Endgame Exploration (Part 1) – Ethereum is Winning

I believe the ultimate goal of the crypto industry in the financial sector is to establish a massively scalable, efficient, and neutral asset platform, serving as the “Internet Finance Center” for all of humanity. I will elaborate on this in two parts: 1) Why only a decentralized blockchain with sufficient throughput can build such an Internet Finance Center; 2) Why a blockchain-based Internet Finance Center is particularly needed in our era and what it might look like in the future.

The Internet Finance Center, built on blockchain protocols, serves as the global foundation for finance, directly and indirectly reaching billions of users, with assets totaling at least trillions of dollars. The Internet Finance Center issues a multitude of asset types, and since assets exist on the blockchain, they inherently possess “programmable” attributes, undergoing efficient operations on the blockchain day and night: transfers, trades, staking, packaging, splitting, issuing derivatives based on underlying assets, and more.

Why is blockchain valuable?

Why is blockchain valuable? This is a question that every cryptocurrency investor has asked. The widely accepted answer in the crypto industry is: because of decentralization. I believe this answer is correct, but when we talk about “decentralization,” what are we really discussing?

I believe “decentralization” is a means, and the goal is “trustlessness.”

So, what is trustlessness?

First, let’s talk about what trust is. When you give trust to others, you give them the “power” to hurt you. At the same time, you have positive expectations for the other person and believe that the other person will not hurt you. People first deposited gold into a vault, and the vault gave you a depository receipt, promising that as long as you come with the receipt to withdraw it, the vault will return the gold to you. You have given trust to the treasury, and the treasury can now hurt you and have the ability not to return the gold to you, but you think it should be okay and the treasury should return it to you. Everyone knows what happened later. The treasury found that it was impossible for all depositors to come back to retrieve their gold at the same time, so they lent out part of the gold to earn interest. This eventually developed into the “fractional reserve system”, and the treasury became a bank, and then Bank run crises occurred again and again. Again in 1971, the promise of exchange between the U.S. dollar and gold was broken, the “depositary receipts” were directly invalidated, and the “U.S. dollar” became an unanchored “U.S. dollar.” From then on, legal currency became a wild horse, and we entered the era of wanton issuance of legal currency. The era of credit money.

What is trustlessness? Trustlessness means that you do not need to grant the other party the power to harm you. Therefore, “trustless services” imply receiving services without giving the service provider the power to harm you, while still being able to obtain the desired service. Blockchain provides trustless services. In the world of blockchain, as long as you control your private key, no one can seize or freeze your BTC or ETH; by paying blockchain transaction fees, you can reliably send coins to any address. Yes, no one can harm you. These trustless services are achieved through decentralization, representing the core value that blockchain offers. Trustless services are particularly suitable for applications in the financial sector, including activities such as predefined rule-based asset issuance (BTC, ETH) and various asset disposals like transfers, trades, staking, and more.

In today’s traditional financial centers, such as New York, London, and Singapore, without exception, they are built upon robust legal environments because, in the traditional model, only a sound legal system can provide sufficient trust. Your money stored in a bank is protected by the law, and if someone takes it without authorization or freezes it, they will face legal consequences. Therefore, you trust that they won’t do so. This falls under the category of “don’t be evil,” but it does not imply that they “can’t be evil.” Former financial centers can turn into “financial ruins” because they have the ability to be evil, as evidenced by the ongoing transformation in Hong Kong today.

Trust is inherently fragile. While it may not encounter problems for an extended period, once issues arise, the trusting party may incur significant losses. Examples include the Cyprus Bank Deposit Haircut in 1971, people holding gold convertibility (USD) in 1971, and current emigrants from Hong Kong unable to retrieve their pensions despite Hong Kong law allowing it.

Conversely, trustlessness is inherently anti-fragile and extremely robust because it doesn’t grant the power to harm from the beginning. Blockchain, through decentralization, achieves “can’t be evil,” going beyond the conventional understanding, establishing the Internet Finance Center effortlessly through witty interactions.

Blockchain is ten times better!

Peter Thiel mentioned in his book “Zero to One” that if a new product is at least 10 times better than existing products, it will sweep the market like a storm, leading to a massive migration of users. In the context of creating an Internet Finance Center, I believe blockchain is more than 10 times superior to traditional methods: 1) in providing trust, “trustlessness” is more than 10 times better than traditional trust; 2) creating addresses on the blockchain is more than 10 times easier than opening a bank account in Switzerland; 3) a globally established financial platform on the blockchain will possess significant “network effects,” and its efficiency in handling transactions far exceeds traditional financial infrastructure by more than 10 times in both aspects. Have you ever felt that after using blockchain, you can never go back to using banks? Regarding why a blockchain-based Internet Finance Center is constructed and why it is a calling of our era, I will elaborate in the next part of this series. This article will discuss why this blockchain is based on Ethereum.

