The Economist keeps missing the point

Plus is it a good idea to stake ETH with Coinbase?

In this issue:

  • The Economist keeps missing the point

  • Is it a good idea to stake ETH with Coinbase? (reader submitted)


The Economist keeps missing the point

We talked last week about central bank digital currencies (CBDCs) when we talked about China’s efforts to develop and launch a digital yuan. Following our lead the Economist dedicated their own cover story this week to CBDCs or govcoins.1 The piece continues the Economist’s established tradition of being very excited about applications of crypto technology while staying quite dismissive of Bitcoin itself. In 2015 that looked like "blockchain, not Bitcoin" and in 2021 it looks like "cryptocurrencies, but only government cryptocurrencies."

A helpful (but counter-intuitive) thing to understand about CBDCs is that they are not really a new kind of money so much as a new kind of banking. The way the banking world works today is that retail customers have accounts with commercial banks and commercial banks have accounts with central banks. CBDCs are basically just a way to let retail customers open accounts directly with the central bank. Self-custodying govcoins may feel like stuffing digital cash into a digital mattress, but since the central bank sets the rules for how the CBDC works it is functionally no different from having an account on a central bank server.

For consumers CBDCs could be much cheaper since they would cut out intermediaries like banks and credit cards. For banks and credit cards the news is less good - they are the intermediaries being cut out. For central banks the promise of CBDCs is intoxicating - any kind of taxation, surveillance and monetary policy could be programmed directly into the money: imagine a currency that automatically reported and taxed itself with every payment.

CBDCs increase central bank control and displace traditional banking infrastructure. China is a fringe player in traditional finance (~2% of international payments) and an eager wielder of tight financial controls, so they are eagerly pursuing the development and rollout of a digital yuan. America is the main beneficiary of existing financial infrastructure and has traditionally supported the privacy and free movement of capital (at least relative to China) so they have been more cautious about the possibility of developing an American CBDC.

Displacing the retail banking sector comes with its own risks as well. Central banks have lower costs and a natural size advantage over commercial banks so they could easily undermine the entire banking industry. If CBDCs absorb a substantial share of consumer deposits it could damage commercial banks’ ability to make loans. In the limit CBDCs could effectively nationalize retail banking, taking credit allocation out of the market and into the hands of bureaucrats at the central bank.

The Economist argues that CBDCs are inevitable:

"Over 50 monetary authorities, representing the bulk of global gdp, are exploring digital currencies […] Governments and financial firms need to prepare for a long-term shift in how money works, as momentous as the leap to metallic coins or payment cards […] state digital currencies are the next great experiment in finance"

Given the number of central banks already considering it, perhaps they are right. But they make a much clearer case about the risks and potential downsides than they do what problem exactly CBDCs are meant to solve. CBDCs are just ways of codifying the rules of banking in code. You can’t really make the case for one without laying out the rules you think are worth codifying.

The Economist keeps drawing the wrong lesson from Bitcoin. Bitcoin is pointing at the moon and the Economist is staring at its finger. Attaching a blockchain to a central bank currency is confusing method for purpose. Bitcoin is not interesting because it has a blockchain, Bitcoin is interesting because of its rules: absolute scarcity, freedom of movement, freedom from seizure. The blockchain is just an expensive way to enforce those rules.


Is it a good idea to stake ETH with Coinbase?

"Coinbase now gives you the option to stake ETH for a return but you have to lock your ETH up. Is that a good idea?" - JH

Ethereum is in the process of a multi-stage upgrade to Ethereum 2.0, one of the major goals of which is migrating Ethereum from proof-of-work (where miners prove their honesty by spending resources) to proof-of-stake (where validators prove their honesty by putting money "at stake" which they lose if they are caught misbehaving).

The first validators are now operating on Phase 0 of the Ethereum 2.0 rollout, known as the beacon chain. Validators on the beacon chain put up ETH as a stake and then earn a yield on that ETH in return for their service validating. Coinbase is one of those validators and is offering let you help bankroll them. You give them your ETH, they stake it for you and you split the reward. The terms of the offer are laid out in human readable terms here and in more precise legal terms here.2

At the moment ETH validators are being paid ~7.5% APR - Coinbase’s page says you can earn "up to 6.0% APR" not sure if that is a cap or just out of date. Either way the returns are not guaranteed - as the amount of capital being staked increases the rewards remain constant, so if more people start staking the yield will go down.

To me that isn’t really the headline risk. Ethereum has been working on the transition to proof-of-stake more or less since launch in 2015. It took more than five years to reach Phase 0. Any ETH committed to staking on the beacon chain will be locked until at least Phase 1.5:

(b) Lockup Period. If you choose to stake your ETH, your ETH will be converted to ETH2 and will be locked on the Ethereum protocol until Phase 1.5 of the Ethereum network upgrade is completed. Coinbase has no control over the duration of or end date for the lockup period […] you will not be able to trade, transfer or otherwise access your staked ETH during the lockup period.

Coinbase does say on the support page that they expect to enable trading of staked ETH sometime later this year, but in the legalese of the User Agreement they say:

Coinbase may offer you the ability to exchange or sell your staked ETH prior to the completion of Phase 1.5 of the Ethereum network upgrade. Coinbase does not guarantee that the offering of any such option will result in a successful exchange or sale, and Coinbase will not backstop or otherwise intervene to guarantee liquidity.

So it isn’t clear yet when you would be able to withdraw staked ETH on the network but it seems reasonable to assume it will be a while given progress so far. Coinbase plans to set up a market to let people buy and sell their staked ETH but they aren’t promising they will and they especially aren’t promising anyone will want to pay you anything for your staked ETH.

If you are committed to staying invested in Ethereum for the long term and don’t mind an indefinite lockup in exchange for earning interest on your ETH then staking may be a reasonable option. But if you want to retain the option to sell or transfer your ETH anytime in the next few years you may want to think carefully.


Other things happening right now:

  • We talked on Monday about how you can think of Binance Smart Chain as a bet that the market cares about what you can build on Ethereum but not whether it is actually decentralized. Apparently it is no longer possible to run an independent BSC node, which is about as far from decentralized as it possible to get. On the other hand the tokens are still trading at an all time high. So the market has apparently decided.

  • The Lightning Network is a second layer built on top of Bitcoin intended to allow faster, cheaper and more private payments. In fact the Lightning Networks’ privacy guarantees are strong enough it is difficult to actually observe usage of the network to gauge how large it actually is. But you can see the available capacity of publicly advertised connections and those are at an all time high and are still growing steadily.

  • Elon Musk hosted SNL and (predictably) used the moment to pump Dogecoin, mentioning it in the monologue and also during Weekend Update. The market was apparently unimpressed by his performance - Dogecoin rose as high as ~$0.74/DOGE this week but fell to ~$0.48/DOGE at time of writing.

  • Presented without comment:

1

Take a moment to enjoy how this cover image borrows from the imagery and branding of Bitcoin to lend legitimacy to the idea of govcoins.

2

Sorry New York residents, the BitLicense means Coinbase won’t let you come to their staking party. Consider moving to Miami?