2022 Dec 05
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Special thanks to Matt Huang, Santi Siri and Tina Zhen for feedback and review

Ten, five, or even two years ago, my opinions on what Ethereum and blockchains can do for the world were very abstract. “This is a general-purpose technology, like C++”, I would say; of course, it has specific properties like decentralization, openness and censorship resistance, but beyond that it’s just too early to say which specific applications are going to make the most sense.

Today’s world is no longer that world. Today, enough time has passed that there are few ideas that are completely unexplored: if something succeeds, it will probably be some version of something that has already been discussed in blogs and forums and conferences on multiple occasions. We’ve also come closer to identifying fundamental limits of the space. Many DAOs have had a fair chance with an enthusiastic audience willing to participate in them despite the inconveniences and fees, and many have underperformed. Industrial supply-chain applications have not gone anywhere. Decentralized Amazon on the blockchain has not happened. But it’s also a world where we have seen genuine and growing adoption of a few key applications that are meeting people’s real needs – and those are the applications that we need to focus on.

Hence my change in perspective: my excitement about Ethereum is now no longer based in the potential for undiscovered unknowns, but rather in a few specific categories of applications that are proving themselves already, and are only getting stronger. What are these applications, and which applications am I no longer optimistic about? That is what this post will be about.

1. Money: the first and still most important app

When I first visited Argentina in December last year, one of the experiences I remember well was walking around on Christmas Day, when almost everything is closed, looking for a coffee shop. After passing by about five closed ones, we finally found one that was open. When we walked in, the owner recognized me, and immediately showed me that he has ETH and other crypto-assets on his Binance account. We ordered tea and snacks, and we asked if we could pay in ETH. The coffee shop owner obliged, and showed me the QR code for his Binance deposit address, to which I sent about $20 of ETH from my Status wallet on my phone.

This was far from the most meaningful use of cryptocurrency that is taking place in the country. Others are using it to save money, transfer money internationally, make payments for large and important transactions, and much more. But even still, the fact that I randomly found a coffee shop and it happened to accept cryptocurrency showed the sheer reach of adoption. Unlike wealthy countries like the United States, where financial transactions are easy to make and 8% inflation is considered extreme, in Argentina and many other countries around the world, links to global financial systems are more limited and extreme inflation is a reality every day. Cryptocurrency often steps in as a lifeline.

In addition to Binance, there is also an increasing number of local exchanges, and you can see advertisements for them everywhere including at airports.

The one issue with my coffee transaction is that it did not really make pragmatic sense. The fee was high, about a third of the value of the transaction. The transaction took several minutes to confirm: I believe that at the time, Status did not yet support sending proper EIP-1559 transactions that more reliably confirm quickly. If, like many other Argentinian crypto users, I had simply had a Binance wallet, the transfer would have been free and instant.

A year later, however, the calculus is different. As a side effect of the Merge, transactions get included significantly more quickly and the chain has become more stable, making it safer to accept transactions after fewer confirmations. Scaling technology such as optimistic and ZK rollups is proceeding quickly. Social recovery and multisig wallets are becoming more practical with account abstraction. These trends will take years to play out as the technology develops, but progress is already being made. At the same time, there is an important “push factor” driving interest in transacting on-chain: the FTX collapse, which has reminded everyone, Latin Americans included, that even the most trustworthy-seeming centralized services may not be trustworthy after all.

Cryptocurrency in wealthy countries

In wealthy countries, the more extreme use cases around surviving high inflation and doing basic financial activities at all usually do not apply. But cryptocurrency still has significant value. As someone who has used it to make donations (to quite normal organizations in many countries), I can personally confirm that it is far more convenient than traditional banking. It’s also valuable for industries and activities at risk of being deplatformed by payment processors – a category which includes many industries that are perfectly legal under most countries’ laws.

There is also the important broader philosophical case for cryptocurrency as private money: the transition to a “cashless society” is being taken advantage of by many governments as an opportunity to introduce levels of financial surveillance that would be unimaginable 100 years ago. Cryptocurrency is the only thing currently being developed that can realistically combine the benefits of digitalization with cash-like respect for personal privacy.

