Welcome to the world of Ethereum investing! This guide aims to give you an overview of what you should consider if you’re intrigued about investing in Ethereum but don’t know where to start. Perhaps you’ve heard about Ethereum on the news or from a friend, and would like to read more – in which case, this guide is for you.
For traditional investments, there are standardised, well-understood methods for evaluating whether or not an asset is fairly priced, such as the price/earnings ratio of a stock, or the yield or credit rating of a bond. This doesn’t exist for cryptocurrencies – so how is it possible to determine if they are a good deal? How do we evaluate if they will rise in value in the future?
Your Risk Appetite
It goes without saying that cryptocurrencies are a high risk investment, compared to more traditional investments. This naturally means that it excludes certain investors from investing, such as those close to retirement. However, for others, the highly liquid nature of cryptocurencies, the global, 24/7 nature of the trading, and the possibility for extremely high capital gains makes them a very attractive investment.
See the image below for Bitcoin’s price over the past number of years. If you bought Bitcoin at the “wrong time” (something which is impossible to predict in advance) you would’ve been at a loss for quite some time afterwards.
Courtesy of blockchain.info
Benefits of Investing in Ethereum
– The potential for truly enormous capital gains. This is a very attractive reason to consider investment, given the current low-interest rate environment.
– Control your funds directly. You can store them offline (known as a cold storage wallet) or on a trusted exchange.
– After you purchase Ether, there are no middlemen taking a cut of your investment. You are free to buy more, sell as much as you like, send Ether to whoever you like (as long as they have an Ethereum wallet, with almost no restrictions.
– Some countries, such as Germany, have zero capital gains tax on currency, including cryptocurrencies (with certain restrictions). Obviously this situation could change completely in the future. However, there are almost no assets with similar upside to Ether that are lightly taxed or not taxed (check with a local tax adviser to be completely certain).
Read on for a detail description of the indicators you should consider when deciding whether or not to invest in Ethereum.
Indicators to Use
These are long term indicators which I have successfully used in the past when deciding on whether or not to invest. Most of these indicators will not affect the price immediately – the investor behaviour aspect of Ether (and other cryptocurrencies) is quite different to the stock market. For example, recently there were several conferences and Ethereum-related events, well known in advance, however the price still rose around the time of these events – not as soon as they were announced, as it normally does with the stock market.
Below are a list of indicators that I like to use.
- POW Mining difficulty
- Daily transactions
- Overall market cap
- Developer mindshare
- New exchanges adding Ether support
Let’s explore each indicator in more detail.
Buying and holding Ether is basically a bet that the Ethereum project leadership is competent, able to execute the Etherem project roadmap as planned (most notably the scaling challenge and the Casper/Proof of stake transition), and is honest. I strongly believe that the Ethereum project team can be relied on for all three.
Individuals such as Ethereum founder, Vitalik Buterin and Vinay Gupta are amazing people to tackle the challenge of moving the world towards adopting blockchains and smart contracts in many aspects of life.
Proof of Work Mining Difficulty
Proof of work is the current method by which Ethereum, Bitcoin and many other Altcoins are secured and can be relied upon to hold your funds securely in a wallet, and send them securely to someone else, without a middleman. It is a very reliable method of achieving this, and it is well understood having been around since the inception of Bitcoin. However, proof of work has one very serious drawback – it requires enormous amounts of electricity to operate a blockchain at the scale of Ethereum or Bitcoin.
In order to “mine” Ethereum, individuals purchase expensive computers and graphics cards, load them up with specialised software, and secure the Ethereum network. They get rewarded in Ether for supplying their computing power (aka “hashing power”). Since miners often spend thousands or tens of thousands or even millions of dollars, euros, yen, etc on computer equipment and electricity, they expect the price of Ether to stay reasonably constant or rise in the future, to ensure the see a return on their investment.
As more and more Ethereum miners are added to the network, the hash rate increases. You can see this effect in the image below.
