I’m not sure how controversial this thesis is, given that some people consider the entire cryptocurrency industry to be a gigantic bubble that’s already worth more than it should be. But I believe the world’s second-largest digital asset, Ethereum (ETH-USD), could eclipse the original gangster of this space: Bitcoin (BTC-USD).
At the time of writing, the combined valuation gap between the two assets is a jaw-dropping $855 billion. That’s the market value of Facebook (FB). Bitcoin accounts for 56.5% of the entire crypto industry’s value at the moment, while Ether accounts for just 12.5%. Closing this gap is going to be a monumental challenge.
Nevertheless, I believe this gap will eventually narrow. My thesis is based on the simple premise that Ether is more useful and has grander ambitions than Bitcoin. It’s also based on the fact that the success of these two assets is tightly correlated. Cementing my position is the upcoming update to the Ethereum network that could slash supply while mainstream adoption gathers steam. If these trends continue, Ether’s market value could surge past Bitcoin within the next few years. Let's dive in.
The top two cryptocurrencies always have been heavily correlated. Both surged to record highs during the 2017 boom, with the correlation between ETH and BTC approaching 0.916. It seems Bitcoin’s adoption and success tend to make Ether more “acceptable” for investors.
However, Ethereum is working off a smaller base which makes it more likely to outperform its larger peer. This is clear from the recent bull run. Bitcoin’s price is up 730% over the past 12 months, while Ether is up 1,290% over the same period. Bitcoin’s market cap has already surged past $1 trillion while Ether’s aggregate value is $242 billion. In other words, ETH’s outperformance is driven by the law of large numbers.
Not only does ETH have a smaller base but it also has a larger market to address.
Total Addressable Market
In recent years, investors seem to have established the consensus that Bitcoin is a store of value and an uncorrelated asset. In other words, it’s now accepted as “digital gold.” That means BTC’s total addressable market is the current market value of physical gold: estimated to be worth $10 trillion.
In fact, even Goldman Sachs CEO David Solomon said Bitcoin's path to disrupting gold was "inevitable." In other words, the digital asset seems to have found its market fit.
However, Ethereum isn’t attempting to be “digital gold” or a “safe haven asset.” Instead, it’s trying to be a global decentralized virtual computer. It’s designed to run decentralized applications. That means the utility is nearly boundless. That means its TAM could range from a few billion for the digital collectibles industry, to over $266 billion for cloud computing to nearly $100 trillion for the global bond market.
Simply put, we don’t really know how big the market is for Ethereum and whether we will see any viable applications that tap into it. But just because we don’t know what’s ahead doesn’t mean the potential isn’t evident. All Ether needs is a catalyst - a killer app.
One killer app
Six years into the Ethereum project, we’ve seen several applications emerge with varying degrees of adoption. Perhaps the most popular application emerged just last year: Non-fungible tokens (NFTs). NBA TopShot is perhaps the first decentralized product with mainstream adoption. It’s an early peek into Ether’s future as a base layer for creative and unique digital industries.
However, NFTs are clearly overhyped and the market for digital collectibles is nowhere near as big as digital gold. Instead, Ether’s killer app is much more likely to emerge in the FinTech space.
This year, Visa (V) adopted the technology to settle transactions on their global network. This is probably the greenest of flags that Ether could someday live up to its potential as a global virtual computer. Meanwhile, developers have been experimenting with other exciting FinTech applications such as flash loans, prediction markets, peer-to-peer loans, insurance and stablecoins under the umbrella term Decentralized Finance (DeFi).
All these experiments have had varying degrees of success. But a single killer app that lets people borrow, lend or create wealth in a unique way will unleash a flood of adoption and push Ether’s utility far beyond Bitcoin’s.
Institutional investors have only recently adopted Bitcoin as a store of value. But Ether adoption isn’t far behind.
More institutional investors increasingly see Ether as a store of value away from traditional instruments. Hong Kong-based Meitu became the first public company to hold ETH as a digital reserve. Likewise, altcoin continues to see a significant increase in institutional capital inflows as they seek to profit from its strong returns.
Increased investments by institutional investors also continue to affirm Ether price bump from current levels. The second-largest cryptocurrency has attracted hundreds of millions of investments as mainstream adoption continues to gather pace.
Ether has seen more than $4.2 billion in capital inflows in the first quarter alone, the highest level on record. Grayscale is the biggest investor, having invested more than $43 billion in digital assets of the likes of Ether. Grayscale has on its portfolio about 3.18 million ETH under management, valued at over $5 billion.
In February 2021, more institutional money started flowing into ETH than BTC for the first time. In a single week that month, Ether products accounted for 80% of institutional crypto trading. An influx in retail and institutional investments into the crypto might explain the 120% plus rally in 2021 alone. As it stands, whales own more than 68% of the total ETH supply. As supply continues to diminish, the crypto value stands to increase significantly.
