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Ether (ETH-USD), the currency for the Ethereum blockchain, benefits from a unique set of macroeconomic and technological drivers. Ether issuance is slowing and the amount of Ether available for trading is being reduced, while investor demand increases. As a result, the value of Ether is likely to increase in the coming years.
How Ether is different from Bitcoin
The bitcoin blockchain validates, stores and replicates transaction data across a distributed network of computers. Ethereum takes this idea a step further because it also has the ability to execute computer code, known as smart contracts.
Bits on Blocks describes it succinctly:
What bitcoin does for distributed data storage, Ethereum does for distributed data storage plus computations.
While bitcoin (BTC-USD) is basically a form of digital money. Ethereum is a programmable smart contract platform.
Smart contracts can be used for almost all types of financial transactions. The use of smart contracts, sometimes referred to as decentralized applications or DApps, can eliminate the need for intermediaries in financial transactions. Potential applications of decentralized finance could disrupt industries such as insurance, financial derivatives, securities trading and real estate. Ethereum makes decentralized finance possible.
Smart Contract Ecosystem
Ethereum has the first mover advantage as the dominant agreement network for decentralized finance. Several large companies are building products on Ethereum including Nike, Ernst and Young, and Barclays. Enterprise Ethereum Alliance board members include Santander, JP Morgan, and Intel, among others. Organizations that have not yet started blockchain projects are likely to follow these organizations’ lead, rather than taking a greater risk on less tested platforms.
The chart below shows how dominant Ethereum is compared to other smart contract / DApp platforms.
Source: State of the DApps
Ethereum has undergone several minor updates since it launched in 2015. It is now in the process of rolling out its biggest update, to a new system called Ethereum 2.0. Implementing will move the system from proof of work to proof of stake consent. This is a more energy efficient method than proof-of-work because it depends on the people sending warranties, rather than performing massive calculations that require powerful computers. It will also improve security and decentralization.
Perhaps most importantly for Ether investors, Ethereum 2.0 will make the platform more scalable, allowing it to conduct more and more transactions on its network. There is a risk of technical problems with the implementation. However, if successful, it will increase the value of the Ethereum ecosystem and, combined with the other dynamics of supply demand, could drive the price of Ether up.
Supply
Unlike Bitcoin, Ether has no maximum issue limit. Instead it issues just enough tokens to keep the network functional. Critics of Ethereum argue that this prevents it from being a reliable store of value. However, fixed amounts of coins are added each year, so as the Ethereum Whitepaper notes, Ether’s supply growth rate will tend towards zero over time. In fact, the emission rate of Ether in the coming years will be even slower than that in bitcoin.
This chart shows the historical and projected emission rates of Ether and BTC.
Source: Nicoya Research
As the emission rate of Ether decreases, two factors will cause it to be blocked and unavailable for trading. First of all, decentralized finance apps are built using the Ethereum blockchain, plus Ether is locked for use in smart contracts. Likewise, as existing apps become more popular, the supply of Ether available to traders decreases.
Source: Defipulse
The second factor that reduces the offer is the impact of Ethereum 2.0 staking.This refers to people who hold a certain amount of Ether blocked as collateral to participate in the Ethereum 2.0 network. This Ether cannot be accessed and is being staked until Phase 2 of the implementation is complete, probably several years from now. Indeed, this staking process will reduce the amount of Ether available for purchase by speculators and investors. Many people who stake their Ether are likely to be long-term holders already anyway, but even a small amount of tighter cash is significant given that Ether has such a small market cap. This aspect of the Ether 2.0 Rollout is bullish for ETH, according to Eric Conner of Gnonnis, quoted in a recent research paper by Coindesk
This contraction in the supply of liquids will be satisfied by the increase in demand.
Increasing demand
The implementation of Ethereum 2.0 is likely to increase Ethereum’s network value. By improving scaling solutions for Ethereum, it will attract larger institutions to build applications that rely on it. The implementation of Ethereum 2.0 will allow people who stake their Ether to earn returns from holding coins, just like holding a bank deposit. This mechanism turns Ether into a positive carry resource and should support Ether’s function as a store of value.
Closely related, the growing institutional acceptance of digital assets that is so central to the short-term bitcoin thesis is also good for ETH. Just as the largest institutional investors have invested in bitcoin as a hedge against fiat currency devaluation, they will also be turning to Ether as a complement to cash and securities. Ether’s current market cap of ~ $ 53 billion is less than ⅙ that of Bitcoin, but as it gets bigger, it will attract larger institutions, creating a self-reinforcing feedback loop. As it becomes easier to buy cryptocurrencies, more retail investors will enter the market. In particular. Paypal recently added Ether login functionality alongside BTC.
Conclusion
Cryptocurrencies protect against systemic risk because they are external to the system. Like all currencies they depend on some sort of consensus among users, but unlike fiat currency, cryptocurrencies do not depend on the existing institutional architecture. Although BTC has gotten more attention from mainstream investors, Ether remains a bit under the radar. Currently the market cap of Ether is ⅙ of Bitcoin. Ether serves as the foundation layer for a smart contract ecosystem that has the potential to overturn or replace many existing financial institutions. As technical factors reduce the amount of Ether available for trading and more people start using smart contracts on the Ethereum blockchain to conduct transactions, the value of Ether could increase substantially.
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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