Examining the Relationship Between Ethereum Usage and the Value of Ether

  • Commentary
  • July 11, 2020

Despite stablecoins and decentralized finance (DeFi) continuing to drive demand for gas consumption on Ethereum, and the smart contract network seeing higher usage than ever before, the price of Ether has remained largely range-bound in recent months both versus USD and BTC, raising important questions concerning the relationship between the network and its native asset as well as broader questions surrounding cryptoasset valuation.

Although Ethereum is positioned as a general smart contract platform suitable for a range of applications, the network, for now, has found product-market fit around stablecoins and DeFi. For instance, following months of sustained growth, there is now $8 billion worth of stablecoins issued on the network and $2.14 billion in capital locked in Ethereum DeFi protocols. On top of this, a third trend, closely tied to DeFi, has also recently emerged: the tokenization of Bitcoin on Ethereum. In total, $135.8 million worth of BTC has migrated to Ethereum, with 92.4% of such activity having occurred since the beginning of the year. As a result of these new use cases, the Ethereum network has never been more widely used, with gas consumption recently hitting new all-time highs, following a period of sustained growth even before the recent gas limit increase. Notwithstanding this increased usage, Ethereum’s network value, determined by the price of Ether, has been largely in-tune with other major cryptoassets whose respective networks have not seen at all similar increases in demand, pointing to a disconnect between network demand and Ether value capture.

Network Value of Ether vs Bitcoin, XRP & Bitcoin Cash (1 Year Log Scale)Screenshot 2020-07-10 at 11.03.21.png

Source: Coin Metrics

It has been highlighted by some that, unlike during the 2017 ICO period, whereby users were required to purchase ETH to participate in token sales, today’s use cases typically do not impose the same requirement and can be conducted via stablecoins. This has arguably undermined the main incentives for accumulating ETH and leaves the requirement to hold ETH for funding gas costs as the main fundamental value accrual mechanism. Over the medium- and long-term, it is plausible that the introduction of staking as part of ETH 2.0 and the possible introduction of a burning mechanism through EIP-1559 or similar proposals will dampen liquid supply and introduce incentives to hold the asset sufficient to support value capture for ETH. In the shorter-term, however, such a reversal is less certain. Some analysts have suggested that the use of Ether as collateral in DeFi could plausibly serve as an emergent value driver, however, such claims frequently underestimate the counterpressure on the amount of ETH required to fund debt positions that lower collateralization ratios will engender, should robust credit scoring, identity and reputation systems emerge. Perhaps the greatest chance of ETH price appreciation over the next six months, however, is ultimately the willingness by market participants to price-in the projected value of the asset based on the assumption of staking and new cryptoeconomic mechanisms being introduced, in much the same way as equity prices supposedly represent predicted future cash flows.

Ultimately, whether ETH and indeed other cryptoassets trade at all in concert with their underlying network metrics is still questionable. While the field of cryptoasset valuation has developed substantially over the past two and a half years, there is negligible evidence that any asset trades in accordance with newly proposed frameworks, with most assets seemingly continuing to respond to macro theses and narratives above anything else. The ability for a community to deliberately steer the valuation or token economic narrative surrounding a network’s native asset should not be underestimated and is indeed something many in the Ethereum community have attempted to push with memes such as ‘ETH is money’. One can look to the successful pivot, consciously directed or otherwise, concerning Bitcoin, which, despite almost no changes to its fundamental technical or economic architecture, is now largely perceived, at least by those favorable to the asset, as ‘digital gold’ due to its supposed store of value properties and resulting value accrual potential rather than peer-to-peer electronic cash as originally underscored in its whitepaper. Indeed, the lesson from Bitcoin and the struggle that Ether is arguably undergoing, for now, offer valuable lessons for all cryptonetworks, especially those whose security and ecosystem funding rely principally on the value of their native cryptoasset.