Nov 4, 2021 | Articles, Personal Finance

The transformation that could see it overtake bitcoin



THE WORLD’S second-most valuable cryptocurrency, ether, has been touching all-time highs in price ahead of a major upgrade of its underlying platform, ethereum.

Ether is currently worth in aggregate just shy of US$500 billion (£363 billion).  That’s still slightly less than half that of the biggest cryptocurrency, bitcoin—but could this upgrade, a vital step towards a much greener and faster version of the current system, put ethereum on the path to becoming the dominant platform on the internet and make ether number one?

First of all, it’s important to understand the difference between bitcoin and ethereum.

Bitcoin is a system for allowing people to send value between one another without the need for banks.  It is built on a technology known as blockchains, which are online ledgers whose transactions are checked and recorded by a decentralised network of computers known as validators.

These validators are incentivised for their work by receiving newly minted bitcoin as rewards, in what is known as ‘mining’.  To make this more attractive, bitcoin is relatively scarce—only around 18 million coins are in existence, and the protocol is such that there can never be more than 21 million.

Ether works in a similar way to bitcoin, but ethereum is different.  It is a worldwide software platform with no host, on which developers are building thousands of blockchain-based applications.

This means that these applications can all run without being controlled by a company.  Examples include crypto-currency exchanges, insurance systems, and new kinds of gaming.

At the heart of the platform is the idea of smart contracts, which are automated agreements that ensure that money and assets change hands when certain conditions have been fulfilled.

All transactions on the platform ultimately use ether, and the success of the platform is why ether has been the second-largest cryptocurrency after bitcoin for the past few years.  The fact that ether fuels the platform—even being referred to as ‘gas fees’—gives it a utility and an intrinsic value that bitcoin does not have.


Why ethereum 2.0?

Ethereum has several major problems, however.  The first is that ‘gas fees’ have become very expensive in the last couple of years—because the network has become so popular, and is therefore very congested.


Validators prioritise users who are wil-ling to pay the highest fees for their transactions.  For example, the average transaction at the time of writing on crypto exchange Uniswap costs around US$44 in ‘gas fees’.


Bitcoin has comparable issues with congestion, which its developers are trying to solve by building applications like Lightning on top which boast faster transaction speeds.


The second problem for ethereum is that, as it has become more popular, the amount of computational power used by validators has rocketed.  It’s the same problem that has brought a lot of negative publicity to bitcoin, because it uses a lot of electricity.


Bitcoin is currently using as much power as the whole of the Philippines, although its supporters argue that much of this is power that would otherwise be wasted—for example, oil rigs burning off natural gas because it’s not profitable to sell it.  Proponents also point out that the network is shifting towards using much more renewable power over time.

At any rate, the eventual creation of an ethereum 2.0 will solve these problems by moving the platform’s system of validation from ‘proof of work’ to ‘proof of stake’.


Without getting into too many details, ‘proof of work’ is a protocol in which validators all attempt to solve complex equations to prove that each proposed transaction is valid.  With ‘proof of stake’, there’s no need for all validators to do this power-hungry work, because the system chooses one at random to confirm each transaction.


Many in the bitcoin community are against ‘proof of stake’ because it gives the most power to the biggest validators, potentially allowing them to corrupt the system of validation if they can get control of more than half of the network.  Ethereum supporters counter that ‘proof of stake’ has checks and balances built in that would prevent this from happening.


Either way, ethereum 2.0 promises to reduce the platform’s power consumption by 99.9%, making it far more sustainable.  It should also solve the problem with ‘gas fees’ by raising the platform’s processing ability from 30 transactions a second to potentially 100 000, as well as making possible more sophisticated smart contracts than before.


How it’s going

The transition to ethereum 2.0 has been a slow one, riddled with technical issues that have dragged on for over two years.  For the past few months, the new ‘proof-of-stake’ blockchain has been running in a test format in parallel with the existing system, allowing the developers to prepare it for a merger in 2022.


The forthcoming upgrade is essentially a warm-up for this merger.  Known as Altair, it introduces numerous technical changes that are designed to keep validators honest and make the system more decentralised.  Assuming that this goes ahead as planned, all eyes will be on the merger—and then later, another change known as ‘sharding’ which will greatly increase the system’s processing capability.


