Bitwise Investor Letter: Why Does Ethereum Have Value?
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Bitwise Investor Letter: Why Does Ethereum Have Value?
Ethereum's current market cap is only a small fraction—around 10%—of the total fines paid by U.S. banks since the 2008 global financial crisis. If Ethereum becomes the foundational layer for a new alternative financial services system, the upside potential is enormous.
Navigating Web3 tides with focused insightsAs we write this letter on July 8, Bitcoin is up 32% year-to-date, outperforming equities (down 1%), bonds (up 6%), and gold (up 18%). Its strong performance has come amid growing investor interest in the "digital gold" investment thesis.
However, what many investors don’t realize is that Ethereum, the second-largest holding in the Bitwise Top 10 Crypto Index, has returned nearly triple that of Bitcoin this year—up close to 95%. Ethereum’s strength has helped drive the Bitwise 10 up nearly 37% this year.
In last month’s letter, we discussed Bitcoin’s long-term investment case (“Why Bitcoin Has Value—Debunking the ‘Greater Fool’ Theory”). Given Ethereum’s strong performance, in this letter we’ll spend a few pages diving deeper into it.
Ethereum & One of the Largest Market Opportunities in Crypto
Many newcomers to crypto assume that, in the long run, only one major crypto asset will matter—and the investor’s challenge is simply picking the “best” one.
We disagree with this view.
Why? Because different crypto assets (and their associated blockchains) focus on different use cases.
For example, Microsoft and Salesforce are both software companies, but they serve different markets—one winning doesn’t preclude the other from succeeding.
Uber and Instagram are both apps, yet have distinct functions and use cases—so both can win.
Likewise, different crypto assets may rely on the same core blockchain technology, but target different applications—and therefore, multiple winners are possible.
As we often discuss, Bitcoin’s blockchain excels in security and immutability, making it ideal for the digital gold use case. Other blockchains prioritize features like speed, privacy, or price stability to serve as payment tools—such as XRP, USDC, Zcash, and Monero.
In contrast, Ethereum was the first—and remains today the largest—blockchain optimized for programmability (or digital contracts). Importantly, this may be one of the most exciting applications of blockchain technology.
Let’s explore this further.
The Rise of Programmable Money: One of Crypto’s Foundational Breakthroughs
"Programmable money" (or assets) is a new tech term meaning that crypto assets can be transacted in ways impossible with physical assets.
What does this mean?
Most people think of crypto asset transactions as simple cash-like payments—e.g., "Alice sends crypto asset X to Bob as payment."
With programmable money blockchains like Ethereum, more complex forms of transactions become easy—e.g., "Alice sends crypto asset X to Bob, but only after Carol also approves the transaction."
This may sound similar to an escrow arrangement, commonly used when individuals buy homes or companies execute M&A deals. The difference—and breakthrough—is that crypto technology allows you to do this without an escrow company, without lawyers, without banks—thus avoiding fees, delays from waiting for institutions to respond, and human bias.
The above transaction is just one example. Adding further complexity is also easy—e.g., "Alice sends crypto asset X to Bob, but not before five years, and only after Carol approves"—which resembles a trust—or "If Carol wins the race, Alice sends crypto asset X to Bob; if she loses, Bob sends crypto asset Y to Alice"—which looks more like a contract.
The ability to execute transactions more complex than direct payments defines the concept of "programmable money." Many crypto assets (including Bitcoin) can handle the simplest forms of these transactions, but the Ethereum blockchain is designed to support full customizability and complexity.
Ethereum’s core value proposition today centers on a question: What if we could apply "programmable transactions" to rethink nearly every type of financial service—from simple custodial accounts and trusts to complex ideas like capital raising, secured lending, product design, loans, and margin trading?
What if we could replace large parts of the financial system—rife with rent-seeking, a history of misconduct, and solvency risks—with a software-based system that is easily auditable, doesn’t rely on human judgment, and reduces counterparty risk?
Ethereum’s Recent Explosion in Usage: Stablecoins and Lending Surge into the Billions
The crypto community has coined a term for this category: "Decentralized Finance," or "DeFi."
