Ethereum : From “Three-Point Assets” and “Super Sound Money” to “Perpetual Bonds”

Although the Ethereum network plays a key role in the cryptocurrency ecosystem, the ETH asset itself is difficult to define. Previously, ETH was described in Ethereum circles as a “three-point asset” and “ultra-sound currency” due to its utility and scarcity. Recently, Arthur Hayes, former CEO of BitMEX, believes that when Ethereum completes its merger with PoS, ETH will be worth like a bond. This article will explore the origin of Ethereum’s native asset class concept and whether it can be considered a perpetual bond.

Evolution of Ethereum 

Since its inception in 2015, the cryptocurrency market has been debating how to define it. The Ethereum network itself is often described as the base layer of Web3, but its native asset, ETH, is not so clearly defined.

As with all new technologies, how to conceptualize them with reference to existing systems is an ongoing debate, and Ethereum is no exception. Ethereum has gone through various tests since its inception, and its roadmap has stretched over several years, and there is still a long way to go before the final vision can be realized.

During upgrades, Ethereum users have plenty of time to think about the impact of each fork and speculate on the impact of future upgrades. Descriptions like “three-point asset” or “ultra-sound currency” distill Ethereum’s complex properties into memes, quickly grabbing market attention and providing a powerful rallying cry for those who believe in the ETH asset.

As Ethereum prepares to move from PoW to PoS, Arthur Hayes believes that conceptualizing Ethereum as a bond is critical for its next phase of growth. Hayes, who is highly regarded in the crypto community for his insights into crypto and global financial markets, believes that institutions can view ETH as a bond once Ethereum moves to PoS. Based on this bond classification, he believes the value proposition of buying and staking ETH should propel ETH to $10,000 by the end of 2022.

ETH asset class exploration 

Before exploring how ETH became a bond, it is necessary to understand what led Arthur Hayes to the idea of ​​bond theory.

In 2019, Bankless co-founder David Hoffman was one of the first researchers to try to define ETH with reference to the traditional monetary system. In an article titled “Ethereum: A Three-Point Asset,” he noted that ETH is the first asset to span three asset classes, namely store of value, capital asset, and expendable asset.

When ETH is pledged, it becomes a capital asset as it generates income and can be valued based on its expected return, similar to a bond; when ETH is used as gas to pay for transactions, it acts as expendable The role of an asset is similar to paying taxes with USD; ETH acts as a store of value when holders deposit ETH into DeFi protocols like Aave or Compound as collateral.

Ethereum : From "Three-Point Assets" and "Super Sound Money" to "Perpetual Bonds"

This three-point asset definition forms the cornerstone of the Ethereum ecosystem, provides a path for ETH’s further adoption and growth, and demonstrates ETH’s similarities to key assets in the traditional economy. For example, the triple structure of dollars, U.S. Treasuries, and IRS taxes that make up the U.S. economy also exists within the Ethereum ecosystem.

While the definition explains how ETH compares to capital assets such as bonds, it is still a long way from the definition of “perpetual bonds.” At this time, I have to mention the description of “ultra-sound currency” , which was coined in early 2021 by Justin Drake, a cryptographer researcher at the Ethereum Foundation, and is respected by Ethereum enthusiasts. Vitalik Buterin agrees, arguing that ETH is on its way to becoming an “ultra-stable currency.”

Criticisms of the traditional financial system, especially the U.S. economic system, have grown in recent years. An important argument driving BTC up is that BTC is “sound money” because of its limited supply. Unlike the U.S. dollar, which is experiencing rapid inflation as the Fed prints money, the BTC supply cap is only 21 million. However, the ultra-sound money argument takes this idea a step further, because a better investment than a limited asset is an asset with increasing scarcity that eventually becomes deflationary as usage increases – this is what “ultra-sound money” stands for the concept of.

Ethereum : From "Three-Point Assets" and "Super Sound Money" to "Perpetual Bonds"

In August 2021, Ethereum released an update that paved the way for ETH to become an “ultra-sound currency.” The London hard fork introduced EIP-1559, a major update designed to change the way Ethereum fees work. Before EIP-1559, users had to bid to include their transactions in new blocks in the chain. Now, users pay the base fee and can pay miners an additional tip. Among them, the base fee is burned, significantly reducing the supply of ETH over time. This largely offsets the roughly 4.5% inflation from PoW mining and staking rewards combined. So far, EIP-1559 has burned about 2.09 million ETH.

