Ark: What properties make ETH different from all other crypto assets except BTC

Original title: Why Ether Stands Out Among Digital Assets

Author: Lorenzo Valente, Ark Invest Researcher; Translated by: 0xjs@黄金财经

Foreword

As Bitcoin consolidates its position as a reliable digital store of value and the only asset with a rule-based monetary policy, the Ethereum network and asset Ether (ETH) appear to be gaining momentum with similar potential. In fact, ETH is becoming an institutional-grade asset with income potential.

As the only digital asset that truly generates income, ETH appears to have unique and distinctive characteristics that make it a "reference indicator" within the digital asset space. ETH already plays a key role in private and public financial markets, influencing the monetary policies of other digital networks and applications, and measuring the health of the broad digital asset ecosystem. With a market cap of approximately $315 billion and millions of monthly active users, the Ethereum network is achieving meaningful economic value, as shown in the chart below.

Source: ARK Investment Management LLC, 2024. This ARK analysis is based on a range of underlying data sources and can be shared upon request. Data as of August 15, 2024. For informational purposes only and should not be considered investment advice or a recommendation to buy, sell, or hold any specific security or cryptocurrency.

ETH’s staking yield has influenced other smart contract ledgers, setting it apart from other digital assets besides Bitcoin.  

Similarly, U.S. Treasuries play a key role in the traditional economy in multiple ways: setting benchmark interest rates, acting as a quality store of value in uncertain times, and influencing market expectations of future economic conditions. Our research shows that ETH as an asset is beginning to develop similar properties to U.S. Treasuries in the digital asset space. ETH’s potential to generate yield — and its widespread use as collateral in digital asset trading — are becoming two of its most unique and important qualities.

Investors can earn ETH yield by staking ETH to protect the Ethereum ledger. In other words, this yield is not technically native to the ETH asset. Liquid staking derivatives such as Lido, Rocket Pool, or Frax provide ways to tokenize staked ETH and its yield. Liquid staking allows users to stake their ETH while maintaining liquidity by receiving derivative tokens representing their staked ETH. Another method called "Solo staking" allows more direct control of the staked asset and earns a higher rate of return, but locks up ETH.

The goal of this paper is to identify and define the unique characteristics of ETH. What is special about ETH? How does it stand out in the broader asset class? We aim to answer the following questions:

1. How does ETH generate yield?

2. How does the miner extractable value (MEV) yield predict economic cycles?

3. Does ETH have bond-like properties?

4. Does staking and re-staking enhance ETH's ability to serve as programmable collateral? If so, how?

5. Will ETH's Staking yield become a reference yield for the crypto economy? If so, in what sense?

6. What is the hybrid attribute of ETH in the standard classification of traditional assets?

1. How does ETH generate income?

"Proof of Stake" (PoS) is a fairly new "consensus algorithm" that is more energy-efficient than "Proof of Work" (PoW). Why? In PoS, the consensus algorithm selects "validators" - equivalent to "miners" in PoW - to create new blocks and verify transactions based on the number of tokens held by the "validator" and the number of tokens willing to "stake" as collateral. The more coins staked, the higher the probability of being selected to build and verify the next block. Therefore, the PoS system does not require a lot of computing mining power, but requires validators to make a lot of investments in the network - if they verify fraudulent transactions or violate core protocol rules, they may lose these stakes. Validator staking deters fraud, as does the electricity costs that Bitcoin miners pay to participate in the network. Both ensure that every participant acts with economic rationality and good faith.

When the Ethereum network upgraded to Ethereum 2.0, its protocol shifted from proof-of-work to proof-of-stake. The implementation of Ethereum's latest monetary policy upgrade, EIP-1559, introduced a novel fee market structure. Both changes changed the way ETH generates and distributes yield.

ETH yield is based on three factors:

Issuance (≈2.8% APR) + Tips (<0.5% APR) + MEV (<0.5% APR)

Let's look at each component of yield in more detail.

