Why an ETH price of USD 10,000 is likely in the current bull cycle
Ethereum is on a tear. Ether (ETH), the blockchain’s native token, once again hit new all-time highs this past week. The price of ETH briefly surpassed $4,350 after dropping to $2,200 just three weeks ago. There is arguably heavy demand for transacting on the Ethereum blockchain, in part because it caters to two of the main narratives of blockchain: Decentralized Finance (DeFi) and Web 3.0 which set out to revolutionize finance and the Internet. Today, users typically get access to “free” Internet services by giving up control of their personal data. Likewise, banking and payments is controlled by powerful gatekeepers, with many of them operating on an outdated legacy financial infrastructure. These technology and financial services behemoths can deplatform, defund, censor or block their users at their own discretion. In contrast, decentralized applications that run on Ethereum are open, neutral and permissionless by default. These dapps already empower millions of users who only need a wallet to participate in a budding ecosystem.
Ethereum at a glance
Ethereum is an open-source, globally decentralized blockchain platform that runs programs called smart contracts. The Ethereum platform enables developers to create powerful web applications, called decentralized applications (Dapps), with built-in economic functions. These Dapps are a rapidly growing movement that use Ethereum to disrupt business models and create entirely new ones. Unlike Bitcoin, Ethereum’s main purpose is not simply to be a cryptocurrency network. Rather, it is designed to be a general-purpose programmable blockchain that runs a virtual machine capable of executing complex code which is why it is often referred to as a “world computer”.
Ethereum can also be distinguished philosophically from Bitcoin. While both are based on open source software, they are organized differently. The Bitcoin community is managed by contributors that focus on stability and security, preferring to move slowly and with great care. In contrast, Ethereum offers a broad platform for anyone to develop on which has resulted in a sprawling community with tens of thousands of developers and a “move fast and break things” approach. Since its launch in 2015, Ethereum has grown into the world’s most used programmable blockchain. It has a burgeoning ecosystem of composable and symbiotic DeFi protocols often referred to as “money legos”.
On the downside, Ethereum’s rapid growth is also the source of its challenges. In recent months, the blockchain has experienced increased congestion and rising transaction fees rendering many use cases virtually inviable. The community has high hopes for Ethereum 2.0, an ambitious network upgrade, and a long-awaited remedy. At its core, Ethereum 2.0 aims at increasing throughput, security and energy efficiency which will all have wide-ranging implications for the network. The upgrade also involves a migration from its current Proof-of-Work (PoW) system that involves mining similar to Bitcoin to a Proof-of-Stake (PoS) consensus mechanism. If everything goes as planned, it will turn Ethereum into a “superhighway of interconnected blockchains”. Moreover, the upgrade will also fundamentally alter Ethereum’s monetary policy.
One of the most widely accepted frameworks for valuing Bitcoin and cryptoassets has been Fisher’s Equation of Exchange, or MV = PQ. The theory holds that the price of money is linked to its supply and how often it is used. The equation states that the money supply (M), multiplied by velocity (V) is equal to the average price of transactions (P) times the quantity of transactions (Q), or PQ – also known as GDP. The implication of this model is that the value of a cryptoasset has an inverse relationship with velocity. In other words, the more economic activity that is denominated in the currency the higher the network value, and by extension the value of the token or cryptoasset. And secondly, the higher the velocity, the lower the value of the token. Bitcoin’s velocity has decreased significantly in recent years as price has increased, which fits nicely with the model.
Remember that Ethereum is not primarily a network for digital money. While ETH is integral for Ethereum, it was originally intended as a utility currency to pay for the use of the Ethereum platform - similar to the fuel of the network. Every transaction or smart contract on Ethereum requires Gas. Previously, investors had often approached ETH (or gas) as a working capital-type of investment, implying that velocity will be very high as users lack the incentive to hold large amounts of utility tokens. As shown above, if people are willing to store their wealth in a cryptoasset, then velocity needs to be low. Bear in mind that a primary reason why institutional investors and corporate treasuries have started to allocate to BTC is its perception as an emerging digital store of value and a macro hedge. Bitcoin’s non-discretionary monetary policy, its predictable supply schedule and its hard cap supply are credibly backing this narrative. So far, Ethereum’s economic policy and high inflation rate had been a deterrent for institutional investors given its perpetual issuance, its arbitrary supply schedule and theoretically uncapped supply.
New ETH tokenomics
However, recent developments around the monetary policy of ETH suggest that future upgrades and improvements could have wide-ranging implications for its tokenomics and its long-term value capture. Based on the changed circumstances, we believe that the price of ETH has considerable upside in the short to medium term despite its recent rally. Spirit adjusted its price target to $10,000 per ETH by the end of this cycle. To put this in context, at this price, ETH’s market cap would be above the current Bitcoin market cap of $1 trillion. As described in a previous note, we expect Bitcoin’s market cap to at least double within the next twelve months.
