Eaglebrook IQ
What is Ethereum?
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September 14, 2021

Ethereum Introduction

Ethereum was launched in 2015 by programmer Vitalik Buterin as a technology that grew upon Bitcoin’s original ideas. While similar to Bitcoin in its ability to transfer value without a central intermediary, Ethereum is different in that it allows developers and entrepreneurs to build applications with the use of smart contracts. Developers and users can create, build, and monetize applications built on Ethereum, with ether (ETH) as the native token that powers the blockchain. Ether is used for every transaction that occurs between users, applications, and wallets. Today, Ethereum processes the most transactions of any blockchain and is the second largest digital asset by market capitalization ($300 billion+).

What are Smart Contracts?

Smart contracts are programs that execute transaction and contracts when predetermined conditions are met, using if/then logic to transfer ether, digital assets, and data. They are written as a code that is both transparent and publicly available on the Ethereum ledger. An example of a smart contract is, “if Bob has 100 Apples, then Alice will pay Bob 1 ETH”. When the smart contract confirms that Bob has deposited 100 Apples, the transaction will automatically execute and settle instantly, and Alice will pay Bob 1 ETH. Another example is, “if Bob pays 10 ETH, send him the title of the car.” Here, the smart contract is storing data and sending value and ownership as warranted.

Smart contracts are fully automated and transparent with much greater efficiency than traditional financial contracts or value transfers. They enable developers to build products and applications that were previously not possible.

Ethereum as a Platform

Companies, developers, and entrepreneurs can build software applications on top of Ethereum as the base layer protocol (layer 1). Ethereum is comparable to the internet protocol HTTP, the standard platform and protocol for websites and web browsers that was developed in 1989. In the first wave of the internet, companies such as Amazon, Netflix, and Facebook built their applications on HTTP as the base layer protocol. In the second wave of the internet, companies such as Instagram and Uber built their applications on mobile using IOS and Android as the base layer platforms. Today, the third wave of the internet has the world’s leading developers and entrepreneurs building applications on Ethereum as the base layer platform.

The major difference is that Ethereum offers investors and users the opportunity to take part in the growth of the protocol with the native asset ether (ETH). In another analogy, one can think of Ethereum as the highway, applications as cars, and ether (ETH) as the gas that powers the cars. As each application requires ether to run, their usage is a significant driver of ether demand.

The major advantages of building applications on Ethereum is that apps are decentralized and permissionless with value transfer and financial transactions that are fully automated. Because of this, top developers, engineers, and wall street talent are now building decentralized applications across various markets such as finance, banking, payments, gaming, and art. These applications are gaining adoption from both traditional crypto users as well as newcomers interested these opportunities. Because Ethereum is decentralized and permissionless, anyone with an internet connection can access these financial services, digital art, and gaming applications.

The Platform for Stablecoins (Payments)

Stablecoin applications are built on Ethereum and allow users to transfer value at rates that are expected to be the same in the future. These protocols peg assets to fully backed reserves such as fiat currencies or gold to maintain a stable value against their collateral. In these applications, users deposit dollars and receive equal amounts of stablecoins in exchange. These tokens can move freely throughout the Ethereum ecosystem and can be returned to the application for conversion back to dollars.

This development has allowed users, developers, and traders the ability to transact through Ethereum with stability. Ethereum users can send and receive payments with stablecoins, while traders can move in and out of positions within the ecosystem. Users can lend stablecoins to receive income or use them as collateral to borrow a set amount for either payments or leveraged exposure. Stablecoins have approximately $180 billion in market cap and supply, with USDT, USDC, DAI, and GUSD among the most popular.

The Platform for DeFi (Finance & Banking)

Stablecoins provided a platform of stability for the next step in the Ethereum ecosystem, decentralized finance (“DeFi”). DeFi leverages Ethereum-based tokens and smart contracts to create applications that offer traditional financial services without central intermediaries. The front-end of these applications are internet webpages, while the back-end processes through Ethereum. Ethereum as the base layer protocol provides an efficient, transparent, and permissionless offering of banking and money services. Primary applications within DeFi involve borrowing, lending, exchanging, derivatives, and insurance.

