PitchBook’s Key Factors for Ethereum Report can be downloaded here.
Crypto-assets like Ethereum are most akin to early stage venture investing. These products are typically in the proof-of-concept phase and carry a high-level of risk due to the extreme uncertainty over the long-term outcome. For this reason, investors should expect many crypto-assets to fail, and a small proportion to deliver outsized returns. However, unlike more established assets classes that benefit from standardized benchmarks and regulatory oversight, Ethereum and other blockchain technologies lack industry-wide standards and protocols. This detailed report attempts to bridge that gap by providing the following factors for investors to use when evaluating Ethereum:
- The Incentive Structure: The Ethereum network is maintained by miners who act as individual servers and are incentivized for verifying transactions through a process called Proof-of-Work (PoW). Other participants include decentralized application (dapp) developers who build smart contracts (i.e., software programs) and the protocol developers. Ethereum is developing a proof-of-stake (PoS) model that will dramatically reduce the costs of maintaining the network and the amount of energy it takes to mine and verify transactions, creating greater incentives for miners. As this shift occurs, we anticipate that it will lead to these network participants specificaly capturing a much greater portion of value than token holders.
- Token Distribution: Ether (ETH) serves as Ethereum’s medium of exchange for developers who pay for its computational power. It also acts as a financial incentive for miners to uphold the network by providing newly minted tokens and transaction fees for every transaction verified and added to the blockchain. The protocol initially launched with 72 million Ether tokens and the current market supply sits at more than 97 million, with the inflation schedule capped at 18 million new Ether per year. In terms of the distribution concentration of Ether, a very small number of individual accounts control a substantial percentage of ETH tokens. This represents the biggest single risk to Ethereum’s success, as a coordinated sell-off from a handful of the largest token holders could plummet Ethereum’s price and significantly damage its market.
- Market Opportunity: The closest existing market to Ethereum’s decentralized, open-source network is the cloud computing subset known as infrastructure-as-a-service (IaaS), which Gartner estimates to be worth $82.5 billion by 2021. Compared to more established centralized IaaS platforms like AWS, Microsoft Azure and Google Cloud, the decentralized nature of Ethereum’s protocol offers three distinct benefits: immutability, redundancy and increased transparency. On top of these benefits, the enormous Ethereum ecosystem is its largest competitive advantage. With thousands of applications and an array of supportive institutionally backed entities, there are a myriad of individuals, businesses and investors financially and emotionally committed to its success.
- Founding Development Team: The creator of Ethereum, Vitalik Buterin, and his co-founders Jeff Wilcke and Mihai Alisie bring strong blockchain and technical expertise to the development team. Their proficiency will be critical for Ethereum to overcome considerable scalability issues if it wants to compete in the IaaS market. The team is currently working towards two solutions: Sharding and 2-Layer Systems. The former involves splitting the blockchain into sub-parts (i.e., Shards), which streamlines the mining process by eliminating the need for every node on the network to verify every single transaction. The latter involves adding an extra layer to the blockchain and only recording these transactions as participants enter or exit the second layer, thereby reducing the computational load on the primary protocol.
- Network Strength: Ethereum’s network of unique users has grown exponentially from 1.4 million in Q1 2017 to 27.5 million by the beginning of March 2018. The blockchain’s average daily transactions have also shown strong growth, rising from almost 59,000 to nearly one million over that same period. Based in Switzerland, Ethereum benefits from the country’s friendly regulatory environment for crypto assets and a node mining infrastructure that is fairly dispersed on a geographic basis (trading on at least 69 exchanges).
The complete PitchBook Crypto-Asset Framework for evaluating the long-term potential of the asset class is available here. Visit the PitchBook News & Analysis site for the latest updates on the industry.
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