Ethereum: A broken engine?

Taurus Group SA Market analysis – Launched in 2015, Ethereum has been the second largest digital asset in terms of market capitalization after Bitcoin. Market capitalization peaked at approximately $135 billions in January 2018, with a maximum relative weight of 32% of the total digital assets market cap in June 2017. However, Ethereum’s performed noticeably worse than Bitcoin lately, especially the last 12 weeks. Are there reasons to worry?

From smart contracts to dApps

Ethereum popularity came through a feature Bitcoin lacks: its capability to run programs on a decentralized platform, as opposed to mere money transfers. Such programs are created thanks to smart contracts, pieces of software whose logic is enforced via the Ethereum blockchain. By combining several smarts contracts, any developer or organization can create their decentralized application(dApp).

The ICO Boom

2017 was a phenomenal year for Ethereum’s native token ether(ETH). The surge in ether demand was driven by the countless ICOs relying on Ethereum (see graph below) as a funding instrument or as a platform to create new tokens. Indeed, ERC20-based ICOs accounted for 77% ofthe total ICO market[1]in 2017, for a total of $6.3bn raised. The ICO market is pursuing its growth in 2018; as of the time of writing, a total of 731 ICOs raising $18bn took place in 2018[2]. 2018 also saw two record ICOs with EOS and Telegram, which raised $4.2bn and $1.7bn respectively.

Ethereum’s five main challenges

 Ethereum is no exception to the market correction that took place since the beginning of the year. However, a few other structural and seasonal reasons may explain the relative underperformance of Ether vs. Bitcoin (see figure below) over the last 12 weeks. In our opinion, this is mainly due to the following 5 factors:

  1. Scalability roadmap delays: with approximately 15 transactions per second[3], performance and scalability remain top priorities for Ethereum. Everybody remembers the Cryptokitties incident at the end of 2017 and its embarassing impact on the network performance. Since then, Vitalik Buterin made scalability a top priority for Ethereum, with ambitious deadlines. Unfortunately, there has been shifts and changes to the protocol’s priorities (see figure above). It is now likely that the long-awaited proof of stake implementation (Casper), a first version of which[4]was expected earlier in 2018, will not be deployed before 2019-2020.

2. Governance: For the first time since its launch, the Ethereum community is facing internal disagreements on the short-term direction to choose, especially in relation to the October 2018 release, regarding three issues:

  1. (i) Difficulty bomb: A piece of code that makes blocks less efficient to mine over time and which was designed as an incentiveto adopt proof-of-stake consensus. The key question is either to delay it (EIP 1234) or suppress it (1227,1240, 1276);
  1. (ii) Ether issuance: The current reward of 3 ETH per block is challenged for economic and energy consumption reasons. EIP 858, 1234, 1276, 1277 propose to reduce the reward while EIP 1227 propose to increase it to 5 ETH (back to pre-Byzantium level);
  1. (iii) ASIC resistance: Dedicated mining hardware is becoming available, whereas Ethereum’s proof-of-work, based on the Ethash algorithm, was designed to minimize the efficiency of hardware mining. Although this does not come as a surprise, it may change the economics of mining and could encourage more efforts towards proof-of-stake integration. See below an example of Ethereum poll (from etherchain.org) regarding proof of work:

As of today, no clear consensus emerged. A call between core developers and miners on 24 August 2018 did not result in any significant decision. A follow-up discussion is scheduled on 31 August 2018.

3. Seasonal ICO cash out: Organizations that ran successful ICOs in 2017 have started to cash out some of their ether balance, triggering selling pressure. Taurus brokerage operations have seen an increase of cash-out requests over the last couple of weeks. Additional selling pressure also comes from the sales of large chunks of ether, such as the sales of a large block (871,852 ETH[5]) by a holder of the genesis block, which is seen by some as an additional bearish signal.

4. Doubts about the fat protocol thesis and dApps: The market challenges the Fat Protocol Thesis, which essentially asserts that Ethereum, as a protocol layer, accrues more value than the application layer—dApps running on top of it. Today, less than 10% of the total transactions on the network are coming from the top 100 applications built on Ethereum. The scalability issues faced by Ethereum is another negative factor that could jeopardize Ethereum’s leadership.

5. Competition: Other dApps platform are challenging Ethereum’s dominance. The last two years saw the emergence of other protocols with smart contract capabilities, for example Stellar, NEO, Cardano, or TRON. The most recent competitor is EOS, which has raised $4.2bn through an ICO and cashed out 100% of its Ether. EOS is positioning itself as an alternative to Ethereum with the following differentiating factors: no transaction fees, delegated proof of stake (DPoS), higher transaction rate (6,000 per second), and robust governance with a community-written constitution.

Conclusion

Taurus keeps an eye on the development of Ethereum and related protocols. Although we recognize that Ethereum faces a number of challenges justifying a downside pressure, we remain positive that the protocol is here to stay. Thanks to its solid developer community, Ethereum has still all cards in hands to sustain its leadership position and avoid contentious forks à la bitcoin. To do so, it needs to deliver on its roadmap and resolve governance issues. The next main monitoring points will be in particular the October release (Constantinople) and the devcon4 conference in Prague (10/30 to 11/2 2018). Stay tuned.

Taurus Group SA, all rights reserved.

Article in pdf here.

Appendix:

Proposition 1: Remove the difficulty bomb permanently, leave issuance unchanged at 3 ETH / block.
EIP 858: Delay the difficulty bomb, reduce issuance to 1 ETH / block.
EIP 1227: Remove the difficulty bomb permanently, increase issuance to 5 ETH / block.
EIP 1234: Delay the difficulty bomb, reduce issuance to 2 ETH / block.

Footnotes:

[1]ICO Watch List, December 2017 [2]According to coinschedule.com [3]Visa network is able to sustain 25,000 tx/sec  [4]Hybrid proof of work and proof of stake [5]See http://www.dappcapitulation.com for more details on “whales” ETH movements


Important disclosure

The information and opinions in this article were prepared by Taurus Group SA (“Taurus”).  Taurus Group SA or the writer of this article has a significant financial interest in some digital assets such as Ether, Bitcoin, Litecoin, Bitcoin Cash or EOS.  Taurus does not provide individually tailored investment advices. This articlehas been prepared without regard to the circumstances and objectives of those who receive it. Taurus recommends that investors independently evaluate particular investments and strategies, and encourages investors to seek the advice of a financial adviser. The appropriateness of an investment or strategy will depend on an investor’s circumstances and objectives. The securities, instruments, or strategies discussed in this articlemay not be suitable for all investors, and certain investors may not be eligible to purchase or participate in some or all of them. This paper is not an offer to buy or sell or the solicitation of an offer to buy or sell any digital assets or to participate in any particular trading strategy. The value of digital assets may vary a lot because of changes in interest rates, foreign exchange rates, default rates, prepayment rates, securities/instruments prices, market indexes, operational or financial conditions of companies or other factors. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. If provided, and unless otherwise stated, the closing price on the cover page is that of the primary exchange for the subject company’s securities/instruments. This articleis based on public information. Taurus makes every effort to use reliable, comprehensive information, but we make no representation that it is accurate or complete. We have no obligation to tell you when opinions or information in our research change apart from when we intend to discontinue equity research coverage of a subject company. Taurus may make investment decisions that are inconsistent with the recommendations or views in this report.
2018-08-30T16:35:42+00:00August 30th, 2018|Categories: Analysis, ethereum|