Will Ethereum Continue to Under-Perform Bitcoin?

In September 2022, Ethereum eschewed its Proof of Work roots and switched to a Proof of Stake consensus mechanism. At the same time, it began a period of significant under-performance against BTC. Contrary to the consensus view that several tailwinds will see Ethereum outperform Bitcoin in the coming year, our analysis suggests that its inability to succeed against Bitcoin with existing pressures on supply indicates a structural re-pricing of the asset following the Merge.

Crypto

Derivatives

While both have rallied along with the wider crypto-asset market, Ethereum’s price has consistently underperformed Bitcoin’s over the last 15 months despite several downward pressures on supply and an increased demand for staking that we would have expected to act as support for its price relative to BTC. We do not see an obvious circuit-breaker to the trend of underperformance, which we note could even accelerate if the aforementioned tailwinds to ETH supply and demand do not continue.

This is by no means a popular view – most market participants are arguing for the opposite, including JPMorgan who recently stated “While we are cautious on overall crypto markets into 2024, we are looking for Ethereum to outperform Bitcoin and other cryptocurrencies next year helped by the forthcoming EIP-4844 upgrade or Protodanksharding”. They argue that most of the positive news for BTC (including the potential ETF approval and the impact of halving) is already priced in, while the EIP-4844 upgrade is not.

Simply comparing BTC & PoW vs ETH & PoS is a somewhat shallow analysis. We think ETH moving to PoS is viewed by the market as ETH moving towards becoming a different asset class, and that the market continues to be in the price discovery phase of these two different asset classes. We consider several key factors that we think suggest a potential shift in the dynamics between the two prominent cryptocurrencies and lead us to our out-of-consensus view.

Post-Merge Impact

Ethereum's transition from Proof of Work to Proof of Stake, termed “the Merge”, was anticipated to enhance efficiency and scalability. However, since this transition, Ethereum’s spot price has exhibited a trend of weakness compared to BTC. This observed weakening may signify a structural shift in how the market is valuing Bitcoin versus Ethereum. This change might imply a diminished perception of Ethereum's comparative strength in the cryptocurrency landscape.

As you can see in the chart below, since the Merge (highlighted in the chart by the vertical line on the 15th Sep 2022) ETH price has, albeit with some volatility, trended weaker versus BTC. The trend in ETH under-performance seems to mimic the trend seen in the growth of the total ETH issued to stakers in the PoS ecosystem.

Figure 1 BTC / ETH spot cross pair price (white) and 12H sum of gross new ETH issuance (pink) from Jan 22, with the Merge highlighted (purple vertical line). *Source: Block Scholes*

On the face of it, The chart above could lead one to conclude that it is simply a supply argument that is leading to ETH’s underperformance. However, it is not that straightforward. Firstly, the quantity of burnt fees* has been consistently higher than the new issuance (reward) meaning that the net ETH in circulation has been decreasing. The chart below shows the ETH new issuance net of burnt fees – as you can see, it has been negative since the Merge.

Figure 2 BTC / ETH spot cross pair price (white), post-merge trend line (orange, linear regression with r-squared = 0.75), 12H sum of *net* new ETH issuance (purple, Beacon chain reward minus burnt fees), with the Merge highlighted (purple vertical line). Source: Block Scholes

Secondly, the amount of ETH staked on the Beacon chain has also increased near-monotonically since the Merge (see below), with almost 25% of total ETH in circulation currently locked up by stakers. This factor also has a positive effect on demand for spot ETH, theoretically arguing for a smaller total supply of ETH at a time when available staking yields are driving increasedemand, hence acting to drive the relative price of ETH higher.

In future, plans to increase the minimum stake to 2,048 ETH may slow the tide of ETH onto the Beacon chain and stabilise the fall in circulating supply. However, liquid staking solutions (which make up over one-third of the ETH staked on the Beacon chain) mean that the impact of this minimum level may be limited.

Figure 3 Total supply of staked ETH on the Beacon chain, with the Merge (2022-09-15) and the Unlock (2023-04-12) marked with white vertical lines. *Source: Block Scholes*

Conclusion

Ethereum's supply has shown a declining trend owing to the burning of ETH surpassing the issuance of new coins and incredible demand for staking on the Beacon Chain. While this has supported both the supply and demand sides of Ethereum’s price, ETH has trended weaker against BTC since the Merge. We do not see an obvious reversal to this trend as we judge it unlikely that the market will retrace the last 15 months of price discovery between a PoW and PoS asset. Instead, we expect the process to converge on a new price level until there are further structural changes made to either market.

However, it is possible that the trend will accelerate should those factors no longer support ETH’s price. The net new ETH supply could turn positive as a result of an increase in the issuance of new ETH or a decrease in the quantity of burnt ETH in each block. Similarly, a stall in the growing demand for staking ETH on the Beacon chain could have a similar impact. Both factors could see an acceleration of Ethereum's under-performance against Bitcoin, and our analysis informs our view on Ethereum’s relative performance against BTC: rallying less and selling off harder.

Scroll back to the top ↑