The Investment Case for Ethereum

Ethereum and bitcoin are commonly lumped together under the cryptocurrency moniker, but they’re very different. Satoshi Nakamoto, the pseudonymous founder of bitcoin, designed it as a medium of exchange, whereas Vitalik Buterin, who launched Ethereum in 2015, wanted to overcome bitcoin’s limitations and bring greater functionality to blockchain technology. To help investors understand the differences between the two biggest cryptos by market cap, this article explains how Ethereum works and explores some of its use cases.

Introducing Ethereum

While the Bitcoin blockchain was designed to simply support the exchange of value, Ethereum launched as a platform for hosting decentralised applications (dapps). It introduced the concept of smart contracts, digital agreements that automatically execute when predetermined conditions are met. In addition to processing transactions, smart contracts enable a vast range of use cases, like sophisticated financial products, some of which feature later in this article, or the creation of new digital assets. As a pioneer in blockchain functionality, Ethereum has attracted a sizeable community of developers.

Ether is Ethereum’s native token. Its utility comes from its role in executing smart contracts, as users pay transaction fees, known as gas fees, in ether. It also supports the governance of the Ethereum protocol, as validators must ‘stake’ (lock up) 32 ether for the right to process transactions and earn staking rewards. 

It should be noted that the functionality of the Bitcoin blockchain has expanded recently through the launch of ‘Layer 2s’ (L2s). L2s are networks built on top of the original blockchain that allow it to scale. Examples include the Lightning Network and Rootstock.

Ethereum’s Use Cases

Like Amazon Web Services (AWS), Ethereum is a large computing network, but the comparison ends there as it has several unique features:

• Permissionless- the decentralized nature of blockchain technology means that dapps function without intermediaries. Anyone who holds ether can use them.

• Open source- any developer can view and change Ethereum’s underlying code as long as they submit a proposal (called an Ethereum Improvement Proposal) and the community approves it.

• Composable- developers can build dapps on top of one another, similar to Lego blocks, which increases the protocol’s functionality. 

• Decentralised- the protocol is distributed across thousands of privately owned computers, which prevents a central authority from controlling it.

The combination of these features is what makes the Ethereum protocol valuable. Unlike Facebook and Twitter, which have destroyed companies overnight by changing the terms of service at short notice, users and developers can participate on Ethereum without worrying about a central authority interfering. Decentralisation also strengthens the protocol’s security by removing the risk of a single point of failure.

CoinShares has conducted proprietary research into how users interact with Ethereum based on gas usage (the computing power needed to process a transaction on the protocol). As the chart below shows, the highest gas fees come from decentralised finance (DeFi) apps (29.3%) such as lending and derivative trading platforms. Next come token transfers (16.26%) and ether transfers (10.8%). But Ethereum’s broad range of applications- others that generate fees include Maximal Extractable Value (MEV) opportunities (6.34%) and contract management (4.52%)- make the protocol resilient to cyclical changes in market conditions.

Conclusion

While bitcoin and ether are both cryptos, they serve very different purposes. Bitcoin originally launched as a medium of exchange, but Ethereum is a platform for building dapps enabled by smart contracts. Ethereum’s native token is ether, which is used for transaction fees and the protocol’s governance (known as staking). 

Ethereum can be considered a large computing network, but it has several unique properties distinguishing it from rivals like AWS:

• Permissionless

• Open source

• Composable

• Decentralised

DeFi apps, which allow investors to transact directly with counterparties, generate the highest volume of gas fees on Ethereum. Other lucrative applications include token transfers, MEV opportunities and contract management.