Both Ether and Bitcoin are mined by solving highly complex computational problems.
Additionally, as more blocks are mined, the difficulty of finding new blocks increases in both cases.
Where Bitcoin currently has a clearly defined use case in which disruption is
possible, the possibilities for Ethereum to enter the market are far less distinct. Ethereum benefits
from the possibility of much greater eventual impact. Bitcoin is currently better positioned to leverage and be incorporated into innovations that occur across many industries, whereas Ethereum is trying to drive the innovations. Ethereum is at a greater risk of experiencing disruption, as their network is the major driver of value (while the Ether‘ gas’ simply drives the network). This network which drives innovation opens up Ethereum to be disrupted by future
entrants looking to build upon the existing framework. Bitcoin is largely safe from this threat of new entrants as Bitcoin’s explicit purpose of acting as a digital currency has been effectively
accomplished, where future innovative networks can use Bitcoin as an underlying asset.
1. Comparison of BTC and ETH
Bitcoin: Explicit niche, limited range of uses, MVCC, more widely adopted, leverages innovation
Ethereum: Use of 'smart contracts', versatile, Ethereum Virtual Machine, Turing-complete, dramatic growth, IoT, innovation driver, blockchain 2.0.
Will History Repeat Itself?
Using historical data to forecast values of both Bitcoin and Ethereum
in five years proved to be very difficult, as there was insufficient data to project future prices with confidence. When examining the trends in both sets of prices, the 5 year forecast for Bitcoin is $2550 which represents growth of 301%, while Ethereum’s forecasted value is approximately $88, which represents growth of 634%. Both values represent absolutely incredible growth rates due in large part to the dramatic growth driven by hype and adoption in the early stage of the life cycle. Upon further analysis, the high growth and volatility of both Bitcoin and Ethereum are the result of news, hype, and speculation. This is shown by the extremely high correlation between prices and Google searches for each respective currency. When looking at Bitcoin the time-series correlation between price and Google searches for “Bitcoin” is 0.64, while Ethereum’s correlation is even higher than that, at 0.88. In order to account for the hype in our regression forecast, the significance of spikes resulting from increased type and Google searches were discounted by a factor of 30%. As can be seen in the following figure, prices are significantly depressed when the hype and speculation surrounding each currency is decreased by 30%. The depressed impact of Google searches led to a growth rate for Bitcoin of approximately 300%while Ethereum’s is reduced to 506%. Although the reduced importance of hype and speculation does lessen this forecast, Ethereum has clearly experienced more growth in the recent past.
An Investor’s Comparison of Bitcoin and Ethereum Bitcoin or Ether, as organizations are looking to maintain control of their leger and transaction validation process, something that could be challenged with the adoption of Bitcoin or Ether (Torpey, 2015). While blockchain technology is likely to be adopted by financial institutions during the five-year timeline, it is unlikely that either Bitcoin or Ether currencies will be widely adopted by major financial institutions.
Bitcoin has benefited from largely permissive regulation in western countries, but has been subject to much more restrictions in Asia. The ban of Bitcoin in China led to a significant depression in Bitcoin prices worldwide, indicating the importance of global acceptance to blockchain in order to drive value (Spaven, 2013). Conversely, it has been inferred by numerous sources that in order to achieve widespread adoption among financial institutions, regulation must be in place to ensure safe and secure transactions (Spaven, 2015). Global deregulation would impact both Bitcoin and Ether, to varying degrees. Bitcoin, being treated as a currency, would see significant value growth as a result of deregulation, allowing access into numerous market and ease of transactions across borders. While Ether would likely see greater value as a result of widespread adoption and reduction of limitations with the smart contract application. The intrinsic value of a unit of Ether would not necessarily grow, but the widespread adoption of the Ethereum Network would likely grow, leading to greater demand for smart contracts and Ethereum.
Major Network Compromise In an ecosystem that promotes highly complex and anonymous exchanges of data, the possibility for major network compromises (i.e. ‘hacks’)seems high. The recent example of the DAO attack causing 3.6 million individual units of Ether to be siphoned into an alternate DAO indicates the possibility and potential severity of such hacks (Siegel, 2016). While the possibility of a ‘51% attack’ in which a majority
stakeholder can significantly impact the value of Bitcoin, the possibility of a major hack is unlikely thanks to the rigid framework of Bitcoin and the relative lack of widespread utility, the only notable exception being Bitcoin Exchange failures as in the case of the Mt. Gox meltdown. Conversely, Ether has already experienced a significant hack, leading to the fork between Ethereum and Ethereum Classic. More freedom, more nodes, and more risk is inherent in the Ethereum Network, and as such, the risk of a major hack is much higher. There is some risk of major hacks regarding the various exchanges in which both Bitcoin and Ethereum are traded.
These hacks while not typically indicative of flaws with the cryptocurrency’s code, have historically shown to impact the price of each currency (Nakamura, 2016).
