Why Is Everyone Investing In Ethereum?
Everyone's Talking About Ethereum
Ethereum is starting to reach borderline Bitcoin levels of hype and online shilling. No matter where you look, you see constant tweets, posts, interviews and even blogs (like this one!) about the mysterious blockchain network that's touted to have more promise than Bitcoin. Today, I'm going to attempt to demistify what Ethereum actually is, along with its main token: Ether. I'm going to talk about what it is, why it exists, how it works and how it's performed over the years as an actual investment. Then I'll chat about Ethereum moving forward, chiefly compared to its main rival, Bitcoin.
One quick note: I'm going to assume that you read my primer on Bitcoin, which discusses concepts like cryptocurrency, the blockchain and investing in the space in great detail. You can find that article here. If you haven't read it yet, go read it. I'll wait. Done? OK cool, now it's time for Ethereum. Let's go.
What Is Ethereum?
According to the official Ethereum website, "Ethereum is the community-run technology powering the cryptocurrency ether (ETH) and thousands of decentralized applications." Confusing, I know, but it's worth it to include the literal description straight from the horse's mouth because it contains a key term: "decentralized."
If you're familiar with my Bitcoin piece, you'll know that the whitepaper for Bitcoin was published back in 2009 amidst the recovery phase of the Great Recession. Basically, Bitcoin and the advent of blockchain was a libertarian-style response to the "broken" banking and economic system. Well, it was an excellent idea with a few limitations, namely speed of transactions and total applications. Bitcoin was an excellent one-to-one currency exchange, but that was about it. This white space gave rise to a new network purpose-built to fix this issue. In 2013, Ethereum was born.
The brainchild of computer programmer Vitalik Buterin, Ethereum was built to function beyond money, instead creating a decentralized blockchain network that could be affixed to pretty much any type of asset. It is based on a different type of programming scripting language than Bitcoin that allows more sophisticated decentralization and a greater application suite than Bitcoin.
Before I hop into the actual nuts and bolts of the technology itself, I want to talk about Buterin. When the price of Ether passed $3,000, Buterin officially became the world's youngest crypto billionaire at 27 years old. He was also given over $1 billion in the meme-token "Shiba Inu" at the back end of 2020. How did he celebrate? He donated it all to relief efforts in India, as well as an additional $600,000 in Ether. So what is he up to now? Well, aside from working on the Ethereum upgrade I'll speak about in a later section, he has a pretty long list of varied interests...
How Does Ethereum Work?
That brings us to how this bitch actually works. This can get super complex to the point where I lose the thread and end up wandering through tech forums like a lost kid in a Wal-mart, so I'll try to break it down as simply as I can. Ethereum, in its simplest form, is a programmable blockchain. But what does that actually mean?
How Smart Contracts Work
Well, quite a lot, it turns out. A programmable blockchain has quite a few different applications, the first (and most major) being smart contracts. Smart contracts are literal contracts between multiple parties that are executed and verified in a decentralized manner on the blockchain, resulting in what's called an "immutable contract." The main difference between a smart contract on the blockchain versus a traditional contract you might engage in is the security. Tampering is not possible in a smart contract because it's verified by a community, rather than a single third-party. It's tough to wrap your head around, I know, so here's a helpful illustration of a smart contract execution from Simplilearn:
Ether: The Token of the Future
So this might raise the question: "If the blockchain and smart contracts are used to pay people, what currency are you paying them in?" Great question, me! The token of the Ethereum blockchain is Ether, which is currently the second largest cryptocurrency by market capitalization at time of writing, only trailing Bitcoin. But how do you actually get Ether?
Proof of Work and Proof of Stake
I'm going to leave aside the "just buy it on an exchange, idiot" response out of this part because it's obvious and unhelpful. Let's talk about how these tokens are generated, which again ties back to that old friend, the blockchain.
Ethereum 1.0 essentially built its value proposition on the back of what Bitcoin had already accomplished on the blockchain; that is to say "mining." Again, I spoke about mining a bit more in-depth in my Bitcoin piece, but as a quick refresher, mining is the process of using a computer to solve complex mathematical equations on the blockchain to unlock blocks of tokens as a reward. It's essentially a payment to the miner for their time and labor, and this transactional model is referred to as "proof of work." You're being rewarded tokens for proof of your work. The main advantage of this type of model is data security, mainly due to the sheer volume of miners working to solve the same problem which essentially eliminates the ability for an individual to meddle with the blockchain. However, proof of work has some key drawbacks, mainly the amount of energy needed in order to get rewarded, which is causing considerable discussion at federal levels due to massive energy draws by mining farms. There's also a scalability issue that proof of work networks struggle with, especially in decentralized environments. So how do you fix this?
You may have noticed that I said "Ethereum 1.0" at the beginning of that last section. That's because Ethereum is currently undergoing an evolution like someone just hit Pikachu with a Thunder Stone. Ethereum, dealing with scalaiblity issues from something we'll chat about in a second, is struggling under the load and is having to develop a new blockchain named "Ethereum 2.0." In this transition to the new blockchain is a transition in how their Ether token is dealt, which is named "proof of stake."
In this proof of stake model, tokens are rewarded not for computers solving math problems, but for current token owners to provide their own tokens into a "staking pool." This staking pool is used to validate new transactions on the blockchain, which in turn rewards the staking party with more tokens, upon which they can stake more of their assets to continue the feedback loop. It's sort of like interest in a savings account: the more money you have, the more you earn from the bank in interest. You can take that interest and put it back into the savings account in order to gain more interest and continue the snowball rolling down the hill.
