Cryptocurrency titans have recently shone a spotlight on Ether (ETH) by debating its value and legitimacy in an online dust-up. These online arguments can be confusing for the casual investor, especially when serious accusations are levelled at a cryptocurrency. This article examines some of the strengths and challenges of ETH, and aims to give readers useful context for performing their own analysis.

ETH Supply  

The unrestricted supply of ETH has long been a point of concern for Ethereum followers. The problem stems from simple supply and demand economics. Free market pricing is guided by buyers and sellers reaching a mutually agreeable price for making an exchange. Resource scarcity (aka low supply) drives buyers to compete with each other by offering sellers higher prices. Conversely, oversupply of a resource forces sellers to hunt for buyers by lowering the cost of their goods.

Supply and demand curve

To see these economic forces at work in the crypto world, consider the example of bitcoin. One factor driving the value of a bitcoin is its hard limit of 21 million coins. Because there are a finite number of bitcoins investors recognize the cryptocurrency’s potential as a store of value. When national currencies suffer from inflation people can buy bitcoin in an attempt to preserve their purchasing power. As prices go up, the value of bitcoin rises as well, allowing holders to effectively sidestep the financial damage of inflation.

Ethereum has no hard limit for total ETH production. In 2018 ETH had an inflation rate around 10% per year. The upcoming Ethereum 2.0 switch to proof-of-stake consensus may reduce that rate to 2% or less. This inflation problem has not escaped the notice of Vitalik Buterin, who once proposed a hard cap of 120 million for ETH. His suggestion failed to change the limitless nature of Ether, but Buterin’s attempts to address inflation indicates he is working on the problem.

A hard cap on coins is not the only solution to inflation. Additional inflation-fighting proposals like EIP 1559 suggest “burning” some ETH during transactions to reduce supply. This proposal, made in 2019 and endorsed by Buterin, has not yet been implemented. Policies incentivizing holders to stake 32 ETH to become Ethereum 2.0 validators can artificially create short-term scarcity, but the long-term inflation problem remains. As it stands, ETH is a cryptocurrency without an upper supply limit which makes its inflation rate a long-term concern.

Smart Contract Woes

A company in crisis is more likely to make headlines than one operating within normal business parameters. For this reason, a company's response to crisis can be a critical factor in forming public opinion. As Joseph Hall, an English clergyman and satirist once observed, “A reputation once broken may possibly be repaired, but the world will always keep their eyes on the spot where the crack was“.

Ethereum experienced a sizeable crack in 2016, with The DAO Hack. This event led to the loss of 3.6 million ETH (about $70 million USD at the time) through the exploitation of a smart contract. The response by Ethereum was to implement a hard fork, returning money to the original holders. This decision came at the cost of violating the concept of the immutable ledger and led to the creation of Ethereum Classic (ETC). While many sources refer to the incident as a “hack”, the smart contract functioned as written. The problem was not weak security measures by Ethereum or The DAO, it was simple human error in the form of exploitable coding.

More recently Opyn lost around $371,000 USD to another attacker exploiting vulnerable code in a smart contract. Again, nothing was actively hacked as far as breaching security, outsiders simply saw flawed coding and took advantage. These examples raise two concerns when considering the value of ETH. The first, will further hard forks be coming to Ethereum? The second, can people consistently write smart contracts at the level required to disrupt the financial sector, or is the task simply too demanding?

ETH and Ethereum Use Cases

Ethereum is the foundational blockchain used for building decentralized applications (DApps) and a primary force behind the decentralized finance (de-fi) movement. As such, it has considerable growth potential, particularly within the de-fi sector which recently eclipsed a billion dollars USD.

Performing transactions or executing smart contracts on Ethereum requires users to pay “gas fees” with ETH. This system guarantees there will be some demand for ETH as long as users are actively performing transactions on Ethereum.

Chart of ETH being used as gas to power transactions, taken August 2020

Will people continue to use Ethereum based services far into the future? It is impossible to know, but it seems likely as Ethereum is currently used for:

• Decentralized Finance (de-fi)
• Decentralized Applications (DApps)
• Digital Identification
• ERC-20 token compliance and facilitation
• Creating decentralized autonomous organizations (DAOs)
• Crowd funding
• Gambling

This list is not exhaustive, and the potential uses cases for Ethereum in the future are considerable.

Ethereum Partnerships and Market Cap

Another method of evaluating ETH is by looking at how much it is worth, and who believes in it. As of this writing the market cap for ETH is $43.7B USD, greater than that of Honda, General Motors, and Foxconn. This indicates that the Ethereum project has strong support from investors. Ethereum has also established a number of partnerships with major companies including Google, Intel, Samsung, and VMware. The Enterprise Ethereum Alliance is an organization of companies seeking to promote Ethereum “as an open-standard to empower ALL enterprises”. Group members include notable names like Microsoft, JP Morgan, British Petroleum (BP), and Intel.

Andrew Carnegie, famous American industrialist once said “As I grow older, I pay less attention to what men say. I just watch what they do.” By this measure, Ethereum’s financial backing and alliances speak volumes for its worth. Several influential professionals and large-scale companies believe in the potential of Ethereum.

Conclusion

Ether is necessary to power Ethereum transactions, and is therefore valuable for its utility in growing sectors like de-fi. However, if the endless creation of ETH continues unchecked then inflation may negatively impact its performance. Smart contracts, one of the most innovative uses of Ethereum, are a double-edged sword. They hold incredible potential for disrupting the finance sector but have also caused Ethereum its greatest embarrassments. Ethereum enjoys a large market cap and strong partnerships with Fortune 500 companies, both positive signs for its future. Ultimately, each investor must decide what ETH is worth to them and trust the market to reflect the popular consensus.   

Obligatory Disclaimer:  I am not a financial advisor. Nothing in this article constitutes professional and/or financial advice. This document is for informational purposes only.