The blockchain for constructing an Internet Finance Center must be: (A) sufficiently decentralized; (B) able to provide services with sufficient throughput. These two points must be satisfied simultaneously, and one cannot be lacking. In my humble opinion, Ethereum is the only contender on this track.

Why must it be sufficiently decentralized? Looking back at our discussion above, the decentralized attribute provides trustless services, and trustless services form the foundation of an Internet Finance Center. Why is trust, or rather “trustlessness,” so crucial?

Imagine if the Bitcoin blockchain were not decentralized but instead ran on a centralized server:

• Satoshi Nakamoto would need to open an account for each user on the Bitcoin network, requiring Nakamoto to review documents such as identification and proof of address provided by each user.
• Nakamoto would inquire about the source of your BTC and request financial proof.
• Nakamoto would need to apply for operating licenses from governments worldwide.
• Nakamoto would have to report various suspicious transactions to governments.
• Nakamoto would need to provide tax-related information to governments.
• Nakamoto would have to comply with government orders, freezing BTC and sometimes transferring the frozen BTC to specified accounts.
• When Nakamoto receives an order from the U.S. government to freeze the Central Bank of Russian Federation’s BTC, what would Nakamoto do? After all, Nakamoto has also obtained an operating license in Russia.
• Nakamoto receives another order: let’s have some BTC “quantitative easing” – please help print 700 billion BTC. Thank you.

Satoshi Nakamoto realized that obviously, a single server could not run the Bitcoin network. So, why is a decentralized network sufficient? It’s because decentralization serves as a “military force,” providing blockchain networks with a form of “national sovereignty,” thereby offering neutral, independent, and predictably secure services for the Internet Finance Center.

Indeed, a blockchain network resembles a nation and, in some aspects, provides services akin to a government, excelling particularly in safeguarding property rights by more than 10 times.

Firstly, let’s discuss why people need a government. What should the government do for people? The Enlightenment pioneer John Locke elucidated in “Two Treatises of Government” that every individual possesses inherent natural rights, including the right to life, liberty, and property. And these natural rights are not granted by the government but are innate to human beings. People consent to cede a portion of their rights to society, forming a government to safeguard these natural rights. If a government deprives individuals of these inherent rights, it is considered evil.

Are there many evil governments in the world? Indeed, there are many, and their numbers have increased in recent decades, especially concerning the protection of property rights. This is the era in which Bitcoin was born, with the genesis block containing the headline from The Times on January 3, 2009: “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks.”

The independent space constructed by blockchain can better protect property rights than governments because decentralization provides trustless protection. The numerous decentralized nodes in the blockchain form a “military force,” creating a long-term independent space that will give rise to a massively scalable “Internet Finance Center” convenient for all humanity. This independent space, as the name implies, is independent of the government. However, it is not about undermining the government and the order it establishes but rather competing and, in some aspects, providing services and products that are more than 10 times better, establishing a better order.

Governments dislike competition because, like everyone else, they dislike others competing with them. Switzerland maintained neutrality during World War II, relying on its unique geographical advantage and a strong military. “Independence” is never begged for; it is established through one’s own strength, standing firm among the world’s nations. Blockchain operates similarly. The blockchain hosting the Internet Finance Center must possess sufficient decentralization to establish its sovereignty, protecting an economy of trillions of dollars. The military must be powerful enough so that potential external attackers, with governments being the most formidable, find the cost of launching an attack too high, making coexistence preferable. After all, the Internet Finance Center merely provides competitive services and does not threaten the government’s existence or disrupt the order it establishes, much like current offshore financial centers.

The second and third blockchains hide beneath the aura of the first, with lower military expenditures on decentralization. However, the economic value of the second and third blockchains will significantly lag behind the first because the Internet Finance Center has network effects. All applications and users prefer to collaborate on the same platform, optimizing efficiency for everyone. The high throughput (i.e., scalability) of blockchain is crucial for constructing the Internet Finance Center, alongside decentralization. The gap between the first and second blockchains may be similar to the gap between Google and the second-ranked search engine.

As an entity similar to a nation, blockchain’s network consensus serves as the constitution. Unlike a nation, all actions on the blockchain must undergo real-time “constitutional” review by all consensus nodes. “Unconstitutional” actions are eliminated from the beginning, making judicial efficiency more than 10 times better. As a more efficient model for order construction, blockchain has the potential to build the next generation of human systems — a “decentralized system” independent of governments, benefiting all of humanity.

