Ethereum Becoming a ‘Dividend Paying’ Blue Chip!
What makes a great investment? Whether we are talking shares or crypto, I believe great investments have many of the same characteristics: dominant and defensible market position, fast-growing sector or use cases, pricing power due to the strength of their brand or network, a track record of successful execution, recurring revenues, and of course sizable cashflow returns to investors.
As regular readers know, I’m one of the biggest advocates of Ethereum. For years, people in the space have watched Ethereum grow to become the most successful blockchain network for applications.
There was widespread scepticism along the way that they would never amount to much at all. But today, Ethereum is second only to Bitcoin in terms of market cap. In fact, the biggest trends in blockchain — including decentralised finance (DeFi) and non-fungible tokens (NFTs) — first gained traction on Ethereum. And what’s more, Ethereum still remains home to most of this activity even today.
Today, 60% of assets held in DeFi applications live on Ethereum. And roughly 80% of NFT trades by volume occur on the network. Developers are important for blockchain networks as they build novel applications which attract new users and more usage of the network generally. Ethereum incredibly now has 3x more developers working on it than its closest competitor. And it generates roughly 10x more revenue from transaction fees than its closest competitor.
So Ethereum clearly ticks almost every ‘wishlist box’ in terms of an attractive investment: dominant market position, proven concept and track record, fast growing and recurring revenues as well as the beneficiary of massive network effects.
But there is one fatal flaw in Ethereum’s otherwise pretty flawless scorecard: although the network is paying out $1 billion in staking rewards each year to its investors, this reward is currently locked. So while Ethereum is the second-largest blockchain network in the world, it’s the least-staked token compared to other major networks.
You can see that in the chart below…
Source: stakingrewards.com
The reason this liquidity problem exists is that the network hadn’t yet developed a feature to withdraw (or “unstake”) tokens. This means if you stake Ethereum to earn income today, you can’t withdraw your tokens. Meanwhile, you can stake and unstake the other tokens in the chart above whenever you want. People were hoping that big institutions would flock to Ethereum after the ESG-friendly change represented by the Merge upgrade last year. But in the event, it transpired that the inability to access capital indefinitely isn’t a risk that big institutions are willing to accept.
The Crypto version of a Blue-Chip Dividend Stock?
While staking Ethereum may not be a get-rich-quick strategy, I believe many investors will see it as a valuable and pretty secure way of putting their money to work. Rewards are paid out every few days and are proportionate to the value staked — meaning the more you stake, the more you earn. Currently, the annual percentage rate hovers around 4% to 5%, but this rate is set by the Ethereum network and rises and falls based on the number of validators. The fewer validators, the higher the return, which incentivises users to join the network and stake funds. The greater the number of validators, and the APR will fall slightly.
Though staking rewards are therefore currently only in line with Treasury yields, the beauty of staking is that you can reinvest these rewards, let them compound, and reap the benefits of letting your money work for you. In addition, should Ethereum rise in price, the total value you have staked will also increase, thereby increasing your return.
You could think of staking as being similar to a stock that pays scrip dividends. It may not be much in the short term, but consistency over the long run is where true gains can be made. Although the payout might feel minuscule in the beginning, one day it could turn into a significant source of income, especially if Ethereum continues to rise in value as it has over the past few years (NB Eth price is up c.10x over the past 3 years).
Shanghai Represents a Massive Catalyst
Ethereum will roll out its next network upgrade this March — the Shanghai upgrade. After the upgrade, ETH stakers can access their tokens as they please. So what’s exciting about Ethereum right now is that all the capital tied up in these locked staking rewards will be set free. We believe this catalyst represents a massive opportunity.
We in the investment world know well how lack of liquidity represents risk and therefore lowers the valuation. All things being equal, the greater the liquidity in an asset (e.g. large cap shares versus small caps, listed shares versus shares in private companies), the higher the valuation. The chart above clearly shows that Ethereum is the least-staked token because it has the highest risk in the eyes of investors due to its lack of staking rewards liquidity.
Standing back, it is hard not to see a meaningful valuation uplift for Ethereum over the course of 2023 given this risk will be effectively removed.
Now, many market commentators in fact see this unlocking prospect as fraught with risk. They believe droves of stakeholders will withdraw their tokens and sell them — putting downward pressure on prices. And while we’ll likely see some selling pressure in the days following the upgrade, there is actually no reason why Ethereum staking levels shouldn’t match — or likely even exceed — the average levels we see in other blockchain networks. This is incredibly bullish for Ethereum as it effectively means a drastic reduction in the token supply in the market (this coming after the supply reducing move to proof of stake last year).
Forget for a moment that Ethereum is crypto: the change represented by the Shanghai upgrade gives investors better liquidity, i.e. the ability to withdraw staking funds whenever they want. This is likely to attract many new investors currently put off on liquidity grounds. Therefore, I strongly believe the net effect will be that Ethereum is valued more highly by investors who can now access the attractive staking rewards on one of the most established and secure blockchains (which effectively ticks most of the other investor boxes).
Potential for $40 Billion in Income?
Currently, Ethereum generates roughly $1 billion in staking rewards each year. And that’s during a bear market and with locked liquidity. After the Shanghai upgrade and during the next bull market, staking rewards could swell as high as $40 billion annually.
Today, there’s roughly 16 million ETH staked… and they’re earning roughly 4–5%. But during periods of high network activity — like we saw in the days surrounding the FTX exchange collapse — this yield climbed above 10%. That’s because users are willing to tip network validators more to give them priority and execute their transactions faster.
When the bull market resumes, we can expect network activity to explode higher — like it did from 2020–2021. That would translate to roughly 1.6 million in ETH paid to stakers annually. Or $2.5 billion in income if Ethereum remains at $1,600. From my earlier articles regular readers will know that I see a scenario where the valuation of Ethereum skyrockets on the back of the growth of massive trends such as tokenisation.
It’s important to note that staking rewards are also a function of the token price. So my 10x valuation case for the Ethereum price, based on transaction fees generated from the network’s exploding use cases, has a comparable impact on the staking rewards!
If $40 billion in yearly income sounds crazy, just remember that some of the biggest names on Wall Street and major global corporations are entering the market. What’s more many of the largest exchanges are keen to provide ETH staking services to their users and charge a fee for this service — Coinbase, Binance and Kraken alone are staking $7 billion worth of ETH for their users (though new regulatory issues may mean market shares amongst staking providers changes).
Final Thoughts
I believe Ethereum represents that rare investment beast of an established blue chip enjoying exponential growth in revenues with the added catalyst of a significant short term step change in liquidity of income. Crypto or no, I believe many investors will increasingly see its unique risk/reward potential!
PTLIB is CIO of Dragonfly Asset Management.
DISCLAIMER: This content is for EDUCATIONAL AND ENTERTAINMENT PURPOSES ONLY and nothing contained in this blog should be construed as investment advice. Any reference to an investment’s past or potential performance is not, and should not be construed as, a recommendation or as a guarantee of any specific outcome or profit.
