Bristol Banking and Investment Society Analyst
Programme
Ethereum or Bitcoin? Which will stand the test of time?
Markets Team
Charlie Hyams (Head of Programme), Rafi Ikram, Erasmus Kahane, Leonard
Kaun, Tim Ajanlekoko, Teddy Walker, Sasha Bonacina, Ted Turner, Joshua
Ang
Cryptocurrency
Bitcoin and Ethereum are both digital currencies. They are examples of cryptocurrencies,
which use cryptographic functions to secure transactions making them impossible to
counterfeit. These digital assets are decentralized, they only rely on a peer-to-peer network
for exchanges without being issued or regulated by a central authority.
Just like fiat money (eg. USD, GBP etc.), cryptocurrencies are highly fungible, transactable
and portable as transactions are safe and fast between digital wallets. However,
cryptocurrencies are generally more scarce, divisible and durable than fiat currencies as
digital assets cannot degrade overtime.
Intro to Bitcoin and Ethereum
Bitcoin and Ethereum are the two largest cryptocurrencies by market cap but they differ in
many aspects. The main purpose of each is fundamentally different. Bitcoin was established
as an alternative international monetary system used for storing value, Ethereum’s aim was to
facilitate the deployment of smart contracts, decentralised finance and applications with its
own currency even though it developed into Bitcoin’s main competitor. Bitcoin is considered
deflationary because of its limited supply of 21 million Bitcoins to be mined which is not the
case for Ethereum which has an unlimited amount of blocks to be mined. However, Ethereum
2.0 which the second phase of Ethereum could lead to this deflationary aspect as the money
paid above the base fee would be burnt which could cause more money burnt than created.
Another difference is the speed of transactions which is far quicker for Ethereum than Bitcoin
even though Bitcoin remains more secure than its competitor.
How does bitcoin’s technology work?
Cryptocurrencies keep track of transactions using a distributed ledger. This is a record which
is kept in the cloud and which is shared by all individuals in a network, or the nodes of a
network. When a cryptocurrency like bitcoin is minted, it is verified using proof of work,
which means that a transaction is recorded along with a successful hash. A hash is the input
which corresponds to a given output from a cryptographic function. In the case of Bitcoin, the
sha256 function is used. Sha256 is an asymmetric one-to-one function, meaning that only one
input can have a specific output, but there is no way of inversing the function to determine
the input of a given output other than by trial and error. The string “RASITEDDY123” is
represented by another string when run through sha256, (using this website
[Link] ), we see that the output is
a8f043dce8f3a534495205fe34507d65517edb1b14d6be2640147c53f8e7384b. No other string
can output the monstrosity I just copied and pasted above when run through the sha256
function (because it is one-to-one). It requires very little computing power to determine the
output of a sha256 encryption (as I have just demonstrated), yet an infinite amount of
computing power to determine the input which would cause a specific output from a sha256
function (because it is asymmetric). In the process of mining, specialised computers called
ASICs (Application-Specific Integrated Circuit) use a process of trial and error by hashing
(running random strings through sha256) until an output is found below a target number. If a
miner finds a hash which corresponds to a number below the target number, they will be
rewarded with 12.5 bitcoins when their proof of work is loaded onto the blockchain. Proof of
work contains the successful hash which created an output below the target number. If the
majority of the network signs off on the proof of work, it will be accepted onto the
blockchain, and minted in a block which contains all the transactions which were made using
bitcoin since the previous set of bitcoins were mined. This is why bitcoin is so secure from
attack – because 51% of nodes on the bitcoin network would have to be corrupted for an
invalid proof of work to be accepted (which requires an incredible level of organisation).
Mining requires large amounts of energy, which costs money (we pay our energy bills in
GBP/USD/CNY), so when we mine bitcoin for a profit, we are doing so in the belief that the
12.5 bitcoins will be worth more than the fiat currency we expend in energy bills to mine it.
