So that's about $5,000 every single minute being burnt. Now, historically, if you really zoom out, the fee volume, which is the total amount of fees on the Ethereum network since Genesis has grown a factor of 10 every single year for the course of six years. So that's how long, that's how old Ethereum is, only six years old. And what we've observed is that over the six years of Ethereum, we've had an exponential growth, a factor of 10x increase in the total fee volume for Ethereum. Now, today, even today, the fee burn is greater than the proof of stake issuance by a factor of four.

Starting point is 00:19:32 So in the last 24 hours, the proof of stake issuance was 1,125. whereas the burn was over 4,500. So what we say colloquially is that we've reached ultramac 4 in the sense that not only have we broken the ultrasound barrier, but we've broken it by a factor of 4. And so once we don't have the proof of work issuance, which will happen at the merge, then almost certainly the supply will start decreasing. And as I mentioned, because the fee volume historically has just kept on increasing and it's a very nascent system, which is providing relatively little utility for the whole world, we can expect that the total fee volume will dramatically increase as the utility that Ephraim is able to provide grows. Okay. So before we get to the merge, at which point it could be that the eat supply does become just truly deflationary,

Starting point is 00:20:39 We will also, or now we do have these three main drivers of Eith. And I know that the Ethereum community likes to describe them in terms that might be appealing to people who like physics. Because they're described in terms of features like a solid, features like liquid and like a gas. So can you explain that analogy? Absolutely. So I like to think of money as water kind of flowing in a system. And water has different states of matter depending on its temperature. And it turns out that there's three scarcity engines in Ethereum that corresponds to different states of matter for water.

Starting point is 00:21:27 So on the cold side of the spectrum, on the minus zero, we have this idea that money, if is frozen when it is staked. So when you stake if, you take your if, you place it as collateral, and you don't get to touch it while you're validating. And if you do want to exit the validating process as an exit queue, so that not everyone can leave the queue at the same time. It actually takes several months for this ice cube to melt, as it were. On the other side of the temperature spectrum, we have the very hot. We have the above 100 degrees where basically water becomes gas. And this is the idea of the burn, the fee burn, where we're literally vaporizing EF and we're having it leave the supply. And then on the middle, we have this third scarcity engine, which is DFI.

Starting point is 00:22:22 So what is DFI is basically taking EF as collateral, but it's not as cold as staking in the sense that you can take it out, more freely, and you can think of it as being liquid water which is trapped in the pipes of of defy. And so these three mechanisms in their own different ways are basically sucking out the liquidity and like literally the liquid money that is kind of on exchanges and things like that, thereby effectively reducing the liquid supply of EF and improving the scarcity properties of EF. Yeah, and for the liquid version, when you talk about it being stuck in the pipes of defy, since it's used as collateral of, you know, if in the case of MakerDAO it's put up as collateral to mint dye, then that dye is used for something, you know, unless that person gets their position liquidated, then that if there is also kind of, it's not exactly cold the way it would be if it's stakes, but, you know, it's kind of, it's kind of temporarily. locked up and not easily burnt.

Starting point is 00:23:33 So one last question for you. I think that each of these states has a fun sound effect attached to it. Do you want to Absolutely. Let me get my states. So we have gas money which is being burnt which sounds like this.

Starting point is 00:23:49 And so every time you make a transaction on if you need to hear in your mind the satisfying sound. And then we have the process of taking liquid and solidifying it when you're staking, which sounds like this.

Starting point is 00:24:07 So you should imagine kind of the water crystals forming as you're freezing the money. And then you have, you know, the defy pipes where you have water slushing around. That sounds a bit like this.

Starting point is 00:24:27 Great. Great. I love it. All right. So let's now talk about that big milestone that we keep referring to, which is the next big step to ETH potentially becoming ultrasound money, and that is called the merge. So can you explain a little bit more about what the merge is and why that is going to be such an important step to ETH potentially becoming ultrasound money? So the merge is a very important step for Ethereum because it fundamentally changes the way

Starting point is 00:24:59 that Ethereum is secured. So right now, we have proof of work and proof of stake running in parallel, both at the same time, but all the economic value, all the defile, all the dapps and whatnot are being secured by the proof of work. The proof of stake really right now is in its testing phase. We want to make sure that it's robust and that there's enough if that is being staked so that this proof of stake beacon chain is solid enough to receive all the economic value that's being secured by Ethereum.