Issuance

As of September 2024, the Ethereum network is adding about 940,000 ETH per year, which equates to an annualized yield (APY) of about 2.8% at today’s staking ratio. The staking ratio changes over time based on the amount of ETH staked. The higher the staking ratio, the lower the issuance yield, as it is evenly distributed among the participating validators based on their weighted stake. Importantly, the Ethereum network guarantees a minimum annual issuance rate of 1.5%, which would require 100% of ETH to be staked and no transactions on the blockchain, which is unlikely. All validators who secure the network by reaching consensus and processing transactions receive issuance.

Tips

“Tips” are optional fees introduced by the London upgrade and EIP-1559 that users can include in Ethereum transactions. Tips are “priority fees” because they incentivize validators to prioritize transactions within a block.

When users want to send a transaction, they must pay a base fee and can choose to pay a tip. The base fee is adjusted dynamically based on network congestion, increasing when the network is busier. Priority fees, or tips, are optional if users want to speed up their transactions. In effect, the priority fee is a cost that changes with network usage and congestion.

MEV

In addition to issuance and user tips, validators collect a “miner extractable value” (MEV) reward, or the extra profit they make by including, excluding, or reordering transactions in the blocks they generate.

MEV is the equivalent of “payment for order flow” (PFOF) in traditional markets — the extra revenue that high-frequency market makers and traders pay validators to prioritize their transaction flow. Like the priority fee, its yield is volatile because it relies on the supply and demand of block space and takes advantage of less-informed traders transacting on the network. Importantly, MEV rewards are only available to validators running MEV clients such as MEV Boost.

Base Fee 

Importantly, the base fee (again, the standard cost of sending a transaction) has no impact on yield. Instead, it is “burned” and does not provide direct cash flow to stakers. As part of the EIP 1559 upgrade, the base fee mechanism makes fees more predictable and the Ethereum network more user-friendly.  

Only the base fee and issuance can change the total supply of ETH. ETH tokens that users pay the base fee are permanently removed from the total supply. If the base fee is high enough (greater than 23 gwei in today’s market) and the amount “burned” exceeds the network issuance (940,000 ETH per year), the total ETH supply will decrease over time, making the protocol deflationary. Conversely, if the network issuance is higher than the base fee burned, the network will be inflationary.

Two dynamics support the deflationary trend of ETH supply. First, Ethereum’s Proof of Stake (PoS) mechanism enables validators to reduce the operating expenses (Opex) and capital expenditures (Capex) associated with running network servers. In other words, the energy and data center costs associated with PoW and ASIC machines are non-existent in PoS.  

Second, as the premier smart contract platform, the Ethereum network operates at a base layer limit of 14 transactions per second. Thanks to its well-tested code, Ethereum has attracted the most active developers, the widest application, and the highest settlement value in its short nine years of development.

Since the transition to PoS and the implementation of EIP 1559 on September 15, 2022, ETH has been acting as a net deflationary asset, reducing its supply by an average of 0.106% per year. If Ethereum continued to operate with PoW without switching to POS and without EIP 1559, the network’s supply would have inflated by 3.2% per year, as shown below.

Source: Ultra Sound Money. Data accessed on August 15, 2024. Comparison of inflation rates of ETH (PoS) vs. ETH (PoW) vs. BTC (PoW) since the merger. For reference only and should not be considered investment advice or a recommendation to buy, sell or hold any specific security or cryptocurrency.

2. How does the miner extractable value (MEV) yield predict economic cycles?

As mentioned above, Miner Extractable Value (MEV) returns are part of the ETH staking returns. In this section, we will dive deeper into MEV, with a particular focus on how it is generated and how it predicts economic activity and market cycles.

MEV is the equivalent of Payment for Order Flow (PFOF) in traditional finance, which occurs when market makers and high-frequency trading firms pay validators extra fees to bypass the standard Ethereum "Mempool" queue and thus prioritize their trading packages. Similarly, in the traditional financial world, companies like Citadel Securities pay platforms such as Robinhood, TD Ameritrade, Charles Schwab, and Fidelity to steer customer order flow to them. In fact, MEV was born during the ETH ICO craze in 2017 as a basic form of priority "bribe". In the ICO era, participants and investors who purchased tokens of certain projects had to deposit ETH into a smart contract in exchange for the native token of that project. As they become more popular, token offerings become oversubscribed and operate on a first-come, first-served basis. To be among the first to deposit ETH into these smart contracts, participants “bribe” validators off-chain.

