Macro flows in Ethereum's economic model

From US Dollar System trade deficits to Ethereum's security budget

International trade and financial flows

Daniel Neilson has a great simplified series¹ on macroeconomics that builds up a simple model for the world economy, relating participants such as ‘households’, ‘businesses’, ‘government’ and ‘rest of world’ to each other through value flows illustrated in a T-account balance sheet.

‘Sources’ refers to an inflow of value and ‘Uses’ an outflow. For each sector, every inflow must have a matching outflow. Similarly, every source must have a corresponding use in another sector.

To be clear, the two rules are:

1. total uses equal total sources for each sector, and

2. each entry appears as a use and a source, in equal amounts.

US Dollar System

In the below example, Households generate Income as a Source (paid by Businesses as a Use) and spend it on Consumption and Taxes. In the case of the US, they also spend it on Net Imports from abroad, where the corresponding contra flow is Net Exports. For the picture to balance, the ‘ROW’ picture must have a financial Use, in this case US Treasuries.

This idealized T-account model sort of illustrates the mechanism for US exorbitant privilege today. The simplification the model makes is dusted with Keynesian idealism about investment in the private sector. The theory of fiscal deficit spending is that investment in the private sector will return more growth through feedback into the domestic economy.

The reality is a lot of this excess government spending is inflationary but not actually productive. Instead of going to the most efficient use in the private economy, it is more likely than not to get malinvested or just used for more random government spending. By effectively ‘skipping’ the private sector this fiscal deficit effectively drags on the long-term potential of the economy and hollows out business sectors.

Something like this reasoning is probably part of what is behind Trump’s issue with the US trade deficit.

Ethereum

I wonder if you could make a similar macroeconomic flow model for Ethereum:

1. A user derives some amount of utility from an application built on Ethereum

2. There is an additional enabling amount of ‘security’ provided by the validator, in that it removes counterparty risk for transaction settlement by virtue of being verifiable in a decentralized and cryptographically secure way

3. The application in question could be anything, for this example we use ‘tokenized asset swap’ as a stand-in for purchasing BlackRock’s BUIDL but it could also be a collateralized overnight repo transaction on an Ethereum money market like Morpho

4. The application settles for a small fee or spread, that the user invests in by dint of its utility and security

5. The user also has to pay a base fee to validate the transaction on the Ethereum protocol

6. Part of the gas fee is also a priority tip that the user may choose to pay to increase the speed of transaction inclusion by a validator running the Ethereum protocol

7. An incentive balancing mechanism present in Ethereum burns a portion of the base fees to reduce the supply of outstanding Ether

8. Validators secure their activities and are discouraged from manipulating transactions by posting collateral that can be ‘slashed’ in the event of malicious behavior or being offline, collateral that is held ‘in escrow’ by the Ethereum protocol

9. Ethereum closes the loop by ‘spending’ on issuance, or new Ether, that is used to compensate validators for their activities

In the long-term, a structurally balanced flow of value would have a vibrant ecosystem of many validators capable of sustaining themselves from priority fees alone. Today, quadrillions of dollars² flow through Large Value Payment Systems recorded by the Bank for International Settlements, alone. In contrast, stablecoin transfer volumes over the last twelve months on Ethereum were in the $10tn range³.

As long as Ethereum represents some small percentage of global capital flows (<0.5% today), there is always more room to grow. The remainder of that growth of economic activity has to come from new sources of application utility, which depend on increasing the amount of security utility capable of safely ‘hosting’ these applications.

In some regard, it could be said that Ethereum is running a deficit in some account (probably application utility) and using issuance rewards to subsidize the growth of security utility. Unlike in the case of US trade deficits, the accrual of excess security utility is actually maximally productive. Greater levels of security utility accrue to application builders who use it to secure ever more complex applications or apps that ‘host’ or calculate asset balances with higher value-at-stake.

Or maybe I am trying to fit a round peg in a square hole and the macroeconomic modeling doesn’t work at all but it is fun to think about all the same.

1. Models

2. https://data.bis.org/topics/CPMI_FMI/tables-and-dashboards/BIS,CPMI_T9,1.0?view=value&dimensions=REP_CTY%3AUS

3. https://www.theblock.co/data/stablecoins/usd-pegged/on-chain-volume-of-stablecoins-monthly