The first questions that arise when we think of the native cryptocurrency of the Ethereum Blockchain are: is Ether a consumable commodity, a capital asset or programmable money? And how does the possibility of having Ether in a wallet add value to the Hodlers?
The current version of the Ethereum blockchain is similar to a distributed operating system with a native token, Ether, which is used to cover computing costs on the network. In short, the members of the network that maintain the network are the miners who work under a Proof of Work (PoW) protocol and who provide the necessary computing resources to discover new blocks, being rewarded through rewards for each block and through transaction validation.
In this current model, Ethereum users pay the transaction cost in Ether. The token economy of a protocol or a blockchain is a growing field of study that links the issuance of tokens with the generation of economic incentives.
We can face the valuation of a cryptocurrency or a token in different ways, just like the shares of listed companies can be valued. Factors that impact the valuation are: (1) the governance of the network and (2) the initiatives carried out to give value to the network and its native token, as in the case of the Ethereum network, the EIP- 1559. Even so, we are going to simplify this analysis and focus on the sustainability of the Ethereum network and its cryptocurrency thanks to the scalability proposals planned for the medium-long term, the most determining factor in the valuation model being: the issuance of new Ethers.
Issuance is the number of new coins that are created every day on the blockchain. However, it is not strictly necessary to understand why there is issuance of new coins to understand why the native Ethereum token could be very undervalued. We start from the premise that the existence of a native token is a necessary aspect of all Blockchains whose gasoline is their own cryptocurrency associated with the cost of keeping the Blockchain safe (through payment to miners to validate transactions and discover new blocks) .
Going deeper into the concept of issuance, since it is necessary, we must assess the other side of the coin: the demand for the same token / cryptocurrency.
The cost of keeping the price of Ether stable would be equal to the number of new Ethers issued each day multiplied by their price. Let's take the example of Bitcoin. 900 new bitcoins are created every day. If each bitcoin is currently valued in the market at $ 51,000, the cost of keeping the price of Bitcoin stable would be approx. of 45.9 million new dollars each day entering as new demand to compensate for the increase in the supply of the daily issuance. In the case of Ethereum, approximately 13,500 Ether is issued each day. At an average price of $ 4,100 per Ether, it would cost $ 55.35 million per day to prevent the Ethereum price from falling.
The big change that the entire community is waiting for is the complete transition of Ethereum to the governance protocol known as Proof of Stake (PoS), which is estimated to reduce the daily emission of Ethers by 90% (consumption will also be drastically reduced energy of the network, but that is the subject of another article). The reader does not need to fully understand what the Proof of Stake (PoS) protocol is to understand this analysis, one just has to bear in mind that the number of new Ethers created each day is going to be reduced considerably.
In this article we are going to determine why $ 20,000 is a fair long-term price for Ether after the evolution to ETH 2.0 (PoS). The first part of the argument is easy to understand: just algebra. The algebra of reducing emissions from new Ethers.
Today the daily broadcast is:
13,500 Ethers x 4,100 for Ether = $ 55.35 million new daily cost to keep the price stable.
This means that the cost of preventing the price of Ether from falling is $ 55.35 million per day. After the transition to proof of stake (PoS), we will have a 90% reduction in issuance, reducing to around 1,350 new Ether created per day:
1,350 Ethers x $ 41,000 / Ether = $ 55.35 million.
In other words, if the market continues to inject new $ 55.35 million per day into the acquisition of the new Ethers (as it has been doing during 2020 and 2021) once the Proof of Stake is implemented, the price of the Ether could well rise to $ 41,000 / Ether.
The million dollar question is: When will this happen?
We are going to try to answer that question using a method called Inelastic Market Hypothesis. This hypothesis, developed by professors Xavier Gabaix & Ralph SJ Koijen, raises the idea that markets respond inelastically to investor flows. In the following article you can read it: "In search of the origins of financial fluctuations: the inelastic market hypothesis ".
The authors put forward the proposition that today's stock market reacts inelastically to investor flows. Its simplest model, which includes a bond market and a stock market, indicates that selling $ 1 in bonds and buying $ 1 in stocks generates an increasing effect in the capitalization of the American stock market in a range of $ 3 to $ 8 increment. His article goes on to demonstrate, both theoretically and empirically, how this case occurs. The main reason for the inelasticity of equity markets, according to the authors, is related to the behavior of retailers and institutions, which own the majority of the shares listed in the US (more than 80%).
As an important detail, both retailers and institutions are participants in the illiquidity of the market when they buy listed shares and hold them for long periods, regardless of price fluctuations, but why does this happen?
In the case of institutions, they usually have mandates from their investors that oblige them to keep a part of their shares always invested in equities. Retailers who do not actively manage (intraday trading / speculation) in the stock market often prefer "buy and hold" strategies.
This lack of liquidity in the stock market causes greater volatility as there is no market depth. This volatility can be quantified and explained by the inelastic market hypothesis. The inelasticity factor of the North American listed stock market would be in the range of 3 to 8, which means that for every dollar invested in stocks, the market capitalization could increase from 3 to 8 dollars for every new dollar invested in the market.
