Ethereum should be valued like a tech stock – Deep Dive

Considering how much of my time these days is spent navigating the waters of the cryptocurrency market, I figured it was well overdue to collate my thoughts on Ethereum into one place. It is, after all, the second-biggest crypto in the world.

If nothing else, it could be fun to look back on this piece in a few years’ time, when it will no doubt read like American economist Paul Krugman’s take on the Internet in 1998:

The growth of the Internet will slow drastically…most people have nothing to say to each other! By 2005 or so, it will become clear that the Internet’s impact on the economy has been no greater than the fax machine’s

In fairness, maybe Krugman was just really bullish on the fax machine?

Anywho. Let us spill some digital ink on this weird and wonderful thing that we refer to as Ethereum.

I hold Ethereum

Firstly, I hold some Ether.

It’s never been a large chunk of my portfolio; it has mostly flirted around the 5% mark over the last few years. So, you can probably take my opinion as somewhat impartial – or at least, as close to impartial as something could be on the home of well-balanced and measured takes, i.e. the Internet.

During previous explosive run-ups, my ETH has briefly jumped up to 10% of my portfolio, or even 15% mark, but I have pared this down pretty quickly in most instances. On the flipside, ETH is no stranger to the odd dirty day, so it has also dipped down well below my 5% – but for the most part it has threaded around the 5% mark.

Which, according to Twitter, a measly 5% holding makes me a boomer. And yet, according to traditional investors, 5% makes me a renegade Gen Z-er. Go figure.

Ethereum is technology

I have written extensively about Bitcoin. It is an asset I believe is one of the most fascinating that humanity has ever seen, in terms of its unparalleled power to both polarise and befuddle – and the fact we have seen nothing like it before, for better or worse.

Bitcoin has serious macro implications. Its goal, regardless of whether you believe it will be successful or not, is to achieve a store of value status and offer an alternative to government-controlled money. A separation of money and state.

Ethereum, on the other hand, has nothing in common with Bitcoin.

There is a saying that floats around online circles: “ETH is money”. Honestly, I am not really sure what that even means. To me, Bitcoin is money (or it might be, to be diplomatic). Ethereum, however, is technology.

Ethereum is a playground for developers, where decentralised apps can be built with the hope of disrupting various industries.

As of last month’s Merge update, it runs off an entirely different consensus mechanism than Bitcoin, which still uses Proof-of-Work (that is “mining” – the practice which often causes controversy for its energy consumption).  

This underlying framework for Ethereum allows a whole assortment of projects to be built on top of it. Blockchain gaming platforms, DeFi protocols, NFT-related start-ups, cartoon monkeys selling for hundreds of thousands of dollars – the list is endless.  

If I had to describe Ethereum simply, I would describe it as a supercomputer built to power a decentralised economy, where anybody and everybody can come develop programmes using that computer – and it is aiming to be the heart that pumps an alternative, decentralised world.

But it’s not money.

Decentralised finance and NFTs

NFTs are one of these applications. They bore me, for the most part.

The concept is cool. A unique digital token which can be traded- there are all sorts of implications here. You can tokenise bonds, illiquid real-world assets like houses, or anything really. But does a col concept warrant paying thousands of dollars for them in their current form?

The most well-known, of course, is art. Internet anons putting cartoon monkeys as their profile pictures, something which they pay thousands of dollars for. It may make me a boomer, but this doesn’t intrigue me at all. I’d rather right-click save the thing and spend the money on some ice cream or something (preferably a Magnum mint, a truly underrated gem).

But that is neither here nor there. Ethereum allows these things to be built. Sure – a lot of it is silly in my view, and NFTs are what befuddle me the most. But this is just one such application that is offered on Ethereum.

More intriguing, in my view, is DeFi.

Ethereum is home to decentralised finance (DeFi), the burgeoning industry which aims to revolutionise our traditional finance system by cutting out the middleman.

Living outside the remit of banks, governments and institutions, DeFi is a purely peer-to-peer system aimed to streamline efficiency, reduce fees and disrupt the legacy banking sector. The latter has undergone suspiciously little mass disruption over the last decade or two, a time period during which nearly every other industry in the world has been flipped upside-down by technology.

Sure, the credit card is nice. But that is more how we use banking rather than the underlying pipeline itself. A bank transfer abroad still involves multiple business days wait and often a dirty forex fee. A mortgage application can take months. Rates are still way out of whack for retail compared to big institutions.