How much decentralization is needed?

If external hostile forces aim to attack the blockchain network, the attackers must target numerous “decentralized consensus nodes.” For example, a government of a major country demands freezing BTC on a particular address, requiring more than 50% of Bitcoin network consensus nodes to reject all “categorically unreasonable” blocks, should they include any BTC transactions from that address. Similarly, a large cross-border remittance company wishing to prevent transactions on Ethereum, potentially disrupting competition, needs over 1/3 of Ethereum consensus nodes to refuse service, ensuring that the Ethereum network never achieves “finality.”

There are various methods to launch these attacks, such as 1) sending legal letters to operators of consensus nodes (yes, laws can sometimes be arbitrarily formulated); 2) disconnecting nodes from the internet; 3) infecting nodes with a virus; 4) launching missiles at nodes; 5) shutting down the entire internet; and so on.

How can decentralized consensus nodes defend against these attacks as a whole? 1) Increase the number of nodes so that even if a few are taken down, it does not affect the overall operation of the blockchain network; 2) Nodes naturally operate on a “pseudonymous” basis, making it less straightforward to identify the real person behind them and send legal letters; 3) Nodes are distributed across various jurisdictions with different legal systems; 4) Becoming and exiting consensus nodes is dynamic, allowing nodes to operate guerrilla-style.

From this, it can be seen that if there are enough decentralized nodes and the organizational mechanism is strong, defeating this “army” is not that easy. If the attacker’s motivation is not strong enough and the difficulty of the attack is significant, there is no reason to launch an attack. The motivation for an attack is related to the scale of the blockchain economy itself and the adverse effects on powerful potential attackers caused by the blockchain. Regarding the former, the larger the scale of the Internet Finance Center, the more powerful the “army” needed for protection. Concerning the latter, blockchain practitioners should not actively provoke powerful potential attackers. For instance, I believe that anonymous services on the blockchain are unacceptable to governments as they could cause significant disruption to existing national orders, potentially provoking a coordinated attack by governments.

So, how much decentralization is sufficient? Each person’s judgment is different, and this threshold is dynamic, depending on the severity of the external environment.

We know that the current external environment is not friendly. China has already banned all cryptocurrencies, and many people within the U.S. government are not fond of the crypto industry. For example, the U.S. Securities and Exchange Commission, after a 10-year delay, reluctantly approved the application for a BTC spot ETF this year.

In my opinion, tens of consensus nodes are certainly not enough to build the Internet Finance Center; a few hundred may not be sufficient either; a few thousand would begin to inspire confidence. The degree of decentralization is not only related to the number of consensus nodes but also highly dependent on the nature of the nodes themselves. For example, if the hardware requirements for nodes must be data-center-level, even with a few thousand nodes, this “army” remains vulnerable because node privacy is almost non-existent, and the “soldiers” cannot engage in guerrilla warfare. The Ethereum community believes that it is essential to enable ordinary people’s computers to run consensus nodes to maintain the decentralization of Ethereum.

Regarding how much decentralization is enough, another factor to consider is preventing the decentralization from turning malicious and corrupt. If billions of people entrust their innate property rights to 21 nodes, allowing these 21 nodes to dominate, how can we ensure that they will not become corrupt? How can we ensure that “we are not mining people but serving the people”? Will the 21 nodes collaborate with certain countries, enforcing control over “capital outflows,” effectively controlling our hard-earned money even if people migrate?

The greed for profit and power is the “factory setting” evolution has given humans. From Louis XIV of the Bourbon dynasty declaring “I am the state” to the revolutionary party leader Robespierre overthrowing the Bourbon dynasty for personal dictatorship, and then Napoleon consolidating power by upholding the achievements of the French Revolution, each proclaims human greed. Plato’s “Philosopher King” in “The Republic” does not exist in the “real country”; instead, there are Robespierre and Napoleon. Therefore, we must sacrifice some efficiency and follow the democratic route of power checks and balances, decentralizing in the blockchain world, allowing this “decentralized system” to benefit all of humanity.

Throughput is equally important!

To build the Internet Finance Center on the blockchain, it not only needs sufficient decentralization but also must provide sufficient throughput. However, before the proposal of Layer 2 (L2) technology, the crypto industry once embraced the “impossible triangle” doctrine. This doctrine asserted that it is impossible to simultaneously achieve scalability, decentralization, and security; one must be sacrificed for the other two. Obviously, security cannot be compromised, so either scalability (high throughput) or decentralization must be chosen. Consequently, many blockchains compromised decentralization significantly for high performance, such as relying on 21 high-performance hardware consensus nodes for the entire blockchain network. As discussed earlier, I believe such compromises have eliminated them from the competition to build the Internet Finance Center.