This general behavior of retailers and institutions in the stock market reminds me of the HODL culture of the Crypto community, which prides itself on conserving its cryptocurrencies / tokens regardless of price fluctuations. Developing this thesis, we establish the premises that (1) volatility is closely related to illiquidity and (2) that if the inelasticity of the American stock markets is from 3 to 8, assuming that these two listed markets (cryptocurrencies and American stocks) have a similar behavior, what is the inelasticity of the cryptocurrency market compared to the American stock market?
We are going to define Elasticity (in order to understand inelasticity) in economic terms as “the sensitivity of one variable to changes experienced by another”. In other words, the elasticity (variation) of the price of Ether would be affected by variations in the Demand or the Supply of Ethers in the market.
Using the previous Bitcoin Halving cycles as a basis for analysis, we have measured the inelasticity of the Bitcoin market and extrapolated that same view to Ethereum. The inelasticity factor found for Bitcoin was 20, which means that "every dollar invested in Bitcoin causes the market capitalization to increase by $ 20." Using this inelasticity factor, it gives us clues, after the implementation of PoS, that the price of Ethereum should increase at an average rate of 8% per month due only to the reduction in emission.
Let's go back to Bitcoin, the most capitalized cryptocurrency in the ecosystem and which has already suffered drastic reductions in its issuance (halving). The method used will be to analyze the previous Bitcoin Halving cycles and measure the effect that the supply impact of each Halving had on the acceleration of the Bitcoin price increase after the Halving date. We will then try to predict by comparison how Ethereum's EIP-1559 solution and the transition to Proof of Stake (PoS) will positively affect the price of Ether. The result will come from the estimation of the magnitude of the impact of the supply of each of these two points, taking into account the inelasticity factor found in the Bitcoin market.
Let's explain how new Bitcoins are issued
Every day new bitcoins are created and sold on the market. The amount of new bitcoins produced is halved every four years. This event is called Halving.
Let's put our first point in context. If new bitcoins are created and put on the market every day, the general supply of bitcoins increases every day, making Bitcoin an inflationary asset. As you can imagine, if there were no new buyers for the new bitcoins, the price of Bitcoin would tend to decrease until the buyers determine a fair price. The Law of Supply and Demand: if there is surplus of an asset, it tends to be cheaper by being more accessible. Hopefully, at some point, the price of this asset becomes cheap enough that people consider buying an amount equal to what is being created, keeping the price stable. However, if there are more people who want to buy than assets to sell, the price goes up. Let's say that we have reached a stable price, in which the newly issued bitcoins are bought by a group of investors on a recurring basis. If the price of Bitcoin remains the same for an extended period of time, this indicates that there is a constant demand for bitcoins. Otherwise, if there were no investors willing to buy the newly issued bitcoins, the price of Bitcoin would drop.
This is where the concept of Supply Shock comes in. Let's think about the Bitcoin market just before the Halving. The day of the same arrives and, as expected, the production of new Bitcoins is reduced by half. If we assume that the demand remains the same as before, this will force the price to rise over time due to the “Supply Shock”. The impact of the offer will be the reduction in the amount of Bitcoins issued after the Halving date. In other words, the Offer Shock is equal to the number of coins that would have been issued if the Halving had not occurred. My argument is that the Supply Shock multiplied by the average value per Bitcoin accumulates in the value of the Bitcoin network over time. This can be represented as "Invested Capital", since the flow of money works as a capital investment:
Supply Shock x Average Price per Bitcoin = "Invested Capital"
The "Invested Capital", which used to prevent the value of Bitcoin from declining, now contributes to increasing the value of Bitcoin. The factor by which "Invested Capital" increases market capitalization, represented by h1, is Inelasticity:
"Invested Capital" x Inelasticity = h1
Here is a simple example to clarify these concepts: Let's imagine that we have an office building and that we pay for air conditioning approximately € 100 per month in summer. Every summer month, we will have € 100 less in our account that will be used to pay the air conditioning bill. When the summer ends, we no longer need to pay € 100 because it is colder. The bill is reduced to € 50 per month. This means that we now have € 50 more to invest in other things. We register this € 50 in the account every month as added value that we did not have in the summer months The difference between the previous example and Bitcoin (and the listed stock markets) is the concept of Inelasticity, which means that those 50 € of "Invested Capital" can represent, for example, a € 200 increase in the capitalization of the asset (inelasticity factor of 4, in this example, since each € of "Invested Capital" represents a € 4 increase in the market value of Bitcoin). Plus, considering that Halving acts like a perpetual winter, it cuts your air conditioning bill in half every four years.
