Preface: The purpose of writing this post is to attempt to reconcile several of my own conflicting thoughts about Ethereum and provoke discussion by presenting a scenario where long term value could accrue to Ether without it becoming a monetary store of value. The views expressed here should not be construed as investment advice.

The Great (Store of Value) Debate

Over the past few weeks it has been fascinating to observe the debate heating up over the likelihood of Bitcoin or Ether becoming a global monetary non-sovereign store of value that could be worth tens of trillions. While there are extremely intelligent and passionate people on both sides, there seems to be a tangible shift of Ethereum proponents evolving their beliefs towards Bitcoin as the more likely candidate to become sound money. This raises important questions for the viability and security of smart contract platforms in a future scenario where their native assets are not held as a monetary store of value.

At the same time, we continue to see significant growth and activity (#BUIDLING) in the Ethereum ecosystem with new financial primitives and infrastructure that show promise of creating enormous economic value. The crucial question is whether some proportion of the value of economic activity on top of it will be captured in the price of Ether. Brendan Bernstein’s well written post compares this to the open source Linux community that created massive economic value but had no way to effectively capture it. He argues that developers and applications don’t create value in a native cryptocurrency as the only way that value can accrue is if investors are willing to hold it as sound money.

Demand for Smart Contract Platforms

The growth of the Ethereum ecosystem indicates demand for a smart contract platform that could power new native digital financial assets and protocols. If the demand for smart contract platforms continues to grow, the Ethereum network could potentially support billions or trillions of dollars of economic activity. But if Ether is not held as a store of value and only used as a commodity to pay gas fees, its value may not grow in proportion. As it shifts to proof of stake, this could make Ethereum inexpensive to attack and therefore not secure, limiting its viability for use in many of its potential applications.

Most Bitcoin proponents argue that smart contracts are either not viable or should sit on a second layer on top of Bitcoin. However, it’s possible that smart contract functionality on Bitcoin won’t be able to compete with Turing complete smart contract platforms like Ethereum or that it won’t come soon enough. Will developers be willing to wait for this second layer functionality on top of sound money, or will they push ahead and build on available platforms like Ethereum despite the longer term question of native asset value?

While the viability of dapps as consumer facing applications is still unclear, there is no question that there is growing adoption of financial infrastructure including tokenized securities, decentralized exchange, lending, prediction markets, and stablecoins.

Credit to @set-protocol

So the key question is, could there be a future where Ethereum becomes critical public infrastructure supporting trillions of dollars of economic activity on top of it without its native asset Ether being held as a global monetary store of value?

Impact of Tokenized Securities

As a thought experiment, let’s use tokenized securities as an example. Anthony Pompliano and Stephen McKeon have presented strong arguments for the value of issuing equity as blockchain based tokens to create greater efficiency and update the infrastructure to bring trillions of dollars of traditional assets into the digital age. I’ve also argued that while censorship resistance and immutability aren’t necessary for this use case, a global database that isn’t owned by one company in the industry provides a significant benefit.

If Ethereum becomes the leading permissionless blockchain and open standard for tokenized securities, this would create demand for Ether to be spent as gas to transfer these assets. However, on chain transactions could be limited as second layer scaling solutions gain traction. One of the common bear arguments is that large financial institutions and companies with traditional cash flow businesses utilizing this technology may view Ether as “working capital” leading to high velocity that would significantly limit the value that accrues to it. This view would present a strong conflict as it could hurt their core business by reducing the security of the underlying infrastructure that powers the products that generate their profits.

Is it possible that the significant potential of Ethereum to create economic value for traditional cash flow businesses could lead to a new thesis where it becomes critical public infrastructure? Could this make it “too big to fail” causing value to accrue to Ether as a “store of national security” that protects a large portion of the new digital economy?

A New Target for Cyberwarfare

Governments already invest hundreds of billions of dollars in defense budgets to protect their economic interests that directly influence their national security. As cyberwarfare becomes a primary method of conflict into the future, governments will dedicate increasing resources to cybersecurity (both defensive and offensive) to protect their most valuable companies and economic systems from attacks perpetrated by both private and state actors. North Korea’s cyberattack of Sony presents a recent example of this constant threat.

As greater amounts of economic value are secured by public blockchains, there will be increased attacks on them that could be disruptive to the economies of countries that rely on them the most. If there is significant value of tokenized securities on top of the Ethereum blockchain, it would be in a government’s interest to protect this value from attacks by hostile actors. When Ethereum shifts to proof of stake, the best way to increase the security of it may be to buy and hold large amounts of Ether to increase the cost required to attack it.

If governments, large financial institutions, and cash flow generating companies depend on Ethereum as public infrastructure for their economic stability and profits they could be incentivized to buy and hold Ether not as a monetary store of value but as an investment in their digital security. This value would likely need to accrue in proportion to the growth of economic activity on top of Ether as the level of disruption that an attack would cause would increase providing a greater incentive for hostile actors. Governments, companies, and investors could also speculate on the growth of economic activity on these platforms betting on increased buying of Ether from these large entities to secure this activity providing an additional profit incentive and greater security for the network.