Starting point is 00:25:38 Now, at the merge, which is when we will determine that, you know, the beacon chain is secure enough, we will basically remove the proof of work and replace it by proof of stake. The contracts don't have to do anything. It will just keep on working. It's just that underneath, you know, behind the curtains. the security mechanism will change. So that's one big change. It's like from a security standpoint where we're changing.

Starting point is 00:26:07 And we're actually dramatically improving the security of Ethereum. And there's basically two reasons. One is around the concept of economic security. Like how much does it cost to actually attack the beacon chain? And you can look at basically how much if is being staked. So there's roughly 17, actually maybe 8.000. $18 billion of if staked right now. And so if you want to perform kind of this 51% attack,

Starting point is 00:26:35 you have to match as an attacker the $18 billion if. It's a very expensive attack from a budget standpoint. But we have this other cool trick up our sleeve, which is that if an attack does happen, and it is possible that an attack will happen, then we can penalize the attacker economically with slashing. So we can take a very large portion of this 18 billion Eiff and just destroy it. And this is a process that can happen automatically with automatic smashing.

Starting point is 00:27:08 So we basically have a system which is self-healing. So it is possible to attack it, but it's self-healing. And this is very different from Bitcoin. If for some reason or another on Bitcoin, an attacker has more than 50% of the hash rate, then they basically have God mode. They can do whatever they want. They can do arbitrary long censorship. They can do these reorgs.

Starting point is 00:27:32 They really have God mode without the possibility of the system healing itself. So that's the security aspect. But the other very exciting thing is the economic efficiency. We will be dramatically improving the economic efficiency. And the reason is that proof of work issuance is too dime high to use this common meme. And just to give you kind of a reason for that is because the proof of work issuance has to pay for two things. It has to pay for the mining hardware and it has to pay for the electricity running the mining hardware. And these are two expenses that we don't have in proof of stake.

Starting point is 00:28:18 The main expense for stakers is the cost of money, right? So they're taking their if, they're locking it. And so the opportunity cost of not having this EF kind of working for them somewhere else. That's the real cost. And so that's what we need to kind of account for and compensate in terms of issuance for proof of stake. And to give you kind of an order of magnitude, the cost of money is roughly, you know, three, four, five percent, kind of the low single digits percentages. On the other hand, the cost of economic security on proof of work systems is more like

Starting point is 00:28:55 100% annualized. So for every $1 of economic security, you're going to have to spend in terms of issuance $1 to cover both the hardware and electricity. And so you have this roughly factor of 20x improvement in the issuance. And for Ethereum specifically, the issuance is actually going to go down roughly by 10x. And we have this meme, which we call the triple happening. right so in bitcoin land every time you haven the issuance uh it reduces by a factor of two but we're going to be doing at least three happenings in one go because we'll be reducing by more than

Starting point is 00:29:37 eight x the issuance and so once we remove the proof of work issuance we're left with just the proof of stake issuance and that as i mentioned the proof of stake issuance is smaller than the burn at least in the first 24 hours where the burn was four times large and than the proof of stake issuance. And so if that trend continues, meaning that if the proof of stake issuance continues to be smaller than the burn, then the EF supply will decrease.

Starting point is 00:30:06 And the rough projection is that the Ethereum supply will peak at the merge, and that will be when the EF supply is roughly 120 million. So 120 million will kind of become the equivalent of Bitcoin's 21 million. But of course, Bitcoin will inflate for another century until it reaches 21 million. A firm will be kind of a century earlier reaching its peak and will from that point onwards start

Starting point is 00:30:35 decreasing. Yeah, which this part is incredibly fascinating to me. So in a moment, we're going to talk a little bit more about your projections and how all this will play out. But first, a quick word from the sponsors who make this show possible. With over 10 million users, crypto.com. is the easiest place to buy and sell over 90 cryptocurrencies. Download the crypto.com app now and get $25 with the code Laura.

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Starting point is 00:31:40 TASOS lets you easily exchange smart money throughout our digital world. A self-upgradable blockchain with a proven track record, Tezos seamlessly adopts tomorrow's innovations without network disruptions today. Because of this adaptability, engineers, conservationists, entrepreneurs, collectors, game developers, and artists from around the world are building, creating, and using Tezos every day. Discover how people are reimagining the world around you on Tezos. Back to my conversation with Justin Drake of the Ethereum Foundation. All right. So you came up with this pretty interesting spreadsheet that had different projections for how this issuance versus burn.