Ethereum, through this new decentralised finance concept, is meant to be able to fix all these issues. A purely decentralised system.

Only it’s not true.

Well, the decentralisation part at least. And that takes us on to the next section.

Centralisation

I have long written about what I believe is a complete misconception within the space about how decentralised Ethereum is.

There are three separate factors to this fallacy of decentralisation:

1. Stablecoins

The first is stablecoins.

A large chunk of Ethereum is run through popular stablecoin issuers like Circle (USDC) and Tether (USDT).

The vast majority of the total value locked across all these various apps and protocols is denominated in USDC and USDT. These are stablecoins issued by centralised companies and hence are subject to regulation, censorship and whatever else lawmakers require them to do.

I was too lazy to chart this myself, so I stole the below graph from Kaiko, which gives an insight into quite how dominant centralised stablecoins are on some of the biggest decentralised exchanges on Ethereum.

Uniswap comes in hotter with 66% of swaps in USDC alone, and 76% with centralised stables.  Curve and Sushi aren’t far behind. Is it too late to whack some inverted commas around the “decentralised” part of decentralised finance?

How is Ethereum centralised if the bulk of the funds on the platform are denominated in centralised coins? The simple answer is, it’s not. As anti-crypto as it is, the US government could flick a switch and shut down Ethereum if it wanted to.

Tether and Circle have repeatedly shown that they must abide by regulations. They have frozen wallets interacting with protocols in the past – the most recent case was regarding the mixer Tornado Cash. If big Joey B Tether or Circle in the morning, Ethereum could essentially be turned off by the time you finish your morning coffee (by big Joey B I’m referring to Joe Biden rather than Joe Burrow, although there could be an argument at this point that the latter would do a better job in managing these economic “troubles” we are seeing).

Vitalik Buterin, crypto god and founder of Ethereum, commented himself on this issue, even hypothesising last month that future forks of Ethereum could be decided by these companies, such is their influence.

I think in the further future, (the issue of centralised providers deciding the direction of Ethereum) definitely becomes more of a concern. Basically, the fact that USDC’s decision of which chain to consider as Ethereum could become a significant decider in future contentious hard forks.

Vitalik Buterin

This was also a question I put to the CTO of Tether, Paolo Ardoino, when he joined me on the Invezz podcast last week. “On our side, we are not there to pick winners…it would have been a suicide mission not to respect Proof-of-Stake”. 

Paolo is right, obviously – and that is why Tether “chose” the Proof-of-Stake blockchain alongside the rest of the market. However, the very fact this is a point to mention at all highlights how centralised Ethereum is. What happens down the road if there is a more contentious fork? What if Tether has a genuine decision on its hands?

Vitalik does not even have that much of a solution for this issue going forward (if it even is an issue – but more on that later). “The best answer I can come up with is to encourage the adoption of more kinds of stablecoins”, he said. But whether that happens on a big enough scale is another issue – right now, there is no large and reliable stablecoin that is not centralised.

I’m not saying this is a good or bad thing – I’ll comment on that later when I assess ETH as an investment. But just for the moment, this paragraph is simply underlining the fact that ETH is a centralised system. DeFi may have decentralised in its name, but that is just for show, really.

If Ethereum is decentralised, then I look like Brad Pitt and play football like Bruno Guimarães.

2. Staking

Ethereum completed its long-awaited Merge upgrade last month, upgrading from Proof-of-Work to Proof-of-Stake.

Cutting the umbilical cord to Bitcoin once and for all, from that moment on there really is nothing in common with its older brother, aside from their seemingly identical price paths.

Staking makes ETH a lot more centralised – precisely why Bitcoin will never flip to Proof-of-Stake (remember, Bitcoin needs to be decentralised to deliver on its alternate store of value goals). Proof-of-Work is as decentralised as it gets, really – and for Bitcoin, that is very important given its aims.

I wrote about the Merge implications in a deep dive last month, so I won’t repeat myself here in depth (I do that enough already). But in short, it requires 32 ETH to become a validator on Ethereum. That is a fat chunk of change – $50,000 or so, which would nearly be enough to fill up your car with petrol.

Enter staking pools.

