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Why Crypto: Evaluation by Productivity
Traditionally, stocks are valued through discounted cash flows or by comparing PE ratios from different sectors. This works well for some first-derivative value stocks when you have a reasonable idea of the trajectory of the top and bottom lines.
Another way to calculate value is to look at the total size of the market and predict the market share. For example, assuming the electric vehicle market is $ 160 billion and growing at a CAGR of 22.6% for the next 5 years, you can rationalize the acquisition of a 20% stake that is worth $ 88 billion. [1]. Do this for all secondary assets of $ TSLA and you get a very different number than the income statement.
But you would have extreme difficulty predicting cash flows for some growth stocks, even by combining these two strategies above. With the boom of $ WORK lately I have approached valuation from a different angle. Look at productivity as an indicator of value. Productivity is defined as output divided by input or GDP by hours worked; how efficient is a company’s workforce or a nation’s economy. Increasing productivity means cutting costs and / or increasing production, either through an optimized assembly process or, in the case of Slack, better communication. For the cost of a dozen employees, if we assume Slack can improve communication and reduce costs by just 1% on average, that means millions of dollars saved. In a perfect market, the corporate world will buy the product. Likewise, Ethereum’s platform for smart contracts and dApps could disrupt multiple sectors if done correctly.
Warren Buffett compared the cryptocurrency hype to gold, saying it is a non-productive asset that is only hoped to part with a higher price later. Although there are many ignorant speculators out there, I haven’t been able to find anyone who understands decentralized blockchains which are also bearish.
In this article, I explain the technical reasons why Ethereum is so much more exciting to me than Bitcoin, even though both are revolutionary in their own ways. If you’re curious about how blockchains work, the best explanation on the internet is this 3B1B video, but it’s not mandatory to understand this article.
1. Compare as a currency
Ethereum as a currency can verify transactions in 10 seconds, instead of 10 minutes on the bitcoin network [2]. However, this is subject to statistical variation and, in the case of Ethereum, it depends on how much gas was added.
A minor advantage of Ethereum over bitcoin is the concept of gas, or cost of computing power set by miners. It maintains a separate unit of price between the value of a cryptocurrency and the actual computational cost, while the bitcoin bulk premium is subject to the whims of the floating price. In practice the difference is debatable, but the gas is fairer and more flexible.
What does transaction time mean for adoption? Vitalik Buterin describes this in a push towards a 12-second block time from 2014:
In many cases, this is fine; if you pay for a laptop online and then manage to withdraw the funds five minutes later, the merchant can simply cancel the shipment; online subscription services work the same way. However, in the context of some in-person purchases and digital goods, it is extremely inconvenient.
And the blocking time will become even shorter. On December 1st, Ethereum 2.0 will launch from proof of work to proof of stake.
Compared to traditional centralized retail outlets or credit card companies, decentralized cryptocurrency should be treated as an imminent threat or investment opportunity.
2. Proof of Stake vs. Proof of Work
When potential transactions are transmitted to the network, Ethereum and Bitcoin miners fervently perform trial and error calculations to find the nonce that produces a valid block. More powerful mining rigs can give more processing power to the crypto puzzle and therefore are more likely to mine the winning block.
The limit is that proof of work is vulnerable to a 51% attack. This is where a small concentration of malicious conspirators own more than half the computing power of the entire blockchain network. If a bad actor wanted to start injecting fraudulent transactions into the blockchain, they could defeat the other 49% of the network. Proof of work means that the longest blockchain is the real blockchain, so attackers could write blocks where all the bitcoins in the world would be sent to their wallets. A mining pool briefly reached this benchmark in 2014 but was voluntarily split. Today, a small concentration of computing power is growing in Shenzhen, China.
An alternative protocol, proof of stake, provides more mining power to people with larger amounts of ETH. Randomly selected validators put their ethereum on blocks that they have validated as legitimate. A blocking mechanism automatically “cuts” or removes that stake if they try to introduce fake blocks. If they validate the real blocks, they get the coins and the transaction fee back. The benefit is a faster block time, lower transaction fees and lower power consumption.
