Ethereum Investors May Be Looking at the Wrong Enemy

Astute readers will recall that I’ve previously described Ethereum’s (CCC:ETH-USD) blockchain architecture as a sign of natural progress in the cryptocurrency narrative. As you know, the introduction of Bitcoin (CCC:BTC-USD) wasn’t just significant for the digital token itself but also for introducing the blockchain concept. With it, peer-to-peer transactions were possible and, quickly, a crypto-based economy blossomed.

A stack of ether or ethereum coins on a gold background.
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But the main problem with Bitcoin was that its creator or creators apparently didn’t anticipate how wildly popular BTC would become. As more people used Bitcoin’s blockchain, the entire system became unwieldy, cumbersome and expensive. In other words, it wasn’t performing its intended P2P function very well. Soon, BTC became a store of value.

On the other hand, the programmers behind Ethereum intended a much grander application. Taking the blockchain concept, they realized that you could conduct various other transactions besides virtual currencies across a public, decentralized and distributed ledger — we’re talking business deals, real estate transactions, legal documents, etc. Thus was born the concept of smart contracts.

Inflation Hedge (or Not)

To be fair, though, how many people are buying Ethereum tokens with that purpose in mind? Obviously, I can’t speak for everyone’s motivation, but the profitability factor is probably the strongest factor. And driving this sentiment is the idea that cryptocurrencies represent a hedge against inflation.

This is hardly a new concept. As you know, central banks essentially have the power to “print” money. Yes, I understand it’s not quite that simple but nevertheless, central bankers certainly have multiple monetary tools at their disposal to address and influence economic matters.

On the other hand, Bitcoin has a hard cap of 21 million coins that can ever be created. Obviously, this contributes to BTC’s wildly high price tag. As such, it’s a viable inflation hedge. However, under a similar logic, Ethereum is also a solid candidate for an inflation hedge.

While ETH doesn’t have a hard supply limit, it has a fixed issuance schedule. So long as demand continues to outpace supply, this crypto is an effective inflation hedge.

Ethereum and Others Chasing the Wrong Enemy

Over the last several weeks, we’ve seen wild pricing dynamics impact the Ethereum price. As I write this, ETH is back riding the bull, moving toward $1,900 and perhaps well beyond that. We’ll see what happens.

Still, one of the concerns that I have about Ethereum and the broader crypto complex is that it appears retail investors are chasing the inflation narrative. Frankly, this is an enticing story for two reasons. First, it makes sense. Again, central banks can print money at will while public consensus among crypto miners determine ETH’s supply.

Second, you have the familiar tale of media coverage. Recently, I saw a headline from The New York Times that read, “Inflation Fear Lurks, Even as Officials Say Not to Worry.” This type of coverage reiterates that inflation represents investors’ greatest concern; hence, you should buy stores of value or safe-haven assets.

The problem is that it might not be true. For starters, if inflation was truly the biggest threat, then gold prices should be moving higher. They’re not.

Second, Robert Barone, Ph.D., a Georgetown-educated economist made an excellent observation that every single bleeping investor should note. “Last year, during the pandemic, because of the rapid move toward automation, productivity actually grew (4%) much faster than wages (1%).  That’s deflationary!”

Further, Barone argues that “Systemic inflation is a process and it occurs only when whatever is causing it is persistent.” About the only thing that’s inflationary is the mainstream media talking about inflation at seemingly every corner. But the deflation story doesn’t get as much airtime.

Frankly, we may have systemic deflation. I’ve mentioned this before but the personal savings rate is at multi-year highs. Moreover, money velocity, or the rate that each unit of currency circulates in the economy, is near record lows.

In other words, it’s hard to spark inflation if no one is spending money.

Be Aware of a Possible Downturn

In this round, I’m not here to give you buy/sell recommendations. Rather, I hope you’re assessing the deflation risk and how that might affect Ethereum and other cryptocurrencies. Likely, we may face a correction over the next few months, if not weeks.

This doesn’t mean that over the long haul, Ethereum can’t make a massive comeback. But I think it’s quite telling that if you analyze its technical chart, the ETH price has been rising this year while volume has generally declined. This type of contradicting movements typically results in a bearish resolution.

While I will refrain from buy/sell ideas, I will say that if you’re thinking about going big on Ethereum (or other cryptos) today, you might want to perform your due diligence first. As for me, I’m not comfortable about the monetary setup, so I’m in a holding pattern.

On the date of publication, Josh Enomoto held a long position in ETH, BTC and gold.

A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.

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