The concept of sound money has been around for millennia, but our current understanding of sound money gained prominence as a more refined concept early in the 19th century amongst liberal (classical) economic theorists, financiers, and political power brokers during American and European based globalization. These thinkers were trying to answer deep questions about what type of money and economic system secured economic efficiency, multi-polar coordination, and human liberty best.
Gold and other precious metals have enjoyed the privilege of monetary premia for millennia because of their superior money-ness, but creating social and financial systems on top of them is still tough. Sound money based systems were far from perfect and cost a lot to maintain. There is a highly imperfect and impure social layer that we must inevitably contend with. However, a “sound money” foundation creates high assurances around the money a group is anchored to, which in time builds compounding trust and buy-in between the members and users, while simultaneously reducing transaction costs over time and space for everyone connected to the sound money network.
Enlightenment political and economic theorists thought sound money was an important pillar in which we could build an efficient economy and a free world on top of, preserving liberty for all and allowing multi-polar, decentralized coordination between rival nations.
Sound money to the Classical Liberal Economist was defined by three primary attributes:
- Reliably stores value over time; silver is a better SoV than whiskey which is better than bananas
- Low volatility in the short, medium, and long term; this allows for a good measure to emerge; we can account for things and keep score so to speak; we can somewhat predict what goods and services the money will buy well into the future
- It’s not subject to arbitrary, costless decisions by a central organization or small group; there are high assurances amongst the participants in the money network; it can’t arbitrarily be devalued by anyone or any group that is a part of the value network
Our Money Frame at Edge
Before we get into what Ether is, we need to be in the frame of mind that almost everything has SOME, or can have some, subjective value to someone. And since money is used as a low resolution universal representation of our collective subjective valuations, everything has some level of moneyness. This is to say, money exists on a spectrum, in the sense that there is no perfect money and even bananas can serve as money in some very limited capacity over very short time horizons. There are gradations to moneyness. We often want to reduce everything to binary oppositions, money or not money, but this isn’t the way we think about the issue and it’s the easy way out. It takes less intellectual resources and energy to think in binaries rather than gradations. Binaries can be an efficient way to make decent decisions in a stressful situation but they definitely aren’t thorough and they leave out a lot of nuance and context necessary to make great decisions over time.
What many of the early detractors missed with Bitcoin was often a problem of their own ego and not necessarily an indictment of their intellect. A lot of intelligent, reasonable people not only dismissed Bitcoin, but actively made fun of it, especially those with “credentials” or financial “street cred”. Even many of those currently dedicated to the Bitcoin project readily admit they dismissed Bitcoin at first glance. A few big reasons for this initial “missing” resulted from them (1) not seeing the value in it for themselves (2) it didn’t fit in their preconceived frame of what money “is” and/or (3) hardly anyone else they knew would value it, so it couldn’t be valuable, could it? If no one smart, reasonable, educated, and credentialed like them sees the value in something claiming to be money, how could it gain any traction?
“It can’t work”
Actually it can, and it did, still does, and will continue to work. People have all sorts of use for all sorts of stuff that large groups of other people don’t understand. Just because we might not find value in something personally or don’t understand how it brings value to others, doesn’t mean others can’t mine immense value from it, pun intended. Early Bitcoiners did see value in what Satoshi Nakamoto built, didn’t really care that others didn’t “get it”, and they derived immense value from it and still do to this day.
Was Bitcoin sound money in 2009? Barely if at all, BUT did it have the architecture and vision to become sound money? Yes and with every block its soundness and moneyness leveled up. And it doesn’t look like there is anything that can stop it from improving its soundness and its moneyness.
Now that we’ve moved away from the lazy binary of” money or not money”, we need to build off our “moneyness” frame, understand what ETH is, and then apply that understanding to our conception of sound money.
Ether’s (ETH) intended function, or its highest use value, derives from its ability to pay for the deployment and execution of programs that are stored in the Ethereum Virtual Machine (EVM). Developers can deploy smart contracts (programs) to the EVM and pay for the resources necessary to execute those contracts with Ether. These payments for computation, storage, etc., are known as gas fees. When you pay “gas” on the Ethereum network you’re paying the EVM for the use of its digital resources. But like everything, Ether doesn’t have just one possible use. Some use it as a money-like asset. This shouldn’t surprise anyone in crypto.
Ether is highly divisible, up to 18 decimal places, and is highly portable like Bitcoin and other crypto-assets. Ether can be sent anywhere in the world and for the proper fee will be confirmed in about ~15-45 seconds. On these two dimensions of moneyness Ether has a high level of moneyness, higher than gold, higher than the USD, and on par or even superior to other crypto-assets.
But How Sound Is It?
How has Ether stored value across time?
This depends on what your time frame is. Those that were accumulating ETH early on didn’t have a store of value for two years, they’ve had something even better: an explosive multiplier of value. But those who entered an ETH position in late 2017 through mid-2018, assuming they stopped there, are still way under water. If someone started accumulating ETH near the end of 2018 until this present day, you’d have a nice return. Although it has been a multiplier of value for some, Ether hasn’t been the most reliable store of value for others. It’s been better than terrible fiat monies like the Venezuelan Bolivar, Lebanese Pound, and Argentinian Peso, but it hasn’t been nearly as reliable at certain times as the USD, EUR, Gold, or Silver..
ETH’s store of value function is a mixed bag much like BTC. ETH has been a huge value multiplier for almost everyone that consistently saves in it, but there have been long stretches of time that fresh savings put into ETH would result in immediate or impending devaluation due to the incredible speculative upticks and drawdowns. On this dimension ETH can be said to be pretty good because it has generated immense upside for many of its holders, but we have to acknowledge there have been long drawn out devaluations that can’t be ignored. Most businesses and consumers don’t want to expose themselves to so much risk of a potential long drawn out devaluation.
