ETH is the High Quality Liquid Asset (HQLA) of crypto
In anticipation of the ETH ETF launch, I’ve written a mini paper explaining what an HQLA is, why we need a natively digital one, and why ETH is the most likely candidate. My analysis compares it to BTC and SOL.
Here’s the summary:
Why HQLA?
HQLA is a concept from TradFI used for banking regulation. It’s a designation for assets that have almost universally recognized value and deep liquidity—things banks can own safely and sell in a pinch without moving the market. I’m loosely applying the concept to crypto because such an asset is something we can use to build an entirely new decentralized financial system.
A natively digital HQLA means better decentralized stablecoins, safer credit, and more trustworthy derivatives. My analysis explains why this can’t be a dApp token, centrally issued stablecoin/RWA, or L2 token. The best candidates are the native coins of L1s.
Why isn’t it Bitcoin?
BTC is the most valuable and liquid asset in crypto, but you can’t do much with it. There’s no native DeFi or alternative assets on-chain, like stablecoins. The only ways to use it as collateral is custodially or to bridge to another chain, both of which introduce new risks and somewhat defeat the purpose.
Perhaps things will change with new covenants or L2s, but I’m skeptical. The soul of BTC is to fulfill a different purpose, which is to become an HQLA for TradFi.
It comes down to ETH vs SOL
Solana, the network, has many appealing properties. But that’s a separate issue from SOL, the asset. When put to economic scrutiny, SOL has weak fundamentals and is thus a medium quality asset.
First, SOL ownership is concentrated, thanks to its youth, multiple VC rounds, allocations to the Labs and Foundation, and the fact that it launched with staking. Concentration decreases liquidity. ETH did a modest raise years ago, only gave a small amount to the Foundation and founders (by current standards) and had years of PoW before the merge.
Second, SOL has relatively high inflation, over 5%. That will ratchet down eventually, but supply will grow by 25% before it plateaus at 1.5%. During that time, SOL will have a high cost of capital in DeFi.
DeFi always prefers the native asset—LSTs introduce their own risks—but using native SOL in DeFi means forgoing the high staking yield. DeFi will always have to compete with staking to attract capital.
What this means is that SOL has a high nominal interest rate. ETH on the other hand is borderline deflationary, it has a near-zero nominal rate. You can already see this in action: the cost of borrowing SOL on Kamino is currently almost triple that of ETH on AAVE.
Third, a high nominal rate leads to greater staking. SOL owners would be foolish not to stake to avoid dilution, but this hampers liquidity. The staking participation rate on Solana is over double that of Ethereum. ETH holders don’t miss out as much by not staking. That means there will always be relatively more free-floating ETH in the market than SOL.
To make matters worse, Solana has a fragmented LST ecosystem. Liquid staking tokens are not as appealing as HQLAs, but people do use them, there’s tons of Lido stETH in Ethereum DeFi. Concentration in a single LST might be bad for chain security, but it is counterintuitively good for DeFi. It means more liquidity in an asset that might be considered “too big to fail”.
Fourth, and perhaps counterintuitively, Solana has low transaction fees. This might be good for users, but it’s bad for the fundamentals of SOL--fees are a cost to users but also a revenue to stakers. Low fees mean most of the reward paid to stakers must come from new issuance, aka debasement.
The interplay between issuance and fees determines the real interest rate of a crypto asset (MEV also plays a role, but not included in my analysis).
ETH has very low issuance and high fees, virtually all of which go to stakers. This means it has a positive real yield. In this regard it’s even better than Bitcoin. BTC also has low issuance and high fees, but both accrue to miners, not coin holders.
SOL has a borderline negative real yield. Other than times of peak activity, almost all the yield to stakers comes from increasing money supply.
ETH also has a burn mechanism. This increases its positive real yield, and also returns value to non-stakers, thus decreasing the incentive to stake, and reducing the staking participation rate, leading to more liquidity. Solana had a burn mechanism but decided to get rid of it.
Lastly, Ethereum’s high fees mean that ETH has a higher convenience yield: users will want to always hold some (and not stake) to pay future gas fees, thus more available supply.
ETH has better moneyness properties than SOL, and moneyness is very important to being an HQLA.
This is a complicated argument with many moving parts, but the lack of importance of SOL in the success of Solana hampers its qualification as the ultimate asset to build on top of.
You can even see this in Solana culture, where no lesser an authority than @aeyakovenko argues that cryptoeconomic security is only a meme. But if that’s true, so are some of the fundamentals of the chain's coin.
The circularity of security->coin value-> security is the ultimate source of value for any cryptocurrency. This was Satoshi Nakamoto's greatest insight.
None of this means that SOL can't appreciate, or even outperform ETH, memetics and momentum currently matter more in crypto than fundamentals.
But these dynamics reduce the importance of SOL in a re-architected financial system with a brand new asset as its foundation.
ETH is the HQLA of crypto
As the market slowly realizes this, it might grow disproportionately as a DeFi coin to SOL, and possibly overtake Bitcoin someday in value and prominence. The winner-take-most tendency in finance is very strong.
This analysis is at the cutting edge of thought, so all comments, questions, and rebuttals are welcome. Here's the full analysis:
My thanks to @brettpalatiello for his feedback on these ideas. Not investment advice, more thinking advice. I own BTC and ETH and have at various times owned SOL.omid-malekan.medium.com/eth-is-the-hig…
In anticipation of the ETH ETF launch, I’ve written a mini paper explaining what an HQLA is, why we need a natively digital one, and why ETH is the most likely candidate. My analysis compares it to BTC and SOL.
