It sounds silly to me when the bitcoin brigade bad mouths ether, or ether enthusiasts barf all over bitcoin. The 2 are completely different. Bitcoin has qualities that make it the ideal currency, while ether is the gas that powers the world of DeFi. The correlation in price has more to do with the fact that the same investors are buying both rather than an overlap in their qualities. Quoting Bully Esquire, “it's like comparing Tesla and Gold”
To set the record straight - I like both.
Let’s start with a quick look at the ETH spike and crash of 2018
ETH touched an all-time high in 2018 and crashed immediately after that, losing over 90% of its value by the end of the year. There’s no point investing in ETH if there’s a risk of that happening again. I explain below how things are very different this time and list out reasons that make ETH a compelling buy.
So what happened in 2018?
=> The ICO mania happened in 2018
What is an ICO?
=> ICO is a play on the acronym IPO. Blockchain projects looking for funding, raise capital using an Initial Coin Offering (ICO)- crowdfunding conducted on a blockchain for crypto projects.
Why did ICOs lead to a spike in ETH?
=> 95% of ICOs were conducted on the Ethereum blockchain. Since funds are raised in the native currency of the blockchain used, those who wanted to subscribe to the ICOs had to send funds in ETH, which of course meant that they had to first buy ETH. 1Q’2018 saw over US$6bn raised through IPOs. That is over $6bn worth of demand for ETH in 1 quarter.
Why did the ICO mania lead to a crash in ETH immediately afterward?
=> The limited regulation of ICOs meant that many questionable projects with little more than a whitepaper and website landing page were able to raise millions. The unscrupulous teams running these projects immediately dumped the ETH raised and exit scammed.
=> There were several legitimate projects with sensible business models too that had raised money through ICOs in ETH. They had to pay their development expenses in fiat though and hence had to sell at least some of the ETH raised.
(Both the above, created selling pressure)
=> Further, the token buyers were not particularly sophisticated and had essentially jumped on the cryptocurrency bandwagon with get-rich-quick dreams. They panicked and sold at the first sign of trouble.
Why is it different this time?
This time the demand for Ether is coming from 3 solid sources:
1. DeFi (Decentralized Finance)- DeFi has seen Total Value Locked (TVL) climb from $2bn to $20 bn in 2020. Since most of DeFi exists on Ethereum, this essentially means that almost $20bn worth of ETH is locked in DeFi, and hence out of circulation limiting available supply.
=> Remember that DeFi participants are far more sophisticated than ICO subscribers. Those who participate in DeFi have the technical know-how to use digital wallets and understand concepts like yield optimization, liquidity pools, liquidation risks, etc, and therefore represent more sticky money.
2. ETH 2.0 staking - Ethereum blockchain is moving from Proof of Work (PoW) to Proof of Stake (PoS). The Beacon chain was launched in Nov’2020 when sufficient funds were staked to secure the network. With roughly 2mn ETH staked to ETH2.0, over $2bn worth of ETH has been removed from circulation further reducing supply.
3. Stablecoins- Stablecoins grew 4x in 2020. Further, the Office of Comptroller of Currency (OCC) has recently issued a guideline that banks can use stablecoins for transaction settlement. The implication of this cannot be overstated. Interbank transfers in the US run into the trillions, at least some price-conscious banks are likely to use the cheaper mechanism of stablecoins vs the expensive legacy Swift/ACH/Fedwire system.
=>How does this help ETH? Ethereum is the main settlement layer for stablecoins. Gas (transaction processing charges) on Ethereum must be paid in ETH. An increase in stablecoin creation and transactions will therefore lead to increased demand for ETH in the form of gas payments.
2 more reasons to be bullish on ETH:
a. Interest from sophisticated Institutional Investors- With the combined market cap of the cryptocurrency market reaching $1tr, cryptocurrencies are viewed as a legitimate asset class that can be a sizeable holding in an institutional portfolio. Announcements of bitcoin purchases from the likes of Paypal, Square, Stone Hedge, MicroStrategy, etc have drawn attention to the entire cryptocurrency market including Ether. Grayscale Trust has seen ETHE AUM rise from $210 mn in May’20 to $3.5bn in Jan’21.
b. CME ETH Futures - While ETH futures have been available on other exchanges for a while now, they are not available on CME yet, where several institutions have accounts. CME launched BTC futures 3 years ago and is scheduled to launch ETH futures in Feb’21. This is a game-changer. Futures will give institutions a tool to hedge ETH spot positions. One can also expect ETH options to be listed in CME soon.
But there’s no cap on ETH supply you say? EIP1559 to the rescue.
One of the points on which BTC scores over ETH is that the total supply of BTC is capped at 21mn while ETH has no supply cap. Ethereum Improvement Protocol 1559 (EIP1559) is an attempt to address this criticism.
Block miners currently have 2 ways to get paid. One is Block Rewards and the other is Transaction Fees. EIP1559 says that miners will continue to receive the Block Rewards. However, the bulk of the Transaction Fees will go to the Ethereum Protocol.
What will the Ethereum Protocol do with the Transaction Fees?
It will burn it. So while Block Rewards will increase supply, Transaction fees will reduce the supply of ETH. Whether this will merely reduce inflation or lead to deflation will depend on many factors that are not clear yet. This mechanism does however ensure that everyone benefits from transaction fees and not just the miners.
Note that this is only a proposal and has not been implemented yet. However, it seems like the broad community is in favor of this change even if the miners aren’t happy about it.
Will ETH Killers manage to kill Ethereum?
Several Eth Killers have sprung up. Some like Polkadot, Cardano, and Cosmos are truly credible. Some like Tron are less so. Metcalfe’s law says that the value of a network is proportional to the square of the number of users on the network, and hence it is no surprise that new blockchains have difficulty attracting projects. However, while 83% of all tokens are on Ethereum currently, there is a risk that new projects might want to launch on other blockchains given the lower fees and higher transaction speeds they offer.
It must be pointed out that Ethereum is the most secure smart contract supporting blockchain out there. In case of a security issue with any of the Eth killers (even if it is from the less credible ones), project developers might have further incentive to continue to go for the default choice of Ethereum.
Final words
You don’t have to diss every other cryptocurrency to prove your loyalty to bitcoin. Ether is likely to give disproportionate returns just like bitcoin. Understand the difference and keep track of developments in both.