Use cases of Bitcoin
With the global average cost of sending $200 aboard being $13.60 one possible use for
Bitcoin is overseas remittances. Due to the typical high cost of traditional methods, using
bitcoin as a means to send money overseas, allows users to send directly to recipients and
hence save money. Due to the borderless nature of cryptocurrencies and as anyone can access
the blockchain, sending with bitcoin cuts out the middle man such that here's no need to send
payments through a bank or RSP. While a possible concern may be that the sender must need
have sufficient knowledge about bitcoins, many software’s now can facilitate remittances to
those who do not have sufficient knowledge.
El Salvador have been the first country to recognise bitcoin as legal tender as a means to
boost economic development and jobs. Due to the decentralised nature of Bitcoin, central
powers cannot control it. The lack of transaction fees, may help poorer people increase
returns and invest without any extra fees. As Bitcoin runs entirely on the blockchain, there is
less outside interference in investment, allowing for an even playing field for wealthy and
poor. And as governments and banks cannot interfere with transactions, the poor can’t be
discriminated against while using the currency. On top of this remittances, which are an
important source of income will also increase. While other cryptocurrencies can do the same,
for the moment Bitcoins insane security allows it to be the best choice for El Salvador and
remittance’s. This security is credited to turing-incomplete smart contracts, meaning that it
makes it very hard to double spend (needs 51% computing power).
However there are downsides. Due to Bitcoins high volatility, there are serious risks involved
with using bitcoin as a national currency. Furthermore, as a large share of the population live
below the poverty line, many Salvadorians do not own a smart phone, let alone know what a
Bitcoin is. Therefore a large chunk of the population do not intent to use Bitcoins, and
furthermore in a survey it was found that more than two thirds wanted the Bitcoin law
repealed.
Proof of stake
Ethereum uses a verification method called proof of stake rather than proof of work. Whereas
with bitcoin, all nodes on the network verify the proof of work that is provided alongside any
transaction or minting, on the Ethereum blockchain, nodes must stake a set number of coins
to become a validator. In the case of Ethereum, the minimum stake is 32 eth. The size of the
stake determines the likelihood of a node being randomly chosen to validate a block of
transactions. For each block, a two-thirds consensus is required to accept a block as valid.
Given that each validator loses their staked eth if they are caught lying about the validity of a
block by the consensus, there is a large financial incentive to behave truthfully and therefore
the proof of stake method preserves trust in the system without the need of a central
watchdog/authority. There are 128 validators for each blocked, selected randomly from the
pool of wallets with at least 32 eth in their account. Given the large number of wallets of this
size and the lack of personal information connected to these wallets, it would be prohibitively
difficult to organise a 51% attack on Ethereum.
The proof of stake validation method is considered to be favourable to the proof of work
method because it is non-competitive. There is no advantage to be gained in owning
advanced hardware or large amounts of energy in mining Ethereum – because validators are
selected randomly. Therefore, proof of stake validation has the advantage of more scalable
and ecologically friendly than a proof of work system. The trade-off is in the security
drawbacks. Whilst we have discussed the difficulties in organising a cyber-attack on the
Ethereum network, the proof of stake system necessarily must have fewer validators than a
proof of work system (because only relatively large wallets can become validators).
Therefore, Ethereum is less secure from attack and corruption than Bitcoin.
Validators earn money in a PoS system through gas fees. Here is a good link to find out more
about Ethereum gas fees: [Link]
Use Cases of Ethereum
Characterised as a growing list of data that are linked together using cryptography,
blockchain applications extend far beyond cryptocurrency and bitcoin. With its growing
capabilities in creating more transparent and fair digital services while also saving businesses
time and money, the ever-growing technology actively impacts a variety of industries in ways
that range from easing cross-border transactions to pushing forth for increased transparency
in governance. Among the most common use cases for blockchain technology such as the
enablement of Bitcoin and Ethereum, we note down 5 other prominent applications that stem
from the technology,
Cross-border transactions/payments
With the world being increasingly interconnected, globalisation leads to international
businesses and organisations performing an increased number of cross-border transactions.
