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Congestion and Caution: A Tale of Two Cryptocurrencies

As the weekend came to a close, Bitcoin’s rise to $3,000 seemed to be inevitable as it hit the mark on a handful of exchanges. Almost on cue, the cryptocurrency proceeded to dip to well under $2,664 on Monday, showcasing just how volatile the cryptocurrency market still is. While it is challenging to argue with legitimizing events like Japan’s adoption of bitcoin, South Korea’s push for further integration, or Russia’s desires to regulate it further, Bitcoin’s market share has dwindled in recent years as more alternative cryptocurrencies, often called Altcoins, continue to join the market. Measuring at an over 500 percent year-to-date market capital increase, these inflows have shoved bitcoin down from a lofty position in which it held over 80 percent of total market share to one where it is barely treading above 40 percent, according to numbers from metric-site CoinMarketCap.com.

Despite its continuing appreciation and increasing popularity, the cryptocurrency has faced increasing competition, particularly from rival currency Ethereum. While Ethereum shares the burden of the unregulated, volatile market the same way that Bitcoin does, it has seen considerable appreciation in the past year alone. Charles Bovaird of Coindesk.com reported that its market share has gone up to almost 33 percent, and it has soared by over 3,000 percent in value. Additionally, Ethers, which are the currency traded on the Ethereum system of blockchain technology, have surpassed Bitcoin’s trading volume and in the gross number of transactions, according to CoinMarketCap.com. Ethereum’s sudden and steep appreciation has raised several fundamental questions. Firstly, what exactly has caused this new alternative cryptocurrency to climb so swiftly? And secondly: what exactly has caused Bitcoin’s sharp decline from an overwhelming market leader to one that is vying to keep its leading spot?

For Ethereum, its value has increased very much in line with the meteoric rise in Initial Coin Offerings, or ICO’s. These ICO’s are the cryptocurrency world’s way of crowdfunding projects. How an ICO works is relatively straightforward: a startup puts forth an idea for a project and states that they are willing to sell cryptographic “coins” that function in the same way that other cryptocurrencies do. People who are interested in whatever this group is offering can then sell whatever currency, be it Bitcoins, Ethers, or even cash, that the firm is willing to exchange for coins. This trade means that now the group has the money they need to fund their project and the people with the coins are hoping the startup is successful, so the coins they bought will increase in value.

So, how are ICOs and Ethereum related?

Nearly every ICO uses Ethers as the primary medium of exchange when selling their respective coins to interested patrons. With some of the largest ICO funding venture eclipsing over $152 million this year, it is hardly surprising to see Ethereum’s value skyrocket given its mechanism as the primary vehicle for ICO’s. Ethers are preferred over Bitcoins for ICO’s because the Bitcoin blockchain is substantially slower than the Ethereum one and, as a result, Bitcoin-based transactions often either require ever-increasing fees or simply are slower to process than Ethereum-based ones.

The number of coins sold in an ICO is often limited and, as a result, the more coins one can buy to cash in on potential future value, the better. Paul Vigna of The Wall Street Journal wrote about how one ICO, which dealt with a digital platform called Gnosis, sold out in 12 minutes flat, generating around $12.5 million in revenue for the company via Ether inflows. With such a massive uptick in what is essentially digital venture capital, many are optimistic about the future of Ethereum, citing its usage in ICO’s and its streamlined blockchain infrastructure.

With all crowdfunding projects comes the risk of failure, and while the cryptocurrency market is undoubtedly attracting a considerable amount of talented investors and innovators, some of the ICOs will invariably fail, leaving those that invested in them with nothing but now-worthless coins to show for it. A quintessential example of this was The Decentralized Autonomous Organization (DAO) presented by German startup Slock.it in 2016. David Siegal of coindesk.com said that they promised what was a “decentralized version of Airbnb.” After raising just over $150 million for the venture, the DAO was hacked, and millions were lost.

Later in Bovaird’s article, he talked about how, since a significant portion of Ethers are being used by these ICO startups, Ethereum’s value may be closely tied to the value of ICO’s due to there being not as many in direct circulation. Should some of the more heavily funded ICO’s go belly-up, there may be a considerable drop in the cryptocurrency’s value. Only time will tell, but if the popularity of ICO’s continues to rise, the demand for Ethereum to fund them likely will as well.

For Bitcoin’s decrease in market share and its increasing competition with Ethereum, the answer is perhaps less clear. As mentioned before, the Bitcoin blockchain network has less processing power and thus cannot handle as many transactions at once. Alex Sunnarborg of Coindesk reported that, with an average of 300,000 transactions a day on the network, the “blocks” in the digital chain that contain individual transactions are operating almost at capacity all the time. As a result, people who want their transactions processed quicker often pay fees to have them included. These fees, while minimal or non-existent only a year or so ago, had averaged over $5.00 on June 7, the report says. Despite the congestion, Bitcoin continues to appreciate, and this explanation fails to connect to why Bitcoin is losing market share.

A simpler answer could just be that, due to these scaling issues, Bitcoin is less liquid than Ethereum, and as such is just adapting to a different role in the market. Competitive pressures from alternative cryptocurrencies could spur capacity-enhancing changes in the technology behind Bitcoin, and the gains that Ethereum is making on the historically dominant cryptocurrency may equalize out.

It is important to note that the volatile nature of the cryptocurrency market due to lack of regulation and insurance against collapse has made it one that could be prone to bubbling in the same way that traditional markets did throughout the early 2000’s. Writers like Clem Chambers from Forbes claim that cryptocurrencies are a bubble, but will not be gone when it inevitably bursts. While the Senate is pursuing some oversight, the continuing short-run appreciation of Bitcoin, Ethereum, and other alternative currencies could further fuel concerns of bubble-like behavior, particularly given the risks of hacking and ICO’s failing.

Given Japan’s adoption of Bitcoin and others countries’ increasing legitimization of the currency, it is possible that Ethereum could also emerge as another digital method of payment somewhere down the line. Fortune reports that even large companies such as Microsoft and JP Morgan are adopting the technology behind it. Consumers may eventually be able to find themselves with the ability to choose which digital currency suits their needs best, with a whole range of digital, ICO-based products to buy with it.

 

Read More:

“Bitcoin Monday: From Record High to Down 10% Before You Got Out of Bed” (Paul Vigna, Wall Street Journal)

“Cryptocurrency Market Capitalizations” (CoinMarketCap.com)

“3,000% gains in 2017: What’s Next For Ether Prices?” (Charles Bovaird, Coindesk.com)

“Charts: Bitcoin’s Network is Objectively More Congested Than Ever” (Alex Sunnarborg, Coindesk.com)

“Cryptocurrency is a Bubble” (Clem Chambers, Forbes)

 

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