What About Volatility?
On the next dimension, volatility, ETH gets a very low score like almost all other crypto-assets besides “stable”-coins. Although crypto-assets like ETH have stored and even multiplied value for many of its holders, its volatility is extremely high, substantially reducing its “soundness”, for now.
Is ETH subject to arbitrary changes by a central organization?
No, there is no official organization like the Fed or ECB that can change the monetary policy of ETH and do with it as they please. There is no group that can decide tomorrow to mint more ETH than other network participants expect to be minted and then go and buy Apple’s corporate bonds like the Federal Reserve can and does with the USD.
Although it’s true that no organization can change ETH’s monetary policy arbitrarily, it has in fact changed over its short lifespan. This is possible in these networks, even in Bitcoin, as long as the participants on the network come to consensus about the change to monetary policy. The difference for Bitcoin being, the unchanging 21 million cap of Bitcoin supply is a key selling point of its hardness and a dogmatic rallying point of the Bitcoin community. A rallying point we very much agree with, we think is entirely appropriate, and will never want it to change. However, the Ethereum community doesn’t want a cap on supply and they think it would hamper the specific goals they are trying to achieve.
Bitcoin is seeking to be the hardest and soundest money in the world. Capping the supply at 21 million is consistent and appropriate with that aim. However, Ethereum is not trying to be as hard or sound as Bitcoin in the sense that the Ethereum community is ok with making changes to ETH’s monetary policy for the good of the applications running on the network, as they see fit. Ethereum isn’t designed to be the hardest money on the planet, we have BTC for that, and instead aims to enable the creation of decentralized applications that use the Ethereum blockchain for settlement and the EVM for executing smart contracts (programs).
ETH monetary policy is a tool to serve the purpose of securing and serving decentralized applications. BTC’s monetary policy is a tool used to serve the purpose of creating incredibly sound digital gold that puts it in a league of its own. These are very different goals that require their own unique strategies. Neither is right nor wrong in the absolute sense. They are only right-ish or wrong-ish given their respective context and goals.
But It’s interesting when you look into the details of these changes to ETH’s monetary policy; we see that the Ethereum community has had:
(1) a track record of reducing issuance,
(2) the network has never agreed to increase the issuance rate,
(3) ETH 2.0 is slated to reduce the issuance rate
(4) Ethereum Improvement Proposal (EIP) 1159 has a provision in it that burns part of the ETH gas fees in each block.
Put simply, If ETH 2.0 and EIP 1159 work as designed, ETH will be a hardening asset.
This doesn’t mean the Ethereum community can’t raise the rate of issuance in the future, nor should anyone have blind faith that the Ethereum community won’t decide to dilute supply at some point in the future. The Ethereum community knows the importance of an instrument that retains value and builds trust and buy in, while also serving the needs of the network. Although not as hard as BTC, ETH can still be considered harder than almost all 190 or so fiat currencies, and in the next decade might become harder than gold and silver.
The ETH community wants ETH to be hard enough to retain value and build trust, but also soft enough to keep its security budget expanding. Cutting off supply of a crypto-asset is positive in the sense that it stops diluting old supply but it necessarily puts a ceiling on how much economic value you can protect on your chain.
Concerns & Controversies
The DAO Hack
In June 2016 there was an exploit of a smart contract that held about 55 million USD worth of ETH funds at the time. This was known as the DAO hack. This led to a controversial split in the community that led to the formation of two factions: (1) one faction wanted to reverse the hack and get funds back to the investors, developers, and users who had deposited money in the contract and (2) another faction who thought a rollback was a dangerous precedent to set and went against the ethos of immutability of the Ethereum and the greater crypto community. The factions within Ethereum eventually split into two chains: Ethereum Classic (ETC) which refused to rollback the DAO hack and Ethereum (ETH) which quickly became the chain that most of the hash power and economic weight supported and has never looked back.
Whether or not we agree or you agree with how the DAO hack and fork was handled, the market shrugged it off and has had many opportunities and still does to dump ETH for ETC but the opposite has happened. ETH has clearly been the market winner in many aspects. The market seems to be more than ok with the Ethereum community’s reasoning and trusts the community going forward. It’s been over 4 years since the hack and Ethereum hasn’t rolled back the chain at all. It isn’t guaranteed that they won’t at some time in the future but those that disagree with a large majority of the network can always sell their ETH and/or fork away.
We also had a recent “gotcha” moment where some hostile Bitcoiners were trolling and negging the Ethereum community about there being no easy way to calculate and audit the total existing supply like for users of Bitcoin. Because of a multitude of factors it’s technically harder for an individual to confirm the current supply of outstanding Ether compared to BTC at any given point in time. This doesn’t mean Ether’s real time outstanding supply isn’t something that can’t be calculated, it just takes more work, time, and technical sophistication. Ether’s supply changes every 15 seconds compared to Bitcoin’s every 10 minutes, and Ethereum allocates mining rewards differently than Bitcoin which makes it harder for the average user of the system to calculate and verify the current total supply for themselves.
What we want to emphasize is that crypto-assets like ETH evolve and are not great at everything right off of the bat and will never reach perfect soundness or perfect moneyness for everyone. Every money system has its issues. But, does ETH have the potential to be a phenomenal store of value and furthermore, sound money? It looks like it does to us.
On the super unofficial and unscientific sound money-ness scales, ETH looks to be at best OK right now. It’s definitely not great, but it has the architecture and potential to be another sound digital money option, alongside BTC, for the 21st century.
ETH has many more trials and tribulations to go through to become a mature, sound money but we believe it has the potential to get there. Nothing is guaranteed but there aren’t many assets in the financial world that we could even come close to saying the same about.