According to Smarter Payment Tracker, cross-border business-to-business payments
accounted for a whopping $125 billion in revenues in just 2018 alone. Blockchain technology
has the potential to moderate these large-volume transactions by enabling secure and efficient
payments via the removal of intermediaries such as pre-funded accounts. An example of an
establishment striving to achieve this is RippleNet. The company offers connections to
hundreds of financial institutions around the world via a single API, which helps global
companies move around money quicker and more reliably. This is made possible through
Ripple’s eminent liquidity solution, On-Demand Liquidity (ODL), which utilises its
characteristic cryptocurrency, XRP, to source liquidity during cross-border transactions.
Decentralised finance (DeFi)
Decentralised finance is a term used to coin a collection of emerging financial technology
that are based on secure distributed ledgers similar to those used by cryptocurrencies. A
notable platform built on the basis of DeFi is Enterprise Ethereum. A collection of
customised software and networks centralised around ETH, Enterprise Ethereum allows
enterprise clients to retain over the architecture, the validators, and the users of the
established software or network. Maintained by a member-led industry organisation known as
the Enterprise Ethereum Alliance (EEA), many private businesses such as Microsoft and J.P.
Morgan are currently experimenting with private editions of Ethereum for enterprise
purposes. The Infura Ethereum API is an example of an Ethereum-backed development suite
for decentralised applications, which provides flexible availability for Ethereum
infrastructure.
Non-fungible tokens (NFTs)
As everything around us becomes increasingly digital, there is a growing need to replicate the
properties of physical items such as scarcity, uniqueness, and proof of ownership. A form of
digital ledger that achieves this demand are non-fungible tokens, which is a collection of
digital assets commonly used in the gaming and art industries to ensure the provenance of
luxury goods. Powered by smart contracts and largely built on the Ethereum blockchain,
NFTs are characteristically crypto tokens that represent an indivisible and provably scarce
digital asset that are not interchangeable with one another. With interest in top NFTs like
Bored Ape Yacht Club and CryptoPunks steadily growing, OpenSea, a peer-to-peer NFT
marketplace, allows consumers to trade unique NFTs freely with ease. Established
organisations like the NBA and Ubisoft are also experimenting with the potential capabilities
of the growing NFT space.
Figure 1: An example of NFTs offered by Bored Ape Yacht Club and CryptoPunk. Valued
characteristically high, Bored Ape #472 (left) is currently listed as 104.9 ETH ($309,061.63).
Transparent Governance
The usage of blockchain technology in areas of governance is not yet well-established, but
presents itself as a promising solution that can potentially enhance a wide variety of services
provided by governmental bodies. For example in healthcare, electronic health records that
are built on a blockchain-based infrastructure could theoretically eliminate redundant
onboarding procedures and tests, enable digital prescriptions to be easily screened for
potential adverse reactions, and allow citizens to take private ownership of their health data.
Additionally, identity management is a fundamental block within governmental services -
blockchain-based identity management systems can potentially offer citizens the opportunity
for self-sovereign identity, which allows citizens to have granular control over access to their
personal information.
Security Tokens
Based on an arguably similar basis of NFTs, security tokens are a blockchain-based
representation of real-world assets, built on a block infrastructure. An example of an
establishment attempting to achieve this is Polymath - the company allows issuers to transfer
and transact tokens much more easily than if they only had a contractual representation on
paper. To this day, Polymath has thus facilitated the deployment of 200+ tokens on their
Ethereum-based solution, ranging from $2 billion+ in payments linked to real estate, to
corporate loans facilitated by an Australian lending marketplace.
Figure 2: Flowchart detailing the process of a blockchain-based infrastructure for the
issuance of a company’s stocks through digital tokens. Blockchain technology ensures every
step is rolled out in an adaptive, fair, and safe manner for both the company and its
consumers.