The other aspect that makes this interesting is if Ethereum becomes used directly by governments or NGO platforms to power key digital services. There are already trials under way with organizations like the United Nations piloting Ethereum based solutions to distribute aid to families in Pakistan and a Swiss city looking at using Ethereum based Uport for digital identity and voting.

Of even greater significance is the remote but real possibility that smaller nations suffering from hyperinflated fiat currencies may see their economies shift to decentralized stablecoins like the Ethereum based Dai. If any of these state backed use cases gain traction, the security of Ethereum as the underlying infrastructure becomes paramount to national security that foreign adversaries would look to disrupt. In this scenario, a collapse could result in a global economic catastrophe. How would central banks respond to future financial crises? Would the major financial institutions that depend on this infrastructure convince central banks that Ethereum is too big to fail?

This possible scenario of governments holding Ether also has important implications for Ethereum’s value prop of censorship resistance. While they would want to prevent attacks from hostile actors disrupting economic activity, there’s a huge amount of subjectivity in what is considered an “attack” on the network. Would governments attempt to censor transactions that they consider illegal and risk loss of confidence in the permissionless nature of Ethereum that would lead to hard forks?

Rough Model

Here’s some quick back of the napkin math to demonstrate what this thesis might look like with a comparison to traditional defense spending.

US GDP: $18.6T (2016)

US Defense Department Spending per year: $600B (2016)

Percentage of GDP spent on defense: 3%

Total US Cybersecurity Spend per Year: $28B

Yearly Growth Rate of Cybersecurity Spend: 30%

Global Equity Market Value: $70T (2016)

Potential Percentage of Market Value Spent on Public Infrastructure Defense: 3%

Potential Value Held in Ether to Secure it: $2.1T

This comparison uses several big assumptions. First, the assumption that in the long term future (10+ years) there could be tens of trillions of dollars in global value in tokenized securities. This could include global debt, real estate, and new crypto native tokenized cash flows in addition to equities.

It also assumes that defense budgets will continue to rapidly evolve from the majority of the spend on manufacturing physical weapons, aircraft carriers, etc. to funding cybersecurity defense. Will this digital defense spend be in similar proportion to the global “digital GDP”? If so, will it involve purchasing and holding native blockchain assets like Ether. How will the “free rider” problem play out if companies and governments want to take advantage of this public infrastructure but don’t want to hold value in Ether to secure it? As an aside it’s fascinating to consider national defense budgets used to develop or purchase ASICs to secure Bitcoin as well.

Conclusion

The timing that the market converges upon a common view will have an instrumental impact on the potential for Ether to accrue value in the long term. This Ether as a“store of national security” thesis could benefit from a collective illusion in a similar manner to Bitcoin hodlers spreading the belief that it will become a store of value. The longer that the ecosystem considers the possibility that Ether could accrue value in the long term (under any thesis), the more economic activity is created that depends upon the underlying infrastructure, creating a demand for maintaining security of the Ethereum blockchain.

If the market converges in the near future on the belief that Ether will never accrue value, there is a risk that it will prevent developers and companies from building products on top of it that create economic value never giving it a chance to create the demand to be protected.

Notably, the potential value held in Ether as a store of national security in the low single digit trillions is still significantly smaller than the addressable market of a global monetary non-sovereign store of value that John Pfeffer estimates at $5T — $15T.

There are undoubtedly significant flaws with this rough model and many “ifs” in this thesis that make it improbable. There are still major questions on Ethereum scalability and the ability for the network to be able to effectively scale to meet demand and maintain sufficient decentralization. However, it’s still helpful to consider best case scenarios and alternative addressable market opportunities for Ether without it becoming a monetary store of value. I hope this presents some interesting questions and a different angle to consider in this debate. For example, what percentage of overall economic activity on top of a public blockchain needs to be held in the native asset to secure it? These questions are relevant to Bitcoin as well in a potential future where there are other assets or stablecoins issued on the Bitcoin blockchain.

Rather than optimizing for growth of the amount of future computation on Ethereum that drives greater use of Ether for fees, developers may be better served optimizing for use cases with the highest amount of economic value stored as assets on Ethereum, even if they generate less fees. While not as exciting as new decentralized applications, tokenized securities on Ethereum have greater potential to create “skin in the game” for traditional financial institutions and national economies. Ultimately, as the store of value use case is generally seen as a winner take all or at least “winner take most”, it’s important for Ethereum proponents to consider other paths to significant value accrual that don’t rely on Ether becoming a “better money” than Bitcoin.

Thanks to Stephen McKeon, Yannick Roux, Sar Haribhakti, and Blake Henderson for providing feedback on this post.

For more thoughts and commentary follow me on Twitter