Starting point is 00:32:22 and all that would play out. And, you know, as you mentioned, it's kind of too early to really say how will your projections have done because we just have 24 hours worth of data. But why don't you just describe what those projections look like from the conservative to the optimistic viewpoint? There's various variables that come into play. For example, if you want to estimate at what if supply we will have when we peak at the merge. And by the way, there's this really good tool on ultrasound.money where you can just play with the assumptions as sliders and there's a pretty graph which will just show you the projected supply.

Starting point is 00:33:03 But basically the three key variables are one, how much if is being staked. So it turns out that the more if is being staked, the greater the proof of stake issuance. And in the worst possible case, if all the EF is being staked, we're looking at less than a million EF issuance per year. The second variable is how much are we burning every single day? So in the first 24 hours, we burns about 4.6, or actually closer to 4.7,000 if. but we will see how that progresses. My guess, as I mentioned, is that this amount of fee burn will increase, for example,

Starting point is 00:33:52 as we provide more utility through scaling, right, because scaling is an opportunity to provide much more utility to many, many more people. And so even though the individual transaction fees will go down, the aggregate fee volume will be greater. At least that's what we've observed historically, where the fee volume just keeps on increasing despite the scalability increases. Okay, and wait, just so I understand that, because when there's congestion on the network, people tend to pay much higher fees.

Starting point is 00:34:26 So what you're saying is even though the individual fee per person will decrease, because scaling will enable so many more transactions, that aspect of it will increase the fees for minors, or the tips we should call them. Or, well, it would be both base fee and tip, I guess. Right, exactly. Yeah, base fee and tip. Yeah, I mean, one of the things that we've observed historically as Ethereum has scaled, and it has scaled, so for example, the gas limits when Ephem was created at Genesis was only

Starting point is 00:35:00 3 million gas per block, and now it's 15 million gas per block. So we've had this 5x increase in scalability. We've also had indirect scalability improvements, for example, as small contracts get optimized for gas. So, for example, Uniswop v3 versus Unisovvvv2 and various other Defi contracts have tried to optimize for gas. And of course, we also have various roll-ups, which are now live providing even more scalability. And what we've observed historically is that, you know, as you increase utility, you also increase the transactional value that's provided by this utility.

Starting point is 00:35:42 on an aggregate basis. What might happen is that in the short term, as you increase the supply, you'll have a supply shock in the sense that you'll have too much scalability and then the kind of fees dip. But over the long term, as adoption kind of picks up and fills this gap, this gap, this demand gap, then the end result is that the final fee volume is much larger than the initial fee volume. Okay, so that's the fee burn per day. And then you have the final variable, which is when we're actually going to merge, right? Because the proof of stake issuance is extremely high.

Starting point is 00:36:23 It's 13.5,000 eph every single day. And so the sooner we merge, the better it is because the sooner we remove this huge fire hose of issuance that we're drowning under in the context of proof of work. Yeah, and so I've heard you talk about that as net cell pressure. Can you define that and describe what the net cell pressure used to be and how it's changed now or, or, you know, eventually will by the time of the merge? Absolutely. When a miner receives income in the form of either issuance or fees, they will sell most of that

Starting point is 00:37:09 income. And the reason is that they have to pay their expenses. And there's basically three forms of expenses. One is hardware. Two is electricity. And then there's a third one, which is a bit more subtle, which is the income tax. So my rough estimates, you know, because we're in a competitive market, basically the profit margins 10 to 0. But let's say that profit margins are 5%, you know, very, very low for the miners. In effect, they're going to be selling almost all of the EF that they receive. Now, when you compare this to proof of stake, not only is the income much, much lower, because the one, the issuance is roughly 10 times smaller, but two, a large portion of the fees are burnt. When you compare and contrast the two systems kind of from a week ago to post-merge,

Starting point is 00:38:05 we're actually in a situation where we're going to be reducing the cell pressure of Ethereum by 7 million if every single year. That's roughly the equivalent of all the if being staked right now. Every single year that is not being sold. So you can kind of think of it as by pressure relative to the past. So yeah, in the recent past, we've just had this huge dampener on a, effectively the EF price. And the reason is because there's lots of EF that just goes on the market to be sold,

Starting point is 00:38:41 to go buy for electricity, to go pay the taxes and to go buy the hardware. And this $7 million EF is no longer going to be sold. And seven million EF at current prices, that's what, there's something like $20 billion. Right. So that's the equivalent of roughly $20 billion of buy pressure in the future, every single year relative to the past. The taxes. You also mentioned you were going to describe that.

