Summary ETH could outperform BTC in the next 6 months due to its recent underperformance and changing market conditions. It should easily outperform the S&P 500. Other altcoins have been rallying and ETH should follow. It has the biggest and most impressive DeFi and Web3 ecosystem in crypto so the underperformance seems misplaced. Ethereum's proof-of-stake consensus is centralizing and fragile. This is okay for most cases, but people need to understand what they are getting and be intellectually honest. A good mental model for Ethereum is that the blockchain is the most sophisticated casino ever created. ETH has great value for that reason, but there are caveats, such as cyclicality. ETH probably will not outperform BTC over a 10-year timeframe. I talk about why over here as well. Bitcoin (BTC-USD) has been rallying this year. Anyone who followed my Bitcoin buy ratings would have made quite a bit of money and outperformed most other assets. Many are wondering where this rally leaves the altcoins. This article is about the role of Ethereum (ETH-USD) within this backdrop. Here’s the bottom line up front: Do not be surprised if ETH outperforms BTC over the next 6 months. ETH has been lagging BTC for a while and there seems to be some expectation that conditions will change. This is not something I am personally betting on. When I take short-term bets, I usually use derivatives. When it is a long-term bet, I usually stick with the spot asset. I have a large BTC allocation and 0 ETH, since I expect ETH to significantly underperform BTC over the next 5-10 years. ETH is a buy if you are looking to beat the S&P 500 and it is a hold if you are looking to beat BTC in the next few months. Let’s reason through all this. My last article about ETH talked about how it is poised to benefit from AI. The thesis is playing out because there are quite a lot of Web3 AI projects that have received funding this year. The integrations they make with the Ethereum public blockchain will be interesting to watch for 2024. In that article, I also provided a heavy breakdown of ETH’s tokenomics. For those who don’t know, tokenomics is basically the fundamentals of any digital asset. This is why you shouldn’t trust the people who only use technical analysis on crypto without a fundamental overlay. Whenever I read a crypto article, I scroll through to see if there is any talk at all about supply schedule, token burn, fees-based yield, value accrual, multiples (yes, most crypto have multiples just like stocks!), revenues, earnings, cost structure, etc. I also look for market indicators like open interest, funding rates, put/call skews, etc. I usually see none of this. What I do see are lots of lines on charts. I usually just exit the page at that point. I too can draw lines, so there isn’t much to learn over there. ETH’s tokenomics is quite complex but I had determined that it was a fluid asset which can seamlessly switch between money, commodity, and security. Something like it has never really existed before. I really encourage you to check out the article , skip the parts about AI, and just read the tokenomics section which is called “ETH Valuation.” Ah yes - you can do an actual valuation as you would a stock! If you wanted to see lines on charts, I’m afraid you’d have to go elsewhere. Centralization and Fragility Here’s what I didn’t mention in that article, mainly because it wasn’t important in the context of AI. You may notice that ETH has strong centralizing tendencies. Everyone who holds it is incentivized to stake ETH because that is how they can benefit from all three sources of ETH cash flows: the base fee gas burn, the issuance, and the priority fees. Unstaked ETH earns only the gas burn, but the gas burn is mostly cancelled out by the issuance of new ETH to ETH stakers. ETH stakers basically earn more and more at the expense of non-stakers. As mentioned in the article: Staking ETH makes your ETH position resemble an equity position – you benefit from both the dividend (from the gas that is distributed to stakers) and the buybacks (from the gas that is burned). Technically, stakers also benefit from a Cantillon effect where they get newly issued ETH from the block reward. Think of this as issuing shares exclusively to shareholders who are promising not to sell their shares. Those shareholders promising not to sell are clearly getting a larger and larger portion of the company because they receive exclusive share issuance. Over time, the bigger you are, the exponentially larger your portion of ETH will become. This is a feature of proof-of-stake consensus. This centralization is okay for most cases, but it is fragile. It would never survive an attack by a nation state actor, in which the majority of the stakers are in the jurisdiction of the attacking nation state. If the US decided to crack down on major ETH holders, that would be the end for Ethereum. Proof-of-work is different and much more antifragile. Just look at China’s attack on Bitcoin in 2021, back when most of Bitcoin’s hashrate was in China. Global Hashrate Shares (Statista) The network never got interrupted. The hashrate simply left China and went to friendlier jurisdictions. And the network’s total hashrate is now way higher than it was back in 2021. Antifragile. The main difference in fragility comes from the indisputable fact that BTC ownership does not mean even a tiny bit of control over the Bitcoin network, while ETH ownership does mean some control over the Ethereum network . It’s a difference you could never know if you just drew lines on a chart. And this difference is exactly why I don’t see ETH or any