More specifically, Spirit’s ETH price target is based on the following drivers:
- Real-world use cases: To a large extent, the recent ETH rally has been driven by retail or crypto-native investors. As always, on-chain data backs this up, showing that ETH addresses holding between 0.01 and 1 ETH have increased by about 250% YTD over the past 2 years to 13.6 million. Although DeFi is not yet competing with traditional finance, it has the potential to create new financial instruments that are orders of magnitude cheaper to create and distribute. Compelling yield opportunities and improved UX/UI will continue to attract users. Likewise, Non-Fungible Tokens (NFTs) will increasingly go mainstream boosted by new use cases and big names entering the space. Layer 2 scaling solutions like optimistic rollups and ZK rollups are already being rolled out (e.g. ImmutableX, Polygon) and will help to bring down transaction costs in DeFi and NFTs.
- Institutional adoption: The Chicago Mercantile Exchange (CME) added ETH futures in February, 2021. While CME’s ETH futures trading volume are nowhere near those of their Bitcoin (BTC) counterparts, is has shown strong momentum in recent weeks surpassing $500M while those of BTC have been trending sideways.
- Reduced supply: In the short term, the upcoming EIP-1559 activation introduces a deflationary mechanism by burning ETH in the form of transaction fees. A key element of the upgrade is that each block’s base fee will be burned and no longer allocated to the miners. This will permanently remove a portion of supply from circulation and decrease the daily net issuance of ETH. While it remains to be seen what the exact number of burned ETH will look like, daily net issuance could drop by a whopping 75% once EIP-1559 goes live as part of the London hard fork in July. The annual inflation rate could then drop to 1-2%.
- Monetary policy: In the medium to long term, Ethereum 2.0’s monetary policy will also have profound implications for velocity. Once implemented, sell pressure will be materially reduced – so the theory goes – as PoS issuance no longer involves miners that are forced to liquidate their ETH to cover their electricity and hardware costs. Instead, the new PoS consensus mechanism will incentivize validators to lock up ETH, introducing a so-called “velocity sink”. This will reduce free float while also turning ETH into a yield-bearing asset. The more predictable PoS rewards means that ETH could then be valued on the basis of discounting the expected future cash flows. Moreover, ETH supply is then on a deflationary trajectory while the community targets a “minimum necessary issuance” reducing inflation to 1% annually, if not lower. Some Ethereum developers project future ETH supply to peak at about 120M, with overall supply eventually dropping to 100M ETH over the next decade on the back of burned ETH from transaction fees.
- Additional drivers: Other bullish short to medium-term factors that will constrain supply by locking up a significant amount of ETH are Grayscale’s Ethereum Trust and the current Ethereum 2.0 deposit contract which currently hold $11B and $4.6B worth of ETH, respectively.
Despite ETH’s significant price appreciation in recent weeks, the bullish backdrop remains intact. Notwithstanding the elevated gas fees that have crowded out users as small transactions have become uneconomical, Ethereum will remain the platform of choice for DeFi and NFTs. With scaling solutions underway, chances are that the bottleneck that was created by high gas fees is just temporary. The Ethereum ecosystem has attracted hundreds of millions in venture funding from large VCs and a growing number of specialized DeFi and NFT funds. With most projects holding ETH in their treasury, the community remains well-funded and an extended runway courtesy of the price increase. Going forward, tokenomics look set to improve significantly on the back of burned transaction fees, a reduced total supply of ETH and a reduced free float. We note that investors that seek exposure to ETH need to consider that the asset’s new all-time high in USD terms cannot belie the fact that it is still lagging BTC when denominated in BTC terms compared to their previous all-time highs in December 2017 (BTC) and January 2018 (ETH). Last month, BTC reached about 3.2x of its peak price during the previous cycle in December, 2017 while ETH has only reached about 2.4x of its previous all-time high set in January, 2018. Another way to look at this: ETH is currently trading at about 0.08 BTC vs. 0.13 BTC at its peak in July 2017. A new high is in the cards: Ethereum’s evolution is entering its next stage and institutional investors are likely to play a much bigger role. This is a watershed moment for Ethereum in terms of adoption, and the price of ETH is likely to hit USD 10k by the end of the bull cycle.
About SPIRIT Blockchain
SPIRIT aims to become a leading Blockchain & Digital Asset company focused on streaming, royalties and cryptoassets investments. The firm provides investors with a direct exposure to the sector, without the technical complexity or constraints of purchasing the underlying cryptoassets. SPIRIT’s strategy is based upon Management’s conviction that the Blockchain and Digital Asset ecosystem will register significant growth and outperform traditional asset classes over the medium to long-term. As a result, cryptoassets will become an integral part of diversified portfolios. Additionally, SPIRIT is building the bridge between North America and Europe/Switzerland.