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Many years ago, I believed that the assertion of the “impossible triangle” was incorrect because it erroneously assumed that each node must individually verify every transaction in a block. However, in reality, L2 (Layer 2) technology has broken this assumption. There are various types of L2 technologies, and some unscrupulous platforms deliberately misuse concepts, confuse information, and even claim that other independent blockchains are L2 solutions for Ethereum. In my view, the judgment criteria for L2 are straightforward: whether the L2 system, in its design, can ultimately achieve the same level of “trustlessness” as L1 (Layer 1, the underlying blockchain). L2 is an extension of L1 and, together, they constitute the internal ecosystem of the blockchain. If, after extension, the L2 system loses the most critical “trustless” attribute, it is not part of the overall blockchain ecosystem, cannot provide an independent space for constructing the Internet Finance Center, and should not be considered L2. Otherwise, from a logical perspective, centralized exchanges could also claim to be L2 because, after depositing (rebranded as bridging) to a centralized exchange, you can still carry out transfers and trades.

Leaving aside those self-proclaimed “pseudo-L2” systems, among genuine L2 technologies, I believe the most important branch is Rollup technology. The working principle of Rollup technology is to bundle and compress a large number of transactions into a single Rollup transaction, which is then uploaded to the L1 blockchain. There are currently two types of Rollup technology: Optimistic Rollup and ZK Rollup, both of which break the so-called “impossible triangle” in their own ways. Optimistic Rollup outsources the verification work, originally performed by Ethereum nodes, to external entities. Anyone can challenge the state of Optimistic Rollup transactions on Ethereum within a specific timeframe (typically 7 days). The challenge mechanism can be designed with incentives for successful challengers, encouraging active public supervision and challenging any errors. In ZK Rollup, cryptography-based zero-knowledge proofs naturally guarantee the correctness of the state after ZK Rollup. Additionally, zero-knowledge proof technology allows Ethereum nodes to quickly verify a large batch of bundled transactions with minimal computational resources. I consider ZK Rollup technology to be a magical existence. Apart from its high compression efficiency, it cleanly preserves the “trustless” attributes of extending L1 without introducing additional difficult-to-assess security assumptions.

“L1+L2” is the future!

In the long run, I believe the future of Ethereum will be a combination of “L1 blockchain + L2 systems equivalent to L1 trustlessness” (referred to as “L1+L2”), especially when ZK Rollup resolves general smart contract platform technology. This combination not only provides the current decentralization of Ethereum but also offers high-throughput services, making it the best choice for hosting a multi-trillion-dollar Internet Finance Center.

The future is bright, but the road is winding, and there are many challenges in reaching the “L1+L2” endpoint. The two most significant challenges are: 1) Technical challenges; 2) Abandonment of the “trustless” concept.

L2Beat (L2Beat.com 152) is a very useful website backed by a young team deeply committed to decentralization and the “trustless” concept. The site comprehensively details the situations of various L2 projects (including “true L2” and “pseudo-L2”). If you endorse and wish to invest in a future like “L1+L2,” I recommend regularly checking L2Beat for valuable insights.

We will use information displayed on L2Beat to address these two major challenges. The following screenshots show all 38 L2 projects currently running on L2Beat, ranked from high to low based on the “STAGE” criteria.

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First, let’s introduce L2Beat’s “STAGE” evaluation system. L2Beat’s “STAGE” evaluation system is based on five risk factors to assess the completeness of “trustlessness,” referred to as “maturity.” The five risk factors are (1) State Validation, (2) Sequencer Failure, (3) Proposer Failure, (4) Exit Window, and (5) Data Availability. As an example in the provided image, achieving a green rating for all five risk factors is necessary to obtain a STAGE 2 rating. Currently, among all ZK Rollup projects, only one, DeGate, has achieved a STAGE 2 rating, as shown in the image.