Like PFOF, MEV often reflects retail trading activity, as market makers are willing to pay higher prices for less-informed orders than for informed orders. Just as PFOF payouts are a measure of overspending and risk appetite in the retail equity space, MEV plays a similar role in predicting recessions and economic cycles in the Ethereum ecosystem, as shown below.

Source: ARK Investment Management LLC, 2024, based on data from Daytradingz.com and MEV-Explore v1 as of June 9, 2024. For informational purposes only and should not be considered investment advice or a recommendation to buy, sell, or hold any specific security or cryptocurrency.

While MEV on Ethereum generates revenue comparable to that generated by PFOFs on the stock market, MEV as a percentage of the total market cap of ETH and ERC-20 tokens is much higher than that of the U.S. stock market. Since the merger, the $790 million in revenue extracted on a pro rata basis per year represents 0.20% of ETH’s $315 billion market cap. With a combined market cap of around $500 billion for ETH and ERC-20 tokens, the percentage of revenue extracted drops to 0.15%, still 27x higher than PFOF’s $2.891 billion in revenue representing 0.0056% of the $50 trillion market cap of the U.S. stock market. In its early development stages, Ethereum’s order routing mechanisms are more expensive than those in traditional finance, but it’s worth noting that Ethereum supports a wider range of order types through smart contracts — such as flash loans, staking, swaps — and other interactions with decentralized applications. In addition, in traditional finance, other fees and profit centers (brokerage fees, exchange fees, and hedge fund profits) are the primary source of PFOF’s revenue. These costs are not transparent, but are critical to the overall cost structure of traditional finance transactions.

According to historical PFOF patterns in traditional finance, an increase in PFOF revenue correlates with increased retail activity involving less informed traders, while a decrease in PFOF suggests the opposite. For example, between 2021 and 2022, Robinhood’s PFOF revenue fell 40% from $974 million to $587 million as interest rates rose 16-fold, signaling the start of a bear market. The same is true for MEV, where block space used by high-frequency trading firms and MEV bots fell fivefold from July to October 2021, ahead of the severe 2022 crypto bear market, as shown below.

Source: ARK Investment Management LLC, 2024, based on data from Explore.flashbots.net as of August 15, 2024. For reference only and should not be considered investment advice or a recommendation to buy, sell, or hold any specific security or cryptocurrency.

Our research suggests that the majority of MEV over the next year is likely to be extracted and redistributed on Layer 2, a secondary protocol built on top of Ethereum. They improve scalability and efficiency by processing transactions off-chain while leveraging its security, reducing transaction times and significantly lowering transaction fees. Within the next two years, we expect over 90% of total transactions to occur on Layer 2. Catering to more price-sensitive retail investors, Layer 2 should dominate ETH trading activity, gaining disproportionate benefits from MEV, which will be greater as collators (or validators for Layer 2) become more decentralized.

Today, the dominant Layer 2 networks Arbitrum and Optimism both operate with a single collator, meaning that block space is not auctioned off to the highest bidder. Instead, transactions are ordered on a first-come, first-served basis and cannot be reordered by block searchers or builders.  

As a result, some forms of MEV (maximum extractable value) are impossible, suggesting that MEV is significantly lower than it would be in a more advanced state with multiple decentralized collators and a more mature MEV infrastructure.

MEV yield is a subset of ETH's overall yield, and it is becoming a reliable indicator of activity and economic cycles on the Ethereum blockchain. Compared with traditional finance, MEV is dominated by retail transactions, and the proportion of insufficiently informed capital flows is higher. MEV is a measure of activity and economic health, which affects ETH's yield in the cycle and provides a framework for evaluating layer 1 ledgers.

3. Does ETH have properties similar to sovereign bonds?

Fixed-income assets, especially bonds, have existed for hundreds of years and are one of the most important financial drivers of the economy. Bonds represent loans made by investors to borrowers, usually companies or governments. Our research shows that although not equivalent to sovereign bonds, pledged ETH (stETH) has similar characteristics to sovereign bonds, and these similarities are worth exploring.