But in either case, cryptocurrency is far from perfect. Even with all the technical, user experience and account safety problems solved, it remains a fact that cryptocurrency is volatile, and the volatility can make it difficult to use for savings and business. For that reason, we have…

Stablecoins

The value of stablecoins has been understood in the Ethereum community for a long time. Quoting a blog post from 2014:

Over the past eleven months, Bitcoin holders have lost about 67% of their wealth and quite often the price moves up or down by as much as 25% in a single week. Seeing this concern, there is a growing interest in a simple question: can we get the best of both worlds? Can we have the full decentralization that a cryptographic payment network offers, but at the same time have a higher level of price stability, without such extreme upward and downward swings?

And indeed, stablecoins are very popular among precisely those users who are making pragmatic use of cryptocurrency today. That said, there is a reality that is not congenial to cypherpunk values today: the stablecoins that are most successful today are the centralized ones, mostly USDC, USDT and BUSD.

Top cryptocurrency market caps, data from CoinGecko, 2022-11-30. Three of the top six are centralized stablecoins.

Stablecoins issued on-chain have many convenient properties: they are open for use by anyone, they are resistant to the most large-scale and opaque forms of censorship (the issuer can blacklist and freeze addresses, but such blacklisting is transparent, and there are literal transaction fee costs associated with freezing each address), and they interact well with on-chain infrastructure (accounts, DEXes, etc). But it’s not clear how long this state of affairs will last, and so there is a need to keep working on other alternatives.

I see the stablecoin design space as basically being split into three different categories: centralized stablecoins, DAO-governed real-world-asset backed stablecoins and governance-minimized crypto-backed stablecoins.

Centralized stablecoins	Traditional legal entity	• Maximum efficiency • Easy to understand	Vulnerable to risks of a single issuer and a single jurisdiction	USDC, USDT, BUSD
DAO-governed RWA-backed stablecoins	DAO deciding on allowed collateral types and maximum per type	• Adds resilience by diversifying issuers and jurisdictions • Still somewhat capital efficient	Vulnerable to repeated issuer fraud or coordinated takedown	DAI
Governance-minimized crypto-backed stablecoin	Price oracle only	• Maximum resilience • No outside dependencies	• High collateral requirements • Limited scale • Sometimes needs negative interest rates	RAI, LUSD

From the user’s perspective, the three types are arranged on a tradeoff spectrum between efficiency and resilience. USDC works today, and will almost certainly work tomorrow. But in the longer term, its ongoing stability depends on the macroeconomic and political stability of the United States, a continued US regulatory environment that supports making USDC available to everyone, and the trustworthiness of the issuing organization.

RAI, on the other hand, can survive all of these risks, but it has a negative interest rate: at the time of this writing, -6.7%. To make the system stable (so, not be vulnerable to collapse like LUNA), every holder of RAI must be matched by a holder of negative RAI (aka. a “borrower” or “CDP holder”) who puts in ETH as collateral. This rate could be improved with more people engaging in arbitrage, holding negative RAI and balancing it out with positive USDC or even interest-bearing bank account deposits, but interest rates on RAI will always be lower than in a functioning banking system, and the possibility of negative rates, and the user experience headaches that they imply, will always be there.

The RAI model is ultimately ideal for the more pessimistic lunarpunk world: it avoids all connection to non-crypto financial systems, making it much more difficult to attack. Negative interest rates prevent it from being a convenient proxy for the dollar, but one way to adapt would be to embrace the disconnection: a governance-minimized stablecoin could track some non-currency asset like a global average CPI index, and advertise itself as representing abstract “best-effort price stability”. This would also have lower inherent regulatory risk, as such an asset would not be attempting to provide a “digital dollar” (or euro, or…).

DAO-governed RWA-backed stablecoins, if they can be made to work well, could be a happy medium. Such stablecoins could combine enough robustness, censorship resistance, scale and economic practicality to satisfy the needs of a large number of real-world crypto users. But making this work requires both real-world legal work to develop robust issuers, and a healthy dose of resilience-oriented DAO governance engineering.

In either case, any kind of stablecoin working well would be a boon for many kinds of currency and savings applications that are already concretely useful for millions of people today.

2. Defi: keep it simple

Decentralized finance is, in my view, a category that s