proof-of-stake coin outperforming BTC in the next 10 years. Trading around for PNL was never the point of crypto. Yield farming on liquidity pools was never the point of crypto. Blockchains were never the point of crypto. The point of crypto from the beginning was to offer an alternative to the current fiat system – an unstoppable alternative, unstoppable because of superior economic incentives. Ethereum is not unstoppable. A government can just print money, buy ETH, and capture the network. It doesn’t even have to use any force. Proof-of-stake is too fragile to be unstoppable. It is therefore another version of the current fiat system, not necessarily because it wants to be or was intended to be, but because it will be forced to be. Proof-of-work, embodied by Bitcoin, is unstoppable. It doesn’t have the centralizing tendencies that are built into proof-of-stake. It is truly decentralized. Do you think a government can be strong enough to break down a decentralized thing? Why don’t you ask the US government how well that has been going in the failed War on Terror? 20 years and $2.3 trillion wasted chasing down a decentralized group of people who don’t even have WiFi all the time! Why don’t you look at how Vietnam went? The winner of both World Wars couldn’t do anything to those decentralized bands of guerilla fighters. It ended up defaulting on the gold standard and then pulling out of Vietnam a few years after. How about trying to trace stuff on Tor, a decentralized software which anyone can run? Any progress on that? I am trying to make this point very clear because this is where people get crypto wrong. I know because I was one of those people. Crypto as an investment started as a bet against the current system. All the smart money knows this or is starting to wake up to this fact. This bet isn’t crowded yet because the current system is still strong and crypto has a ton of naysayers and, frankly, things are okay for now. That said, a bet against the current system makes rational sense because cracks are starting to show. The most powerful expression of that bet is BTC (self-custodied in a cold wallet, not a Bitcoin ETF) because it is the most antifragile and you need something highly antifragile to make a bet like this. If your crypto is not a bet against the current system, then you are betting on the utility of crypto for stuff like speculation, trading, digital financial services for the unbanked, Web3, etc. This is also very useful. Casinos are an enormous business and crypto is the most innovative and efficient version of casinos ever created. There is a huge population of unbanked around the world. There is money to be made here and anyone who denies it hasn’t looked at the data. Here’s the thing: the Bitcoin ecosystem can support this stuff too, but most Bitcoiners tend to be conservative folks who stay away from speculation and trading, so there isn’t a great product market fit. Let’s go back to ETH. ETH is no good for the first bet. It’s too fragile. That said, Ethereum has made great strides in the second bet. Most of the value accrual of decentralized applications is happening on Ethereum. These apps are of course for DeFi, which is almost all gambling, albeit the most sophisticated and accessible form of gambling ever conceived by Man. Some of the apps are for Web3, but this too is largely gambling because they tend to build over DeFi. Some apps are on L2s exclusively. Even so, their value still accrues towards ETH because Ethereum serves as the base layer for all the major L2s. This makes ETH a great investment within the current system. ETH is the base layer of the most sophisticated casino ever created. This casino can serve millions of people, no matter where they are. Moreover, anyone can come along and build more slot machines and games for this casino, which makes the whole thing more engaging for the customers. How’s that for some intrinsic value? More projects will continue to build on top of it, which will mean more utility for ETH and more profits for ETH investors and (especially) ETH stakers. As long as the Ethereum ecosystem maintains a good pace of innovation, ETH should continue to outperform the S&P 500. In the short term, we have seen that altcoins can outperform BTC during BTC bull markets, essentially as a high beta version of BTC. I would not be surprised if this scenario plays out in the next 6 months. It has happened before, and it is likely to happen again. I am not one to say, “this time is different.” Market Analysis Let’s now look at charts. Remember, charts aren’t useless, they are just used too much in most crypto analysis. Occasionally a chart can say something interesting about where things are going. Below is the chart of ETH priced in BTC. ETH/BTC (Google) The price is about to hit a 2-year low. Last time it was there, it rallied sharply. After the Merge (which transitioned ETH to proof-of-stake) near the end of 2022, ETH has been down about 30% in BTC terms. There’re a few ways we can look at this. The first thing is that the market is pricing in the tradeoffs of proof-of-stake and has punished ETH ever since the Merge. The second is that all the talk about a Bitcoin Spot ETF and institutional adoption has been very unilaterally favorable for BTC throughout 2023. There is a strong case to be made that some kind of mean reversion is possible, which means that ETH would outperform BTC. Altcoins have been rallying. Look at Solana (SOL-USD) or Avalanche (AVAX-USD), alternative smart contract chains which have seriously outperformed in the last 2 months. These were marketed as “ETH-killers,” blockchains which could