All views expressed here, unless referenced, are the author’s own, and for informational purposes only. It should not be considered financial advice. You should consult with a professional to determine what may be best for your individual needs.
What is Ethereum?
Ethereum is a platform for decentralised applications built on blockchain. In that way, it is similar to Bitcoin.
While Bitcoin was designed to be a cryptocurrency , Ether (the ‘currency’, or fuel, of the Ethereum network) was meant to pay for specific actions on the Ethereum network, with users receiving it for using their computing power to validate transactions, or for contributing to its development .
This incentivises contributors to write quality applications (wasteful code costs more), and to keep the network healthy (people are compensated for their contributed resources) .
However, since Ether is currently the second largest (by market cap) cryptocurrency traded on multiple online exchanges worldwide, it is currently perceived as a newer, slightly different, alternative to Bitcoin.
Why are cryptocurrencies interesting?
The advantages of cryptocurrencies include:
- A decentralised system, removing the need for third parties like banks and institutions.
- The above means reduced fees incurred, 24/7 availability, and faster and more transparent transactions.
- Every payment is secured using advanced cryptography.
- The possibility of anonymously/privately making payments.
- Price is affected almost purely by supply and demand, and not (currently) directly subject to interventions by nations or governments by laws. However, as such, cryptocurrencies tend to be more volatile, especially in their current nascent stages (Bitcoin, the pioneer cryptocurrency, came online in 2009).
Another key difference between Ethereum and Bitcoin; Ethereum also allows for smart contracts. In a nutshell, these are self enforcing contracts; think of contracts where you don’t need a lawyer to help you facilitate the negotiation or performance of the contract, because it enforces itself, relying on “if-then” scenarios to execute specific terms of an agreement .
For a video explanation on Ethereum, click here.
The Opportunity for you and me
Or rather, Why is this an investment worth considering?
For much of the history of Finance, the bigger players have had the “house edge” over the individual investors like you and me. They
- Spend more time researching companies listed on Exchanges,
- Have better access to the decision makers and relevant news,
- Employ more, and better-trained, talent, to find market-beating returns, and
- Make bigger investments in improving their infrastructure to trade better (computers, servers, etc).
Recognising that limitation has led to the rise of index funds; if you can’t beat the market, join it, and pick out a low cost diversified fund that tracks the market.
The Internet changes everything
It’s only recently in the history of Finance that the Internet has democratised access to the markets, allowing individuals sitting at home or even commuting to work, to trade, without the help of a human broker to execute the trades.
Additionally, with alternative investments like Cryptocurrency, this is perhaps the first time the bigger players do not start so far ahead of the retail investor, because:
- Relevant news on cryptocurrencies is still scarce, and the investments are too volatile to be predicted with any accuracy suitable for large bets.
- Given the current interest rate environment and (at least for U.S.) stock market bull runs, investors can, with more confidence, pick portfolios which offer steady returns with better researched, more physical, and more established assets.
- An increasing variety of potential investments e.g crowdfunding, angel investing, on an international scale, that can dilute attention.
Finally, besides the allure of potentially having a politically-agnostic currency that can be freely traded, and used to pay, and receive payment, there is also the opportunity offered by smart contracts. Hypothetically, and ideally, successful implementation of smart contracts affects and massively undercuts (price wise) compliance and legal services, to name two.
These are currently expensive relative to what they could be, and among the few fields left in the world to be disrupted properly by the Internet and it’s associated innovations since 2000 (sweeping statement, sure, but then it’s just my opinion).
If you believe this makes sense, then you see why Ethereum could be in demand in the future.
Why did I make the investment?
Cryptocurrency (to me) is an example of an asymmetrical investment. i.e., it has limited downside but much more upside.
If you compare ETH to Bitcoin; at the point of writing BTC is currently valued at >1000 SGD, while ETH, which fulfills many of the same functions of a currency (it has value (although not a reliable store), easily traded, and used to fuel the Ether network which is increasing in use), is valued at <10% of that. (A little bit of digging yields that Bitcoin too, once traded at ~$10 and it’s value today reflects a 100x increase. History doesn’t repeat itself, but Ethereum investors are hoping it does rhyme).
In a sentence – while (current) Ethereum supply is ~5.5 times the BTC supply, it’s valued at 1/19th of Bitcoin (refer to above image).
Furthermore, while the current yearly increment of Ethereum is capped at 18 million units, sometime in 2017 changes are expected to be made to the network that should bring down supply more .
Basic economics tells us what happens to price when supply drops, all else being equal, and definitely in the face of rising demand.
Finally, from a qualitative standpoint: for those who read Taleb’s (Nassim Nicholas) books, he refers to the concept and “convex” or asymmetrical events. The example Taleb uses in his books is that of Thales of Miletus.
The same fundamentals apply to option trading; making a prediction which is non-obvious based on chance or factual reasoning (or both), using money to take a position, and cashing out if said prediction comes true. Because it is non-obvious at the point of investment, your investment cost is small compared to the return if it is true.
All of this led me to put in a token amount in Ethereum in January earlier this year. I wish I could say I predicted the spike, but as Ray Dalio (founder of Bridgewater, one of the world’s largest hedge funds) says:
More realistically, I was confident enough the price would go up to invest an amount I was comfortable with losing.
As of late March, ETH has already gone from 15.19 SGD to 72 SGD, booking me a ~4.75x appreciation within 60 days, or a pure profit of 3.75 times my original investment. In percentage terms, that’s a 375% gain.
By comparison, if I pick stocks or bonds, my projected returns are much lower. Even a consistent 10% per annum is above market returns, and unmatchable by most hedge funds and professionals (after fees).
Extending the comparison further, a hypothetical return of 30% per annum is already in “Legendary Investor” league comprising names like Soros and Buffet. And it would take me 6 years with a consistent 30% return to make the same 4.75x appreciation that happened over 60 days; this should illustrate what an outlier this was.
However, I hold no illusions that such feats will be harder to replicate in the future, especially on a consistent basis.
Choosing between ETH vs BTC
This debate can go a variety of ways. What suffices for me is knowing that they fulfil similar functions, facilitate business and transactions using the same protocols, and BTC is valued at 1000+ USD while Ethereum is currently valued ~ 50 USD.
From a pure investment point of view, if you believe in the underlying technologies, and macro trends, you’d have a potentially higher upside investing in Ethereum.
A quick side note – After an attack on “The DAO” (a venture capital fund based on the Ethereum network) with the aim of stealing Ether, the Ethereum blockchain was split into two; a “modified” version fixing the bug that allowed the attach to be successful (which trades under the original ticker ETH, for Ethereum) and the “original” code version (now trading under the ticker ETC, short for “Ethereum Classic”). This article will talk primarily about ETH.
Had I plugged in the amount I have in my index funds, into this ETH trade, I’d have made a life-impacting amount back.
However, fact prevails, and it is this author’s opinion that you see cryptocurrencies as a highly volatile, high risk investment that should take up a small proportion of your portfolio, if at all.
A good rule of thumb is to put in only an amount you are willing to lose. As a comparison, penny stocks also offer the same upside opportunity, but rarely do financial experts advise investing in them.
If you want to learn about the basics of investing with more sound fundamentals, consider the Factor Based Investing Course. Thank you for reading, and please, let me know what you think!
Bonus – Satoshi Nakamoto’s seminal white paper. on Bitcoin, which started the whole thing.