Just when you thought the cryptocurrency market was (finally) on its way down, another remarkable surge kept the headlines pointed to the positive direction. This time around, though, it was Ethereum (CCC:ETH-USD) that garnered the most praise.
While still the No. 2 cryptocurrency by market capitalization, it has been No. 1 in terms of raw percentage moves by established blockchain-based assets. Over the trailing seven days (the time of writing is May 3, 2021), Ethereum gained nearly 32%. Aside from Binance Coin (CCC:BNB-USD) at 22% up, nothing else among the top-ranking major coins comes close.
Further bolstering bullishness in Ethereum is evidence that suggests ETH is moving higher based on its fundamentals. The underlying blockchain will undergo a significant change, labeled as Ethereum Improvement Protocol EIP1559, which I’ll discuss shortly in detail. But the main takeaway is that investors appear to be banking on the protocol change rather than pure speculation.
According to Matthew Dibb, COO and co-founder of Stack Funds, stated “Ethereum’s funding rates remain flat and went negative early today on FTX … Our view is that the spot-driven rally for ETH is primarily due to excitement around the impending EIP 1559 upgrade.”
It’s more than a reasonable assumption. According to Coindesk.com, “The funding rate, calculated and paid every eight hours, refers to the cost of holding long positions in perpetuals (futures with no expiry). A high funding rate implies increased buying in the derivatives market, which doesn’t appear to be the case with ether now.”
While that might be encouraging for Ethereum, which is currently priced above $3,000 and looks primed for a move to $4,000 and perhaps $5,000, the dynamic is a double-edged sword. When people were speculating on the ETH price movement, you can use technical analysis to assess trader psychology.
But if it’s true that ETH is now trading on the fundamentals, you must have a deeper understanding of EIP1559.
Ethereum and the Pandora’s Box of Fundamental Investing
Please note that I’m not going to provide this deeper understanding for Ethereum. I’ll lay out the framework, but it’s entirely your responsibility to perform due diligence.
On a very basic level, Ethereum’s blockchain provides the backbone for multiple applications. But like any system, Ethereum requires administrators to keep the operation running smoothly and efficiently. As you know, blockchains are inherently decentralized, so the process of administration rests on the shoulders of ETH miners.
Of course, nobody performs work (at least not for long) without financial compensation. To incentivize miners to perform their necessary administrative tasks, the Ethereum blockchain requires “Gas” payments to successfully conduct a transaction or execute a contract on the network. Technically, Gas is a fee paid in ETH coins to miners for their efforts.
Practically speaking, though, Gas is a bribe. That’s because during periods of network congestion, miners must prioritize which transactions go first. This is where miners earn their paycheck because their collective tasks keep the Ethereum network running smoothly when it’s under pressure. However, this process also creates inequity because the well-heeled will always get their transactions fulfilled by raising their Gas bid.
To remedy this, ETH advocates proposed EIP1559, which introduces transparency to transaction fees and automates the Gas bidding system. It also strongly mitigates control that miners previously had over the network’s transaction flow in part by doing away with the winner-take-all system of the Gas bidding process.
In other words, EIP1559 disincentives Gas bribes and that will cut into Ethereum miners’ earnings. Not surprisingly, many miners are up in arms about EIP1559.
To me, this poses a Pandora’s box situation. While EIP1559 helped drive ETH’s price to the stratosphere, it could also hurt the valuation if the proposal doesn’t work out as planned. And I think there’s a big possibility of this.
Life Is Never Meant to Be Fair
While economic equity ranks among the most-discussed topics over the trailing year, scientifically, equity is a negative attribute. For instance, you will find equity in a dead battery — dead because the inherent reaction in the battery is at equilibrium and therefore, energy potential is zero.
That’s the first thing I thought about when I read the details regarding EIP1559. In my opinion, the new protocol takes away from the capitalist incentive that drives human innovation. There’s a reason why the Soviet Union failed: it focused on equity among workers and in so doing, created an equilibrium of mediocrity because it disincentivized superior performance.
Why work harder when you’ll get paid the same as everybody else who does the bare minimum?
I’m not an Ethereum miner so I can’t speak from first-hand knowledge. But it appears that the original Gas protocol incentivized miners who did their job well and received handsome profits as a reward. Thus, getting rid of this process may spark unintended consequences.
It almost seems like Ethereum is going economically “woke,” as the kids like to say. While this sounds good on paper, it may not work out well in reality over the long run.
On the date of publication, Josh Enomoto held a long position in ETH.
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.