The most important similarities and differences between staking ETH and sovereign bonds are as follows:

Note: For the maturity period, the pledged ETH can be unpledged at any time, and thereafter, in addition to the income received during this period, the amount originally pledged (called "principal") can be recovered. Source: ARK Investment Management LLC, 2024. For information purposes only and should not be considered investment advice or a recommendation to buy, sell or hold any specific security or cryptocurrency.

When we discuss staking ETH vs. sovereign bonds below, we emphasize that their differences are as important as their similarities. We believe that their risk profiles represent the most significant difference between staking ETH and sovereign bonds.

Credit Risk

Sovereign Bonds: When a government issues debt denominated in the local currency, there is a possibility that the government will default, although this is less likely for stable economies.

Staking ETH: The Ethereum network cannot default on staked ETH because it is not technically a debt. Staking returns are programmatically derived from on-chain activity and network issuance, which means that returns fluctuate based on network performance, activity levels, and staking rates.

Inflation Risk

Sovereign Bonds: Inflation in the local currency can erode the value of bond returns, reducing purchasing power.

Staking ETH: If the issuance rate of new ETH significantly exceeds the destruction rate of the base fee, there is inflation risk, resulting in an increase in supply, which would reduce net yields and dilute the value of interest payments.

Interest Rate Risk

Sovereign Bonds: Changes in interest rates affect bond prices, and rising interest rates generally cause bond prices to fall.

Staking ETH: While Ethereum itself does not issue multiple bonds (multiple staking yields with different maturities), changes in yield expectations on other layer 1 smart contract platforms may affect the perceived value and attractiveness of staking ETH.

Currency Devaluation Risk

Sovereign Bonds: A devaluation of the local currency relative to other currencies can result in a significant reduction in the value of interest payments and principal when converted to other currencies.

Staking ETH: The value of ETH relative to other major cryptocurrencies and fiat currencies may fluctuate, affecting the actual value of staking yields and principal relative to other assets.

Political and Legal Risks

Sovereign Bonds: Changes in government or regulatory regimes may impact bond repayments and could result in changes in fiscal policy and/or debt restructuring.

Staking ETH: This analogy is less direct. Staking ETH carries additional risks associated with network security and governance. If validators misbehave or collude, staked ETH could be slashed as a penalty, resulting in potential loss of principal. Regulatory changes that impact the broader cryptocurrency market could also impact the value and security of staked ETH.

Volatility Risk

Sovereign Bonds: Sovereign bonds are generally viewed as low-risk, low-volatility investments. However, during times of economic instability or political unrest, the volatility of the bonds can increase significantly.

Staking ETH: Staking ETH is more volatile because it is still in its infancy. Volatility can affect both staking returns and principal value.

Modeling staked ETH as a sovereign bond requires understanding the differences in their respective risk profiles. While both are subject to inflation, interest rate changes, and currency debasement, the nature of these risks and their impact can differ significantly. In addition, ETH staking introduces unique risks related to network security, validator behavior, and smart contract bugs that have no direct analogue in traditional sovereign bonds.

Similar to calculating the present value of a sovereign bond, one can attempt to model the present value of a so-called "staked ETH bond." The formula would add the present value of each reinvested coupon to the present value of the par value of the bond at maturity. Then, by modeling the coupon interest with the yield on the staked ETH and the discount rate with the risk-free rate on U.S. Treasuries, one can arrive at the present price of the staked ETH bond.  

Nevertheless, one of the most important differences between sovereign bonds and "staked ETH bonds" is that the yield on staked ETH changes every day. Therefore, modeling a "staked ETH bond" requires calculating the average yield over the maturity period. In addition, unlike traditional sovereign bonds, staked ETH can be unstaked or "redeemed" at any time, and the principal can be redeemed at any time.

Currently, ETH has no yield curve, meaning there is no relationship between the staking yield and the maturity of the staked asset. However, based on our research, the ETH yield curve may change in the coming years, increasing similarities to sovereign bonds, with varying maturities and durations of ETH staked.