Global Economic Event (Business Cycle)Bitcoin has utility strictly as a digital currency. As such, Bitcoin can be
expected to have an inverse relationship to the state of the global economy. Places lacking in financial infrastructure or highly inflated currencies are more likely to identify Bitcoin as an alternative measure for transacting (Magee, 2015). Although Ether should also bear an inverse relationship to the global economy due to these same factors, the magnitude of this relationship would likely be lessened due to the wide array of uses, and the more innovative nature of the Ethereum Network. Where Bitcoin values are likely to act in the same manner as commodities, Ether value should relate more closely to widespread adoption of the network and smart contracts.
There is potential for e-commerce to positively impact the value of bitcoin as well as ether, however bitcoin is better positioned to be used in these transactions. The current payment systems are set up such that there are multiple touch points which leads to costly transactions (up to 10%) and long processing times (Brennan & Lunn, 2016). The cryptocurrencies eliminate the need for these verification procedures and substantially reduce the transaction time. Bitcoin appears specifically useful to minimize these costs, and while the greater potential for hacks and security issues as a result of complexity for Ethereum, the likelihood and magnitude of impact would be less significant for Ethereum’s versatile network.
The blockchain applications for fintech are more favourable for the Ethereum platform as it is a more flexible platform for these institutions to carry out their operations. The benefit that is achieved is a secure
transaction as well as a single ledger that reduces the need to reconcile across each party’s independent ledger (Brennan & Lunn, 2016). Where there could be benefits for the individual currencies is if the fintech companies would like to increase liquidity in low liquidity markets, however this is a The relatively small opportunity. Due to the wider range of application for the Ethereum smart contracts, we have inferred that the likely impact of Fintech adoption would be greater for Ethereum as they can carry out applications in addition to leveraging the benefits of Bitcoin as a cryptocurrency. Quantitative analysis To compile a quantitative analysis, several simplifying assumptions were made to assist with the creation of a 5-year predictive model for the price of each crypto currency. These assumptions can be seen in the Appendix. A Monte Carlo simulation was compiled to project the impact of various events occurring within a single time-series simulation. A total of 100 simulations were run to compile an expected return on each currency after 5 years using a set of four operations to drive the computation. These operations and an example of the simulation can be seen in the Appendix. The results are shown below, with Bitcoin outperforming Ethereum in 58 out of 100 simulated worlds. This is due in large part to the high variance of outcomes for Ethereum and a wider range of factor probabilities due to a less focused potential use case.
Investment Strategy Combined Model Results: To take into account the various analysis that we performed we have given a weighting to each analysis and used this weighting to allocate the funds of the crypto portfolio. The result of the regression analysis are quite positive, though as stated, we need to heavily discount its result in the overall portfolio decision criteria due to its limitation and has only been given a 5%weight. Due to the forward looking nature of the Monte Carlo analysis and its ability to incorporate a
multitude of factors that could potentially play out over the next five years; we have allocated the remaining weight to the results of this analysis. Additionally, to increase the rigor we have come up with three different su-criteria for the results of the analysis. The first was to compare each of the 100 simulations that were produced to determine which cryptocurrency had a higher expected return and to tally the number of times that each currency had a higher expected return than the other. Since this result shows which currency is more likely to have a higher return over the five-year period, we have given this section of the analysis a 40% weight. We also wanted to incorporate an element of risk aversion in the investment decision, therefore we looked at the number of times each investment had a negative return over the five- year period. This element of the investment criteria was given a 25%weight. Lastly, we wanted to ensure that the portfolio would be generating a healthy expected return so we took the average of all of the expected returns to produce a likely expected return for the duration of the investment. The result of this evaluation is given a 30% weight. The table below shows the impact each of these weightings had on the portfolio.
Weight Result –BTC Result –ETH Impact on Portfolio Regression 5%300% growth over 5 years506% growth over 5 years0% to BTC 5% to ETH Monte Carlo –Compared Worlds 40%58 (wins)42 (wins)23.5% to BTC 16.5% to ETH Monte Carlo –Expected Losses 25% 38 (losses)46 (losses)15.5% to BTC9.5% to ETH Monte Carlo –Avg Expected Return 30% 42% (return over the next 5 years)20% (return over the next 5 years)30% to BTC0% to ETH Total 100%-69% to BTC 31%to ETH.
As seen from the results of the analysis bitcoin is consistently the better performer however, ether has proven that it should also warrant an allocation of the portfolio All things considered, we should invest 69% into BTC and 31% into ETH in order to maximize our return over the next five years.
With this allocation, the expected value of this portfolio after five years is; (1.42*0.69+(1.20*0.31)*$1milloion,=$1,351,00.
Conclusion
With the advent of blockchain and cryptocurrencies being as new and revolutionary as it is, predicting the five-
year projected value of either Bitcoin and Ethereum requires numerous factors to be considered. Through a combination of qualitative research conducted through interviews with industry professionals, linear regression, and a Monte Carlo analysis, it can be concluded that Bitcoin can leverage its existing user base and proven use case is likely to experience more growth in the five-year time horizon. Ethereum, while having a lower expected value has a much greater variance as a result of its strong correlation with speculation, news, and hype. Ethereum’s wide range of outcomes, both positive and negative, indicate that it should be included in the investment portfolio to take advantage of this fact.
Regards : Aashu
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