Author: Matteo Leibowitz
Before I start, I would like to disclose that my crypto asset portfolio is heavily weighted towards $ETH and that I do not own, nor have ever owned $EOS. I am incredibly conscious that, while I try and remain as objective as possible in my analysis, my financial stake will inevitably result in some degree of confirmation bias on my behalf.
I encourage anyone reading this to refute my assertions and help me understand the flaws in my perspective. As always, the following is for educational purposes only. This is not investment advice.
All references to spot price and market cap are relevant as of 04/29/18.
EOS, a smart-contract platform developed by Steem and Bitshares founder Dan Larimer, has received a lot of attention in the run-up to its mainnet launch in June.
This attention is directly reflected in the project’s unusual market activity. $EOS, with a market capitalization of close to $13bn, is now almost valued higher than both Litecoin and Cardano combined. $EOS’ daily volume is more than double that of the third largest crypto asset, Ripple ($XRP); and $EOS’s price has continued to trade actively against both market leaders Bitcoin ($BTC) and $ETH.
Before definitively declaring EOS the next Ethereum-killer, it is worth taking a look at this 3rd generation blockchain’s design principles and how they relate to the fundamental value provided by blockchain technology.
To understand EOS’ design principles, it is essential to understand the fundamental scalability trilemma at the heart of blockchain design.
As initially proposed by Vitalik Buterin and further explored by Multicoin, blockchains suffer from a trilemma in that they can currently only simultaneously achieve two of the following three properties:
Scalability — a high number of transactions per second.
Decentralization — a large number of actors participating in block production and validation process.
Security — making it expensive to gain majority control over the network.
For some context, Bitcoin and Ethereum’s current consensus mechanism, Proof of Work (PoW), (theoretically) favors decentralization and security over scalability. BTC and ETH are permissionless, so anyone can participate in mining or run a node, and the security of the network is protected by the price of energy/hardware needed to produce the accumulated hash power.
Ethereum’s proposed Proof of Stake consensus mechanism may arguably be better than PoW in that stakers will not be required to purchase expensive hardware to contribute to the block production process. As a result, the distribution of block producers should be more varied and thus the network further decentralized.
Decentralization over Scalability
Why have BTC and ETH favored decentralization over scalability?
Commentators may justifiably argue that to see mainstream adoption of these platforms; these networks must be able to compete with Visa-like throughput. No one wants to use applications in which interactions take days, hours, or even a handful of seconds.
This is a valid critique of blockchains, and yet it fails to recognize the fundamental value that blockchains provide: censorship resistance. If blockchain platforms do not offer censorship resistance — i.e., they rely on a set number of trusted actors to produce and validate blocks — then we have merely returned to legacy database systems, albeit at the expense of the efficiency that legacy systems like Amazon Web Services provide.
Why is Censorship Resistance Important?
The censorship resistant nature of the Bitcoin blockchain means that anyone can hold value in $BTC without the risk of it being seized by a malicious actor.
Ethereum allows developers to build censorship resistant applications and contracts. If your identity — social security number, birth record, driver’s license, credit information, home ownership, etc. — exists on a blockchain, it is vital that you can be certain that a set of actors can never interfere with your information. The stakes are very high.
Delegated Proof of Stake
The scalability trilemma helps provide context as to the design decisions at the heart of EOS. EOS’s consensus mechanism, Delegated Proof of Stake (DPoS) consciously makes a tradeoff between scalability and decentralization.
In the EOS system, a set of 21 Block Producers (BPs) produce and validate each block. EOS token holders vote for these BPs on a one token:1 vote basis. BPs are incentivized by validation rewards, which are subsidized by a 5% annual inflation rate.
The concentration of BPs allows EOS to achieve levels of throughput that dwarf the 15 transactions/second (tps) achieved by ETH and the 3 tps by BTC: this is made possible because block information only has to propagate across a set of 21 nodes vs. the 18,000 nodes in the Ethereum network. (For some context, someone achieved 1.5m tps on Ethereum in a similarly permissioned environment.)