A killer app and growing mainstream adoption are both demand-side factors. This year, the network also faces a supply-side shift that could propel its value further.
Ether Supply Changes
Ethereum blockchain developers approving one of the biggest network changes since inception promises to be the perfect catalyst for Ethereum. The newly approved changes will destroy some of Ether tokens every time they're used to fuel transactions.
EIP 1559 is the new change that will come into effect in July or August. A reduction in Ether tokens supply should have a significant impact on the forces of supply and demand. As supply decreases at a time of increasing demand, higher Ether prices should be expected. This is partly because a reduction in supply is more than expected to make the asset scarcer.
Bitcoin’s price has increased by more than 700% over the past year. The increase is attributed to BTC supply being capped at 21 million coins and increasingly diminishing. In contrast, Ether has seen its price increase with an infinite coin supply by more than 1,116% over the past year. Likewise, a reduction in supply amid soaring demand should result in a significant price bump from current levels.
Scarcity, coupled with the first-mover advantage and more mass recognition, are the reasons Bitcoin is trading at record highs of more than $58,000. Ether price bump has been chiefly restricted by inflation concerns given that ETH supply is theoretically infinite. However, with the new change prompting some coins' destructions, supply scarcity should come into play, which should positively impact price.
Ether transaction fees
The new change also is poised to take the guesswork out of Ethereum network transaction fees. As it stands, transaction fees are inconsistent, forcing network users to rely on other sites to determine what they are likely to pay as transaction fees. Similarly, transaction fees have been determined based on an inefficient auction process.
EIP1559 is poised to leverage an automated system that will enhance clarity on transaction fees. The system will adjust to the network's congestion level of transactions enabling market rates instead of users referencing prices paid.
Ether fee totaled $600 million in 2020. In January alone, the fees had topped highs of $180 million, putting it on pace to clock record highs of over $3.9 billion. With fees poised to increase by more than 500%, the cryptocurrency appears highly undervalued at current levels given the increased use and acceptance.
Smart Contracts Use Case
Ethereum being more than just a cryptocurrency is another reason that could steer valuation higher. While Bitcoin is mostly used to process transactions, Ethereum has carved a niche for itself in facilitating the development of smart contracts that are used for various functions.
The digital asset is becoming a one-stop-shop where people could sign various contracts from sports wagers to investment agreements. It's also finding excellent use in data storage. Similarly, the digital asset should be envisioned as an ecosystem as it provides a platform that developers can use to build apps.
Fundstrat Global Advisors cryptocurrency team has already initiated coverage of Ether issuing a $10,500 price target. The price target implies a 500% plus rally. The ambitious price target stems from growing confidence that the Ether blockchain will fuel more real-world applications such as smart contracts, stablecoins, and the decentralized finance space.
At Fundstrat’s $10,500 price target, Ethereum’s cumulative market cap would be $1.2 trillion. However, Ethereum’s long-term potential could be multiple times larger. Remember, the global private credit market alone worth $1 trillion today and is growing at a CAGR of 16.4%. Global FinTech market is worth $5.5 trillion and is expanding at a CAGR of 23.6%. Meanwhile, Bitcoin’s market potential taps out at the value of gold, ~$10 trillion.
Source: Preqin / EY
Put simply, if Ether lives up to its potential it could easily eclipse Bitcoin. However, this story could take years to play out and investors may have to experience several severe drawdowns along the way. This is an arguably risky bet for contrarian investors with truly patient capital.
Some have argued that aggregate market value can't be used to justify Ether's value. In other words, the value of the decentralized applications or Dapps built on the Ethereum network is likely to be worth more than the network itself, which implies that the underlying tokens - ETH - shouldn't be valued based on this.
I'm not saying I disagree with this. But even under the assumptions of this model, Ether is undervalued at worst and worth more than Bitcoin at best.
Consider the fact that the combined value of all web platforms - the FAANG stocks, internet companies in China, and mobile apps in the developed world - is magnitudes greater than physical gold today. These are Web 2.0 applications that have created more value than a store of value.
Now consider that the Ethereum network is effective Web 3.0 and the network extracts a fee on every transaction that flows through it. If the combined value of future Web 3.0 applications is as large as Web 2.0 is today, a network that extracts a fee from this new layer of the internet should be worth more than a store of value asset.
Put simply, being useful in wealth creation is more valuable than being a reliable way to preserve wealth.
This idea was first discussed (in much greater detail) with members of my private investing community, Betting on Tomorrow . To get an exclusive ‘first look’ at my best ideas, subscribe today >>
Disclosure: I am/we are long BTC-USD, ETH-USD. 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.