There hasn’t been a hotter investment than cryptocurrencies since the start of the year. Bitcoin and Ethereum, which represent the double victory in terms of the largest market capitalization among digital currencies, have achieved returns of around 300% and 3,200%, respectively, since the beginning of the year. For comparison: that is what it is taken S&P 500 Decades to give back what Ethereum has for its investors in just under nine months.
Cryptocurrencies soar for three reasons
Emotions have obviously played a crucial role in driving the price of digital currencies up. Since financial institutions have either avoided cryptocurrencies like Bitcoin and Ethereum or are prevented by management from trading them, price movement is left to retail investors. John and Jane Q. Investors are far more susceptible to the emotions that influence their investment decisions than large investment institutions. Lately, the “don’t miss the boat” mentality could very well lead to higher prices.
Basically, the blockchain that underlies many of the major cryptocurrencies including Bitcoin and Ethereum is very exciting. Blockchain is a digital decentralized network that records all transactions without the need for a financial intermediary such as a bank. Since these blockchains are often open source networks to some extent, changing data is very difficult. Thus, in the future, blockchain could become the preferred peer-to-peer and business-to-business channel for transactions for a variety of industries and sectors.
Even the US dollar has given cryptocurrencies a boost since the start of the year. The dollar recently hit more than a two-year low against the euro and well over a year low against other major currencies. When the dollar weakens, it tends to raise US exports, which is sure to make President Trump happy.
On the other hand, it reduces the value of the dollars held by investors. Usually, a falling dollar sends investors to seek a safe store of value like gold. Recently, however, they have been opting for the security of Bitcoin, the largest digital currency. However, Bitcoin’s tenure as the cryptocurrency of choice may not last long.
Bitcoin could eat the dust off Ethereum
With the full understanding that the cryptocurrency model itself has no guaranteed future, I suspect that Ethereum has a better chance of long-term success than Bitcoin. In fact, the early evidence suggests that Ethereum could be dusting Bitcoin in a short amount of time.
The main difference between the two digital currency powerhouses lies in their blockchain technology. Ethereum’s blockchain has a key advantage over Bitcoin’s blockchain: it supports intelligent contract applications. Smart contracts, which in their simplest form are computer logs that help facilitate, review, or enforce the negotiation of a contract, help automate complex physical and financial supply chain procedures and compliance processes. In plain language, it is a protocol within the Ethereum network that is aimed at large companies and is intended to enable the secure and efficient processing of business-to-business and client-to-business transactions.
Ethereum already has great interest in its blockchain, as evidenced by the more than 150 organizations that joined the Enterprise Ethereum Alliance in July 2017, including nine well-known brand companies. These organizations are testing a version of Ethereum’s blockchain in various pilot and small-scale programs.
In comparison, Bitcoin is valued more as a payment platform than for the underlying blockchain technology. While there are a few well-known companies that have been accepting Bitcoin since 2014, the network has been significantly disadvantaged compared to Ethereum. Bitcoin traditionally had higher transaction costs, long settlement times, and for a while its capacity was in question. A recent fork in Bitcoin that split the digital currency in two – Bitcoin and Bitcoin cash – could help fill the void a bit, but that remains to be seen.
Participating in this junction was the Bitcoin engineers behind the SegWit2x upgrade, which lowered transaction costs and settlement times while increasing capacity by removing some information from the blockchain. Much of the Bitcoin community endorsed SegWit2x, especially since it would make Bitcoin more attractive to large companies.
However, Bitcoin still did not get the 80% support it needed to keep it from breaking down into two separate currencies. The remaining minority that became bitcoin cash opted to expand capacity within the original blockchain framework. This minority would prefer Bitcoin to remain a libertarian’s dream currency.
It’s really that simple: Big business currently prefers Ethereum’s underlying blockchain more than Bitcoin’s, and that’s likely where the long-term value of these cryptocurrencies resides.
Think about that before you get too excited
However, this author is still not very excited about the long-term prospects for cryptocurrencies in general.
First of all, there is absolutely no way of knowing how much blockchain technology will be worth in a year, three years, or ten years. Although companies are testing the technology, blockchain is not currently being widely used outside of digital currencies. Hence, any valuation of cryptocurrencies based on their underlying blockchain is nothing more than a cube estimate at the moment.
We also cannot overlook the terrifying role that retail investor emotions have played with Bitcoin, Ethereum and other cryptocurrencies. Without the stabilizing power of Wall Street, emotions can whip these currencies in the short term, potentially leading to quick and substantial losses for those who are not prepared or who do not understand how digital currencies work.
Building on this last point, the lack of a central trading exchange is another potential problem. While decentralization is critical to the success of cryptocurrencies in order to reduce the likelihood of a successful cyberattack, it is also difficult to legitimize cryptocurrencies. And around a dozen stock exchanges can increase price volatility.
Even the regulation of Bitcoin and other cryptocurrencies could be worrying. While regulation, in a sense, would mean the acceptance of digital currencies as legal tender, some countries like China might decide to fight digital currencies altogether. China recently blocked initial coin offerings and announced it would close domestic Bitcoin and cryptocurrency exchanges soon.
Long story short, while Ethereum is best positioned to be successful in the long run, there is no guarantee that it or Bitcoin will be available in a few years. My suggestion remains that investors stay away from digital currencies until we have a better understanding of how they are regulated and what their underlying technology is really worth.