Ethereum has a potential similar to Bitcoin (BTC), says Ark Invest.
Ether (ETH) is the native cryptocurrency of the Ethereum network. Although it has a large number of followers and a widely spread community worldwide, its price is not at its best.
Unlike Bitcoin (BTC) and other cryptocurrencies that have hit new all-time highs in 2024, ETH is still far from its peak and, when measured against Bitcoin, has been in a downtrend for several years.
Is Ethereum dead or can it still be a good investment option? Here we will analyze a favorable opinion towards this cryptocurrency.
Ark Invest, the investment firm led by entrepreneur Cathie Wood, has set its sights on Ether and has classified it as an “institutional grade asset” with a performance potential similar to Bitcoin (BTC).
While BTC has solidified its position as a digital store of value, ETH, with its ability to generate returns through staking, is shaping up as an asset with distinctive characteristics that make it increasingly attractive to institutional investors, points out a recent report from the American company.
Unlike other cryptocurrencies, ETH is not just a cryptocurrency. Its underlying network powers a large number of decentralized applications (dApps) and smart contracts. This feature, according to Ark Invest, makes it a sort of “nervous system” of the cryptocurrency world, influencing the monetary policy of other networks and measuring the overall health of the digital asset ecosystem.
In this sense, Ark Invest draws a comparison between ETH and U.S. Treasury bonds. Both entities, although in different contexts (one digital and the other traditional), are showing a significant impact on their respective systems and are acquiring characteristics that make them unique.
This comparison with Treasury bonds suggests that ETH could be evolving into an institutional asset, used by large investors to diversify their portfolios and manage risks.
The report highlights the returns generated by ETH staking, which are beginning to influence other smart contracts within the Ethereum network. This means that ETH is starting to set a standard or a reference for returns in the world of cryptocurrencies, similar to how Treasury bonds set benchmark rates in the traditional economy.
Just like Treasury bonds serve as a store of value in times of uncertainty, ETH is showing similar qualities. Its potential to generate returns and its widespread use as collateral in transactions are positioning it as a reliable and stable asset within the cryptocurrency ecosystem, the company states.
Faced with this scenario, Ark Invest seeks to identify and define the distinctive characteristics of ETH, answering a series of questions.
1. How can ETH generate returns through staking?
In principle, the report provides a detailed explanation of how returns are generated on Ethereum under the Proof-of-Stake (PoS) consensus mechanism. It breaks down the returns into three main components: issuance, tips, and Maximum Extractable Value (MEV).
The Proof-of-Stake (PoS) consensus algorithm is a more energy-efficient mechanism than Proof-of-Work (PoW), mainly because it does not require the intense computational power that PoW mining demands. Ark Invest mentions that traditional mining with PoW, like Bitcoin uses, has security and decentralization advantages.
Ark Invest goes on to explain that in PoS, validators, who play a role similar to miners in PoW, are selected to create new blocks and validate transactions based on the amount of coins they hold and are willing to stake or put at stake.
The higher the amount a validator is willing to stake, the greater the probability of being chosen to validate the next block. This creates a strong economic incentive for validators to act correctly, as if they try to validate fraudulent transactions or violate protocol rules, they risk losing their stake.
When the Merge on Ethereum took place, the network transitioned from PoW to PoS with the Ethereum 2.0 update. This change not only brought greater energy efficiency but also modified the monetary policy through the implementation of EIP-1559.
EIP (Ethereum Improvement Proposal) was activated in August 2021 during the London hard fork. With this update, the way fees are paid changed: a portion is burned, and another goes to miners as a tip, as reported by CriptoNoticias.
The return in three main components: issuance, tips, and MEV
Issuance in Ethereum refers to the creation of new ETH introduced into the network regularly. It is as if new currency were being printed, but in the digital world.
Currently, Ethereum issues approximately 940,000 new ETH each year. However, this rate can vary over time. “This is equivalent to an annualized percentage yield (APY) of ~2.8% with the current staking rate,” it notes.
The higher the staking rate, the lower the individual return each validator will receive from issuance. This is because the issuance is distributed among all validators in proportion to the amount of ETH they have staked.
Ethereum guarantees a minimum annual issuance rate of 1.5%. This means that even if all existing ETH were being used to secure the network, at least 1.5% of new ETH would still be issued each year.
In the case of tips, it refers to additional payments that users can choose to include in their transactions.
By offering a tip, a user is paying validators to include their transaction in the next block. “This is useful when a transaction needs to be processed quickly, such as in the case of high-value transactions or urgent transactions.”
Tips provide an additional incentive for validators, who are responsible for verifying and adding new transactions to the Ethereum network. By receiving tips, validators are more motivated to process transactions efficiently.
Each transaction in Ethereum has two fee components: the base fee and the tip
The fee is mandatory and adjusts automatically according to network congestion. When the network is busy, the base fee increases to discourage users from sending unnecessary transactions. In contrast, the tip is an optional fee that the user can add to the base fee. The higher the tip, the more likely the transaction will be included in the next block.
“In addition to issuance and user tips, validators also collect rewards through MEV (Maximum Extractable Value),” the report indicates.
This is a fundamental concept in the world of cryptocurrencies, especially in Ethereum. MEV refers to the additional profits that validators can obtain by manipulating the order of transactions within a block.
In simpler terms, validators, who are responsible for adding new transactions to the Ethereum network, have a degree of discretion over the order in which they include these transactions. By taking advantage of this discretion, they can obtain additional benefits by including or excluding certain transactions or strategically rearranging them.
Ark Invest explains that MEV is the equivalent of “Payment for Order Flow” (PFOF) in traditional markets: additional income that market makers and high-frequency traders pay validators to prioritize their transaction flow.
Similarly, in Ethereum, users who want their transactions to be processed quickly can offer an additional “tip” to validators to prioritize their operations.
To take advantage of MEV opportunities, validators can use specialized software such as MEV Boost. These clients allow validators to participate in block auctions, where MEV seekers compete for the right to include their transactions in a block.
Finally, Ark Invest mentions the base fee. This is essentially the standard cost that users must pay to make a transaction on the Ethereum network. Unlike tips or MEV, which can vary and generate direct returns for validators, the base fee is not distributed as a reward.
Another important component to consider is the EIP-1559 update, which introduced an innovative mechanism: the burning of the base fee.
This means that the ETH tokens paid as a base fee are permanently removed from circulation. “The idea behind this is to reduce the total supply of ETH and potentially increase its value in the long term.”
If the amount of ETH burned in the form of base fees exceeds the new issuance of ETH, then the total supply of ETH decreases over time. This creates a deflationary scenario. In contrast, if the issuance of new ETH exceeds the amount burned, then the total supply increases, and the network becomes inflationary.
By switching to PoS, Ethereum significantly reduced its operating costs. This allows a higher proportion of the base fees to be burned, contributing to deflation.
“As the leading smart contract platform, the Ethereum network operates at the base layer with a restriction of 14 transactions per second. Thanks to its rigorously tested code, Ethereum has attracted the highest number of active developers, the widest variety of applications, and the highest values settled, all in its nine years of history.”
Ark Invest, investment firm.
Additionally, the growing demand for Ethereum as a platform for smart contracts and decentralized applications increases the number of transactions and, therefore, the amount of base fees burned.
Since its transition to PoS on September 15, 2022, and the implementation of EIP 1559, the Ethereum network “has functioned as a deflationary asset, reducing the supply by an average of 0.106% per year.” If Ethereum had continued to operate with PoW, without EIP 1559, the network’s supply would have inflated by 3.2
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