Crypto for Normies: Ethereum’s “IPO”

We have written much recently about the world of cryptocurrencies. Having been relatively early participants in the space, after a parabolic rise we have felt many times that prices surely can’t rise any further and the echo chamber of Twitter with all the lambo flexing gives us much cause for concern. But then we zoom out and realise we are so immersed in crypto on a daily basis that we lose sight of just how early it is. Of course, there will be boom and busts and just like equities, not all cryptocurrencies are equal. The market is becoming far more multifarious, and this is one of the key reasons we believe crypto is becoming more investable and especially from a long/short perspective.

As always, this is not intended to be financial advice to purchase any instruments. Cryptocurrencies are volatile and while presenting great reward opportunities, are also high risk. Do your own research, call up your private banker and seek professional advice if needed. Happy hunting!

These past couple of weeks have been all about Ethereum. As Ether breaks all-time-high after all-time-high, one cannot help but wonder: this explosive price action surely must end with a pop. Ethereum’s development has come a long way since calls in 2018 for its “inevitable collapse”. Yet time and time again it pulls back (usually violently just like the past few days) and then goes again to a new high.

One thing we often forget is that at 6 years old, Ethereum is still early-stage. Think of how we would all be evaluating Ethereum if it were a more familiar private company without a mark-to-market price 24/7. Ethereum is software that is finding product market fit extremely rapidly. Its spectacular rally since Boxing Day has coincided with the rising popularity for its use cases. On-chain activity is a record high, developer activity is a record high and EIP 1559 (an Ethereum developer community proposal), which completely changes the supply side dynamic of Ether), is being implemented imminently. Furthermore we are edging closer to Ethereum’s shift to the more environmentally friendly proof-of-stake consensus mechanism. Yes, there are scaling issues. Yes, gas fees (the cost of a transaction) are high. Like any early-stage company, there are challenges, and they are being addressed. In a traditional company, one would back the management team to deliver through whatever hurdles the company may face. In this case one is backing the combined intellectual capital of the entire Ethereum community, all of whom provide their valuable time and skills. These community members are incentivised and aligned with every Ether holder to grow the value of the network.

To ascertain the product market fit of Ethereum, let’s have a look at the data we can find.

Here are some charts of transaction volume, active wallet addresses, on-chain volume and developer activity – all the fundamental indicators of use case adoption that one would look for in any ecosystem:

Now, imagining Ethereum developed as a private company through the traditional VC route, perhaps its valuation snapshots would look like this since launch in July 2015:

No different to any private company gaining rapid product market fit and raising money regularly, each time a new “round” unfolds we get to see a revised valuation which is usually in line with the advancement and success of the underlying business targets and metrics.

But the beauty of Ethereum is that it was publicly listed and tradeable from day one. There is a “valuation” being given every millisecond since its creation.

That brings us to the next point. If Ethereum were compared to a private company, who were its early investors? Well, anyone and everyone. Anyone with an inquiring mind and an internet connection has been able to invest in what could turn out to be the most important base layer for future global activity at any point since its launch in July 2015. The wealth generated in all parts of the world in a truly democratised way is already staggering. In time, maybe we will know just how rich some of these early investors are and indeed how much they used their Ethereum gains to contribute to the growth in the rest of the crypto space (and beyond). Just this week, Ethereum founder, Vitalik Buterin donated over $1bn to Indian COVID relief efforts! These investors who have benefitted from the rise could also have exited at any point should they have chosen to. Some did, many didn’t.

What we are seeing now is effectively Ethereum’s “IPO”. The world is waking up to what the opportunity here is. The big money is coming. Like an early-stage company listing on an exchange, Ethereum is now on the global stage: it is going mainstream. And that means hedge funds, mutual funds, pension funds, endowments, sovereign wealth funds, corporates, family offices and many more are only now starting to understand the potential of what this can become. Most of them are only now educating themselves as to the practicalities of how to buy, own, secure and manage it for the first time. It means mandates need to change and brand new systems need to be built. To many of the early investors, the gains are stupendous. Like a smart VC sending a portfolio company for IPO, for them the story is one of great success already but for the new market participants it is a brand-new investment opportunity.

But hold on. Are we actually serious that at $4000 per ETH and a market cap approaching $500 BILLION we are only scratching the surface?