Starting point is 00:39:12 So can you talk about that? Yes. The income tax pressure. So with proof of stake, the main cell pressure, because there's no expense in terms of hardware or electricity, the main cell pressure is actually income taxes. You receive if rewards and you just have to pay some fraction of it to the government. And in order to pay it, you know, you have to go ahead and sell it.

Starting point is 00:39:37 And, you know, income tax in most jurisdictions is, let's say, around 50%. And so the profit margin for stakers is also roughly 50%, roughly 50%, 100% minus the 50% that goes to was taxes. So we have reduced sell pressure for kind of two reasons. One is because the profit margins for stakers are much higher. And two, because the. the income that comes in in the first place is much, much smaller in this new system with EIP-1559 and proof-of-stake relative to the proof-of-work system without EIP-1559. So one other aspect I wanted to draw out for this period between now and the merge is I was looking

Starting point is 00:40:25 at the burn leaderboard on the ultrasound.money website, and it's fascinating because it's basically a snapshot of what's hot in Ethereum right now. And so at least when I checked right before we recorded, it led with OpenC, then it was followed closely by COVID punks, which I actually hadn't heard of until that moment, then Uniswap v2, then Axi Infinity, then Tether, then Uniswap V3, Metamask, and finally, USDC. So I was just curious, like, what does that say to you about how those were the biggest contributors to the burn. And how do you think this will play out in terms of what will be driving ETH to get burned

Starting point is 00:41:05 in the near future? Right. So, I mean, at a kind of a macro level, the fact that we have almost 5,000 EF being burnt in 24 hours kind of suggests that if there is providing a huge amount of transactional utility. Now, as you say, it is very interesting because now we have more insight into which contracts specifically are providing utility. And you know, you highlighted a few, for example, which are NFT and a few which are in Defi.

Starting point is 00:41:36 And I guess roughly, you know, ballpark is kind of 50-50. And, you know, you mentioned this COVID punk. You know, basically what happened here is that there was this really intense period of roughly, I know, half an hour or an hour where the base fee kind of a spiked, you know, to something like 300 Guay or 400 Guay. And there was a huge amount of burn in that concentrated amount of time because they were actually minting a new NFT set. And so people were kind of competing to grab this NFTs because there was a limited supply. And the OpenC also suggests that people not only are kind of buying these NFTs, but they also, you know,

Starting point is 00:42:23 trading them. And that's that transactional utility is reflected in the burn for OpenC. And then there's this this this other category, which I guess is the Defy category with things like Uniswap. And actually we do have this other category, which is interesting, which is gaming. And one of the things that I'll say is that at the Affirm Foundation, our main remit, what we focus on is the consensus layer, the layer one. The, the layer one. the layer two, we kind of want to, we want it to be as organic and as flamboyant and permissionless as possible. And so, you know, I'm just very excited to see, you know, all this, this ecosystem be so

Starting point is 00:43:09 vibrant with, you know, as you said, there's these things that I had never heard of before, like this COVID punk just came out of nowhere and just burnt 500 if in a matter of half an hour, which is a kind of a crazy idea. Yeah, I mean, to me, when I looked at it, it just reminded me because when I first started reporting on NFTs, I didn't realize how kind of gas-heavy they were because I didn't understand from a technical standpoint, you know, like, it's not like an ERC-20 token where you just have that one smart contract. Like you have to mint each of these individual objects. And so, you know, it just reminded me like, oh, right, NFTs take a lot of gas. gas. And yeah, and then the Axi Infinity thing, you know, I've done some reporting on that. And yeah, like you can see, oh, yeah, this game is very popular right now. But yeah, I think one thing I want to

Starting point is 00:44:05 draw out here is, you know, there were people expressing surprise at the fact that gas fees increased after the upgrade, which was counterintuitive since the change was being touted as something that would make them more efficient. So can you just explain why that happened? one of the things that I mentioned is that generally speaking, the fee market is extremely volatile. And so it's difficult to compare it kind of one day to another because there's a lot of noise. Another thing that I'll say is that EIP 1559 does not reduce the demand for making transactions. And as such, it doesn't dramatically improve the efficiency. So it does to a small extent try and avoid overpaying, this idea of overpaying, but it's not a huge thing.