4. Will staking and re-staking enhance ETH's position as programmable collateral?

Liquid Staking Derivatives (LSD) is a protocol designed to simplify the staking process for users who lack technical expertise. LSD works with trusted node operators to manage staking operations on behalf of users. Users who stake ETH through Lido, a leading LSD provider, will receive stETH. stETH is a synthetic version of their staked ETH and functions like a tokenized certificate of deposit. stETH tokens are automatically rebalanced to reflect staking rewards (3.2% APY) and can be converted to ETH on centralized and decentralized exchanges. The tokens or certificates of deposit can then be used for lending, obtaining leverage, re-hypothecation, and many other financial activities within the digital asset space, especially Ethereum-based applications/protocols.

stETH is a yield-generating version of ETH. Because stETH is programmable and liquid, it is beginning to replace ETH in many DeFi protocols and applications. In fact, stETH has been replacing ETH as a high-quality collateral in the Ethereum economy. Today, the total amount of stETH supplied as DeFi collateral is about 2.7 million, accounting for about 31% of the entire stETH supply, as shown below^.

Note: The Y-axis on the left side of this third-party chart is in US dollars (billions of US dollars). Each abbreviation shown on the right side of the above image represents a different asset that can be used as collateral, as follows: cbeth (Coinbase Staked ETH), reth (Rocket Pool ETH), dai (MakerDao Stablecoin), usdt (Tether Stablecoin), usdc (Circle Stablecoin), weeth (Ether.fi ETH), wbtc (Wrapped Bitcoin), eth (ETH), steth (Lido Staked ETH). Source: Dune (https://dune.com/lido/steth-collat ​​eral-compare-to-others) as of August 15, 2024. For reference only and should not be considered investment advice or a recommendation to buy, sell or hold any specific security or cryptocurrency.

There are more than 80,000 stETH in the liquidity pools of Curve, Uniswap, Balancer, Aerodrome and other leading DEXs.  stETH is a yielding asset that is becoming the preferred collateral due to the capital efficiency it provides to users, liquidity providers, and market makers. Currently, the preferred collateral on Aave V3, Spark, and MakerDao is 1.3 million stETH, 598,000 stETH, and 420,000 stETH, respectively, which are locked in these protocols and used as collateral for issuing loans or crypto-backed stablecoins, as shown below. Our research shows that stETH and other liquid staking derivatives of ETH are becoming the preferred high-quality collateral for financial activities within the Ethereum ecosystem.

Note: The Y-axis on the left side of this third-party chart is measured in the number of stETH, not the US dollar amount of stETH. Source: Dune (https://dune.com/lido/steth-collat ​​eral-compare-to-others) as of August 15, 2024. For informational purposes only and should not be considered investment advice or a recommendation to buy, sell, or hold any specific security or cryptocurrency. Note: Each legend label shown to the right of the chart is the name of a specific protocol.

However, what if users wanted to earn a higher yield on their staked ETH while providing more utility as collateral?

This is exactly what Eigenlayer, a re-staking protocol, enables. To date, Eigenlayer has accumulated $13 billion in tokenized CDs of ETH, representing 50% of Lido’s TVL and ~4% of the total ETH supply, as shown below. Liquid collateral derivative tokens representing ETH staked on the Ethereum network can be minted on Eigenlayer Restaking on the platform enables other protocols to enhance their network security for a specified period, a process similar to leasing security services.

Some protocols whose tokens are too volatile to provide reliable network security may face liquidity shortages and/or need to enhance their security, both of which can be addressed by double staking their tokens or renting out their entire security with more stable collateral such as ETH. For their security services, restaking protocols like EigenLayer reward restakers, just as the Ethereum network pays validators.

We believe that the emergence of restaking allows investors to better control their risk and reward profile, thereby increasing the utility and efficiency of ETH as collateral in DeFi.  

