Looking Into Ethereum

In another article, I wrote about gold being a superior currency to Bitcoin. The key difference between the two is that, while gold has value for reasons beyond its use as a currency (and speculation), Bitcoin has no other value. However, there is a cryptocurrency which has value beyond its use as a currency and speculative vehicle. That currency is Ether.

There are a number of Bitcoin related articles on Seeking Alpha. Ethereum is discussed far less frequently. That is not surprising, considering Bitcoin is the granddaddy of cryptocurrencies. But Ethereum is an important technology, with a lot of potential.

Overview

First off, with Bitcoin, and Ethereum, there are two components. There is the blockchain and then there is the currency. The blockchain is the backend, which acts as a decentralized, distributed, ledger system, that is used to record every transaction, allowing secure contracts. With Ethereum, the underlying system is able to implement any program as a contract. These are called smart contracts.

Ether, which for the purposes of this article will be thought of as a currency, is also often described as the fuel for Ethereum. The Ethereum network requires an input of Ether to run code. The more complicated the smart contract, the more Ether is required. When referring to the currency, I will use ETH and BTC. More detail on the differences between Ethereum can be found here.

Value

Gold receives its value, in part because it plays on human psychology and in part because of its use in medicine, electronics, and so on. ETH, right now, does gain most of its value from it being a speculative vehicle, but unlike BTC, ETH has a use. As mentioned earlier, it is used as the fuel in the Ethereum block-chain system, which has the power to run decentralized applications of any type and at any scale, so long as the system grows large enough.

ETH also has one more advantage over Bitcoin. The real issue I have with BTC is that it is highly deflationary. It has a fixed maximum supply. Ether availability grows linearly. It is therefore more disinflationary. I would prefer a version of ETH which has a way to match supply to demand, which gold does, but at least a disinflationary currency is better than an inflationary one. However, the move from deflationary to disinflation will only happen once speculation dies down.

Data

Finding raw data for cryptocurrency is not as easy as it is for stocks or gold. However, Poloniex has data on ETH vs BTC, and many other cryptocurrencies. Cryptocompare has daily price history for ETH.

Ether to Bitcoin Ratio

One reason that Ether has gone up in price over time is because Bitcoin has gone up in price. However, ETH has gone up with respect to BTC as well. This suggests that demand for ETH exists in its own right.

The growth has been inconsistent, but overall appears to be more or less exponential, which makes sense as ETH adoption continues to expand.

ETH vs USD

Since BTC is not exactly a primary currency, perhaps comparing its price to the USD is more useful for most people. Below is the daily graph of ETH prices in USD, from August 7, 2015 through June 1, 2017. Apologies for a different format for the x-axis in the graph.

Recent growth seems to have be even beyond exponential. This makes sense, considering BTC is growing exponentially, and ETH vs BTC has also been growing exponentially. Again, this will likely subside as adoption levels off. However, given that ETH has a market cap of only 20.4B USD and even BTC has a market cap of only 39.4B USD, that might be a while.

Variation in Daily Percent Change

The distribution of price fluctuations is definitely not normally distributed. While the mean and standard deviation of the distribution are 0.0504% and 0.0328% respectively, skewness and kurtosis are 1.01 and 50.8. Skewness is close to normal, but kurtosis is definitely not. Meanwhile, the minimum and maximum are percent changes are -29.0% and 41.9% respectively. For more on what these values mean, see the discussion in “A 47-Year Comparison Between The S&P 500 And Gold.”

But overall, what this distribution shows is that, while most days there is little change in the value of ETH, there are days with massive swings. This makes it more difficult to predict where ETH will be in the future.

Again, it is not reasonable to assume that the type of growth in value will continue indefinitely. It will have to level off at some point. It will likely first slow to exponential growth, when Bitcoin starts leveling off, and then logistic growth as the currency matures, so long as it lasts that long.

Further Discussion

When I started writing this article, about a week ago, there were very few articles on Ethereum specifically. However, Geoffrey Caveney’s beat me to the punchline with “Ethereum Blasts Above $20 Billion Market Cap, Over Half Of Bitcoin.” Still, I think there is a lot that can be added to the discussion. Alpingseeka made some interesting points in his comment.

Bitcoin does one thing, simply, and it’s good at it. Ethereum is a promise to do an infinite number of complex things later, but none of them have materialized yet. it’s an uncertain bet, and no dapps currently operate at a scale significant enough to merit the valuation it finds itself at.

This is a good point. However, this is one reason why ETH is an interesting speculative vehicle right now. It has the potential to become more than it is today. Bitcoin could add smart contracts, but it is not as likely to do so. It has more or less matured in terms of its potential. Buying ETH is much like buying stock in a startup. A startup does very little in the beginning. It does not produce much. However, people invest in startups hoping that they will become more than they currently are.

Bitcoin, on the other hand, is acting like a speculative vehicle, even though it should just be acting as a currency. Indeed, the speculative nature of Bitcoin is limiting how useful BTC is as a currently for now.

The network suffered a contentious split and there are two competing ethereum chains – ethereum and ethereum classic. Classic offers at the very least a decent monetary policy and has been attracting developer talent.

Ethereum has more difficult scalability issues than bitcoin. Its blockchain is already larger in size.

I included these two points together because they might go hand in hand. Bitcoin does have a scalability issue, and how to solve that issue is threatening to split Bitcoin in two. Read “Why Bitcoin May Split In Two And How To Prevent It” and “Bitcoin’s ‘Segwit2x’ Scaling Proposal: Miners Offer Optimistic Outlook – CoinDesk” for more on the topic. While it is possible that Ethereum could split again, it is unlikely. The main threat of this happening comes from the switch to PoW to PoS.

It has a ‘difficulty bomb’ that will make mining impossible unless a switch to the Proof of Stake
(PoS) algorithm is completed next year

That is actually on purpose. The idea is to eventually make it difficult enough to mine new ETH that there will be no split. The risk is in timing. If the switch to PoS is too soon, there will be a split. If it is too late, people will stop mining, and the system will become vulnerable to security breaches.

Regarding Geoffrey’s actionable trade,

Mind you, I say this as a strong believer in precious metals as a safe haven to preserve one’s wealth. I think 10% of your portfolio in gold is a good idea at all times. Gold has been valued as a store of wealth by civilizations around the world for 6,000 years.

I am with him on this. I will take gold over BTC and ETH. It is just nice to have a little bit in your portfolio as a lottery ticket, and that is exactly what both cryptocurrencies are right now: lotto tickets. I will likely purchase a small amount of ETH, if there is a significant price drop. I would like to see it go below $200 before purchasing any.

Conclusion

All cryptocurrencies are speculative vehicles right now. This means that they are incredibly high risk. They should not be treated like safe haven assets such as gold. However, ETH is better positioned to become a generally used currency and is likely to be around for longer than BTC. A lot of its longevity will be determined by how well the Ethereum blockchain is adopted for the deployment of applications. Additionally, if ETH continues to grow in value, relative to BTC, it will continue to offer better ROI.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I am not currently positioned in any cryptocurrency, but may purchase some if there is a dip in the near future.