Starting point is 00:44:58 And so one of the things that we'll be able to do actually in the coming weeks is kind of look at the data and see how much were users actually overpaying the miners to get into the block. One thing that I'll notice is that there's this concept of induced demand. Like when you improve something, there's just more demand for it. So, you know, I already mentioned induced demand when you have scalability. When you improve scalability, just more people come in. But there's actually more subtle ways in which you can have induced demand. So one thing that we mentioned already is that EIP.559 improves U.X. It's just better to be transacting on Ethereum.

Starting point is 00:45:40 So because the user experience is better, people will just transact more. It's induced demand. You know, one example, for example, is, I mean, even personally, like, let's say I want to make a transaction. I'm going to spend 10 minutes making my transaction or five minutes because, you know, I don't want to overpay for gas. So I set a relatively low gas price. And then I wait a few minutes and it doesn't go through. So I kind of give up and then I bump up my gas price. And then, you know, it's just a whole faff.

Starting point is 00:46:09 And then I end up taking, you know, a whole 10 minutes just to make one transaction. If instead the UX is, I want to make a transaction, it just happens, well now, you know, 10 seconds later, I'm ready to make another transaction. So there's also induced demand in that sense. Another aspect in which this induced demand is what I call eco pain. So right now, or at least before EIP 1559, every time you made a transaction and you paid, for example, $10 in transaction fees, I knew that these $10,000, would really be bad for the ecosystem in the sense that $5, roughly half, would go to the landfills

Starting point is 00:46:51 in the sense that you're going to buy this mining hardware, which will deprecate over time. And then the other half is going to be used as electricity, literally like as an electric heater, like $5 worth of electric heating somewhere in the data center. And so I didn't feel good about making transactions on the theory in that sense.

Starting point is 00:47:13 But post EIP159 is good for two reasons. On the one hand, there isn't this echo pain aspect, but there's kind of this monetary pleasure, I guess, in the sense that you know that you're improving the monetary properties of EF when you do transact. And so I think the behavior change of Ethereum users will affect the demand. So there'll be this induced demand. I find that interesting. So one other thing that I wanted to circle back to was we did talk about, you know, how Bitcoin is sound money and how now, you know, ethosal just sound money. And one thing that I do know, you know, you have thoughts on is what Bitcoin might look

Starting point is 00:48:04 like once it transitions to only transaction fees and there's no block reward. Can you talk a little bit about, yeah, the security of that? because that was something I don't feel like I'd heard before and was really interesting to me. Right. So when you look at the security of a system, there's kind of multiple things at play. Like one is, for example, what is the flavor of consensus? So you could have proof of work versus proof of stake. You could look at decentralization of the consensus participants. And then you can look at basically what is the fuel to the consensus engine? What are the incentives for these consensus participants go do their work? Now, every single blockchain, with no exception as far as I can tell, is secured by issuance,

Starting point is 00:48:54 meaning that there's freshly minted tokens that are given to the consensus participants as incentives to go secure that blockchain, to go provide scarce resources to secure that blockchain. Now, a Bitcoin hopes to be secured by transaction fees. which is different from today where it's secured by issuance. And so there's kind of this grand experiment that Bitcoin is embarking itself on from a security standpoint, which is that can it be secured by transaction fees? And my guess is that the answer is no. And the answer is no for several reasons.

Starting point is 00:49:33 One is that you can look at transaction fees from a quantitative standpoint. So transaction fees originate from transactional utility. Now, Bitcoin is not optimized for transactional utility. The utility of Ethereum is non-transactional. It's in the hoddling, right? So the way that you benefit from the utility of Bitcoin is you go buy a Bitcoin, you put it in a hard wallet, you forget about it for a decade, and then maybe in a decade you go make another transaction to send it to the exchange and sell it.

