ETH210808 - quick overview & idea pitch. Tuesday, August 10, 2021, 1:00 PM by JF (PogueMahone.eth, @corp_scapegoat).
Ethereum (ETH) Opportunity: Ethereum is a decentralized, open-source blockchain with smart contract functionality. Ether $ETH is the native token of the platform and is the 2nd largest crypto by market cap. Ethereum was created by Vitalik Buterin and launched in July 2015.
ETH viewed as top crypto asset ideas for C2021. Ethereum's open-source platform and smart contract technology expands the use cases and has potential to accelerate mainstream adoption of blockchain technology. ETH is the gas that fuels the Ethereum network and is expected be in high demand driven by increasing transactions (Tx), the popularity of DeFi, NFTs, and ERC-20 tokens, and development of new protocols and dAPPs on top of Ethereum’s highly programmable base layer, all of which require ETH and support higher ETH return environment for investors. There is also now potential for ETH to become deflationary after EIP 1559, which we believe would lead to further upside opportunities as well. While we don't expect full impact of supply deflation to be realized soon, as it likely won't be until sometime after the launch of ETH2.0 during C22-23, but we think it’s a positive development that puts to rest a lot of the concerns around ETH inflation and its comparability to BTC. We expect the forward-looking bullish factors of Ethereum and its ecosystem of apps to begin getting priced into ETH token price in the near future, driving 2H21 outperformance.
The roadmap to ETH 2.0 should also be positive ahead of its launch closing in as early as C22 via the merge when the beacon chain POS replaces the existing ETH1.0 POW. We expect strong ETH returns continuing over the next 1–3-year duration as ETH2.0 is rolled out and significant longer term upside potential from the network effect of Ethereum that starts to take shape in the years following ETH2.0. Over the long-term expect continued strong Sharpe ratios vs traditional assets, declining volatility correlated with increasing ETH market cap, and for % allocations to Crypto based asset classes to rise overtime. A hypothetical ETH price target of $10K (assumes market cap > $1T, discount to web 2.0 peers like APPL, FB, GOOGL) offers 3x upside opportunity following the ~50% pullback to ~$2,500-3,000 support levels of today, that can materialize as early as C22-23.
Valuation Exercises: DCF & Stock to flow model
Investment Case
Ethereum improvement of Bitcoin's technology: Â Ethereum's world computer, the EVM is an improvement of BTC's Blockchain, due to its integration of Turing complete processing language, allowing execution of smart contracts. Smart contracts are highly programmable conditional transactions w/ "IF this, THEN that" code functions at varying complexities, which drastically expands the potential opportunities and use cases of blockchain technology. The technology/software advantage is clear and goes well beyond just currency protocols or becoming "future of money" , which makes it stronger than BTC in our view and more disruptive. Ethereum has the potential to see more upside to other crypto assets in the space and traditional assets/incumbents by capturing a greater share % multi-trillion global TAM estimated to be at risk of disintermediation, with first effects of ETH impact likely to be seen in the financial system with the recent rise and popularity of DeFi values locked.
Strongest Ecosystem and value proposition: Ethereum also differs from other coins in the sense that the utility of its native token is more like a crypto commodity, since ETH is the gas that fuels the network and must be used to send tx and develop dAPPs. Tx demand has been so far driven by an ecosystem that includes Decentralized exchanges (DEX) like UniSwap and 1inch who gained Billions in TVL value over 1-3 mos in 1H21 C21 and likely led to speculation, contributing to the blow off top seen ~May 15th > $4K levels, stablecoins, DeFi lending, yield farming, DAOs, and ERC-20 and ERC-721 tokens of goods and services built on top of Ethereum's software that benefit from Ethereum's network security and will have to tx using ETH such as ICOs & other cryptocurrencies, NFTs, video games, social media, cloud computing, data storage, buildout of the metaverse, web 3.0, among others. As the ecosystem continues to build out, we believe ETH’s value proposition will constantly be in demand, and therefore support rising prices over for many years to come.
