Opinion: Ethereum - what is it and why has the price gone parabolic?
Posted 22 January, 2021
The price of the world’s second largest cryptocurrency, ether, hit a (opens in a new window)new all-time high of US$1,440 (£1,050) on January 19. This breached a previous high set three years ago and gave ether a total value (market capitalisation) of US$160 billion, although it has (opens in a new window)since fallen back to around US$140 billion.
Ether, which runs on a technology system known as the ethereum blockchain, is worth over ten times the price it was when it bottomed during the COVID market panic of March 2020. And the cryptocurrency is still only five years old. In part, this remarkable rise in the value is due to (opens in a new window)excess money flowing into all the leading cryptocurrencies, which are now seen as relatively safe store-of-value assets and a good speculative investment.
Ether/US$ price
But ether’s price rise has even outstripped that of the number one cryptocurrency, bitcoin, which “only” had a seven-fold increase since March. Ether has outperformed partly due to several improvements and new features being rolled out over the next few months. So what are ether and ethereum and why is this cryptocurrency now (opens in a new window)worth more than corporate giants such as Starbucks and AstraZeneca?
Ether and bitcoin
Blockchains are online ledgers that keep permanent tamper-proof records of information. These records are continually verified by a network of computer nodes similar to servers, which are not centrally controlled by anyone. Ether is just one of over 8,000 cryptocurrencies that use some form of this technology, which was invented by the anonymous “Satoshi Nakamoto” when (opens in a new window)he released bitcoin over a decade ago.
The ethereum blockchain was (opens in a new window)first outlined in 2013 by Vitalik Buterin, a 19-year old prodigy who was born in Russia but mostly grew up in Canada. After crowdfunding and development in 2014, the platform was launched in July 2015.
As with the bitcoin blockchain, each ethereum transaction is confirmed when the nodes on the network reach a consensus that it took place – these verifiers are rewarded in ether for their work, in a process known as mining.
But the bitcoin blockchain is confined to enabling digital, decentralised money – meaning money that is not issued from any central institution unlike, say, dollars. Ethereum’s blockchain is categorically different in that it can host both other digital tokens or coins, and decentralised applications.
Decentralised applications or “dapps” are open-source programs developed by communities of coders not attached to any company. Any changes to the software are voted on by the community using a consensus mechanism.
Perhaps the best known applications running on the ethereum blockchain are “smart contracts”, which are programs that automatically execute all or parts of an agreement when certain conditions are met. For instance, a smart contract could automatically reimburse a customer if, say, a flight was delayed more than a prescribed amount of time.
Many of the dapp communities are also operating what is known as (opens in a new window)decentralised autonomous organisations or DAOs. These are essentially alternatives to companies and seen by many as the building blocks of the next phase of the internet or “(opens in a new window)web 3.0”. A good example is the burgeoning trading exchange (opens in a new window)Sushiswap.
Ethereum has evolved and developed since its launch six years ago. In 2016, a set of smart contracts known as “The DAO” (opens in a new window)raised a record US$150 million in a crowdsale but was quickly exploited by a hacker who siphoned off one- third of the funds. However, since then, the ethereum ecosystem has matured considerably. While hacks and scams remain common, the overall level of professionalism appears to have improved dramatically.
Why the price explosion
Financial interest in ether tends to follow in the wake of bitcoin rallies because it is the second-largest cryptocurrency and, as such, quickly draws the attention of the novice investor. All the same, there are other factors behind its recent rally.
The first is the pace of innovation on the platform. Most activity in the cryptocurrency space happens on ethereum. In 2020, we saw the emergence of (opens in a new window)decentralised finance (DeFi). DeFi is analogous to the mainstream financial world, but with the middleman banks cut out.
Users can borrow, trade, lend and invest through autonomous smart contracts via protocols like (opens in a new window)Compound, (opens in a new window)Aave and (opens in a new window)Yearn Finance. It sounds like science fiction, but this is no hypothetical market – approximately (opens in a new window)US$24 billion is locked into various DeFi projects right now. Importantly, DeFi allows users to generate income on their cryptocurrency holdings, especially their ether tokens.
The second factor behind the ether surge is the launch of (opens in a new window)ethereum 2.0. This upgrade addresses major concerns impacting the current version of ethereum. In particular, it will (opens in a new window)reduce transaction fees – especially useful in DeFi trading, where each transaction can end up costing the equivalent of tens of US dollars.
Ethereum 2.0 will also eliminate the environmentally wasteful mining currently required to make the ethereum blockchain function (the same is true of many other cryptocurrencies, including bitcoin). Within the year, ethereum should be able to drop the need for vast industrial mining warehouses that consume huge amounts of energy.
Instead, transactions will be validated using a different system known as “(opens in a new window)proof-of-stake”. The sense that ethereum addresses problems like these quickly rather than letting them sit could prove a major differential from the sometimes sluggish and conservative pace of the bitcoin development culture.
A final factor is the launch of (opens in a new window)ethereum futures trading on February 8. This means that traders will be able to speculate on what ether will be worth at a given date in the future for the first time – a hallmark of any mature financial asset. Some (opens in a new window)analysts have said the recent bitcoin rally has been fuelled by traditional investment firms, and the launch of ethereum futures is often touted as opening the doors for the same price action.
However, as every seasoned cryptocurrency user knows, both currencies are extremely volatile and are as liable to crash by extremes as rise by them. Bitcoin’s (opens in a new window)price fell 85% in the year after the last bull market in 2017, while (opens in a new window)ether was down by 95% at one stage from its previous high of US$1,428.
Whatever the valuation, the future of ethereum as a platform looks bright. Its challenge is ultimately external: projects such as (opens in a new window)Cardano and (opens in a new window)Polkadot, created by individuals who helped launch ethereum itself, are attempting to steal ethereum’s crown.
But as bitcoin has shown, first-mover advantage matters in cryptocurrency, and despite bitcoin’s relative lack of features it is unlikely to be moved from its dominant position for some time. The same is most likely true for the foreseeable future with ethereum.
By (opens in a new window)Paul J Ennis, Lecturer/Assistant Professor in Management Information Systems, (opens in a new window)University College Dublin and (opens in a new window)Donncha Kavanagh, Professor of Information & Organisation, (opens in a new window)University College Dublin
This article is republished from (opens in a new window)The Conversation under a Creative Commons license. Read the (opens in a new window)original article.