Technical Analysis
As Bitcoin and Ethereum fall dramatically into correction territory from their November
highs and as such, volatility reaches extreme levels, people are once again expressing their
concerns with the legitimacy of cryptocurrencies to be used as anything more than a quick
way to make (or lose) money. In this section I will present analysis which addresses the
volatility issue and discusses the future price potential of both Ethereum and Bitcoin.
Regarding Bitcoin we are currently seeing a distinct ABC correction, based on previous lows
from 2021, it looks like there is a lot of support around the $30,000 level. Based on this and
that every year since Bitcoin launched apart from 2015, the lows were always higher than the
previous year's lows, it means Bitcoin is unlikely going to fall below $27,500. This idea of
higher lows overtime is due to the idea that diminishing returns sets in as adoption of Bitcoin
increases.
When we take a logarithm of the y axis Bitcoin has a parabolic shape, this parabolic shape
implies that initially the returns would effectively be exponential and overtime these returns
would decrease but with higher highs, and higher lows overtime. This parabolic nature of
Bitcoin is represented as triangles in the Logarithmic-MACD.
So as momentum reduces overtime, represented by the MACD, so do the returns and every
cycle is followed by a higher high, and higher low, if this relationship remains and mass
adoption increases, volatility will be reduced, the returns will become miniscule as people
will be using Bitcoin for a currency, and not to seek gain as a result we will see a
convergence of Bitcoin’s price, potentially to $200,000. This is demonstrated by the
parabolic trend curve flattening as the price approaches $200,000.
Historically, Bitcoin’s price tends to influence the entire crypto market, with a downtrend,
correction, or uptrend in Bitcoin having a ripple effect into Ethereum and other
cryptocurrencies. This is true with the current correction as we have seen Ethereum follow
the same ‘ABC correction’ as Bitcoin. Based on the same ‘ABC correction’ we should see a
bottoming out of Ethereum around the $1700 level.
Additionally we can look at the RSI, Ichimoku Signals, support/resistant lines as well as
50,100 and 200 day moving averages to make decisions about future price direction.
Currently there is quite a strong bearish sentiment, for the following reasons
1. Ichimoku clouds show the trend and future direction of Ethereum’s price movement-
right now the Ichimoku signal is predicting a downward trend.
2. The price of Ethereum has broken below the 50,100 and 200 day moving averages,
which are usually used as support, suggesting stronger downward future potential
3. The RSI which represent momentum have seen a steady decline overtime but hasn’t
yet passed the point where Ethereum is considered oversold, which means there is still
downward potential
Although the short term price action of both Ethereum and Bitcoin don’t look positive and
returns for Bitcoin may dwindle in the long term-it may not all be bad news. By Bitcoin
becoming more stable it achieves the long term goal of cryptocurrencies-a method of
financial freedom.
So as Bitcoin becomes more stable, Ethereum and a multitude of other projects will take its
place as a method of making money.
To conclude, let us think about the history of all great changes; with every revolutionary
technology, theories or even art pieces they were always ridden with skepticism and doubt
initially. When the first iPhone was released, people never thought it would lay the
foundation for touchscreen technology, app stores and a full web browser which changed the
way we can access information. When Van Gogh was painting his masterpieces, at the time
they were overlooked.
With the introduction of cryptocurrency, it has gained mass media attention and created a
buzz around the finance world with stories of people making millions from it and the
prospects of it being the future of the monetary world. I think one of its biggest attributes that
a lot of people like is the decentralized nature of it, as a lot of people don’t trust the
government and big banks to have all the power. Its transparent governance creates a
trustworthy system for all users. Forget the antiquated way of dealing with intermediaries in
transactions, blockchains provide a direct path for these procedures. The only questions are:
will the whole population accept this new way of life, is this just another means for wealthy
individuals to control the market and how far can crypto actually transform our way of life?
Bitcoin remains the one that launched the excitement for crypto currency and has the biggest
market cap, however, with Ethereum on the rise and other alt coins innovating, it seems that
it mainly made room for other coins to prosper in unlimited potential.