Well, let’s get expansive for a bit. The potential total addressable market for Ethereum is so large that should we throw out a number, many would simply laugh it off. But what would you consider the TAM to be for a software layer that could power everything from global finance (think DeFi) to the creator economy (never mind everything in between)? To throw out silly numbers, one can for sure imagine it to be in the trillions of dollars (maybe even tens of trillions in time) should it be the premier base layer for these use cases. There are no geographical boundaries to worry about and importantly, with the initial success of some layer 2 solutions (see note at the bottom of this piece for a brief explainer) promising to solve Ethereum’s congestion problem, there is credence to the tantalising possibility that there is one chain to rule them all. That does not mean that there is one single chain, and the others die. On the contrary, it is becoming increasingly clear we will live in a multichain world. Other chains may offer superior speed and convenience (and these are fantastic and sizeable opportunities themselves in a pie that has a very long way to grow) but as it stands, it is becoming clearer that it would be very very difficult for any others to compete with Ethereum’s network effects.

If there is going to be one dominant chain to rule them all, you don’t get a second shot to buy it once you’ve missed it.

It also gives rise to another thought – that of Ethereum as a base currency. Now this is wildly speculative but if Ethereum becomes the default way to transact in the future it would mean that one would need to make sure one’s spending power in Eth terms doesn’t fall. If I live in the UK and all my costs are in British Pounds, I know that I must save in pounds, unless I specifically think the pound is at major risk of collapse. Likewise, if in the future I am going to do the majority of my spend in ETH, then I need to make sure I have a balance of ETH savings. So why swap out of it if you are going to need it in the future. It means maybe that one would need to start thinking in ETH terms. Many already think in BTC terms but maybe ETH is even more practical given its use cases.

And will ETH flip BTC? This maximalism debate inside the crypto community is a little silly. BTC and ETH are completely different and one’s success doesn’t impinge on the other’s. An investor would own them for completely different reasons. But in terms of TAM and use case, it doesn’t take huge leaps of faith to think that ETH’s potential size could be far larger.

Ethereum is graduating and with that, it is logical to look at the exponential price action we’ve seen and be afraid. But this is a brand-new technology with possibly the largest total addressable market out of any asset out there. Balaji Srinivasan believes that the creation of Bitcoin and Ethereum will go down as one of the most important developments in history and he is someone who tends to get these things right. Even if he is half right, anyone with an open mind and a willingness to embrace something completely new and different can create generational wealth for themselves.

As ever, over the short-term volatility is scary but over time volatility is your friend. Volatility isn’t for everyone, but for some of us, it’s a chance to embrace the madness and join the fun. Stepping out of your comfort zone is hard. But for those willing to run ahead we may be going somewhere none of us have ever been before. Buckle up and enjoy the ride.

Appendix: Layer 2 solutions, (perhaps overly) simplified

Layer 2 solutions on Ethereum sound like a complicated idea, but for the sake of a brief explanation, and at risk of gross oversimplification (apologies, crypto-native gurus), we’re going to draw some analogies with logistics.

Think about the global logistics network: huge jets, ships, tankers and trucks – that’s layer 1. At the wholesale level, that makes sense: while the cost of chartering a container ship (or even a single container) is large in absolute terms, it makes sense if one is shipping say 25 tonnes of electrical appliances to pay for a 20ft container, since as a percentage of the total value being transferred, the freight cost of a single container is rather small.

On the flipside, if one were shipping a parcel to a friend in Australia, for example, contacting a freight forwarder directly would make very little sense. The best option would be to head to the local post office, buy a global postage stamp and post it. There would be no visibility or control of which route the parcel takes, or even which logistics company handles the long-haul shipment – but does it matter? The parcel gets there in the end and that’s what counts.

The post office, in this case, is layer 2.

The fact that an individual sending a box of chocolates finds booking a cargo flight space expensive and cumbersome doesn’t invalidate the integrity of the logistics network. It simply meant that the scale of business done on an individual level didn’t justify the overkill of using “wholesale” infrastructure. Everything has its place – big and small transactions alike.

The same could be said of the decentralised web.

Ethereum is layer 1 of the decentralised web – the wholesale, bulk trunklines that are best suited to moving large amounts of value across wallets, contracts and protocols. The fact that it is expensive doesn’t detract from the reality that almost all other DeFi protocols are built on it. And it certainly doesn’t render Ethereum “useless”.

Conversely, Layer 2 solutions constructed on top of Ethereum fundamentals (e.g. Polygon) or other Ethereum Virtual Machine (EVM) compatible blockchains like Binance Smart Chain complement rather than supplant its efficacy by handling the equivalent of last-mile small transactions at much lower costs, albeit sometimes with more “centralisation”. These alternatives may seem like “competition”, but the pie is big enough to be shared between multiple protocols – just as the Post Office and DHL/Fedex don’t automatically render Maersk shipping “useless”, to complete the analogy.

Who should be using Layer 1? Large institutions, traders and maybe even... banks?

For everyone else, there’s Layer 2.