Jason Guthrie, Head of Digital Assets, WisdomTree
The prospect of cryptocurrencies has become a hot topic for market participants, audiences, and the press. While the cryptocurrency market has recently suffered a setback amid a string of negative news flows, it is not all doom and gloom. Much has been said about bitcoin (BTC), but ether (ETH) presents an increasingly attractive opportunity for investors.
On May 12, 2021, ether hit a new all-time high and with that event came questions from investors asking if the momentum is sustainable and whether they should add digital assets to their portfolios. While the recent sell-off may have tapped into the positive momentum, there is still a lot of positive to be pushed. Any price developments in the crypto space are complicated but I will try to provide some context and outline the main drivers of the ether narrative.
Ether, the original cryptocurrency of the Ethereum network, is a cryptocurrency like bitcoin but has fundamental differences at the network level that drive very different use cases for each. Bitcoin is primarily a store of value, driven by tough supply limits, and seen as a layer-1 solution to the global payments infrastructure. This is where the digital gold analogy comes from.
Ether is used to “power” the Ethereum network, which is essentially a decentralized software platform, designed to run compiled computer code known as smart contracts. These smart contracts can be used to automate various functions from very simple value exchanges to insurance contracts to decentralized exchanges, all of which are run by the decentralized Ethereum network. The complexity of smart contracts dictates transaction fees (known as gas fees) which are priced in ether. In this way the price of ether is a factor of the expected quantity and complexity of transactions on the network, and the potential value generated by various applications built on Ethereum smart contracts – if the transaction has high economic value, people are willing to pay more for the transaction. Additionally, ether has also attracted some degree of “safe haven” status in the crypto sphere due to the fact that it is the second largest cryptocurrency, its demand is very persistent and, although not fixed, the supply expansion is highly predictable. and relatively tame when compared to post-2008 fiat currency standards.
So why has there been so much interest in ether in recent months?
Excitement over ETH 2.0
There is a lot of excitement around proposed future developments to the Ethereum network which many are lauding as the next big thing to push the ecosystem forward. There are many changes planned, but the two main developments are, first, the move to Proof of Stake (POS) from Proof of Work (POW) as a consensus mechanism and, second, the development of “layer 2” solutions to help with network scaling. There is speculation that these changes will help drive the use of the Ethereum network bringing more users and more projects to the platform.
In addition, potential changes to POS are entering into a heated debate in the crypto field: Energy use. POS is much more energy efficient than POW and, as such, some speculate that this could be a drag for platform adoption.
Development of Decentralized Finance (DeFi)
One of the most innovative implementations of smart contracts is the rapid growth of DeFi which is mostly happening on the Ethereum network. It essentially uses decentralized technology to automate the way value is transferred, a role that has historically been performed by large institutions and which has been highly lucrative. There are DeFi products aimed at replacing exchanges, disrupting lending, innovating bond issuance and the list goes on. For example, the LINK and Uniswap DeFi projects on Ethereum have attracted a large amount of capital and are showing great potential. If Ethereum can maintain its dominance in this space, it must continue to drive demand for ether.
Cyclic rotation of bitcoin due to sideways price trend
Bitcoin is still the most ubiquitous cryptocurrency. Its bull moves garner the most attention in the media and are by far the most common entry point for new money entering the market. But we all know that market moves come in cycles, so, when steam escapes bitcoin, we see investors looking for profit and turning to something else. Ether is often their next choice. This is not a new phenomenon and is followed by crypto experts talking about trend following markets from BTC to ETH to large cap Altcoins and DeFi and finally to the microcap project. This is a pattern observed in the 2017 market and we may see something similar now.
That said this trend never follows a straight line. The recent sell-off helps remind us that every investment needs to be made in a risk-adjusted manner. The future looks bright for cryptocurrencies but deciphering the exact path of adoption is nearly impossible. For this reason, digital assets currently represent a niche, but growing, part of a portfolio with a spread allocation across high-confidence crypto assets.