Starting point is 00:50:07 So you basically made two transactions over a period of a decade. And so the transactional utility is very, very small. And so the amount of transaction fees that the blockchain could hope to extract a relatively small as well. And there's other aspects like the fact that there's very, very little block space in the first place. And so because there's very little block space, there's also very little opportunity to go extract these fees. And this is reflected empirically today, you know, when you look at the total fee volume. So if you go to cryptofees.com, I believe, you will be able to see that

Starting point is 00:50:47 Ethereum has roughly 20 times the fee volume than Bitcoin. And the fee volume for Bitcoin is kind of laughable almost, like it's half a million dollars versus, you know, $10 million. dollars. There's no way the money of the internet, you know, a hundred trillion dollar market cap can be secured by, you know, half a million dollars in fees. But there's actually another problem with transaction fees. So let's just assume that magically, you know, transaction fees will be sufficient to secure Bitcoin. For example, let's imagine that, you know, Every transaction fee is $1,000. People are willing to pay $1,000 per transaction.

Starting point is 00:51:31 There's this other problem, which I alluded to, which is that transactions can be stolen from one minor to another. So if you have a transaction with a very large transaction fee, let's say a $1,000 transaction fee or $10,000 or $100,000, it can get included in Block A or it can get included in Block B. So let's imagine that Block A included that transaction. Now, block B has a, you know, the miner for block B needs to ask himself, do I mine on top of block A or do I mine on top of the parent of block A? Because if I mine on top of the parents of block A, then I can go take these very juicy transactions and include them in my block.

Starting point is 00:52:16 So that's the concept of basically minor extractable value, MEV, which is the fuel for reorgs. Now, in a consensus system, you want this idea of convergence, right? You want all the miners to agree and converge very, very quickly on a chain. And this is achieved through issuance. In a way, transaction fees is the opposite of convergence. It's divergence. It encourages forking. And so it would be in a situation where Bitcoin is unstable.

Starting point is 00:52:49 Now, another thing that I mentioned is that transaction fees are volatile. And they're also cyclical. For example, we know that on weekends there's a dip in transaction fees and then during the weekdays, a bump. And so if there's zero issuance, what will happen when Bitcoin is only secured by transaction fees is that block times will closely match the incoming transaction fees because that's the incentives that are coming in. And so on weekends, you might have 20, 30 minute block times. And then on weekdays, you might have five minute block times, you know, because on the weekends, the least profitable miners will have to disconnect their mining hardware because there's not enough transaction fees to justify them running the hardware and paying for the electricity. And so very, very quickly, you realize that Bitcoin will be a very unstable system. And it won't happen, you know, a hundred years into the future when the issuance is zero.

Starting point is 00:53:51 It will actually happen 20 to 30 years into the future where the issuance will be, you know, close enough to zero. And the reason is that issuance decreases exponentially every four years it halves. And so even in our 20 to 30 year time scale, the issuance will be very, very small and most likely insufficient to secure the Bitcoin blockchain. And so one of the things that both Bitcoin, and Ethereum's agree upon is this idea of predictability, right? We want to have a system which can be relied upon for decades and centuries. And we've taken a very different approach to predictability. Bitcoin has taken a short-term approach to predictability. They decided to not change since day one. And basically, the fact that you're not changing means that you can predict

Starting point is 00:54:44 will happen in the short term until, of course, you know, the system is unsustainable and then something massive has to happen. For example, they could remove the 21 million block limit. They could start increasing the issuance again and start reviving the blockchain from a security standpoint. Or, you know, another scenario that I have in mind is that there is a decoupling of Bitcoin, the blockchain and BTC, the asset. And BTC, the asset, which is super scarce like gold, can go live somewhere else on another blockchain that will host it for free.

Starting point is 00:55:22 And that blockchain, for example, could be Ethereum. So that's another scenario that I see. Yes, another scenario is for Bitcoin to start adopting some of the technical innovations that we've had on Ethereum, like for example,

Starting point is 00:55:35 implementing EIP-159 or implementing proof of stake. And so this approach to predictability for Bitcoin, which optimizes for short-term predictors, is very different from Ethereum where we actually, we are happy to trade off short-term predictability. So if you look at Ethereum over the last six years, it's changed its monetary policy, for example, three times. It's once it reduced its block reward from five-eif to three-efe, and then it reduced it from three-eif to two-eif, and then it's reducing again, you know,

