Jason Guthrie, Head of Digital Assets, WisdomTree
The outlook for cryptocurrencies has become a hot topic for market participants, spectators and press alike. While the cryptocurrency market recently experienced a pullback amid a series of negative news flow, it is not all doom and gloom. Much has been said about bitcoin (BTC), but ether (ETH) is increasingly presenting an interesting opportunity for investors.
On 12 May 2021, ether hit a new all-time high and with that event came questions from investors asking whether the momentum was sustainable and if they should be adding the digital asset to their portfolio. While the recent sell-off may have knocked the positive momentum, there remain plenty of positives to be encouraged by. Any price development in the crypto space is complicated but I’ll attempt to give some context and outline key drivers of the ether narrative.
Ether, the native cryptocurrency of the Ethereum network, is a cryptocurrency like bitcoin but has fundamental differences at a network level that drive very different use cases for each. Bitcoin is primarily a store of value, driven by its hard supply cap, and is viewed as a layer-1 solution for global payments infrastructure. This is where the analogy for digital gold comes from.
Ether is used to “power” the Ethereum network, which is essentially a decentralised software platform, designed to run compiled computer code known as smart contracts. These smart contracts can be used to automate a whole range of functions from very simple exchanges of value to insurance contracts all the way up to decentralised exchanges, all of which are run by the decentralised Ethereum network. The complexity of the smart contract dictates the transaction fees (known as gas fees) which are priced in ether. In this way the ether price is a factor of expected quantity and complexity of transactions on the network, and potential value generated by various applications built on the Ethereum smart contracts – if transactions have a high economic value, people are willing to pay more for transactions. In addition to this, ether also has attracted some degree of “safe haven” status within the crypto sphere owing to the fact that it is the second largest cryptocurrency, its demand is very persistent and, whilst not fixed, the supply expansion is very predictable and relatively tame when compared to fiat currency standards post-2008.
So why has there been so much interest in ether in the last few months?
Excitement over ETH 2.0
There is a great deal of excitement in the space around proposed future developments to the Ethereum network that many are lauding as the next big thing to drive the ecosystem forward. There are wide ranging changes planned, but the two major developments are, firstly, the move to Proof of Stake (POS) from Proof of Work (POW) as a consensus mechanism and, secondly, the development of “layer 2” solutions to help with network scaling. There is speculation that these changes will help propel the usage of the Ethereum network bringing more users and more projects on to the platform.
Additionally, the potential change to POS is tapping into a raging debate in the crypto sphere: Energy usage. POS is much less energy intensive that POW and, as such, some speculate that this could be a tailwind for the platform’s adoption.
Decentralised Finance (DeFi) developments
One of the most innovative deployments of the smart contracts has been the rapid growth of DeFi which has mostly occurred on the Ethereum network. This is essentially using decentralised technology to automate the way value is transferred, a role historically done by big institutions and one that that has been very profitable. There are DeFi products which are 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 large amounts of capital and are showing huge potential. If Ethereum can maintain its dominance in this space it should continue to drive demand for ether.
Cyclical rotation from bitcoin as prices trend sideways
Bitcoin is still the most ubiquitous cryptocurrency. Its bull runs generate the most attention in media and it is by far the most common entry point for new money entering the market. But we all know that market moves come in cycles so, as the steam comes out of bitcoin, we see investors looking to take profits and rotate into something else. Ether is often their next choice. This isn’t a new phenomenon and is followed by crypto pundits who talk about the market following a trend from BTC to ETH to large cap Altcoins and DeFi and finally to the micro-cap projects. This was a pattern observed in the 2017 market and we may be seeing something similar now.
That said these trends never follow a straight line. The recent sell-off helps to remind us that any investment needs to be done in a risk-adjusted way. The future looks bright for cryptocurrencies but deciphering the exact path of adoption is almost impossible. For this reason, digital assets currently represent a niche, but growing, part of a portfolio with allocations spread across high conviction crypto assets.