Bitcoin was the first widely adopted cryptocurrency, a type of digital asset built on blockchain technology and secured by cryptography. Those qualities underpin a brand new financial system, one in which electronic transactions can take place without the oversight of banks, card networks, or payment processors.
Bitcoin achieved a price of $1.00 in 2011, and has since soared over 5,380,000%. After that run, its market value sits at $1.0 trillion, meaning Bitcoin is still worth more than any altcoin. That being said, it lacks utility compared to some of the newer cryptocurrencies — specifically, those that support decentralized applications (dApps) and decentralized finance (DeFi) products.
Building on that idea, a recent report from Fidelity named Ethereum (CRYPTO:ETH) as the second-most-popular digital asset among institutional investors (behind Bitcoin). That quality, alongside Ethereum’s support for DeFi products, could make it a very rewarding long-term investment. Here’s what you should know.
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A programmable blockchain
Unlike Bitcoin, the Ethereum blockchain is programmable, meaning it’s possible to build self-executing computer programs (i.e. smart contracts) on the platform. In turn, that technology forms the basis of dApps and DeFi applications — products that, by definition, exist beyond the control of any single entity.
In the context of DeFi, that means you can borrow, lend, save, and earn interest on cryptocurrency without involving a bank. Fund manager Cathie Wood recently noted that DeFi is “collapsing the cost of the infrastructure for financial services.” That disruptive quality is a key part of the investment thesis here, and that thesis should get even more compelling as Ethereum — the most popular DeFi platform — becomes more scalable.
A more scalable solution
The Ethereum blockchain is currently being upgraded to Ethereum 2.0; and as part of that initiative, the network is changing from proof of work consensus to proof of stake (PoS), a mechanism that distributes mining power based on ownership. Making that move has two benefits: First, PoS is more eco-friendly than PoW, meaning its carbon footprint is far more sustainable. Second, PoS offers stronger support for shard chains, which will make the network even faster.
To make sense of that last point, let’s backtrack for a minute. Many blockchains have a serious scalability problem. For instance, Ethereum can process about 30 transactions per second (TPS) in its current form. That figure is sixfold greater than Bitcoin’s throughput, but it falls far short of the 1,700 TPS that Visa handles on a regular basis. As a result, increased traffic on the Ethereum network has already resulted in slower transaction speeds and higher transaction fees — and if the scalability problem is not addressed, Ethereum won’t be able to support mainstream adoption of dApps and DeFi products.
To solve that issue, the Ethereum 2.0 upgrade will swap the consensus mechanism from PoW to PoS, then add 64 shard chains (i.e. side chains) to the core blockchain, distributing the network load more efficiently. In turn, that will boost Ethereum’s throughput to 3,000 TPS, and that figure could hit 100,000 TPS with a few more tweaks.
A decentralized financial system
Since January 2021, the collective sum of cryptocurrency invested in DeFi products has climbed from $21 billion to $258 billion. That’s a twelvefold increase in less than one year. And the Ethereum blockchain accounts for 65% of that total, or $170 billion, making it the largest DeFi platform by a long shot. That gives Ethereum an edge.
Of course, dApps and DeFi products aren’t free. Miners are incentivized to maintain the blockchain with transaction fees (i.e. gas), which are paid by users in the form of the native cryptocurrency. In other words, as dApps and DeFi products on the Ethereum blockchain see greater adoption, the price of the cryptocurrency should rise. And given the rapid growth of DeFi so far this year, I’d say that scenario is likely.
Moreover, Ethereum is the second-most-widely-held digital asset among institutional investors, which have over $100 trillion at their disposal, according to Bloomberg. And as more institutions diversify into cryptocurrency (and even DeFi products), the popularity of Ethereum should draw more money into its ecosystem, driving its price higher.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.