Courtesy of EtherScan
The fact that so many miners are investing heavily in computer hardware is a strong positive signal for the future of Ethereum.
Very important: at some point in the future, Ethereum will switch from Proof of Work (POW), to Proof of Stake (POS). This means that the above chart will no longer apply.
I discuss the potential impact of Proof of Stake/Casper from an investment perspective here.
Daily Ethereum transactions are a straightforward indicator and easy to understand. However, I would put stronger emphasis on other indicators before this – as some transactions are simply one person moving ether between multiple wallets that they own, or other relatively meaningless scenarios. However, this number risen quickly recently, which overall is a positive signal.
Courtesy of EtherScan
Overall Ether Market Capitalisation
Courtesy of EtherScan
Market capitalisation (or market cap) is the overall value of Ether, calculated by the total number of outstanding Ether multiplied by the current price. This is a weak indicator. However, it’s a headline-grabbing figure for mainstream news outlets, therefore when Ether hits a new high, it gets reported on, which brings more newcomers into the world of Ether investing.
An important date in the future to watch out for is the date when (or if) Ethereum’s market cap overtakes Bitcoins market cap. This event will likely bring a lot of media attention, and drive the price higher in the short term. You can track the market cap of Ether and many other crpytocurrencies here.
Most of the current value of Ether is actually based on speculation, not on real-world usage of the Ether currency or Ethereum based smart contracts. Therefore, in order to live up to expectations and justify a multi-billion dollar market cap, Ether will have to be adopted by mainstream users of the technology.
Some recent examples of Ethereum adoption are listed below.
The Enterprise Ethereum Alliance is a very important group in the Ethereum world. It brings together many individuals and companies of all sizes including Fortune 500 companies, startups and Ethereum experts to collaborate on Ethereum projects. The EEA will likely use the Ethereum projects open source code to develop their own applications specifically tailored for large enterprises. Its likely you will hear about many proof of concept projects and gradually mission critical applications, based on Ethereum, being developed and used by the alliance members in the near future.
One important thing to note – enterprises are likely not going to use the public Ethereum blockchain, which is what you use when you buy and hold Ether. It’s likely they will adopt the core Ethereum code, and use it to create private blockchains, for example members-only blockchains between big banks that wish to trade assets with each other more efficiently. This means these etherprises are not buying large amounts of ether. However, the fact that large enterprises are using Ethereums code is a hugely positive signal. I may write more about what private blockchains means for Ether investment in a future post.
Asian Exchanges adding Ether Purchase Option in Local Currency
Originally, most of the interest in Ethereum came from the US and Europe. However, more recently some Korean and large Chinese exchanges added support for investors in those countries who wished to purchase Ether in their local currency. Obviously, this is a long term, positive signal, as more investors points to a long term price rise.
The effect of this adoption can be viewed here. At the time of writing, the two top Korean exchanges alone made up over 14% of the daily transaction volume.
Ethereum has been very successful at getting developers excited about the idea of building decentralised applications based on the Ethereum blockchain. You can find many examples of decentralised apps here. Whether Ethereum ultimately takes over the world, or gradually fades away will depend on the real-world applications that developers build, therefore keeping an eye on the projects being launched is a very important indicator of future growth.
Initial Coin Offerings – ICOs
Initial Coin Offerings are a method by which blockchain startups can raise funds without going down the typical venture capital route. The startup offers digital tokens to the public – tokens which are often built on top of Ethereum – and has an initial sale. Some time afterwards, the tokens can be bought and sold on secondary markets (cryptocurrency exchanges such as Poloniex), similar to how Ethereum and Bitcoin can be bought and sold. The fact that Ethereum makes it easy for startups to create their own ICOs demonstrates how Ethereum is shaking up the world of startup investment.
Coming soon, in this series on Ethereum investment:
- How to Purchase Ether with Coinbase
- Tools to use – Buy, Track and Secure your Ether Investment
- When to Buy Ether – what is a good moment to purchase Ether?