Certainly, the price of ether has been strong ahead of the Altair upgrade.  The recent surge in bitcoin to all-time highs has been helping to lift the entire crypto market—but some of the price movement in ether probably reflects people betting that the upgrade will succeed, while the rest is from speculators switching from bitcoin, and new money moving into the space.


Bitcoin: Not giving up the top spot just yet

Why its value has rocketed once again



BITCOIN’S JOURNEY into mainstream finance has reached another major milestone—and another record price.  The cryptocurrency was trading at US$66 975 (R992 402) following the launch of an exchange traded fund (ETF) in the US, which has dramatically increased bitcoin’s exposure to investors.

The fund, which opened on 19 October 2021, allows investors to speculate on the future value of bitcoin —without actually owning it.  It is the first time that investors have been able to trade an asset related to bitcoin on the New York Stock Exchange, and was preceded by much media attention and hype in financial markets.

It began trading at US$40 (R593) a share and finished the day up 5% with some US$570 million (just under R8.5 billion) of assets, making it the second most heavily-traded new ETF on record (the first was set up by BlackRock, the world’s biggest asset management company).

The impact on the price of bitcoin has been extraordinary.  It soared past its all-time high of $64 895 (R961 582) to the new record of $66 975 (R992 402) and at the time of writing, was hovering around $65 000.  This is a big change from mid-July when bitcoin hit a 2021 low of under $30 000 (R444 525), reflecting its huge volatility.

Many financial institutions have previously tried to get approval for bitcoin ETFs without success.  Until now, the Securities and Exchange Commission (SEC) (the US government agency which protects investors) has been reluctant to approve any. This was partly due to the intense volatility of bitcoin, as well as broader concerns about the unregulated industry of cryptocurrencies.

But Gary Gensler, chairman of the SEC, said the commission would be more comfortable with “future-based” ETFs because they trade on a regulated market. This is a significant change of direction for the SEC which has happened since Gensler arrived at the helm in April 2021.

ETFs trade like any normal stock, are regulated, and anyone with a brokerage account can trade them.  This new fund, named the ProShares Bitcoin Strategy ETF (or BITO for short), is the first to expose mainstream investors to the highs and lows of bitcoin’s value, without them having to go through the complex process of purchasing the coins themselves.

Although US investors could already buy bitcoin futures directly from the regulated Chicago Mercantile Exchange and unregulated exchanges such as BitMEX (as well as bitcoin directly from unregulated exchanges), the launch of an ETF opens up the market to a wider variety of investors, including pension funds—and adds to the growing acceptance of bitcoin in the financial markets.

Some are still sceptical of bitcoin due to its link with criminal activity, although a recent report suggests that this seems to be diminishing.  While Jamie Dimon, chief executive officer of investment bank JP Morgan, claims that bitcoin is “worthless” and that regulators will “regulate the hell out of it”, the bank nevertheless gave its wealth-management clients access to cryptocurrency funds in July 2021.


Banking blockbuster

Eric Balchunas, a senior analyst at Bloomberg, is not surprised by the price appreciation and described the ETF launch as “a blockbuster, smash, home run debut [which] brings a lot of legitimacy and eyeballs into the crypto space”.

However, what impact will BITO have on the cryptocurrency space?  As a new product, it has already exposed more investors to the ups and downs of bitcoin’s value in a regulated market.  Many of these are likely to have previously felt uncomfortable buying cryptocurrencies from unregulated exchanges and having to store the asset themselves.

Other investment funds with an interest in cryptocurrencies will be no doubt be encouraged by BITO’s success, and keen to list ETFs of their own which are exposed to bitcoin and its rivals.  Several other ETF providers are likely to launch their bitcoin ETFs in the days following ProShares’ debut, including Invesco, VanEck, Valkyrie, and Galaxy Digital.

It is a development which is bound to make investing in cryptocurrencies easier and more common—and an important stepping-stone for their adoption into mainstream finance.


Daniel Broby is the director of the Centre for Financial Regulation and Innovation at the University of Strathclyde (Glasgow).

Andrew Urquhart is a professor of finance and financial technology, ICMA Centre, Henley Business School, University of Reading.


These articles are republished from The Conversation under a Creative Commons Attribution-NoDerivatives (version 4.0 International) license.