My Ethereum is staked on Binance. Other popular providers are Coinbase (a public company), Kraken, Huobi, and on and on. I plotted the dominance of the top 4 providers, just for fun, below (note that Lido is decentralised so can be ignored for the purposes of this debate).

Indeed, over two-thirds of validators are required to adhere to the regulations of the Office of Foreign Assets Control – the same office that censored Tornado Cash in the above example.

That’s a big number. And you know what happens when 51% of a network is seized control? Yep – it is prone to a malevolent attack. So, we are at a point where, by definition, the US government could regulate, censor or control the entire Ethereum blockchain.

Remember that quote by Vitalik himself about centralised stablecoin providers exerting a “significant” impact on the future direction of Ethereum? Is it too hard to imagine in this context that the US government could do the same?

(Sidebar – Lido’s absolute dominance of ETH staking is not healthy, regardless of its decentralisation claims)

Lido passing 1/3 is a centralization attack on PoS.

We’re bad at assessing tail risk, but staking in Lido at these thresholds has a lot of it.

In blockchain systems, tail risk isn’t even necessarily so far fetch. Systems tend to hit edge cases, systems tend to get exploited 1/2

— dannyryan ?? (@dannyryan) May 10, 2022

3. Nodes

Ethereum is run on nodes. A node is a client software that is connected to other computers also running Ethereum software. Together, it forms a network.

Only thing is, these nodes are all hosted on centralised data servers. Well, not all. But the top three providers account for over 70% of the hosted nodes on Ethereum. You may recognize some of the names in question: Amazon (48.9%), Google (10.8%) and Hetzner (10.8%).

I drew up a lovely little pie chart to illustrate this.

But centralisation may not be a bad thing

Right, so we get it. Ethereum is a lot more centralised than is often reported. That is objective (trust me, bro) and the above charts kind of say it all.

But where the subjectivity comes in – and this is where I expect some will disagree with me, so please feel free to reach out as I would love to discuss – is that I don’t necessarily think this is as ominous as it sounds.

It could be a good thing – at least for Ethereum’s price. It sounds kind of ridiculous and ugly to write, but the most bullish case in my view for Ethereum is that it continues to be leveraged by centralised entities/the state, providing a regulated smart contract blockchain.

Haha. It’s certainly not a romantic vision. But bear with me – don’t throw the kitchen sink at me yet. Let me explain where I’m coming from, as you recoil at me throwing out these dirty words: “regulated” and “centralised”.

When Ethereum switched to Proof-of-Stake on September 15th 2022, it gave up its previously-unique position as the only Proof-of-Work blockchain (or at least the only big one with realistic hopes of disrupting mainstream finance).

It could now be required – in fact, it might be required to be already, in looking at Tornado Cash and the likes – to abide by state regulations.

It could even market itself as the “anti-crypto” crypto, in bed with the regulators, a pro-ESG combatant to the more rebellious and decentralised blockchains (as well as the energy-guzzling, ESG-sensitive Proof-of-Work Bitcoin).

We can see ESG creeping into the stock markets more, and the “Bitcoin boils oceans” debate is as tiresome as lockdown jokes in 2022 (I genuinely went to a comedy show last week where one of the acts did a 5 minute bit on how hilarious it was that she was “late to a Zoom meeting from her own living room”).

Anyhow, Ethereum.

With gas fees high and ETH being burned in all transactions via the EIP-1559 upgrade, Ethereum as an asset would appreciate massively in this eventuality, as it is required to be used for everything on-chain.

Ethereum already has incredibly stout network effects built up that only Bitcoin trumps. In looking at genuine Proof-of-Stake competitors, none of the others (Cardano, Polkadot, Solana – you can keep going) is worth mentioning – Ethereum is a league of its own.

What’s more, even if gas fees stay exorbitantly high, it won’t be that big a deal as this will only price out retail and small-timers. So who cares if the Solanas of the world continue to put Ethereum to shame over fees?

I’ve referred to Ethereum in my past analysis as the “blockchain of the elites”, but what if it goes full villain and embraces that role? Keeping gas fees high won’t matter to states or big institutions moving massive amounts of capital around. What’s more, the high fees and burning will keep ETH’s price moving upward.

The crypto world could use a villain. Maybe Ethereum is the one?

Can we value Ethereum like equity?

Ethereum, when looking at its fundamentals, is actually in a lot of ways closer to an equity than Bitcoin, which I view as a commodity (or at least, an attempt to be one). I don’t work for the SEC, but I kind of think of it as a security, even.

