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Although the Ethereum network plays a key role in the cryptocurrency ecosystem, the ETH assets themselves are difficult to define.Previously, ETH has been described in Ethereum as a "three-point asset" and an "ultra-sound currency" because of its practicality and scarcity.Recently, former BitMEX CEO Arthur Hayes argued that ETH would be valued like a bond.This article explores Ethereum's conceptual source of its native asset class and whether it can be considered as a permanent bond.

Ethereum evolution

Since the birth of Ethereum in 2015, the cryptocurrency market has been debating how to define it.The Ethereum network itself is often described as the underlying layer of Web3, but its native asset, ETH, is not so clearly defined.

As with all new technologies, how to conceptualize it with reference to existing systems is a matter of ongoing debate, and Ethereum is no exception.Ethereum has been tested since its birth, and its roadmap extends to several years later, with a long way to go before realizing its final vision.

During the upgrade, Ethereum users have enough time to think about the impact of each fork and speculate about the impact of future upgrades.Descriptions such as "Three-point assets" or "ultra-sound money" have distilled Ethereum's complex properties into memes, quickly attracting market attention and providing a strong appeal for those who believe in ETH assets.

As Ethereum prepares to move from PoW to PoS, Arthur Hayes believes that conceptualizing Ethereum as a bond is crucial to its next phase of growth.Hayes is highly regarded in the crypto world for its insight into crypto and global financial markets, arguing that once Ethereum turns to PoS, institutions can see ETH as a bond.Based on this bond classification, he believes that the value proposition of buying and pledETH should push ETH prices to $10,000 by the end of 2022.

ETH asset class inquiry

Before exploring how ETH becomes a bond, it is necessary to understand why Arthur Hayes leads to bond theory ideas.

In 2019, Bankless, co-founder David Hoffman, was one of the first researchers to try to define ETH using the traditional monetary system.In an article entitled "Ethereum: Three Assets," he noted that ETH was the first asset to span three asset classes, namely store of value, capital assets, and consumable assets.

When ETH is pledged, it becomes a capital asset because it generates earnings and can be valued on its expected return, similar to bonds when ETH is used as gas for a payment transaction, similar to dollar tax, and ETH serves as value when the holder deposits ETH in DeFi agreements like Aave or Compound e as collateral.

This three-point asset definition constitutes the cornerstone of the Ethereum ecosystem, provides further ETH adoption and growth, and demonstrates the characteristics of ETH similar to key assets in a traditional economy.For example, the triple structure of the US dollar, US Treasury bonds and IRS taxes that make up the US economy also exist in the Ethereum ecosystem.

While the definition explains how ETH is compared to capital assets such as bonds, there is still a long way from the definition of "permanent bonds."I have to mention the description of "super sound money," which was coined by Justin Drake, a cryptographer researcher at the Ethereum Foundation, in early 2021 and admired by Ethereum enthusiasts. Vitalik Buterin agrees, arguing that ETH is on the path to becoming an "ultra-prudent currency".

In recent years, criticism of the traditional financial system has increased, especially in the US economic system.An important argument driving BTC higher is that BTC is "sound money" because of its limited supply.Unlike dollar, which has experienced rapid inflation with the Fed printing money, the BTC is capped at 21 million units.However, the ultra-sound money argument takes this idea further, because better investments than limited assets are assets with increased scarcity, and as increasing usage eventually becomes deflation —— which is the concept that "ultra-sound currency" represents.

In August 2021, Ethereum released an update that paved the way for ETH to become an "ultra-sound currency".The London Hard Fork has introduced the EIP-1559, an important update designed to change the way Ethereum fees operate.Before EIP-1559, users must bid to include their transactions in new blocks in the chain.Users now pay the base fee and can pay extra tips to the miners.Of these, the base cost is burned down, significantly reducing the supply of ETH over time.This largely offset inflation of about 4.5% from the combined PoW mining and pledge rewards.So far, EIP-1559 has burned down about 2.09 million ETH units.

It is worth noting that burning transaction base costs are not currently enough to make ETH a deflationary asset.However, after Ethereum completes the PoS merger, it will stop paying block rewards to PoW miners.By the end of June, the number of ETH burned in the transaction is expected to exceed that given to PoS verifiers, which will put ETH into a net deflationary phase.

The shift to PoS will also unlock ETH being seen as an important feature for bonds.Currently, sending the ETH to the Ethereum pledge contract is a one-way process, and the pledged funds cannot be withdrawn (or the withdrawal will cause a discount).However, shortly after the merger, the withdrawal function of the ETH pledge contract will be activated.

Perpetual bond

Bonds are fixed-income instruments that provide low-risk yields of about 1% to 2% in traditional markets.Monetary bonds are usually issued by local governments and represent a trust in the government's ability to repay its debts in the future.Traditional bonds also have maturities, ranging from one to 30 years, and bond yields increase as the time frame extends.

Seeing ETH as a bond does not mean that it will become a debt instrument like government-issued commercial notes, but compares the pledged ETH to the risk status and future yields of traditional bonds.

For ETH, the pledge yield is much higher than the interest on the bonds.The ETH standard is currently between 4% and 5%, and is expected to increase to around 8% after the merger.Another key difference is that traditional bond yields are time-based, while ETH's pledge rewards have no time limit.This enables the ETH pledge to be regarded as a "permanent bond," and the property must be taken into consideration when valuing it.

In its article, Hayes used the yield measures applied in the bond market, combined with the projected combined yields of ETH, and concluded that —— is currently undervalued if institutional investors view ETH in the same way as foreign currency bonds.The article also notes that current interest rates to hedge ETH "bonds" generate a positive premium, making trading more profitable.The only factors currently preventing asset managers from entering the Ethereum market are the inability to withdraw the pledged ETH and Ethereum PoW, both of which will be resolved after the merger.

While the argument for ETH as a bond is justified, it also raises the question: If ETH can be valued as a bond, why can't other environmentally friendly PoS projects?There are two reasons: First, other Ethereum competitors could not meet all three requirements to becoming three assets.Take the new public chain Solana as an example, SOL holders can pledge their tokens to yield about 6% to 7%, thus playing their role as a capital asset.SOL is also actively used as a storage of value assets to borrow.However, low Solana utilization and low cost affect its ability to act as a consumable asset, thus eliminating basic value claims.

Because other PoS projects do not have the balance of cost-reducing supply and have sustained inflation, they cannot be defined as deflation of "ultra-sound money" like ETH. An asset that is synchronized with the growth rate of its pledged reward cannot be considered as bonds because its real yield is 0%.In contrast, ETH becomes deflationary because its high usage increases value claims.

The idea that institutional investors may use ETH as a permanent bond will undoubtedly appeal to ETH holders.Hayes' mathematical model does not lie, but several factors may influence the conclusions of its article.Among them, the biggest obstacle is how to persuade wealth managers to see ETH as a bond, because no one can predict what institutions and market participants will do.Another challenge to the ETH bond theory may be the liquidity of derivatives.Hayes wrote that ETH / USD futures could be "underliquid" in the next three months.While buying and hedging ETH may be a positive arbitrage trade, lack of liquidity may hinder its adoption.

In addition, consider the impact of the Ethereum project side delaying further merger.Although development now seems to be proceeding as planned, the risk of another delay cannot be ignored.Despite these uncertainties, the idea of conceptualizing ETH as a bond may continue to gain market attention, and it remains to be seen whether Ethereum will become an important part of the institutional portfolio and soar to higher valuations.

*The views and opinions expressed here are solely those of the author and do not necessarily reflect the views of SparkDAO. Every investment and trading move involves risk, you should conduct your own research when making a decision.