Note: Each abbreviation shown at the top of the above image refers to the protocol to which a different ETH liquidity staking token belongs, as follows: Steth (Lido), rETH (Rocketpool), sfrxETH (Frax), cbETH (Coinbase), ankrETH (Ankr), LsETH (Liquid Collective), oETH (Origin Protocol), mETH (Mantle), SwETH (Swell), wBETH (Binance). Source: The Block as of August 15, 2024. For informational purposes only and should not be considered investment advice or a recommendation to buy, sell, or hold any specific security or cryptocurrency.

The success of EigenLayer shows that users and institutions have a strong interest in leveraging their ETH holdings in more sophisticated ways. By introducing new use cases, EigenLayer allows participants to keep their ETH holdings while generating additional yield. As they emerge from the launch of EigenLayer — just as stETH emerged from native staking — liquid re-staking tokens are likely to serve as collateral on a variety of platforms. Whether in liquidity pools, lending platforms, structured products, or crypto-backed stablecoins, various forms of yield-bearing ETH have the potential to become the preferred programmable collateral for leading applications and products in DeFi — whether deployed on Ethereum Layer 1 or any of the currently available Layer 2s. 5. Will ETH’s staking yield become an endogenous benchmark for the crypto economy?

So far in this article, we have described staked ETH as an asset similar to sovereign bonds in some respects, and described ETH and its liquid staking derivatives as high-quality liquid collateral in DeFi, supporting many widely used applications. In this section of the paper, we focus on another unique feature of ETH staking yields: its impact on investment in the cryptoeconomy, which our research shows is comparable to the role of Treasury bonds and the federal funds rate in the traditional economy.

Today, staking yields influence public and private investment in the digital asset space in the same way that high-quality liquid assets (HQLA) do in traditional finance. First, ETH yields appear to exert significant pressure on the native yields of competing Layer 1 smart contracts, forcing other blockchains to offer higher rewards to validators for their security and long-term commitment, as shown below. Why would investors/validators hold and stake a riskier and more volatile asset if the return on investment is unlikely to be higher? Importantly, unlike ETH, yields on other assets tend to be cash flow dilutive. In other words, if an investor holds and does not stake any other Layer 1 token, network inflation dilutes it.

Source: ARK Investment Management LLC, 2024, based on data from The Staking Explorer as of August 15, 2024. (https://www.stakingrewards.com) For reference only and should not be considered investment advice or a recommendation to buy, sell or hold any specific security or cryptocurrency.

ETH's staking yield also increases the opportunity cost of holding and borrowing stablecoins. As its native yield rises and becomes a benchmark, ETH's activity, MEV fees and overall demand put multiple DeFi protocols under pressure. MakerDAO, Aave, and Compound are three of these protocols.

MakerDAO is a protocol that manages the issuance and management of the DAI stablecoin. DAI is issued through collateralized debt positions (CDPs) as users lock up collateral such as ETH or other whitelisted assets to mint DAI. One of the core features of the MakerDAO protocol is the DAI Savings Rate (DSR), which allows DAI holders to earn interest by locking their DAI in a special smart contract. After DAI faced significant selling pressure and a decrease in circulating supply, MakerDAO governance decided to increase the DSR rate from 5% to 15%.

In money markets like Aave or Compound, where conditions are determined by supply and demand, the returns on supplying/borrowing stablecoins have increased significantly. The supply APY for fiat-backed stablecoins ranges from 5% to over 15%, depending on market conditions. This rate reflects investors' willingness to borrow stablecoins while providing ETH or stETH as collateral without having to sell.

Alternatively, protocols like Ethena Labs, which offers a stablecoin collateralized by spot arbitrage trades between spot stETH positions and perpetual futures short positions, have attracted many stETH holders. Why? Ethena’s stablecoin offers significantly higher yields than DeFi alternatives, not to mention ETH’s average staking yield.

The yield on ETH staking also impacts yield farming opportunities. Teams looking to launch new products or features and attract ETH-denominated capital into their pools must align their incentives with prevailing market conditions. For many teams and protocols, higher staking yields often mean higher user acquisition costs, as potential investors and liquidity providers are more likely to stake ETH for more stable returns rather than the higher risk-return associated with new or less mature yield farming opportunities.