Most investors’ initial reaction upon hearing "DeFi" is that it sounds appealing but somewhat like science fiction—believing real-world applications must still be many years away.
Yet despite limited attention in mainstream media, DeFi has seen explosive real-world adoption in recent months. In fact, during the first half of 2020 alone, two billion-dollar use cases emerged: one around stablecoins, and the other around the highly successful launch of Compound, a decentralized lending market.
• Stablecoins
Stablecoins are crypto assets pegged to fiat currencies (primarily the U.S. dollar). Today, they’re primarily used to bring fiat currency functionality into the crypto world—similar to how ADRs allow foreign stocks to trade on U.S. markets—and represent one of the fastest-growing corners of the crypto market.
Stablecoins enable numerous real-world uses. They’re used by crypto investors who want to hold less volatile dollars without withdrawing from exchanges; by individuals creating dollar-denominated digital contracts (like the Alice/Bob examples above); and by people in countries with capital controls to store funds outside their local monetary systems. Recently, stablecoins have become foundational assets for many decentralized finance applications.
How does this relate to Ethereum? Ethereum has established itself as the leading platform for issuing stablecoins, enabled by its flexible smart contract programming capabilities described earlier.
Two of the most important stablecoins, Tether and USDC, have seen explosive growth over the past year, with total assets on the Ethereum network rising from under $1 billion twelve months ago to over $7 billion today. This growth shows no signs of slowing.
• Lending
Developers have experimented with using Ethereum’s smart contracts to create markets for programmatically lending other crypto assets. One of the most successful recent examples is Compound. Compound is essentially a decentralized crypto money market, backed by prominent investors including Andreessen Horowitz (a16z) and Bain Capital.
Compound offers functionalities you’d expect from a bank. Depositors can earn interest by lending crypto assets, while borrowers can take out collateralized loans on the platform. As discussed, there is no trusted third party between lenders and borrowers—all operations are handled by decentralized software protocols and associated tokens.
Launched at the beginning of this year, Compound now holds nearly $700 million in value. Other similar protocols have also accumulated significant assets, as shown in the chart below. These platforms now collectively manage over $2 billion in assets.
While this isn’t “replacing the banking system,” it’s still significant for a brand-new technology—and the growth is explosive. Just a year ago, this space barely existed.
How Sustainable Is DeFi, and How Much Can It Grow?
An interesting aspect of how the decentralized finance ecosystem evolves is that these programs run on the Ethereum network and can be combined in various ways to deliver new solutions.
A common analogy is that building in DeFi is like constructing a castle with LEGO bricks—each program (stablecoin, lending, exchange, etc.) acts as a standardized LEGO block that can be assembled in increasingly complex configurations.
The more such blocks exist, the greater the number of possible combinations, the higher the utility, and the stronger Ethereum’s leadership in this domain becomes.
As an emerging technological development, DeFi naturally carries significant risks, limited historical track record, and usability challenges. Just as Bitcoin is not guaranteed to succeed as digital gold, Ethereum is not assured of capturing a large market for digital financial contracts.
Nonetheless, we believe it is appropriate for many investors to gain exposure to this opportunity because the potential is enormous... After all, a good investment isn’t about finding something without risk, but identifying risks with commensurate return potential.
In this case, Ethereum’s current market cap is only a small fraction—about 10%—of the fines U.S. banks have paid since the 2008 global financial crisis. If Ethereum becomes the foundational layer for a new alternative financial services ecosystem, the upside potential is immense.
And it’s needed.
Despite decades of fintech startups and banking apps, much of the financial services industry remains technologically backward and charges high fees. An estimated 80% of financial transactions are still processed using COBOL, a programming language developed in 1959—back when most programmers used punch cards.
Perhaps the next wave of innovation doesn’t require another sleek mobile app or backend machine learning model, but rather a fundamental disruption of the current paradigm. Eliminating intermediaries—as blockchain software breakthroughs aim to do—could eliminate fees, end delays caused by business hours and outdated systems, prevent insolvencies through greater transparency, and allow anyone in the world to create contracts of any scale. These are powerful capabilities that could drive truly transformative change.
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