Notably, burning transaction base fees is currently not enough to make ETH a deflationary asset. However, after Ethereum completes the PoS merger, it will stop paying block rewards to PoW miners. It is expected that by the end of June this year, the amount of ETH burned in transactions may exceed the amount given to PoS validators, which will put ETH into a phase of net deflation.

The merged shift to PoS will also unlock important functions needed for ETH to be considered a bond. Currently, sending ETH to the Ethereum staking contract is a one-way process, and the staking funds cannot be withdrawn (or withdrawn at a discount). However, the withdrawal function of the ETH staking contract will be activated shortly after the merger takes place.

perpetual bonds 

Bonds are fixed income instruments that offer low-risk yields of about 1% to 2% in traditional markets. Currency bonds are usually issued by local governments and represent trust in the government’s ability to repay debts in the future. Traditional bonds also have maturities, ranging from 1 year to 30 years, and bond yields increase over time frames.

Treating ETH as a bond does not imply that it will become a debt instrument like government-issued commercial paper, but rather draws an analogy to the risk profile and future yield of staking ETH to traditional bonds.

For ETH, the staking yield is much higher than the bond’s interest. The current ETH standard rate is between 4% and 5%, and it is expected to increase to about 8% after the merger. Another key difference is that while traditional bond yields are time-based, ETH’s staking rewards have no time limit. This allows ETH staking to be considered a “perpetual bond” and this property must be taken into account when valuing it.

In his article, Hayes used yield measures applied in the bond market, combined with ETH’s projected combined yield, and concluded that if institutional investors view ETH in the same way as foreign currency bonds, then It is currently undervalued. The article also notes that the current rate of hedging ETH “bonds” creates a positive premium, making the trade more lucrative. The only things currently preventing asset managers from entering the Ethereum market are the inability to withdraw staked ETH and the high energy consumption of Ethereum PoW, both of which will be resolved after a merger.

While the argument for ETH as a bond is well-founded, it also begs the question: if ETH can be valued as a bond, why can’t other green PoS projects? There are two reasons: First, other Ethereum competitors cannot meet all three requirements to be a three-point asset. Taking the new public chain Solana as an example, SOL holders can stake their tokens to generate a yield of about 6% to 7%, thus playing their role as a capital asset. SOL is also actively borrowed as a store of value assets. However, Solana’s low usage and low fees impact its ability to be a consumable asset, eliminating the fundamental value proposition.

Ethereum : From "Three-Point Assets" and "Super Sound Money" to "Perpetual Bonds"

Since other PoS projects do not have the balancing factor of fees reducing supply and are persistently inflationary, they cannot be defined as deflationary “ultra-sound currencies” like ETH. An asset whose supply is in sync with its staking reward growth rate cannot be considered a bond because it has a real yield of 0%. In contrast, ETH becomes deflationary as its high usage increases the value proposition.

The idea that institutional investors might use ETH as a perpetual bond certainly has huge appeal for ETH holders. Hayes’ mathematical model doesn’t lie, but there are several factors that could affect the conclusions of his paper. Among them, the biggest hurdle is how to convince wealth managers to consider ETH a bond, since no one can predict what institutions and market participants will do. Another challenge to ETH bond theory could be the liquidity of derivatives. In the article, Hayes noted that ETH/USD futures could see “illiquidity” over the next three months. While buying and hedging ETH can be an active carry trade, a lack of liquidity could hinder its adoption.

In addition, the impact of the Ethereum project party may further delay the merger should also be considered. While development now appears to be on track, the risk of another delay cannot be ignored. Despite these uncertainties, the idea of ​​conceptualizing ETH as a bond will likely continue to gain market traction, and it remains to be seen whether ETH will become a significant part of institutional portfolios and surge to higher valuations.

Posted by:CoinYuppie,Reprinted with attribution to:
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