Here’s the summary:
Why HQLA?
HQLA is a concept from TradFI used for banking regulation. It’s a designation for assets that have almost universally recognized value and deep liquidity—things banks can own safely and sell in a pinch without moving the market. I’m loosely applying the concept to crypto because such an asset is something we can use to build an entirely new decentralized financial system.
A natively digital HQLA means better decentralized stablecoins, safer credit, and more trustworthy derivatives. My analysis explains why this can’t be a dApp token, centrally issued stablecoin/RWA, or L2 token. The best candidates are the native coins of L1s.
Why isn’t it Bitcoin?
BTC is the most valuable and liquid asset in crypto, but you can’t do much with it. There’s no native DeFi or alternative assets on-chain, like stablecoins. The only ways to use it as collateral is custodially or to bridge to another chain, both of which introduce new risks and somewhat defeat the purpose.
Perhaps things will change with new covenants or L2s, but I’m skeptical. The soul of BTC is to fulfill a different purpose, which is to become an HQLA for TradFi.
It comes down to ETH vs SOL
Solana, the network, has many appealing properties. But that’s a separate issue from SOL, the asset. When put to economic scrutiny, SOL has weak fundamentals and is thus a medium quality asset.
First, SOL ownership is concentrated, thanks to its youth, multiple VC rounds, allocations to the Labs and Foundation, and the fact that it launched with staking. Concentration decreases liquidity. ETH did a modest raise years ago, only gave a small amount to the Foundation and founders (by current standards) and had years of PoW before the merge.
Second, SOL has relatively high inflation, over 5%. That will ratchet down eventually, but supply will grow by 25% before it plateaus at 1.5%. During that time, SOL will have a high cost of capital in DeFi.
DeFi always prefers the native asset—LSTs introduce their own risks—but using native SOL in DeFi means forgoing the high staking yield. DeFi will always have to compete with staking to attract capital.
What this means is that SOL has a high nominal interest rate. ETH on the other hand is borderline deflationary, it has a near-zero nominal rate. You can already see this in action: the cost of borrowing SOL on Kamino is currently almost triple that of ETH on AAVE.
Third, a high nominal rate leads to greater staking. SOL owners would be foolish not to stake to avoid dilution, but this hampers liquidity. The staking participation rate on Solana is over double that of Ethereum. ETH holders don’t miss out as much by not staking. That means there will always be relatively more free-floating ETH in the market than SOL.
To make matters worse, Solana has a fragmented LST ecosystem. Liquid staking tokens are not as appealing as HQLAs, but people do use them, there’s tons of Lido stETH in Ethereum DeFi. Concentration in a single LST might be bad for chain security, but it is counterintuitively good for DeFi. It means more liquidity in an asset that might be considered “too big to fail”.
Fourth, and perhaps counterintuitively, Solana has low transaction fees. This might be good for users, but it’s bad for the fundamentals of SOL--fees are a cost to users but also a revenue to stakers. Low fees mean most of the reward paid to stakers must come from new issuance, aka debasement.
The interplay between issuance and fees determines the real interest rate of a crypto asset (MEV also plays a role, but not included in my analysis).
ETH has very low issuance and high fees, virtually all of which go to stakers. This means it has a positive real yield. In this regard it’s even better than Bitcoin. BTC also has low issuance and high fees, but both accrue to miners, not coin holders.
SOL has a borderline negative real yield. Other than times of peak activity, almost all the yield to stakers comes from increasing money supply.
ETH also has a burn mechanism. This increases its positive real yield, and also returns value to non-stakers, thus decreasing the incentive to stake, and reducing the staking participation rate, leading to more liquidity. Solana had a burn mechanism but decided to get rid of it.
Lastly, Ethereum’s high fees mean that ETH has a higher convenience yield: users will want to always hold some (and not stake) to pay future gas fees, thus more available supply.
ETH has better moneyness properties than SOL, and moneyness is very important to being an HQLA.
This is a complicated argument with many moving parts, but the lack of importance of SOL in the success of Solana hampers its qualification as the ultimate asset to build on top of.
You can even see this in Solana culture, where no lesser an authority than @aeyakovenko argues that cryptoeconomic security is only a meme. But if that’s true, so are some of the fundamentals of the chain's coin.
The circularity of security->coin value-> security is the ultimate source of value for any cryptocurrency. This was Satoshi Nakamoto's greatest insight.
None of this means that SOL can't appreciate, or even outperform ETH, memetics and momentum currently matter more in crypto than fundamentals.
But these dynamics reduce the importance of SOL in a re-architected financial system with a brand new asset as its foundation.
ETH is the HQLA of crypto
As the market slowly realizes this, it might grow disproportionately as a DeFi coin to SOL, and possibly overtake Bitcoin someday in value and prominence. The winner-take-most tendency in finance is very strong.
This analysis is at the cutting edge of thought, so all comments, questions, and rebuttals are welcome. Here's the full analysis:
My thanks to @brettpalatiello for his feedback on these ideas. Not investment advice, more thinking advice. I own BTC and ETH and have at various times owned SOL.omid-malekan.medium.com/eth-is-the-hig…
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