EIP-1559 / London Hard fork Implemented 8/5/21: EIP 1559 went into effect 8/5/21 and so far, has been viewed as a success by the Ethereum community and investors. EIP-1559 update to fee market w/ base fee that will be burned in ETH and variable block sizes that can increase to 200% to include more tx and decrease wait times. The result of EIP-1559 expected to make fees more predictable for users/wallets and may help alleviate volatility of gas prices and wide ranges of prices seen during network. While positive, EIP-1559 is not expected lower gas prices or overall cost of transactions like many users originally believed. Historically, the Ethereum network saw high tx costs that priced out many smaller users and wallets due to an inefficient first price auction fee model that pushed up gas prices up to ~300 gwei during May 2021. The ETH burn mechanism is probably the more interesting component of the software, as it’s a first of its kind monetary policy change to cap inflation and remove ETH from circulation. We expect that burning the base fee can take inflation from current ~3-4% levels down to near ~ 1% levels annually in line with BTC inflation in short-term and has potential to become deflationary to ETH supply over long-term.
Changing Investor perception of ETH - potential to be Deflationary? We believe the deflationary case for ETH is a strong catalyst for ETH price appreciation and can drive demand from institutional investors that are looking for a way to diversify through allocations to non-correlated crypto assets, further supporting higher ETH prices. It also gives Ethereum credibility in form of a "store of value" argument or that its "ultra-sound money" like BTC. A main talking point historically used by bitcoin bulls was that the 22M Finite bitcoin supply vs the theoretically unlimited ETH supply, makes BTC a superior asset and better investment in comparison to ETH. While we never gave such claims much weight as we found other drivers of ETH upside to be more compelling, nonetheless we view that more comparability to bullish dynamics attributed to BTC and issuance inflation concerns being put to rest following EIP 1559 are overall positive developments for ETH.
ETH2.0 Scaling solutions: The implementation of layer 1 scaling (sharding), which is on-chain, will spread workloads to 64 different shards each controlled by a node & increase Tx/sec throughput 100x combined with layer 2 scaling (optimistic & zero knowledge proof Roll-ups ), which are off chain solutions such as generalized Layer2s like Optimism and Plasma parallel to EVM base layer, side chains like Polygon and Skale , and other application specific zk-SNARKs/STARKS and State Channels running on top of the base layer, among others, that are also expected to increase Tx/s by another 100x. Together sharding and rollups with POS is expected to increase scaling from 15 Tx/sec today to 100,000 Tx/sec. This massive improvement in scaling is expected to be achieved sometime C22-23 and offers Tx processing capability that would outperform payment companies like V, PYPL significantly ~ by a factor of 100x improvement. The increased Tx speeds, faster settlement times, and likely cheaper ETH solutions would drive efficiencies in global payment networks and could accelerate mainstream adoption of Ethereum applications.  In addition to the scaling solutions, we also expect that Staking/validators used in POS will lead to cheaper Tx fees going forward and declining gas prices w/o the need for energy intensive mining hardware and electricity, which would help address the ETH1.0 Tx cost problem.
Outperformance to continue C21: ETH is now the world's largest blockchain in the world, has been outperforming BTC’s user adoption & Tx growth rates, and is clear leader in the rise of DeFI assets with a ~90% share. Demand for ETH is expected be driven by the exponential increase of tx overtime driven by DEX, NFTs, and new protocols, and also partly due to speculative factors like porting of new tokens, development of new use cases, and mainstream adoption by industries. The move to proof of stake during C22 that coincides with the ETH2.0 launch will get rid of mining entirely and result in a ~99% reduction of carbon emissions and make the platform more sustainable in response to the growing calls of ESG concerns over POW blockchains.
