Could Ethereum rise to $10,000 in 2021 and should you invest in Ethereum?
A month and a half ago I did not care for cryptocurrencies. But now my YouTube feed is filled with cryptocurrency experts. I turn on CNBC for my daily cryptocurrency fix. All my WhatsApp groups are filled with cryptocurrency chatter.
Everyone, it seems, is talking about cryptocurrencies. The Bitcoin diehards are bellowing about the dollar being worse than yesterday’s trash. The Ethereum intellectuals are proclaiming an end to finance as we know it. The comics are meme-ing unabated about dogecoin. The altruistic are discussing with conviction about Cardano and the network in Africa. The list of cryptocurrencies is long with a tale for each.
But for this story, I have decided to focus on Ethereum and hopefully, as I write this, I will be able to formulate a thesis on whether I will be investing in it.
But why focus on Ethereum over the other cryptocurrencies. Here are a few reasons:
- I did not want to write about Bitcoin since I have written about it before.
- Ethereum is the second most popular cryptocurrency after Bitcoin.
- Ethereum has the second-largest market capitalization amongst cryptocurrencies after Bitcoin.
- I find Ethereum to be intriguing since it’s being discussed as a means to potentially change the entire landscape of finance.
- Ethereum has outperformed Bitcoin in 2021 and for the most part in 2020 as well.
What is Ethereum?
I prefer to invest only in things that I understand. I know this gets in the way of modern investment theory that is focused on social arbitrage and couldn't be further removed from the principles of fundamental analysis. Social arbitrage, as I define it, is an investment theory that is removed from technical and/or fundamental analysis and is focused on crowd sentiment through various social media platforms. For example, a meme or a tweet, or Reddit chatter can move markets.
Now, I m open to feedback. So if you are compelled to correct my definition of social arbitrage I am sure you will find a way to let me know.
So what is Ethereum in plain English? I am fairly certain I typed those exact words into google.
To understand Ethereum is to understand blockchain. So what is blockchain? Blockchain is a decentralized network. So what is a decentralized network? A decentralized network provides for a platform of exchange between parties that do not involve a central authority. An example of this is Bitcoin.
Duh!
Let’s try this again. Usually, examples are better at illustrating complicated ideas. Let’s look at money. The federal government prints money. The value of money is based on trust. The only reason we know that a $20 bill has more value than a $1 bill is that the US government has told us so and also because 20 is greater than 1. The more significant your trust in a particular countries government, the more conviction you have with its currency.
To exchange money, you typically need a bank. The bank maintains a record of transactions that pass through it. For example, when you withdraw money from your bank account your bank has a record of that transaction. When you give that money to a vendor who then deposits it into a bank account that depositing bank has the transactional record. The banks are acting as a centralized means of handling money.
Now imagine an environment where there are no banks. In this situation, the currency is exchanged directly between individuals. The value of the currency is determined by the network, not by the federal government based on demand and supply. Each exchange of this form of currency is done through a validation protocol across several computers and these computers confirm transactions to ensure their authenticity.
This lack of centralization is often referred to as a decentralized network, a blockchain, which also happens to be how Bitcoin is exchanged.
Thus far we have only discussed currency exchanging hands akin to current day money. If we were to broaden that thought process the core question becomes what other items (goods and/or services) are exchanged that get routed through a centralized authority.
The answer to this is there are several items that are exchanged through central authorities whether it’s stocks, insurance contracts, or mortgages. Outside of finance, central authorities could take the form of cloud service providers such as Amazon Web Services (AWS) which retains data on behalf of their customers. Even Google can be viewed as a central authority since its the most widely used search engine. So while we may perceive that we live in a decentralized world, there's a lot more centralization than one may think.
If the currency which is Bitcoin can be exchanged through a decentralized network, could these other items also be exchanged through a decentralized network such as the blockchain on which Bitcoin is? For example, could there be a world where one party directly interfaces with another party to insure them without going through an intermediary?
This is where the Ethereum network comes in.
The Ethereum network provides a decentralized infrastructure or blockchain to allow for code to be developed for the exchange of more sophisticated contracts beyond simply money. But why not use the Bitcoin network than have to go through the rigmarole of developing a new network, i.e. the Ethereum network?
This is because the codebase in the Bitcoin network doesn’t allow for more complex transactions. The Ethereum network allows developers to create more complex code for facilitating the exchange of more complicated contracts, also called “smart contracts.”
When developing smart contracts, the software developers need to provide clear rules to which the contracts are to be executed. There is no element of judgment and only computer code that determines the outcomes of contracts.
So Ethereum is the platform for executing smart contracts in a decentralized manner. Does this mean when you buy Ethereum, you are buying the platform or perhaps a piece of the platform?
The short answer is No. When you buy Ethereum, you are actually buying the volatile currency that works on the Ethereum platform called Ether.
So what is Ether? Ether is the currency that is used to reward people to run the Ethereum blockchain protocol on their computers. The blockchain is several computers across the globe that are validating transactions thus bringing about its decentralized nature. These “miners” get Ether to run and maintain their technology infrastructure.