And hence my assessment of it is akin to assessing stocks I may buy. Similar thought process. Just a hell of a lot further out on the risk spectrum.

Firstly, look at supply. Shares – mainly through buybacks – often decrease over time. And while it is too early to assess whether Ethereum will become deflationary, or slightly inflationary, the dynamic rate of supply has parallels with equity.

The above inflation rate could come down – as the inflation rate for stocks can. I read an interesting study on Yardeni.com looking into share supply, recently, and it really makes you think. The parallels here are reminiscent of ETH – or certainly more so than gold, Bitcoin or other commodities.

With Bitcoin? The supply is literally programmed in code, with the final supply of 21 million bitcoins slated to be hit in 2140. It is the single biggest reason why it is like a commodity, as opposed to Ethereum which has already undergone several changes in its short history – changes similar to which stocks go under, with buybacks and the like.

This is why I don’t understand the description of ETH as money. It’s not.

It’s way too early to tell if Bitcoin will deliver on its money/store of value goals, and besides – this piece is about Ethereum (and already swiftly turning into a novel). But the fundamentals of scarcity at least offer it the framework to be analysed through a store of value lens.

Gold kind of is too – assuming you don’t discover a bunch of gold in your backyard, its supply is relatively restrained, with the amount mined each year somewhat consistent. But once Ethereum flipped from Proof-of-Work to Proof-to-Stake, there was no longer a real-world investment needed to mine it, like there is for Bitcoin or gold.

To be money, you need this investment. You need to hurt the environment, unfortunately, because that is how energy works. Once Ethereum switched from an exogenous cost to maintain (energy via Proof-of-Work) to an endogenous cost (staking), the texture of the asset changed entirely. It morphed into a security, more appropriate to be valued as equity.

Like I said, Ethereum is not money. It’s technology. And that’s perfectly fine – in fact, it’s better than fine. Ethereum is the world’s leading smart contract blockchain with incredible network effects built up, putting other Proof-of-Stake rivals to shame, and its flip to Proof of Stake is immensely bullish for its long-term health as a smart contract blockchain.

It now offers a yield for holding the asset, has batted away the energy criticism, and is well positioned to capitalise on the “pro-ESG” narrative – perhaps even going head-to-head with Bitcoin as the antithesis to the OG cryptocurrency. This energy debate – which essentially boils down (pun intended, I promise) to the question of whether the environmental cost of mining Bitcoin is worth what Bitcoin offers.

“Gold mining is a waste, but that waste is far less than the utility of having gold available as a medium of exchange. I think the case will be the same for Bitcoin. The utility of the exchanges made possible by Bitcoin will far exceed the cost of electricity used. Therefore, not having Bitcoin would be the net waste.”

That’s Satoshi Nakamoto, who as the creator of Bitcoin, probably is not the most unbiased voice on the matter. But his reference to whether gold is worth the cost to mine it kind of sums it up.

The switch to Proof-of-Stake for Ethereum nuked this debate. Enter ESG lovers, and the potential tpo regulate this bad boy and embrace it like the villain it could be.  The Proof-of-Stake move also nuked any (remote) chance it ever had of being money.

But that’s not a criticism, it just places it in a different category to Bitcoin and gold. And that is exactly where it should be, because that is not ETH’s fight.

I even wrote here in the run-up to the Merge about how I felt that the Ethereum staking yield could become the risk-free rate upon which DeFi is built. Through gas fees and staking, ETH will power the entire ecosystem. With Ethereum’s massive network effects – the number of users should hopefully also continue to grow as the ecosystem develops – there is a real use case for ETH. That is great.

Why am I being so mean?

None of this is particularly pleasant. As someone who is entranced by the macro implications that a hypothetical would where money and state are separated  – i.e. Bitcoin  – and what this alternate reality and society would look like, I am not as excited about analysing Ethereum on a personal level.

Yet I am still really intrigued – and can still it assess it from an investment perspective. And like I said, I am an investor, too – so I think this weird technology can make noise, if the cards fall its way. All of what I am saying may be a little sombre and disappointing, but in terms of a financial valuation of ETH as an asset, I’m viewing it as a bullish theory.

ETH is centralised as f**k. That may let the romantics down a bit, but if you’re just concerned about your bank balance, it’s not necessarily bad news.

