All Eyes on Ethereum
This week in Crypto
A crypto bull market would just not be the same without a full-blown wild alt season, combined with enough exuberance that markets are simply incomprehensible to the average onlooker who is not familiar with crypto. Even for those of us who experienced the mania of 2017’s ICO boom and have become accustomed to PE style returns within weeks and months rather than years and decades, watching legacy alt coins and new tokens pump 1000x and more, in significant volume, is still a sight to behold.
We had already noted in a February Weekly that Bitcoin market share or dominance was testing a key support level of 60% and could fail, giving rise to alts and this is the clear theme that has accelerated in recent weeks. Although, as we pointed out last week, market dominance represented as market capitalization is not the most useful or representative metric for analyzing different assets’ performance, market participants and the media still love to use ‘market cap’ as a leading performance indicator. So too is the issue of unit bias, again often misconstrued by the social media marketing and the memes that drive alts….Dogecoin is only $0.50 per coin vs Bitcoin at $55,000, therefore the upside MUST be greater. Owning 2,000 DOGE sounds a lot more substantial than 0.018 BTC to new uniformed entrants into the market.
Since February, Bitcoin’s market dominance, using market capitalization, has slipped and recently broken the next key support of ~52% and falling to 46% at the time of writing with the next support around 42%. With Bitcoin trading sideways and down from its ~$64k high, money is rotating out of Bitcoin and into alts at an impressive scale, combined with new money flowing into the market attracted by the bright marketing lights of 1000x meme tokens that appear a fraction of the cost and have limited free float and/or liquidity therefore driving up market caps artificially.
Dogecoin and meme tokens aside, leading this cyclical alt season is Ether, the native token on the Ethereum blockchain. Ether has significantly outperformed Bitcoin in the past 6 months gaining over 650% in USD value versus ‘only’ 261% for Bitcoin. Only 261% being a great example of the aforementioned PE style return we have become accustomed to in crypto. This impressive gain in ETH is also being traded heavily in BTC terms, a trade that many of the macro guys and well-known market traders have been publicly disclosing. Long ETH/BTC is the trade and in the past 6 months this trade has returned over 180%, correlating to the drop of BTC market dominance over the same period. These are highly liquid trading pairs and this trade has been put on in size with open interest for ETH markets reaching all-time highs amidst the expectation that ETH/BTC will continue to trend to its 2017 high of 0.156 and overtake Bitcoin’s market cap in the process. The question that we are asking is at what point does the market unwind this trade and move back into the verifiable store of value that is Bitcoin? Bitcoin’s long-term dominance will unlikely be permanently challenged in our opinion, however narratives are everything with crypto and Bitcoin’s role as the most dominant cryptocurrency would likely be damaged should the value of Ethereum surpass Bitcoin and maintain that position of dominance. Although the 2 protocols have very different utility — digital store of value vs smart contract platform (currently) focused on payments, NFT’s and DeFi — the two chains should be able to coexist together successfully in our opinion. Despite our view however, the competition for top spot by market cap is enormously fierce between both Bitcoin and Ethereum maxi camps.
Currently the momentum is shifting towards Ethereum as a confluence of positive news is realized by the market combined with new money, leading towards ETH’s greater perceived upside potential. Is owning ETH at $3,200 more desirable than owning BTC at $55K to those that don’t understand what each chain does?
DeFi continues to evolve and mature with investment pouring into the space and major financial institutions becoming interested (concerned) in how they need to adapt to be part of this sector of the crypto industry. There is now over $76bn locked into the various DeFi projects, of which the vast majority are using Ethereum to build on top of and leverage its superior network effect and security. This growth naturally creates intense competition for block space as increasing value is moved around between users and smart contracts within the DeFi applications. Unsurprisingly, we have also seen USD issuance surge with Tether recently surpassing the $50bn mark and USDC with over $15bn in circulation, this is a product of wider stable coin adoption amidst bull market conditions but also the demand from the growth within the growing Ethereum centric DeFi sector. Higher demand for applications built on Ethereum has resulted in Ethereum gas fees (gwai) recently reaching all-time highs (see chart below), with many users waiting long periods and paying high prices to get their transactions accepted into blocks, a problem which the Bitcoin community like to point out as being a bug and not a feature for Ethereum, the opposite for Bitcoin block space.
Further bullish sentiment is coming from the Ethereum Improvement Proposal (EIP) 1559, originally proposed by Vitalik years ago, but was confirmed recently in early March and likely one of the catalysts of the ETH/BTC move from 0.03 to 0.06 that soon followed. The full technical details are beyond the scope of this Weekly but broadly speaking, the Ethereum community are aiming to address the way fees are structured when paying for block space in order to reduce fee volatility. Currently, block space goes to the highest offer which results in inefficient, unpredictable fees and uncapped increasing volatility when activity increases. This will naturally impede the scaling of the protocol, therefore EIP 1559 which is part of the London hard fork in July, will introduce a predetermined base fee that is adjusted in size depending on the demand for block space at the time. These fees will be known in advance and users can add a ‘tip’ on top to incentivize miners to take their transaction should they wish. Along with predictable fees that adjust for demand, block space will be effectively doubled at the same time to allow up to 25M gwei in fees per block, which temporarily solves some of the scalability issues that Ethereum suffers from and competitor chains are exploiting. Perhaps the most controversial part of this EIP is that the base fee to be set rather than auctioned will be completely burned once the block is mined leaving just the ‘tips’ and block reward for the miner to profit from. This could have potentially deflationary effects on the Ether monetary supply during periods of high network usage should the predetermined base fee paid for by user and then burned turns out to be higher than the ETH block reward generated. If there is a sustained period of congestion then the deflationary effects may well trickle down into the market. Investors are pricing this in now, as well as the impending upgrades, the effect of which are now being seen by the recent impressive rise in ETH price in both USD and BTC terms.
Finally, if we layer on the explosive growth of the Non-Fungible Token (NFT) sector, again predominantly built and settled on top of Ethereum then the stars are aligning for the Ethereum community as focus, attention and positive news flow through the market and drive prices up and with it drawing investment and market share from Bitcoin.
Time will tell if this is just another cycle that is playing out in accordance with the stock-to-flow dynamics of Bitcoin, in which case when the inevitable bear market hits, ETH/BTC will correct and capital caught up in meme coins and some of the lower quality alt coins will flow back to BTC. While we expect this to be the case with the majority of alts, Ethereum is maturing and coming of age. Despite its centralization, its place in institutional portfolios as a yield generating asset when it moves to proof of stake is becoming evident and we watch with interest its trajectory of adoption using Bitcoin as a comparison.