20 Jul, 22
Bitcoin and Ethereum: The Market Leaders
More than 18,000 cryptocurrencies exist, with numerous projects that possess similarities to both Bitcoin and Ethereum. This begs the question; why are Bitcoin and Ethereum the market leaders?
For a fundamental framework around blockchain technology including Bitcoin and Ethereum, check out Zerocap’s Crypto 101 page.
The Seed for Innovation
Bitcoin’s success, derived from its ability to revolutionise money, led to the establishment of countless projects, forks and spin-offs. Some projects attempt to extend on Bitcoin’s underlying technology while others mimic pyramid schemes and are designed for individual gain. Projects beyond Bitcoin and Ethereum are commonly referred to as alternative coins or altcoins.
While Bitcoin’s market dominance has diminished over time and despite the continued and exponential growth of the digital asset space, Bitcoin continues to retain over 40% of market share. Bitcoin’s underlying properties and network effect continually counter any attempts to overthrow its standing.
Store of Value
First and foremost, Bitcoin’s innovative design revolutionises the way individuals view and interact with currency. Like fiat currency, Bitcoin is used as a way of transferring value over the internet. However, unlike fiat currency, Bitcoin is decentralised and has no single entity or intermediaries controlling it. For any currency to be attractive, a store of value is an essential property. Since the gold standard was abandoned in 1971, government-issued currencies have been printed at the discretion of their governing monetary body. Contrastingly, Bitcoin has a total finite supply of 21 million BTC, and the speed at which it is minted is determined by mining difficulty which is automatically adjusted when supply is expanding too quickly or too slowly. Bitcoin also possesses deflationary mechanics, known as the halving. Bitcoin’s fixed supply and deflationary properties are natively coded into law, incorruptible to the network.
Bitcoin’s strictly defined monetary policy and its deflationary properties are bolstered by the strength of its network. Moreover, the underpinning blockchain technology that Bitcoin is built upon ensures transactional legitimacy and security. Not only are its participants diverse, Bitcoin also retains a committed, experienced and expansive community. Tens of thousands of nodes, varying in geographic location, form a wide-reaching, interconnected and robust network.
Exploitation, often driven by financial incentive, has resulted in attackers targeting blockchains. Blockchain consensus models have different rules and parameters defining their function. For example, on Bitcoin’s blockchain, consensus occurs when more than 50% of nodes accurately conclude that a transaction is legitimate. The 51% attack is an example of how Bitcoin’s legitimacy could be exploited. If a single party were to control over 50% of computing power, this would be possible. However, Bitcoin’s expansive network cannot be underestimated. Not only are there tens of thousands of nodes diversified by geographic location but also by association. Correspondingly, Bitcoin’s mining difficulty is so extremely high that a 51% attack would be unfathomably expensive. Unlike many smaller altcoins, who have been victims of malicious attacks, Bitcoin has had a bulletproof track record in terms of security, and the simplicity of its design improves security as the network expands.
The strength of Bitcoin’s network has enabled it to remain active and without an instance of downtime since 2013. Comparing that to other cryptocurrencies such as Solana, having suffered seven full or partial outages in the last twelve months, Bitcoin is the clear king when it comes to stability and security. Even relative to established and reputable software companies such as Google or Microsoft, Bitcoin outperforms in this category.
Bitcoin’s price has experienced numerous climbs and drops in value. Despite its plights, Bitcoin’s market capitalisation and also its participants continue to grow in size. In addition to its increasing market presence, growth in investment products including ETFs and derivatives have created openings for institutional and further retail adoption.
Cryptocurrency’s volatility is a common topic of conversation. Bitcoin and other cryptocurrency’s extreme volatility is derived from their low levels of liquidity. What would be a very small flow of capital in traditional equity markets has the potential to move crypto prices significantly. Given Bitcoin’s greater levels of liquidity relative to the rest of the market, its volatility is relatively lower. In addition, Bitcoin’s volatility is diminishing and can be expected to continue to reduce over time. In a market where volatility is 8 times that of equities, numerous projects fail and many lack historical evidence, Bitcoin’s longstanding presence, diminishing volatility and relatively developed position in the market sends a positive message to new and existing investors alike.
As a first mover, Bitcoin has the largest network and the most legitimacy in the eyes of retail and institutional investors. Built on top of the most secure database in history, Bitcoin has been at the forefront of digital asset adoption.
This theme is affirmed by the recent substantial growth in institutional adoption and involvement. Participation includes the creations of ETFs, Grayscale’s Bitcoin ETF being an example, Fidelity’s 401(k) services allowing for allocations in Bitcoin and some of the largest financial institutions such as Goldman Sachs offering non-deliverable forwards, tied to Bitcoin.