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In L2Beat’s “STAGE” evaluation system, to obtain a STAGE 2 rating, certain requirements must be met. The platform must provide users with an exit window of at least 30 days, allowing users to react within this window to enjoy the same level of “trustless” security as Ethereum L1. I find this evaluation criterion reasonable and in line with the current development stage of the overall L2 ecosystem. I appreciate the L2Beat team not only for their commitment to the “trustless” concept but also for their flexibility. For example, they did not set the user exit window for STAGE 2 as unlimited, recognizing that this would be impractical and could negatively impact the development of the L2 ecosystem. The L2 ecosystem is currently in a rapid development phase. For instance, Ethereum will implement EIP-4844 in 2024, introducing a more cost-effective data type called Blob Data. I anticipate that after the implementation of EIP-4844, the usage cost (Gas cost) of Rollup will decrease by at least 80%. However, to take advantage of the cheaper data services introduced by EIP-4844, various Rollup systems must possess upgradeability. Therefore, it is not feasible to set the user exit period to unlimited, as upgrading systems is necessary. If not, they cannot leverage EIP-4844’s Blob Data, and users would need to migrate their assets to the new Rollup system, incurring significant costs. Such an approach would be demanding and detrimental to the overall development of the L2 ecosystem. Therefore, the current evaluation system by L2Beat is reasonable, adhering to principles while remaining flexible.

Now, let’s discuss the first of the two major challenges: Why is it so difficult to achieve “L1 trustlessness equivalence” technologically? The core reason is that L2 systems are highly complex, and the higher the complexity, the greater the difficulty in achieving secure operation, requiring more time for construction. Whether Optimistic Rollup or ZK Rollup, both are new technologies, especially the zero-knowledge proofs used in ZK Rollup, which are cutting-edge in the field of cryptography. In fact, the application of ZK Rollup is rapidly advancing the development of zero-knowledge proofs in academia. Among the L2 systems displayed on L2Beat, Loopring, the earliest to implement ZK Rollup, has undergone at least five years from project initiation to the present. DeGate, achieving STAGE 2, took three years, undergoing five rounds of security audits and an ongoing security vulnerability bounty program.

Despite numerous technical challenges, as I mentioned earlier, I believe the future is bright because a mature “L1+L2” blockchain system will create a multi-trillion-dollar Internet Finance Center serving humanity. Currently, on L2Beat, five projects have achieved STAGE 1 or above. They are DeGate, Fuel, Arbitrum, dYdX, and zkSync. Thumbs up to them!

The second major challenge is relinquishing the concept of “trustlessness,” meaning the inability to achieve L1-level “trustlessness” in design. I refer to this as “pseudo-L2.” The primary motivation behind this may be to reduce gas costs and provide cheaper services. While cost is important, compromising the core value of “trustlessness” is a line that, in my view, has been crossed. Such compromises render these L2 systems incapable of being part of the “L1+L2” trustless system, and only “true L2” has the capability to jointly support a multi-trillion-dollar Internet Finance Center with L1. On the other hand, “true L2” can also reduce costs through other means. The most significant cost for “true L2” is the data cost of on-chain transactions to L1, which is expected to decrease significantly after the implementation of EIP-4844 in Ethereum this year, with an anticipated reduction of at least 80%.

Recently, there has been a discussion in the blockchain industry about modularizing the Data Availability (DA) layer, with proposals to migrate DA services from Ethereum to other cheaper data services. If DA services are moved out of Ethereum, Rollup systems can still maintain L1-level “trustlessness” in design. I fully support this scenario (see the article on 极客Web3). There are indeed such solutions, and excellent teams are actively exploring and implementing them. However, recent discussions suggest abandoning L1-level “trustlessness,” degrading L2 to “pseudo-L2,” for lower costs.

I believe that all L2 platforms aiming for financial applications have the goal of achieving large-scale adoption and becoming essential members of the “L1+L2” system. Therefore, it’s crucial to think carefully about whether to compromise L1-level “trustlessness” in the initial design, as a “gold necklace” worn around the neck will rust. I believe that relinquishing “trustlessness” will severely hinder the growth of “pseudo-L2” since, among the 38 L2 projects currently running on L2Beat, the capitalization of “true L2” is more than ten times that of “pseudo-L2.”

Conclusion

In conclusion, this article discusses:

• The value proposition of blockchain lies in decentralization.
• Decentralization acts as a “military force” to achieve “trustlessness.”
• A sufficiently powerful “military force” is necessary to provide security for the Internet Finance Center.
• Discussed the degree of decentralization that is sufficient.
• For the blockchain aiming to construct an Internet Finance Center, it must simultaneously fulfill the criteria of (A) sufficient decentralization; and (B) providing ample throughput. Currently, Ethereum is the only player in this arena.
• Explained how L2 breaks the “impossible triangle” of blockchain.
• Provided criteria to distinguish between “true L2” and “pseudo-L2.” Money is smart, and the market has chosen “true L2.”

In the next article, I will discuss why a blockchain-based Internet Finance Center is particularly needed in our era and why it holds significant market potential, envisioning its future characteristics.

Thanks for reading.

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