Through decentralized exchanges, one can swap between tokens or provide liquidity to other traders and receive transaction fees. Through lending and borrowing protocols, users can deposit assets, receive interest, and borrow other assets for either trading or payments. Derivative protocols allow users to gain exposure to synthetic assets tied to traditional financial indices, commodities, or US stocks, while others provide custom over-the-counter contracts between two parties. Insurance protocols allow users of the DeFi applications to pay for coverage against bugs or attacks. DeFi applications are built to interact with each other, creating an ecosystem that is interoperable and accessible to anyone in the world with an internet connection.

As each transaction through a DeFi protocol requires ether (ETH), these applications are a significant driver of ether demand. Over 3 million unique addresses have accessed DeFi protocols thus far, with currently 12 DeFi applications on Ethereum valued at over $1 billion in market cap.

The Platform for NFTs (Gaming & Art)

Non-Fungible Tokens, or “NFTs” are digital assets that represent art, music, games, or videos. Each NFT is a unique, one-of-a- kind asset with ownership that is verified on the blockchain. When NFTs are transferred, ownership is transferred - making each NFT an exclusive opportunity.

Examples of NFTs include CryptoPunks (scarce, generative digital art), Athletes (game highlights), Top Shot (digital basketball cards), and Beeple (artist of NFT that sold for $69.4 million). Games on Ethereum also have NFTs available, with players battling to own the most exclusive goods (Axie Infinity).

The opportunities of NFTs go beyond art. NFT’s are a way to verify ownership. Some NFTs have exclusive rights to conferences, access to CEOs, or other built-in utilities. NFTs also allow for “tokenization” or the sharing of value through token holders. Tokenization use-cases are emerging in shared real-estate ownership or shared fine art, to name a few.

What’s Next for Ethereum?

Ethereum recently implemented EIP-1559, a proposal that improved on Ethereum’s pricing of transaction fees, while also creating a “burning” mechanism that offsets some of Ethereum’s increase in supply. More significantly, Ethereum will switch to a proof-of-stake consensus algorithm in 2022, labeled Eth 2.0. This is expected to make Ethereum more scalable, secure, and sustainable, with the Ethereum community very excited about this transition.

IMPORTANT DISCLOSURES
Investment advisory and management services are provided by Eaglebrook Advisors, Inc., a registered investment advisor. Information presented is for educational purposes only. Past performance is no indication of future results. Please see our Form ADV Disclosures and Privacy Policy in our website. Investing in digital currency comes with significant risk of loss that a client should be prepared to bear, including, but not limited to, volatile market price swings or flash crashes, market manipulation, economic, regulatory, technical, and cybersecurity risks. In addition, digital currency markets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing.
Volatility Risk: Digital currency is a speculative and volatile investment asset. Investors should be prepared for volatile market swings and prolonged bear markets. Digital currency can have higher volatility than other traditional investors such as stocks and bonds and market movements can be difficult to predict.
Economic Risk: The economic risk associated with digital currency is in the lack of widespread or continuing digital currency adoption. The market and investors could decide that digital currency should not be valued at the current market capitalization due to a variety of factors.
Regulatory Risk: Digital currency could be banned or highly regulated by governments that would deter investors from buying or holding digital currency.
Technical Risk: Digital currency is a dynamic network with a codebase that is updated to add new security and functionality features. The updated code that is merged by the core developers could potentially have an error that threatens the security or functionality of the digital currency network.
Cybersecurity Risk: Digital currency exchanges and wallets have been hacked and digital currency has been stolen in the past. This is a potential risk that clients must be comfortable with when investing and holding digital currency. Theft is less likely when holding digital currency at a qualified custodian in offline systems (cold storage) with institutional security and controls.
About Eaglebrook Advisors
Eaglebrook is a tech-driven investment manager specializing in bitcoin and digital assets. The firm offers various Bitcoin and Digital Asset SMAs serving financial advisors, registered investment advisors (RIAs), family offices, and institutions. Eaglebrook is backed by wealth management executives and institutions.
For more information, please contact us at +1 (202) 798-1880 or send an email to contact@eaglebrookadvisors.com.