Growing institutional interest in Bitcoin and the digital asset space is accompanied by governmental interest. Most notably, El Salvador approved Bitcoin as legal tender with reserves now exceeding 2,000 Bitcoin. Most recently the Central African Republic followed suit. Another example of governments using cryptocurrency and their technology is Ukraine, who are utilising blockchain to ensure permanence of their history and culture.
In summary, Bitcoin has led the digital asset space since its inception. Its innovative design and aim to revolutionise the way individuals interact with currency formed the basis for its expansion.
Ethereum, which launched in 2015 extended on Bitcoin’s model by employing smart contracts into its blockchain. Smart contracts are self-executing digitised contracts designed to automate digital agreements. By automatically facilitating negotiations between two parties, smart contracts effectively enforce the terms they are based on. Smart contracts are immutable and recorded on the blockchain.
What appears to be a simple construct actually revolutionised blockchain technology and led to the development of prominent sub-sectors such as DeFi and NFTs. Ethereum’s innovative design has fostered an expansive ecosystem of decentralised applications that rely on its blockchain. Ethereum’s ecosystem has experienced considerable growth and as well as hosting thousands of applications, it accounts for billions of dollars in transactional volume.
Despite its success, Ethereum is often criticized for its limited scalability. Consequently, a number of Layer-1 blockchains were formed to promote transactional efficiency beyond Ethereum’s competencies. Counterparts include prominent blockchains such as Solana, Avalanche and Fantom. Boasting significantly higher transaction per second capabilities when compared to Ethereum, many of these newly formed chains have experienced incredible growth in both users and the number of applications built on their blockchain. While other smart contract compatible blockchains, such as Solana, rival Ethereum’s already impressive usage, the demand for Ethereum’s block space is unparalleled.
Ethereum created the foundations for Decentralised Finance (DeFi). DeFi was placed at the forefront of 2021’s thematics, and consequently projects that aim to revolutionize traditional finance and encourage borderless financial inclusion extended their reach and utility. As a result of their significant growth, protocols such as Aave and Curve have now positioned themselves as leaders in this space, even making waves amongst institutions.
Despite some advancement and growth in its competitors, Ethereum is clearly leading the race. Notably, during times of market distress such as the May 2021 and the current cycle’s drawdown, Ethereum’s dominance shines. In both instances, significant de-risking took place. Historically, there has been a tendency to pull value from ecosystems as investors sell-off. However, in relative terms, Ethereum’s dominance increased in numerous instances. This is suggestive of a lack of underlying confidence in Ethereum’s competitors.
Ethereum’s CV of DeFi market leaders is extensive. Some examples include Uniswap, a decentralised exchange which accounts for approximately 60% of all DeFi revenues, Curve Finance, a decentralised exchange liquidity pool which accounts for nearly 10% of the entire space’s TVL and Synthetix, the market leader for derivatives trading in DeFi. These three DeFi giants, operating on the Ethereum blockchain, account for over 85% of DeFi’s total trading volumes.
Metaverse and NFTs
Since the start of 2021, various thematics have emerged. Web 3.0, data verification and storage, interoperability and the metaverse, have become increasingly relevant and Ethereum is poised to lead growth in these spaces.
McKinsey & Company estimate that the Metaverse could be worth $5 trillion by 2030. Notably, Web 3.0 is undoubtedly multi-chain. Despite losing some of its NFT market share following the rise of its counterparts, such as Solana, Ethereum still accounts for much of the NFT market’s transaction volume.
Layer-2’s and Rollups
Ethereum’s scalability issue, which is largely considered its greatest flaw, is being addressed by its strong community and through on-going development. Bridges and roll ups such as Polygon, a decentralised Ethereum platform focussed on scalability and Web 3.0, have also risen in prominence. By batching transactions, rollups reduce transaction costs and increase scalability. The pace at which these platforms are growing is rapid, reaffirming Ethereum’s place as the market leader. Consequently, Ethereum has become a L1 hub and will likely lead the way into the Metaverse.
Ethereum is expected to soon finalise its merge to Ethereum 2.0. In doing so, Ethereum will transition from proof-of-work (PoW) to proof-of-stake (PoS). This change is expected to enhance scalability, lower energy consumption and promote network consistency. Moreover, what could be considered some of its greatest weaknesses could soon be diminished.
A lack of transparency matched with a surplus of complex developing technologies often creates ambiguity around value in the digital asset space. The evolving nature of the digital asset space often hinders investors’ ability to ascertain effective exposure to leading cryptocurrencies. However, it is always important to take a step back and ask why Bitcoin and Ethereum remain the market leaders.
Zerocap provides digital asset investment and custodial services to forward-thinking investors and institutions globally. Our investment team and Wealth Platform offer frictionless access to digital assets with industry-leading security. To learn more, contact the team at [email protected] or visit our website www.zerocap.com
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