Bullish roadmap to ETH2.0 launch: . ETH2.0 expected to be the real iteration of the World Computer with POS and scaling solutions that will drive strong Tx demand and growth of users, more efficient Tx speeds/throughput, and will have cheaper Tx costs from decreasing gas prices. ETH 2.0 will also alleviate issues of Ethereum overcapacity~ >95% levels today, which should get winded down by layer 2 scaling solutions currently being deployed and layer 1 sharding in C22. We expect that a freed up and more efficient network would see strong growth of ported tokens from other platforms, continued development of apps like DeFi, NFTs, crypto tokens, and the development of new protocols and eventual use cases for ETH beyond the scope of what could be achievable under ETH1.0 today. Overall, the ETH 2.0 network is expected to launch early C22 via the merge and should drive user growth and value to the holders of ETH and the platform. We expect strong ETH investment returns and continued outperformance through C21 and see potential for 2-3x upside for investors over the course of 6-18 months.
Ethereum network effect: The move to POS/ETH2.0 is expected to be followed by implementation of scaling solutions (sharding & roll-ups) through C22-23. It's also expected we'll see additional software updates from the Ethereum community too continuously make improvements all the way up until maturity of the technology. In other words, the larger Ethereum network becomes overtime, the number of developers that are committed to continuously improving the platform increases, making the platform better overtime and more innovative, resulting in more disruptive technologies and new use cases, driving long-term exponential growth of the Ethereum network and its influence well into the future**.** We believe it will take some time to fully grasp the value potential of the Ethereum network effect and that it will slowly take shape in the next 2-3 years and be clearer 5-10 years out. There is a significant TAM opportunity that already exists today for ETH to start disrupting and displacing existing companies/industries that is more identifiable or tangible in nature, and includes industries like Banking, insurance, trading, derivatives, lending, real estate, VC, private equity, legal, administrative, journalism, art, internet content, media, gambling, etc.
Best case scenario - transformational change and creation of new industries and markets: Many proponents of ETH argue that the largest component of Ethereum's upside will be from transformational change and creation of new industries/markets. In this absolute best-case scenario, the potential of returns from new industries and technologies created through the Ethereum Blockchain goes beyond the scope of what we can estimate or sign any value to. Current ideas that are either already in an early stage development or that are starting to gain traction among circles of the Ethereum community and on the internet include opportunities such as Web 3.0: decentralized internet, the metaverse, monetization of one's identity (CryptoPunks), social contracts (FB, Twitter, Disney, Nike, etc - anyone with a loyal customer base tokens), tokenization of sports, music, celebrities, charity, culture, etc. The opportunity would be one that investors wouldn't want to miss as the possibilities are endless and broad in scope, which if it is to believed would result in exponential growth of Ethereum indefinitely well into the future.
Ethereum as a long-term bet on Technology: It is our view that for a technology with the disruptive potential like Ethereum, that history tells us it will be overestimated over the short term and then underestimated as it progresses through the hype cycle. So going forward we anticipate that the disruptive nature of decentralized technologies will take many years to play out, and that overall, we are still very early in terms of adoption, especially by institutional investors where it eventually will become consensus and an asset class built into portfolio risk frameworks and tools. Ethereum is likely to go through periods of overvaluation and bubbles followed by significant crashes, like the ~50% we have seen historically before a resumption of growth like we just saw this year in C21 in May and back in 2017. We expect a crypto asset like ETH to be particularly valuable when deflationary effects of future technologies become more observable in the next 2-5 years as we enter the era or early stages of production of self-driving cars, AI ML/DL, renewable energy, robotics, crypto, smart cities, among others. The aspect of the LT upside opportunity with the Ethereum trade that we believe to be most compelling, is that it offers an asymmetrical bet through the ETH token on the open-source platform itself, opposed to determining the winners and losers of individual tokens or companies as many of them will likely go bankrupt or fail to gain real traction. It's hard to say how the Blockchain will space will look in 10+ years in the future or who the winners in DeFi will be for example, but we believe the common element to many of these trends and tokens is that they will be application derivatives of the Ethereum network or back end technologies driven entirely by the user base, development, and growth of the Ethereum platform, which could be similarly viewed as getting to bet on the Internet as a whole ecosystem in the 1990s, offering substantial return potential.
