Why Ethereum and Other Deflationary Tokens Are Bad For Utility Protocols

Good money is something that can’t be debased like Gold, silver, and Bitcoin. On the other hand, bad money can be easily debased or can be created very easily. E.g. – Nickel, Fiat, etc.

This is the reason people spend their fiat currency while they save their gold and Bitcoin. In the long run, gold and Bitcoin will grow in value because they have lower inflation and it’s impossible to create new ones out of thin air like fiat currency.

Why People Start Advertising Bitcoin as Hard Money or a Store of Value from a Peer-to-Peer Transaction Token

Bitcoin was created to become a peer-to-peer payment network. But the tokenomics of BTC makes it a bad substitute for payments. No one will spend Bitcoin for buying goods and services when they know that the stuff they will buy will go down in value whereas the value of BTC will go up (10000 BTC for 2 pizzas). In the next 9 years, 99% of the BTC will be mined and the only way for the miners to make money will be through transaction fees. Miners help secure the network. If there will be less incentive for miners they will unplug from the network, thereby, making it less secure.

That’s the reason early Bitcoin adopters like Andreas Antonopoulos preach about using Bitcoin for payment so that there will be enough incentives for miners through network transaction fees to continue operating. Now the aim of the BTC is to become the most censorship-resistant hard money that ever existed and its tokenomics and decentralization favor that thesis. In the future, the coin which is the most decentralized and has a predictable monetary principle will become the next global reserve currency and we know that Bitcoin is, by far, the most decentralized.

Does Usability Make Something a Better Asset?

People argue that ETH has more real use cases than BTC and thus, it’s a better form of money. It is true that ETH has more real use cases but this alone doesn’t make something better money.

Let’s compare gold and silver to understand what makes gold better money.

Usability – Around 90% of the silver mined annually is used for industrial use while only 10% of

the gold is used for industrial use. So usability doesn’t make better money.

Cost of Production – It takes around $10 to mine 1 ounce of silver while it takes somewhere between $800-$1000 to mine 1 ounce

of gold. So clearly the cost to produce something is what makes it more valuable. That’s the reason fiat is worthless as it costs nothing to create it. The only reason fiat has value is because of people's trust. The labor people do to earn fiat is what gives it value.

Why Deflationary ETH is Bad, Just Like Other Deflationary Tokens

ETH is used as a unit of account in its ecosystem and by far it’s the best layer 1 protocol. But no one likes to spend anything which they know will go up in value in the long run. A lot of people bought NFTs using their ETH and now their Nfts are down 95% while ETH is down by only 70%. If they would have simply held on to their ETH, they would have been in a much better position.

All these things will lead to less usability of ETH as a unit of account because people will know that their ETH will be more valuable over the long run and Gresham's Law, which we discussed earlier, will come into play here. After some time ETH will only be used as a store of value but people will also realize that there is better money than ETH and they will flock to BTC. This will start the demise of ETH and they will be left with only two solutions. Either to have some inflation of about (3-4) % or to be obsolete and I assume they will choose the earlier one. It’s better late than never.

Conclusion

ETH was created in the first place to be a global settlement layer but to attract more people to invest in ETH they made changes to their tokenomics to become a better asset. Now it will be better for them to become the oil or silver of crypto than to become the gold of crypto. If they will choose the path on which they are going, they might end up becoming the nickel or copper of crypto. ETH has contributed a lot to this crypto ecosystem than any other crypto but it will have to clear its path if it wants to be the leader in smart contracts