The proof of stake model can be a little bit riskier for the person staking the liquidity as an event called "slashing" can occur. Essentially, if your staking node goes offline or if there's corruption in the staking pool, you can essentially lose some of your stake, seeing it get "slashed." But the benefits of this model greatly outweigh the downsides, and this could be the validation method of the future if big government jumps in to attempt to crack down on energy consumption and ecological damage as a result of the proof of work model.
What Else Uses Ethereum?
So I already mentioned that Ethereum is a multi-purpose blockchain thanks to its programmability. It can be used to validate real estate deals, one-to-one transactions and pretty much anything inbetween. However, there's one key application that I want to focus on here that has been the subject of a massive bubble in recent months, and that is NFT's.
What Are NFT's?
I've previously written about the NFT space as an investment, but that was in the early days of my site and honestly the article is clunky and bad, so here's what you need to know: an NFT stands for "non-fungible token." Essentially, they're the original version of a digital asset. For example, anyone can make a meme. But only one person can own the image that the meme is based on, and that ownership is the NFT. It's "non-fungible" because it can't be reproduced as an original. If you, me and a friend each threw a $1 bill in a bowl, mixed them up and each pulled one out, they're identical in nature. They look, sound, feel and spend the same, and there's no difference between them. An NFT would be like putting the original Mona Lisa in a bowl along with two photocopies. Only one person can own that original, and that is what produces the value. Their authenticity, and in turn their ownership, is verified on the Ethereum blockchain, creating a public record of authenticity and ownership.
But why am I bringing these up? Because the market for these things has gone batshit bananas. If you look up "NFT" on Twitter, you'll be greeted by a list of users with pixelated faces or weird monkeys smoking cigarettes. Anyone and everyone is diving into the NFT space because of the sheer amount of money that's been made in the space over the last 12 months. This 32 year-old artist has made over $200k in the space. This 24 year-old did one better and has brought in over $300k in the last few months. The NBA NFT website "NBA TopShot" has brought in over $700 million in total revenue since their launch last year. Former First Lady Melania Trump recently announced that she is launching an NFT company. Want the biggest sign we're in a bubble? Here's PARIS FUCKING HILTON breaking down the NFT space on a cable late-night show:
But why do you invest in NFT's? So you can flip them! It's the same as investing in a piece of art or, say, the Constitution of the United States: because you're banking on someone wanting to pay more for it in the future than you paid today. It's an alternative investment that has risen in a perfect storm: investors have more money than ever thanks to a combination of stimulus checks and being locked inside for two years with nowhere to spend it, as well as near-zero interest rates removing any incentive to save their money in a bank. The stock market is also at all-time highs and is too frothy for some investors to want to dive back in, so alternative investments are on the rise. Federico Iossa, the YouTuber who founded Del Ray Watch Company, has stated that he cannot keep Rolex's in stock because people are viewing them as fantastic alternative investments. But speaking of investments...
Has Ethereum Been A Good Investment?
When assessing whether an investment was worth it or not, you want to look at the total return you've gained, as well as the return of the asset relative to "the market." Why? Because if you underperform the market then you should have just put that money in an index fund? Did you over perform the market? Congratulations! You've done your research. Did you over perform the market for five straight years? Then shoot me your address because I'm going to shoot you a check to invest my money for me.
In short, Ethereum has been a monster since its inception. At time of writing, Ethereum has returned an average annual value of over 600%, and has returned 524% in the last 12 months. This is compared to the S&P 500 total return of 257% since 2013, giving you an average annual return of 15%. Ethereum has outperformed the S&P 500 by over 35x in the past 8 years, which makes Ethereum the top performing investment of the 2010's, even outperforming Bitcoin's insane returns.
What Is The Future for Ethereum?
Ethereum is currently undergoing somewhat of a renaissance. Flipping from the proof of work to proof of stake model is a big deal, and is the foundation for the upgrade to Ethereum 2.0. Why? Because of the fees currently associated with using the platform.
Fees are a natural part of any transaction, but Ethereum's are...steep. Ethereum uses something called "gas" which is the fee incurred for using the network, and it's paid using Ether. The issue is that it's dictated by supply and demand; if there's big demand for the network, then the gas fee incurred in order to execute the transaction will be higher in order to get priority on the network. This is an issue, especially with NFT's currently bottlenecking the network. For example: I wanted to mint a new .eth domain name using ENS (Ethereum Name Service) tokens this week. I typed in the domain, and it was available! I created a smart contract to license the domain for two years, which came to a grand total of $10. I pressed "submit" and then was charged the gas fee which was...$65. The gas fee was 650% of the actual transaction cost, which is a HUGE problem. That's why the upgrade to Ethereum 2.0 was so important.
Assuming that Ethereum 2.0 goes as planned and those gas fees come down, then it could be setting the stage for what's referred to in the cryptocurrency community as "The Flippening." This is the event that would see Ethereum's market capitalization overtake Bitcoin's, making it the largest crypto token on the planet. There are whole forums dedicated to this event, including one you can find here with progressive counters and interactive charts to guide your Flippening experience.
The Bottom Line
To me, Ethereum stands out as the cryptocurrency with the most promise moving forward. It doesn't have the scalability and speed issues of Bitcoin, but it is also large enough to where it's highly unlikely it'll fail. I think that once the NFT bubble has popped, Ethereum gas fees will reduce dramatically and the network will once again be seen as a viable payments platform, which I do think will allow it to overtake Bitcoin as the world's largest cryptocurrency. You'd better get used to Ethereum, because it looks set to hang around for a long time to come.
What do you think of Ethereum? Do you own it? Let me know in the comments below!