It just has nothing to do with Bitcoin. Nor does it have anything to do with commodities, or money. Ethereum is a security – not unlike equity on the stock market. It’s time the world starts looking at it like one, rather than insisting it is a decentralised asset or some sort of new “money”.

Web3, NFTs, memes

Like I said above, NFTs aren’t my jam.

Memes kind of bore me too.

As for Web3, this utopian daydream is just that for now – a daydream. The games are worse than PlayStation 1 games, “tokenising” things that simply don’t need to be tokenised is beyond a joke, and so many of these “metaverse” protocols and tokens are delusional money grabs that somehow pulled the wool over the eyes of too many gullible traders during the pandemic.

But forget that. The silliness and pump-and-dumps will get flushed out – hell, a lot of them already have. Ethereum is continuing to build this playground allowing anyone and everyone to come build on it. Don’t judge it because some of those builders are using it to make a quick buck.

It’s the opportunity that matters here, and ETH is providing that.

ETH is the playground upon which the rest of the ecosystem can be built, if this decentralised revolution ever takes hold – sure there are some terrible playground designers out there, but that doesn’t mean the concept of building playgrounds is bad (I actually went to Amsterdam recently and had a discussion with a friend about how cool a job a playground designer is. My favourite “playground piece” was always the little climbing wall thing with the ropes to pull yourself up. I wasn’t sober for the discussion).

Valuation

But we can’t get around the fact that a lot of the noise on Ethereum has been just that – noise. This pushed it to values that simply could not be justified.

But hey, didn’t we all get a little silly during the pandemic? Jerome hit that printer like there was no tomorrow, and assets inflated all across the board. Ethereum may be down 74% from its highs of close to $5,000 in late 2021, but stocks are down too. Nasdaq is off 35%.

The crypto world lost the run of itself, partially led by a demographic that had never before experienced a “real” bear market, with asset prices across the world rising almost indiscriminately since the Great Financial Crisis.

But with Ethereum sailing past half a trillion in total market cap, there is no defending this valuation. It’s easy to say in hindsight, but there were many saying it at the time too – an asset multiplying 50X between March 2020 and November 2021 is not exactly a subtle price move.

We will lag and flail around until the economy subsides and that printer is turned back on. For the moment, I’m still expecting a pretty torrid winter for the economy at large, and hence find it difficult to convince myself to enter at these levels.

I’m buying stocks and more proven long-term investments for the time being, despite my fears – just off the basis of my long-time horizon and tolerance for short term volatility. But my crypto allocation (which is essentially just Bitcoin and Ethereum) won’t be eating up a greater portion of my portfolio in the near-term.

Closing thoughts

I don’t want what I have written here to come across as a bash on Ethereum. After all, I hold the thing.

It’s a fascinating asset; a breakthrough technology that has implications for disrupting a lot of what is frustrating about the centralised world.

But let it’s important not to get caught up in the decentralised bible-speak that argues for a tokenisation of everything, death to all centralised entities, and ETH to the moon. The concept is sexy; the daydreams enticing. But it’s just that, it’s all bark and bite right now.

There is a lot of rubbish (or trash for you Americans out there) in the crypto space – and that is true also on Ethereum. Asset prices as a whole ripped up immensely through COVID, and now we are seeing the opposite as the liquidity is sucked out of the system to try curtail this beast we call inflation.

That, and the fact everybody is depressed about everything.

But I like my theory about Ethereum potentially becoming a centralised financial network where some inefficiencies can be ironed out. Sure, it’s a bit depressing – and nowhere near as sexy as the decentralised dreamworld, “ETH is money”, NFT picture ruling utopia that a lot of crypto bulls wax lyrical about.

 But I just don’t see how that happens.

This is a proof-of-stake blockchain where the vast majority of transactions are carried out with centralised stablecoins, validated by centralised staking pools, via centralised-hosted nodes. The regulators are coming, people.

But if ETH continues to hold its spot as the top TVL blockchain, retains the immense network effects, and continues to build its platform towards facilitating actual value, while cooperating with these regulators, this new technology can actually make a difference.

Sort of like how people bet on tech stocks like Apple, Microsoft and Netflix. It’s about the technology, really – and the valuation, of course.

So ETH isn’t money; it’s not a commodity. It’s a tech stock.

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