unseat Ethereum as the primary smart contract blockchain. In the charts below, the gold line is the price in BTC and the blue line is the price in dollars. AVAX (CoinGecko) SOL (CoinGecko) Interestingly, the narrative here is overwhelmingly strong compared to the actual fundamentals. Usage in both these chains are quite low compared to usage of the Ethereum ecosystem. Yet, we see SOL and AVAX easily outperforming BTC in the last 2 months. Note that both Solana and Avalanche are proof-of-stake blockchains like Ethereum. I interpret this mostly as extremely high beta, and because both had been either muted or rather oversold compared to BTC’s rally for much of 2023, and that their smaller size gives them a small cap premium. It may only be a matter of time before ETH follows these altcoins into some level of outperformance over BTC. The ETH/BTC chart shown earlier indicates that such outperformance is yet to materialize this year. Quick Comps If we return to the “bets” mentioned earlier, BTC is clearly the bet against the current system. That leaves the rest of crypto to fight out relative positions in the other bet – the bet to be an avenue for speculation, DeFi, Web3, etc. Amongst all non-BTC crypto, I like the fundamentals of ETH the best. It has the biggest developer network and the most infrastructure to build on top of. Also, there isn’t a great need for alternative L1s when Ethereum’s ecosystem of L2s is already offering very high throughput. For example, Solana is said to be one of the fastest blockchains. However, Arbitrum, Optimism, and Polygon – all Ethereum L2s – have a similar level of speed. Plus, a lot of the oft-repeated throughput metrics are also misleading . Moreover, the Ethereum L2s actually have users on them. Look at these metrics from Token Terminal. Arbitrum generates about as much revenue and fees as Solana and Avalanche combined. That should tell you a lot – the fact that one second-layer of Ethereum is generating more value than these other two “ETH Killers” combined. Solana (Token Terminal) Avalanche (Token Terminal) Arbitrum (Token Terminal) So, if the altcoins will rally then ETH should follow eventually. Do not be surprised if ETH outperforms BTC in the next few months. Why Won’t The House Outperform Bitcoin in the Long Run? The only loose end now is to talk through why I don’t think ETH will outperform BTC in the long run. The two blockchains serve different goals. Bitcoin is addressing a dire need of humanity – the need for digital savings which cannot be debased, confiscated, or frozen (Bitcoin is a lot more than that, but this article is about ETH). That is the bet against the current system, because the defining feature of the fiat system is that savings are debased, confiscated, and frozen by decree. It’s defining because it is in plain sight: fiat means “decree.” You have savings not only because you labored, but because the State declared it so. In your part of the world, the State might be benign so there’s not much of a problem. In other parts of the world, the State can be more… overbearing. Ethereum addresses a lesser need. Regardless of how it started off, ETH is now mostly the equity security and Poker chips of the most advanced casino in the world. So, ETH has value. It probably has more upside than the S&P 500 because everything built on Ethereum helps accrue value to ETH. And a lot of things will continue to be built on Ethereum. It is an old observation that all crypto cycles are led by Bitcoin. When BTC rallies, more interest and money flow into the casinos. That is the tide that lifts the boats. There is more to this. ETH is clearly very security-like and this has material impact on its ability to see institutional inflows. For instance, a classification as an unregulated security will make things very difficult going forward. Meanwhile, BTC is clearly not a security and the regulations around it are mostly around getting custodians to comply with KYC and AML regulations. It is entirely a different struggle. We can see the institutional recognition happening for BTC but not for ETH or any other crypto. Just check out the first page this Fidelity’s report on digital assets. You don’t actually have to read the report to see what I am getting at. Fidelity Report (Fidelity) Regulatory clarity is coming to crypto eventually, but when it does, ETH investors may be in for a surprise. The reality is that proof-of-stake creates assets that are a lot like shares. I don’t see a way to get around that. They passively pay dividends which come from fees and they offer control over the chain. And if investors start to treat these assets as stocks, some repricing needs to happen because the multiples are simply too high. We also don’t know how much of the speculation going on in crypto is due to the novelty of crypto. I imagine some of it is due to novelty and hype. Volumes tend to drop off during bear markets, so Ethereum’s utility is also quite cyclical. Bull markets are when the gambling utility becomes more important. Seeing that we are heading into a bull market, this is a tailwind for ETH in the short term. Takeaways Your benchmark ultimately determines what you should do with ETH. ETH could outperform BTC in the next 6 months as the crypto bull market heats up more and altcoins become high beta plays. It is a speculative buy or a hold if you are seeking short-term outperformance over BTC. In the long run, BTC should outperform nearly everything. If you are trying to beat SPY, ETH should do the job. There are too many tailwinds now and ETH is the only big crypto that seems to be lagging recently. That’s an easy buy.