But where do they get their Ether from? Turns out they get their Ether from the individual or company that is looking to deploy their smart contract on the Ethereum network.
(I think I need a drink or perhaps a meme since this is quite the rabbit hole.)
So now that I sort of understand what Ethereum is, the next question to evaluate is what are the prospects for Ethereum which should help with making a case on whether Ethereum is something that I would consider investing in.
What are the prospects for Ethereum?
The prospects of Ethereum certainly seem compelling. However, I am still struggling with the smart contracts concept. I am not an attorney, but the limited experience I have with contracts is that they are frequently subject to a significant amount of interpretation and judgment. How would computers support the development and execution of contracts? Also, if Ether is the form of payment that is native to the Ethereum network, yet is so volatile, how can it be used as a meaningful form of exchange. Perhaps a more concrete example will help with this.
As I continued my research to find an example to at least marginally understand this stuff, I got introduced to my next rabbit hole — Decentralized Finance or DeFi.
The simplest way to describe DeFi is that it involves the trading of financial services without the involvement of a centralized authority such as a bank or insurance company. Examples would include trading stocks without a stock exchange, obtaining insurance without an insurance company being involved, or taking a mortgage from another individual and not a bank.
Now much to my surprise, it appears there are already DeFi services established on the Ethereum network such as decentralized money markets where you can borrow money against your cryptocurrency.
Further, due to Ethers volatility, it is actually exchanged into a different coin called DAI which is an overcollateralized stable coin pegged to the cryptocurrency market which helps bring about the much-needed stability to execute DeFi products.
However, while there are some products available on the Ethereum network it also appears that these DeFi products are in their infancy, and for that matter, smart contracts, in general, are in their infancy as the smartest people continue to work towards finding solutions for all the challenges.
So is investing in Ethereum a good idea?
My take on this is that while the prospects of Ethereum are significant there is much that still needs to be understood. While there are use cases of products on the Ethereum network, the sophistication of smart contracts being widely available is a long way away.
In such nascent stages, buying Ethereum is high risk and potentially high reward prospect. The concept of a decentralized model for smart contracts is certainly compelling and the market prospects are immense, however how it will work pervasively is certainly fleeting, at least for me.
When it comes to cryptocurrencies such as Bitcoin, the value proposition is more clear to me. A decentralized medium of exchange, a finite amount of Bitcoin, and the “halvening” events all make sense to me on how the adoption for Bitcoin can certainly grow. (Note: this is not meant to be an endorsement for Bitcoin and should not be viewed as investment advice.)
Based on my research, the other thing that did strike me as interesting is per Cointelegraph the correlation coefficient between price action of Bitcoin and Ethereum is 0.9 on average, meaning that from a pricing perspective both have a tendency of moving together more often than not.
While I understand that Bitcoin has a tendency of driving price action for most cryptocurrencies, Ethereum seems very different to me relative to Bitcoin. Putting smart contracts on the same playing field as a potential currency doesn’t make perfect sense to me.
I can see some parallels, for example in the borrowings/money market world as cited above but when thinking about it in the context of insurance or mortgage products, comparing Ethereum to Bitcoin seems like comparing apples to oranges.
Therefore, this high correlation coefficient seems very odd and perhaps over time, this correlation will decrease. If these things are in fact so highly correlated it makes limited sense to own both.
Will I invest in Ethereum?
So this is where the rubber hits the road. I view the market prospects for Ethereum to be immense and likely bigger than Bitcoin. However, the proven use cases are few. So it seems more theoretical than practical and therefore very speculative at this time. An extreme example would be investing in something that doesn't have product or revenue — this would be the definition of gambling.
But I don't want to ignore the Ethereum market due to its potential and the fact that there are some extremely smart people and companies working on finding solutions on how smart contracts can work on Ethereum. I am inclined to invest a small portion of my speculative portfolio that is earmarked for cryptocurrency into it.
I have heard of investors who are splitting their speculative investments 60/40 or even 50/50 between Bitcoin and Ethereum. From my perspective that seems too risky even for speculation. You will find me in the 90/10 camp in allocating speculative funds between Bitcoin and Ethereum. But note, as there are more proven use cases, I will quickly ramp up that 10%.
Do I think Ethereum will hit $10,000? Put it this way, if I knew the answer to that I wouldn’t be limiting my investment to 10% of my speculative portfolio and potentially would be putting my life’s savings into it rather than writing this story. But if the high correlation between Bitcoin and Ethereum actually holds true, I would anticipate $10,000 in 2021 being a probable outcome considering the growth trajectory of Bitcoin.
Disclaimer: This story expresses my views and is not to be viewed as an investment or financial advice. Cryptocurrencies are very high risk and the probability of losing all your money is possible. Always do your own research and assess your tolerance for risk. Connect with your financial advisor and obtain as much counsel as possible before investing.
