Global Settlement Infrastructure - The Daily Gwei #376
Let's settle this on the chain.
I believe that Ethereum’s layer 1 is going to become the world’s most decentralized and secure settlement layer. As Polynya notes below, there are a few top criteria that need to be met for a blockchain to actually act as a robust settlement layer and these criteria are pretty much non-negotiable. But what does each of them look like? Read on to find out.
Let’s focus on the first, and arguably most important, criteria - a robust settlement layer needs a strong culture of users running full nodes. This implies that users actually care about validating the chain for themselves and also works to keep the network decentralized by having many replicas of the Ethereum blockchain spread all around the world. Unfortunately, it’s difficult to get an accurate read on exactly how many fully validating nodes are online at any given time, but estimates range from 3,000 to 7,000. Though it’s not enough to just have a culture of running nodes - it also needs to be easy to run them on consumer hardware which Ethereum has optimized for by keeping the chain capacity limited at layer 1 (this is one reason the gas fees are so high).
Next up is a wide token distribution which is actually an incredibly hard thing to achieve for most networks. Bitcoin was able to achieve a good distribution for a number of reasons but I think a large one was that BTC was essentially worthless for a while (basically the first 2-3 years of its life) and BTC has experienced many market cycles which has worked to distribute coins quite well. Ethereum has also gone through a few market cycles at this point (and has had a long PoW distribution phase) but I’d say its distribution is currently worse than Bitcoin’s (but only by a small margin). You may be wondering why distribution is important for a settlement layer and I’d say it’s for a few reasons: no single entity should have too much of a share of the network (for social reasons such as perceived unfairness), Ethereum PoS would be much less secure if a single entity held 5%-10% of all ETH, the network is healthier if more people have a larger share of it and more.
Credible neutrality is critically important for a settlement layer and I would argue that it’s either a very close second to the culture of running nodes or on par with it in terms of importance. I wrote about credible neutrality in detail here but the tl;dr is basically that you can’t have a global settlement layer without it being a neutral platform that anyone can build on, use and also have guarantees that they won’t be de-platformed or censored. If the network wasn’t neutral, it could blacklist certain actors which would give an unfair advantage to others which means the network wouldn’t actually have any credibly neutrality. This, in turn, would push people to build on a network that is open and permissionless.
Next up is Lindy or the ‘Lindy effect’ which describes the phenomenon that the longer something non-perishable (like a technology) has already existed, the higher chance it has to continue existing for a long period of time. Crypto-networks generally are tied strongly to this phenomenon because they are a product of network effects (though most networks will fail to accrue long-lasting network effects and fade away eventually). When it comes to Ethereum, it’s pretty clear to see that it has incredible Lindy for a variety of reasons and Ethereum’s network effect only gets stronger as time goes on. This also works to create a very strong feedback loop where the more network effect Ethereum accrues, the more Lindy it has, the more network effect it accrues - I think you see where I’m going with this.
Finally, we have liquidity, which is important for efficient and healthy markets. ETH is just as liquid as BTC on centralized exchanges and is also incredibly liquid within DeFi itself. ETH’s liquidity profile also makes ETH the absolute best collateral that one can use on Ethereum to do a variety of things - it also means people feel much safer holding ETH instead of some other asset. Liquidity is also a function of network effect/Lindy and as a network grows, so should the health of the overall liquidity for its native asset.
These criteria may seem like overkill to some, but I believe that they are all required if a network wants to become a global settlement layer. Missing even one of these criteria automatically disqualifies a chain and it’s exactly why there are only 2 real settlement layers right now - Ethereum and Bitcoin. Of course, Bitcoin is much more limited than Ethereum and can really only settle BTC on its network which ultimately makes Ethereum our absolute best shot at creating humanity’s first truly global, decentralized, secure and permissionless settlement layer.
So let’s not screw it up!
Have a great day everyone,
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All information presented above is for educational purposes only and should not be taken as investment advice.