3. Smart contracts
Smart contracts are a key feature of the Ethereum network. They are a bit of public code that lives in a chain to be executed by anyone. Think of it as a numb vending machine whose word is final.
Simple example: two people want to sign a contract that is contingent on some future event. If the event occurs, a transaction occurs. Otherwise, there is no transaction. The two parties write down the exact details of this contract up to both are satisfied. As they prepare to sign the agreement, they transmission the contract to everyone else in town to testify. Some time in the future, the event triggers and the funds are transferred automatically.
Concrete example: a young couple, truly in love, want to get engaged. They would never, ever dream of separating, because their souls sing in harmony. Before they get married, they both agree on a smart prenup that outlines ownership of assets, child custody, and alimony. Fast forward 5 years and the couple is up in arms. They can’t stand each other. The gentleman wants the car and the dog, and the lady wants the alimony. There’s no way he’s paying her a dime. Great news! Since it was in the original contract that he signed, the blockchain network acts as the judge, jury and lawyer. Transactions are automatically triggered by the divorce event, leaving no room for denial. It was right there in the code, and everyone on the ethereum network has just seen it happen.
It may take a while to fully realize, but the efficiency implications are huge. The smart contract has arrived absolute truth without a skilled lawyer to donate more money for himself and his client. Code automated the whole process in the classroom. The cost savings are huge!
Now think about the huge insurance industry. All filing complaints, processed in the blockchain. It is ripe for disruption by blockchain companies who want to develop these code contracts. This is the strongest bullish case for Ethereum in my opinion. Using smart contracts is not a question of if, but when. If I were in the health or auto insurance business, I’d leverage them yesterday.
It could be said that there is no way that ordinary people would ever use it. We need lawyers and insurance, bureaucracy is mandatory. Just as you would accuse bitcoin of being blocked by the government due to the government’s difficulty in taxing it. These points are valid, but the idea of smart contracts is too powerful now that it’s out of Pandora’s box. In my openly romantic view, these ideas could survive the government.
4. Distributed apps (dApps)
Distributed apps are developer-created apps built on the blockchain that don’t have a centralized server and do their computation on the blockchain.
Ethereum isn’t quite the computational behemoth to tackle AWS that many had hoped for in the early days. With current technology, centralized web servers are much better in terms of hyper scalability. But some interesting possibilities are still available for decentralized distributed apps.
Check out some dApps on the Ethereum website. You’ll find games, trading platforms, and just about anything that a decentralized, censorship-free network could use.
My favorite dApp? CryptoKitties, without a doubt.
How will I rate the distributed app community? Is it a niche hobby for nerds or a blockbuster far from taking control of everyday life? This is for you to predict.
5. The developer community
The Bitcoin developer community is made up largely of volunteer tech enthusiasts who contribute to the Bitcoin open source repository.
Although Ethereum is also run by open source developers, there is another enterprising class of private developers who write blockchain apps leveraging the Ethereum development platform. These developers contribute to a digital app store with the opportunity to earn revenue. It is difficult for me to predict when the market will become saturated, but there is still a lot of room for growth.
One key thing to note is that Ethereum has multiple features designed from the start. When it comes to blockchain, being the first mover also means making more mistakes in the design and it is next to impossible for Bitcoin to implement smart contracts or distributed apps without starting the blockchain all over again. Ethereum, on the other hand, provides a platform for developers with its own programming language and is extensively extensible.
Are there any advantages of Bitcoin over Ethereum?
- Bitcoin currently has lower transaction fees, but this flip-flop relies on mining volume and network congestion.
- Bitcoin has a stronger mining pool with cryptographic difficulty requiring ASICS instead of GPU, but blocking difficulty primarily controls this.
- Bitcoin has much better brand recognition, being the original cryptocurrency. Ethereum may have to recover a lot to do in the marketing department outside of the developer appeal.
To be a successful investor, I like to have many tools to my credit. If looking at an investment from different perspectives gives you different numbers, this is a great place to start your research.
Disclosure: They are / we are long ETH-USD, BTC-USD. I wrote this article myself and express my views. I don’t get any compensation for this (other than Seeking Alpha). I have no business relationship with any company whose shares are mentioned in this article.
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