Starting point is 00:56:10 with EIP-1559. And then it's going to reduce it again with the, with the, you know, emerge. So we know we have this hardening, I guess, of the monetary policy over time via these various innovations. And we want to be in the point where we're very happy with the system. We have one, guaranteed security. And two, we have this idea of being economically optimal in some sense. So once we've reached this optimal point, there will be no more reason to change a firm because it will already be kind of... either optimal or kind of close enough to optimal. And so we'll have a system which will have evolved in the short term

Starting point is 00:56:51 and not had the short-term predictability, and then it reaches a point where it's good enough, and then it can go live for decades and centuries. Wow. This whole thing has been so fascinating. I just wanted to ask when you said that potentially Bitcoin, the asset could just live on another blockchain that was, you know, that provided the security.

Starting point is 00:57:15 And you said potentially could be Ethereum. Would that be in the form of RAP to Ether? Or like, you know, there was that project that tried to do trustless BTC before. Like, what do you think that would look like? Great question. So in order for this migration to happen, I think it needs to happen kind of gradually. the Bitcoin community is very opinionated. And it's difficult to reach consensus.

Starting point is 00:57:48 And they've designed the system and the culture in such a way that the Bitcoin blockchain kind of never changes. And so you kind of need to find kind of a sly side door and strategy to try and migrate the Bitcoin, the asset onto Ethereum. And I think the strategy that kind of the plausible way forward that I have in mind is, through these bridges. Now, these bridges need to have two properties which we don't have both four. The first one is that the bridge needs to be trustless, right? Because if the bridge is not trustless, then we're basically trusting this centralized entity to oversee the migration of, you know,

Starting point is 00:58:32 one of the biggest assets in the world from one blockchain to another. It's just not viable. Right. Which means wrapped BTC is out because that is managed by a centralized party. So, okay, keep going. Yeah. And the other property that you want is you want it to be collateral efficient. So there's this project called TBTC, which is trustless. But the big downside is that in order to create this bridge, for every single Bitcoin, you need to have more ether and reserves and value than the Bitcoin. So it's extremely collateral and efficient. The good news is that there is this moon math technology, which allows Bitcoin to run smart contracts or to verify snarks. So it's called indistinguishability obfuscation.

Starting point is 00:59:25 It's technology that we don't have today. It's very, very sophisticated, ferretical cryptography. But it's plausible that in 20 to 30 years, we will have it. And that will allow Bitcoin to essentially run the EVM. And so once we have, have Bitcoin running the EVM, even with their tiny blocks, that's sufficient to have a two-way trustless bridge, which is fully collateral efficient. So you don't need any collateral. And so we will be in a position where Bitcoin will slowly start trickling towards Ethereum. And we're actually already seeing it. If you go to defyipose.com slash BTC, you will see over time the unavoidable, you know, increase of BTC on Ethereum.

Starting point is 01:00:13 And I believe, you know, around 1.5% or something like that, maybe a bit less of the whole Bitcoin supply, which currently lives on Ethereum. And then there will be a breaking point for Bitcoin, a breaking point from a security standpoint. Either, you know, the blockchain gets 51% attacked because, you know, the insurance is way too low and the security is way too low. or it could get attacked in another way. For example, it could get attacked in the form of a quantum attack. So quantum computers are coming. If there aren't suitable preparations which are done to protect the assets on the Bitcoin Doctrine, what will happen is that one attacker or maybe a small handful of attackers

Starting point is 01:00:57 would be able to basically steal lost coins from the past. and that would be very bad. It would be kind of the equivalent of the Dow for Ethereum where one of the worries of the Tao is that a single entity would have a huge fraction of the supply and basically destroy the monetary value and also the security story around proof of stake which requires the stake to be decentralized.

Starting point is 01:01:28 And so once there's this event that happens, the Bitcoin blockchain breaks, all the Bitcoin that hasn't yet migrated over to Ethereum can be deemed lost, and the new canonical home for BTC, the asset, can be Ethereum. Wow. I feel like this is going to be fighting words amongst the Bitcoin community. This whole thing is very fascinating. Just out of curiosity, because you started as a Bitcoiner, do you still consider yourself a Bitcoiner? Absolutely. I mean, I hold Bitcoin and I feel, you know, very connected to Bitcoin from a, you know, cultural, not cultural, but from a philosophical standpoint, right? What Satoshi was able to do was a real breakthrough for humanity. And we've seen over the period of 13 years all the innovation that's come out of it. And I, the way that I see it is,