Investors allocating capital to early-stage digital assets are asking the same question: On a risk- and liquidity-adjusted basis, will this project offer a better return on investment than staking ETH? We can explore this question with a hypothetical example. How much better would a closed-end fund with a typical investment horizon of 7 years (the average harvest period for tech startups) need to perform than ETH after compounding to break even? If ETH yields 4% after 7 years of compounding, then the closed-end fund would have to outperform ETH by more than 31% even without considering price appreciation. In other words, early investors in the digital asset space often consider this: on a risk- and liquidity-adjusted basis, does the project they are evaluating provide a higher return than simply holding and staking ETH for the investment period? For example, consider a typical 7-year fund, often called the harvest period, during which investments are expected to mature and provide liquidity. If the same funds were invested in ETH and staked, with an average staking yield of 4%, the project would need to outperform ETH by at least 31% to compensate for the compounding yield effect. In a bull market with oversubscribed private rounds, less attractive valuations, and unfavorable vesting conditions, competition from staked ETH will become more intense.

6. What are the hybrid attributes of ETH?

Spot Bitcoin ETFs may have been successful because of its appreciation potential and stability relative to other stores of value, especially fiat currencies. Human decisions by monetary authorities, which are sometimes arbitrary and inconsistent, have played a major role in the long-term devaluation of fiat currencies. In contrast, Bitcoin is "rules-based" and has a mathematically measured supply of up to 21 million coins. As a result, Bitcoin is becoming a powerful alternative to fiat currencies and a digital asset class similar to digital gold.

As a younger asset, ETH has undergone multiple monetary and technological upgrades over the years. In addition, its Turing completeness and yield cash flow make it difficult to describe, define, and frame within the boundaries of traditional asset classes.

Robert Greer divides assets into three categories in his paper "What is an Asset Class, Anyway":

Capital assets:Assets that are productive and add value to holders in the form of cash flows, such as stocks, bonds, or real estate.

Consumable Assets:Assets that can be consumed or converted into other assets or commodities, such as commodities.

Store of Value:Assets that cannot be consumed or converted into other assets or commodities but retain value over a long period of time.

Source: Greer 1997. For informational purposes only and should not be considered investment advice or a recommendation to buy, sell or hold any specific security or cryptocurrency.

In this article, we illustrate the similarities between ETH yields and those of bond-like instruments, particularly sovereign bonds. We have demonstrated that ETH staking yield is a measure of smart contract activity and economic cycles in the digital asset space, just like the federal funds rate in traditional finance. In addition, like any other layer 1 asset, ETH is a consumable asset used in the Ethereum network to pay for transactions to be included in the ledger. The process involves exchanging assets to pay validators for storing and computing data. We have also highlighted the ability of staked ETH to serve as a high-quality liquidity asset in DeFi, acting like the original collateral that powers the most popular applications and stablecoins such as DAI and USDe.

So, what is the best way to classify and define ETH as an asset?

While the Bankless team believes that ETH is a "three-phase asset" that, according to Robert Greer's classification, embodies the characteristics of three different asset classes at the same time, we believe that Bitcoin has and will continue to be a very reliable means of storing value. That being said, we also believe that ETH is paving the way for a new hybrid asset. While ETH exhibits store-of-value properties in the smart contract economy, what differentiates ETH from any other digital asset is that it is a programmable, cash-flow-generating asset that can be used as high-quality collateral in financial applications. ETH and staked ETH are extremely liquid and widely traded on many exchanges. Their liquidity ensures that they can be easily liquidated and converted into other assets and/or used in various DeFi protocols. While ETH is more volatile than government bonds or real estate, it is one of the most mature, valuable, and widespread cryptocurrencies in the world. With the launch of spot ETH ETFs, ETH's acceptance may increase and its volatility may decrease.

Currently, ETH and its liquidity pledge derivatives have been used as collateral in various DeFi protocols, not only for secured loans, but also for participating in liquidity pools, generating income, and issuing stablecoins. Although ETH may not fit into a single asset class, its multifaceted attributes highlight the charm of its unique asset, which is very attractive to those who want to participate in the rapidly growing global smart contract economy.