The big ETH “bubble” of 2017

Giotto De Filippi
Aug 8, 2017 · 4 min read

If bitcoin did well in 2017 then ETH did extremely well.

It’s never possible to know for sure what causes what in the market however we can try to make an educated guess.

Understanding the principle of price pressure, which is basically determined by offer and demand, we can try to analyze what happened to the price of ETH in 2017. First of all we have to understand that in the world of virtual currencies there are several criterias that will determine the price:
– Desire to hold (reserve of value)
– Need to purchase (use case)
– Lock duration

Let’s look at them in order. If you believe a currency that has certain properties like for example it cannot be taken away from you and allows to make instant payments for any amount without restrictions you may actually want to hold to that currency instead of holding traditional government issued currencies.

This is the idea of reserve of value and is why people have traditionally held on gold despite the fact that it is so impractical (difficult to move, expensive to store, difficult to divide in small units and not accepted anywhere in the world — try to buy a coffee with gold).

Sometimes however you need to purchase something because you have to, let’s say you want to buy something from China then you must buy CNY.
In this case you buy because there is a purpose for it and not because you believe that it’s useful to hold to that currency.
At some point however the Chinese supplier will have to buy raw materials from abroad and may have to sell his CNY for USD (“unlocking”).
The longer it takes however the more we can say that the CNY is “locked” and so the less supply of CNY for American companies to buy from when they need to buy Chinese goods.

In the case of ETH what created the demand is the need for people to buy ETH in order to participate to ICO. ETH allows to create what is called an ERC 20 token. It’s basically some sort of minor virtual currency that runs on the ethereum block chain. It usually gives some rights regarding the use of an application, a network, etc.

The people running the ICO use ETH because it’s very convenient. They can use the smart contract features of ETH to instantly generate those tokens when people send the ETH to the smart contract address. The smart contract can regulate things like the total supply of tokens, the price, etc.

Some people argue that ETH is competing with bitcoin. This is not really the case as the use cases are very different:
– Bitcoin is used to make payments like for example remittances or large payments which needs to be fast and irreversible. People hold bitcoin because they believe it’s a superior form of currency. So when they receive a payment in bitcoin they may decide to store it in bitcoin instead of selling it right away purely for psychological purposes.
– ETH is used by speculators that want to speculate on ICO. They buy it because they have to if they want to participate to the ICO. The people organizing the ICO usually don’t sell their ETH right away but they hold to it probably for different reasons, transparency, hope of speculative gains, and simplicity as they then avoid the banking system altogether.

What happens is that as more and more ICO are done more and more ETH are locked into the smart contracts of those ICO. It is true that at some point they would have to sell some of the ETH in order to cover their operational costs but we also have to consider that:
– The number of ICO keeps increasing so the amount of ETH that gets locked increases faster than the amount that gets unlocked
– Most ICO raise a lot of money potentially to cover their costs for many years, meaning that they may start selling a small percentage of their ETH to cover current costs but they still keep most of it for years.

The result of this is that the available supply of ETH that people can purchase to do ICOs becomes less and less and so the price increases.

My personal view is that ICO are not going to go away anytime soon, so I believe the price of ETH in dollars will continue to increase over the long-term. However it’s a lot more difficult to say how it’s going to perform compared to BTC, especially now that the SegWit issue seem to have been resolved after a long struggle which divided the community and probably helped ETH to increase in value.

However to some extent an investment in ETH can also be considered more risky. The reason is that bitcoin is perceived already as a reserve of value for payments which is a simple application. Bitcoin doesn’t need to compete on features as it is already the gold standard. ETH however needs to compete on innovation meaning that it’s always at risk of being replaced by some other competitor. Considering the very high market capitalization of ETH compared to the initial market capitalization of most ICO that will become potential competitors the risk reward ratio for ETH compared to its challengers is not very favorable.

“murbard” is the founder of Tezos, a competitor to ethereum which raised around $250 million which is around 1% of the market capitalization of ethereum. Meaning that if it can only get 10% of the market share of ethereum investors stand to make 10x gains. In order for ethereum to deliver 10x gains however it would have to reach $200 billion in market capitalization which is much much harder than for Tezos to reach $2.5 billion (10x).

Giotto De Filippi

Written by

ICO Advisor

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