Starting point is 01:02:31 basically, Ethereum is the accomplishment of Satoshi's vision. It is Bitcoin. Ethereum is Bitcoin in that sense. What aspect of Satoshi's vision is Ethereum? Like when you say that Ethereum is Satoshi's vision, what do you mean? Part of the vision of Satoshi was to provide a decentralized trust layer for the Internet. So one of the things that Satoshi tried to do in the very early days and you have commits in the repo is he tried to build a peer-to-peer marketplace that built on top of this money layer. So the natural progression of decentralized infrastructure is to start with money and then to start building blocks that use this money. And you could have, for example, marketplaces and you can have escrow contracts. and you can have stable coins and you can have reputation and you can have identity like the Iffram name system and you can have insurance. And once you have all these building blocks come together, you basically have the substrate for the internet of value.

Starting point is 01:03:45 And I think this is the true Satoshi vision and this is what Ethereum is delivering. Wow, this whole thing is extremely, extremely fascinating talking to you. One thing I will say is I have said in the past that I wished I could be around when Bitcoin transitioned to only transaction fees to see how that plays out. But if your theory is correct, then it looks like I might get to see what happens in 20 or 30 years because I will still be around then. All right, so we're over time, but I really have to ask you about something super important, which is this idea of ETH as ultrasound money becoming a meme. Can you talk a little bit about how that's happening, like what you're seeing in the community, what are the aspects of this meme? Like, what are you seeing in terms of the development of this? Right.

Starting point is 01:04:39 So, you know, when the meme was introduced, I think, it was something like October 2020, it got a reasonable amount of attention on Twitter, but then it kind of got lost and people forgot about it. Until I was

Starting point is 01:05:00 part of a bankless episode discussing ultrasound money, and this is where kind of the concept really became popularized and people started talking about it again. And one of the things that happened which is very interesting is that David Hoffman, I believe, started wearing the bat signal.

Starting point is 01:05:21 Now, what is the bat signal? It's basically a two emoji, the bat emoji and the sound emoji. And it was trying to be a play on words where, you know, because bats produce ultrasounds, kind of the bad signal is going to represent ultrasound money. And people just started copying the bat signal all over Twitter. we have over 2,500 Twitter accounts, you know, huge accounts, including, you know, for example, the Axi Infinity account and many, many DeFi founders and, you know, lots of prominent accounts within the Ethereum space, just adopting the bad signal. And so we have this,

Starting point is 01:06:04 this meme, which is now seems to be spreading across the whole community. And now we have this website. And, you know, the word ultrasound money was picked up on Bloomberg. It was picked up on on CNBC. And so there is kind of a possibility that in the same way the kind of bats kind of infected the whole world with genes, you know, with COVID, that bats yet again will infect the whole world with memes. So, you know, one is kind of negative, but the other one is positive. And actually, it's interesting because the word meme actually comes from gene, the inventor of the Oh, right. The word meme kind of wanted to create a word to describe the propagation of cultural information

Starting point is 01:06:54 and the evolution process of these ideas, which follows a very similar pattern to genes. And so I think the analogy is really, really good in a sense that we have these viral ideas that go spread across the world. Now, right now, the meme has mostly kind of infected the Ethereum community, but it is possible that it will kind of go beyond this boundary and infect kind of a wider population. Well, we will have to see. Yeah, this whole episode has been super, super fascinating. I really appreciate that you came on the show to talk about it. where can people learn more about you and EIP-1559 and the idea of ETH as ultrasound money? To learn more about me, you can follow me on Twitter. I'm Drake F. Justin. To learn more about

Starting point is 01:07:50 ultrasound money, there's four hours of content on bankless, two separate episodes that cover ultrasound money. There's also the ultrasound money website, and there's also the ultrasound money Twitter account. So lots of content for you guys to consume. Okay, perfect. Well, thanks so much for coming on Unchained. Thanks for having me. Thanks so much for joining us today. To learn more about Justin and Eith as Ultrasound Money, check out the show notes for this episode. Unchained is produced by me, Laura Shin, with help from Anthony Yun, Daniel Ness, and Mark Bordock. Thanks for listening. Thank you.

Unchained - Is ETH on Its Way to Becoming Ultra-Sound Money? Yes, Says Justin Drake - Ep.262

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