EOS’ high level of throughput might seem amazing until you recognize that the system relies on just 21 trusted BPs. Proponents of EOS argue that this is not a problem for two reasons:
- A set of 21 BPs produces a level of decentralization sufficient to allow for ‘platform-grade censorship’. Developers may be uncomfortable building on centralized platforms like Facebook or Twitter knowing that these entities could change the rules at any moment with no recourse. A ‘platform-grade censorship’ platform means that the rug cannot be pulled from your feet at any moment.
- Voters (token holders) can vote to remove a malicious BP at any time. Because BPs have to stake EOS to be BPs and are rewarded for their work, they are financially disincentivized from acting maliciously.
These two arguments are inextricably intertwined and do not stand up to critical thinking. The problem ultimately lies with point 2 — on-chain voting systems.
Flaws of On-Chain Voting
On-chain voting systems, which attempt to replicate the conditions of representative democracies, are flawed. Vitalik and Haseeb Qureshi both wrote fantastic articles detailing exactly why — here is a summary:
Because blockchains are designed to be permissionless — meaning any anonymous/pseudonymous party can participate in a combination of usage, validation, and block production — networks cannot solve for Sybil attacks, attacks where a single user creates multiple identities to use a network. As such, the one man:1 vote system of representative democracies is replaced by a one token:1 vote system.
Unsurprisingly, these systems invariably devolve into plutocracies through a combination of both those with more capital disproportionately outvoting their less wealthy peers and those with less voting power becoming apathetic, knowing that their vote will ultimately have little to no effect on the outcome of each election.
Voters, therefore, become receptive to bribes from BPs, who can buy votes in return for some share of their annual rewards. BPs are encouraged to collude amongst each other so that they can fix the rate at which they will share rewards with voters. If they don’t collude, then there will be a race to the bottom, whereby BP profitability will eventually be driven to the equilibrium cost of running the hardware required to be a BP.
Understanding this, it seems clear that the term ‘platform-grade censorship’ is in fact intellectually inane.
Because EOS cannot guarantee censorship resistance, it should be viewed as a centralized system, without the throughput advantages that openly centralized networks as AWS provide. Spencer Bogart of Blockchain Capital writes well on this.
Solving the Scalability Trilemma
So what is the alternative? As we have discussed, scalability is ultimately required if these platforms are to reach a mainstream audience and realize all its revolutionary promises.
The solution is to solve the scalability trilemma rather than skirting around it. Ethereum is trying to do this through various protocol-level and layer-2 scaling solutions including state channels, Sharding, and Plasma Cash (PC).
EOS Βeyond lack of Censorship Resistance
Censorship resistance, or its lack of, is at the heart of EOS’ flaws. I would now like to address several other features of EOS that I think are either unwarranted or overhyped.
This idea of ‘zero user-fees’ is disingenuous because it suggests that economic incentives are no longer required to maintain the network. Fees, whether in the form of inflation through block rewards, transaction fees, or a hybrid transaction fee/block reward model, are ultimately what allows blockchains to exist: they incentivize economically rational actors to continue validating and maintaining the state of the blockchain.
EOS recognizes this. EOS does indeed have fees, but they are hidden in the form of inflation. This is not necessarily a bad thing in itself: indeed, both $BTC and $ETH are inflationary at this point in their life cycles, although both assets will ultimately have their supplies capped and rely instead on transaction fees.
So EOS does have fees in the form of inflation. Yes, their system does mean that users do not have to pay transaction fees each time they interact with an EOS-based application. However, projects will nonetheless have to own some EOS tokens to guarantee some level of network bandwidth, so the cost has been merely shifted from users to developers.
Inflation in the Context of Store of Value
It is hard to justify EOS’ long-term valuation when it relies on a 5% inflation rate to subsidize BPs.
Many analysts agree that a coin or token must have Store of Value (SOV) properties to avoid suffering from near-infinite velocity.
Whether the Medium of Exchange Theory (MV = PQ) is the only way of valuing all crypto assets or not is irrelevant: it is fairly obvious that for an asset to hold value in the long term, people must be willing to see it as a suitable reserve currency.
