What’s Behind Ethereum’s Price Moves Lately?

A notable series of technical events has occurred on Ethereum in the past few days, leading to positive price momentum. We noticed Ethereum breaking above its 100MA for the first time since May 2018 on 17 Feb, helped by short covering in the markets. Market participants then were collectively net-short (52% shorts 48% longs on 17 Feb) on BitMex (which we hardly see).

Source: Twitter

On 18 Feb, price broke convincingly above the descending trendline that has capped Ethereum’s price action the whole of last year. Next, if Ethereum were able to break above its most recent high of $165, then price will have made a higher high for the first time since the bear market started.

This will dramatically increase odds that the bear market is over, although this does not imply price is bound for an immediate V-shaped recovery. The most likely scenario is for price to trade sideways for an extended period of time.

Source: Circuit Capital, TradingView

Why has Ethereum been outperforming Bitcoin to such a large margin?

Fundamentally, we believe this is likely driven by the Constantinople hard-fork upgrade due to happen on the 28 Feb 2019. As the Ethereum network moves towards the upgrade, the algorithm enters what we call an “ice age”. The ice age is a difficulty adjustment scheme implemented to incentivize everyone to move to the new chain.

Due to the ice age, block issuance has slowed dramatically as block times have increased. While daily issuance used to be ~21,000 ETH per day in 2018, this has temporarily dropped to 12,500 ETH/day today. With less overhead supply, (1) there’s much less sell pressure on the open market by miners, (2) miners begin to simultaneously hold onto their mined ETH rather than sell since they expect higher prices in the near-term, (3) smart money begin to speculate on the long side.

Source: Etherscan

Once the 28 Feb Constantinople upgrade (consisting of 5 proposals) goes live, one of the proposals (EIP-1234) to do with monetary policy will permanently institute a reduction in inflation from 3 ETH to 2 ETH per block (~14,000 ETH per day). While initially a controversial proposal with miners pushing back against the change in inflation rate as it would lead to reduced revenue, the community has now broadly accepted the proposal.

https://github.com/ethereum/EIPs/blob/master/EIPS/eip-1234.md

The other piece of the puzzle is that ICOs are most likely done with treasury selling. Based on data, ICOs have collectively raised 15% (15m ETH) of the total Ethereum’s supply of 100m. Because Ethereum’s blockchain is public, we know most of the selling pressure has abated and only 2.8m ETH is still being held by ICOs. Of the 2.8m ETH, the two largest holders DigixDAO and Golem who own 770k ETH collectively have publicly committed to stake instead of selling. Other large ICOs such as Gnosis have committed to the same.

The inflation rate for Ethereum is estimated to be 4.78% for the rest of 2019. Later in the year Ethereum will prepare for the move to Proof of Stake due for end-2019, which will see the next reduction in its issuance rate.

Coincidentally, Thomas Chippas, CEO of ErisX, sent a letter a few days ago to the U.S. Commodity Futures Trading Commission where he talks about the importance of Ethereum futures for the market health. He summarized the benefits in the letter and how an Ethereum-based regulated investment structure would “promote responsible innovation and development in the derivatives market.”

“ErisX believes that the introduction of a regulated futures contract on Ether would have a positive impact on the growth and maturation of the market for Ether, as well as the Ethereum Network more broadly.”

There are other considerations to take note such as the issue of potential security. Since late December last year, there has been around 30% less blocks being produced, which means less incentive for miners as the probability of block rewards is lower as they mine fewer blocks on average. This may result in lower hash rate over time.

Source: Etherscan

The time required to mine a block is now over 40% longer than it was in December. This is the direct result as the network capacity becomes more scarce, although this will normalize post Constantinople.

Source: Etherscan

Even though block time has increased, transaction fees are still quite stable, possibly due to declining number of on-chain transactions on the Ethereum blockchain.

Source: Etherscan

Circuit Capital is a new fund for a new asset class. Crypto requires the application of new strategies, tools and heuristics built on top of a deep understanding of the unique propositions and aspects of this emerging asset class. Our goal is to generate venture-style returns with secondary market liquidity. While it is clear money supply dynamics drastically impacts the price of Ethereum (or any token other than a stablecoin) in the short-term, the longer-term drivers in valuation will be always determined by fundamentals such as network growth, disruption of current business models, and new business applications (think #DeFi).

Please let us know if you want to know how this impacts Circuit Capitals’ views on portfolio construction.

Thanks to Aaron Tay for co-authoring this article.

Disclaimer: This material is for our clients only. This material is based on current public information that we consider reliable, but we do not represent it as accurate or complete, and it should not be relied on as such. Our research is not an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. It does not constitute a personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual clients. Clients should consider whether any advice or recommendation in our research is suitable for their particular circumstances and, if appropriate, seek professional advice, including tax advice.