Assets that do not see their value depreciate on an annual basis will be better candidates for the title of SoV than assets with fixed inflation schedules. I recognize that inflationary assets that have utility can also claim SoV status — the United States Dollar is a prime example.
However, the range of these utility SoV assets is limited, and I imagine that the crypto asset markets will eventually converge around just a few. Those assets like ETH that have both utility and SoV properties are likely contenders for dominant SoV status.
On the topic of valuation, I think that it is difficult to justify EOS’ current market capitalization and I expect there is some foul play at hand.
At the time of writing $EOS sits at just under $13bn market capitalization, despite having not yet launched a mainnet. For context, it took 21 months of mainnet deployment for $ETH to reach $13bn market cap and $BTC almost eight years.
It is difficult to justify any valuation in the crypto markets at this point in the asset class’ life cycle, but I think that comparable price analysis still holds up. Ethereum was processing over 100,000 transactions per day when $ETH hit $13bn. $EOS has yet to process a single transaction, let alone prove that its consensus model can withstand centralization.
EOS has reportedly raised over $2bn from its year-long ICO. Many analysts suspect that a proportion of funds raised have been recycled back into the ICO to inflate the price of $EOS tokens and to signal strength.
Even if these assertions are false, I find it hard to justify such a protracted fundraise, which overtly screams of greed. It does not cost $2bn+ to launch a blockchain. For context, Bitcoin never raised money, and Ethereum raised $18m.
Developer Mindshare and Ecosystem Funds
Block. One, the team building the EOS software, will set aside a portion of the funds raised to give as grants to projects building on top of their platform. This is just not a sustainable growth strategy. Funds are likely to be allocated inefficiently as projects are overly incentivized by grants over actually producing quality applications. Moreover, there is nothing stopping these mercenary-type developers from leaving for the next platform offering generous grants.
A better way of attracting developers is through a strong vision. To date, Bitcoin, Ethereum, Monero and a handful of other blockchains have successfully achieved this, attracting thousands of developers motivated by the idea of building censorship resistant applications.
While these projects did not explicitly give out grants to developers, they did reward early adopters with significant price appreciation of their platform-native digital asset. This will be difficult to achieve with EOS, where the native token is valued at $13bn pre-launch. To achieve returns comparable to $ETH’s, the EOS network would have to be valued at close to $40qd.
Usernames and Private key Restoration
Another supposed advantage of EOS is the username and private key restoration features.
EOS allows users to create human-friendly addresses. On EOS, my address might be @matteoleibowitz, whereas my Ethereum address is 0x23443B1b43E437d6De1fD0v0Za7K3eb0937Y354a.
While these username-wallets are indeed more user-friendly and will probably reduce the rate of mistaken transactions, they significantly reduce user privacy.
In fact, I think that one of the key issues at stake for blockchains right now is lack of privacy. I imagine that any reader would not want to live in a world where anyone could search their name on a block explorer website like Etherscan and see how much money is contained within that address.
EOS will also introduce protocol-level account recovery, whereby a user can specify one or more ‘account recovery partners’ and work with their account partner to reset their owner private key.
However, this only works in situations where private keys are stolen, as the owner needs to use a private key that was active in the last 30 days plus the approval of their recovery partner to reset the private key. This does not protect against the non-nefarious loss/misplacement of private keys, which is likely to be a more common reason for the need to recover account access.
State of the Ecosystem
My last gripe with EOS is that its decision to optimize for scalability incorrectly suggests that scalability, or the lack of, is currently the sole issue affecting the ability of decentralized applications to come to market. I would argue that these applications are still in the conception phase: at best they are in the building phase.
As William Mougayar captures in his State of Tokens presentation (slide 34), we are still very much in the Installation phase of blockchains’ evolution: Vision Realization is only expected to materialize in 2021+.
Indeed, if scalability were such a make-or-break issue at this point, we might expect to see a backlog of dApps planning on building on EOS. If you look at these two lists, you will see that that demand simply does not exist. The brevity of these lists is magnified when you compare it to the number of projects building on Ethereum.