Let's estimate these variables:
The increase in market capitalization due to the Supply Shock, represented as "h1"
"Invested Capital"
With these variables, we can calculate the inelasticity of the price of Bitcoin:
h1 / "Invested Capital" = Inelasticity
This approximation of the inelasticity of the Bitcoin market can be used to calculate the magnitude of the price change that Ethereum will undergo after EIP 1559 and the transition to Proof of Stake.Let's continue to analyze the cycles that arise from each Halving in the Bitcoin network . We will focus on the market cycle of the 2016-2017 period as an example of how to calculate the increase in market capitalization (represented as “h1”) due to Supply Shock and “Invested Capital”. We have used the same process described below to calculate the inelasticity of the post-halving cycles of 2012 and 2020.
Below is a graph of Bitcoin's market capitalization from its inception to the present and what happened in the months after the Halvings noted on the graph:
Let's put all of this in context with an example:
Before each Halving, let's say that the price of Bitcoin was $ 1,000 and that 50 Bitcoins were issued a day. If the price of Bitcoin remained stable or rose over time, this meant that the market was paying $ 50,000 a day for the new Bitcoins. After the next Halving, the market continued to pay these $ 50,000 per day but with the detail that as of this event, only 25 Bitcoins were issued per day.
The million dollar question then would be: Where does that extra $ 25,000 go that previously kept the price stable? The answer: They accumulate as investment in the network!
That is why we call it "Invested Capital".
"Building network value" is just a fancy way of saying that this money will be used to buy old Bitcoins or Bitcoins that were not issued that day. Inelasticity is relevant in this context because that $ 25,000 can cause Bitcoin's market capitalization to increase by $ 125,000 per day if the inelasticity factor is 5.
We are going to start calculating that mysterious Inelasticity.
Let's imagine that the Halving has not yet occurred. In this case, we can assume that Bitcoin's market capitalization would have remained stable, even depreciating. In order to calculate how much of the increase in the market capitalization of Bitcoin after the Halving was due to the reduction of the emissions of Bitcoin we will consider the difference between the market capitalization of each Halving indicated in the graph and the moment in which the color of the graph It goes from yellow to green, which gives us the increase in market capitalization due to the Halving effect, which we call “h1”.
Now comes the final step: determine the "Invested Capital"; is equal to the amount of Bitcoins that would have been issued if the Halving (Offer Shock) had not occurred multiplied by the average price of these Bitcoins:
Supply Shock x Average Price of Bitcoins = "Invested Capital"
Finally, we will use the data obtained in the following formula:
h1 / "Invested Capital" = Inelasticity
The results we have obtained are the following for each Bitcoin cycle after its Halving:
2012 Post-Halving = Inelasticity of 24.9
2016 Post-Halving = Inelasticity of 20.7
2020 Post-Halving = Inelasticity of 70.2
Like you, I was also surprised to see how close the inelasticities of the 2012 and 2016 cycles are and how far 2020 is in relation to the other two. After pondering it, I find an explanation for this.
The Covid outbreak caused markets to plummet just before the Halving, and the effects of new money issuance by Central Banks allowed listed markets to quickly recover just after the Halving, which occurred in May 2020.
These two factors lowered the average price per Bitcoin and decreased the time it took for Bitcoin to get its market capitalization to double in the months after the Halving.
Compared to the Harvard paper, the inelasticity of the stock markets ranged from 3 to 8. So we can tentatively say that the inelasticity of the Bitcoin market is roughly 20, which means it is 3 to 7 times more inelastic than stock markets.
To put this in simple terms, every $ 1 spent on buying Bitcoin results in a $ 20 increase in its market capitalization.
Let's take a look at the case of Ethereum and the impact of EIP-1559 and PoS on the value of its native token.
Let's assume that the “Ethereum market has similar Inelasticity to the Bitcoin market”. Being the second largest cryptocurrency by market capitalization and showing volatility movements similar to that of Bitcoin, this is a fair assumption.
The On-Chain data indicates that people are buying Ethers discounting the future transition to PoS in the price, which is also supported by the decrease in Ethers in the balance of Exchanges, in this post you can see the on-chain analysis previous 👇👇👇
In addition, the day-to-day price fluctuations of these two cryptocurrencies are almost identical, although in the last market crash, Ether came to separate itself from the rest of cryptocurrencies, including Bitcoin, holding its price in a more stable way compared to the other cryptocurrencies. the rest. Still, as of today, we will assume that their Inelasticity values are similar, so we will use our benchmark Inelasticity of 20 to predict Ethereum's price action after EIP 1559 and the transition to PoS.
The steps to follow to calculate the monthly increase in the price of Ethereum due to its catalysts are essentially the reverse process of calculating Inelasticity. The results: EIP 1559 should increase the price of ETH by 2% per month; the transition to PoS in turn, should increase the price of ETH by 6% per month. This means that the combined effect of both catalysts is an increase of 8% per month. This is an ideal average value, which assumes that everything else (and remember that the fundamentals of the crypto market are complex) remain the same. Keep in mind that short-term price fluctuations are impossible to predict, we only take into account the long-term in this analysis.
Without being investment advice, in our analysis of Ethereum, where do we think the price of Ether is heading? From the beginning of 2021 until today, Ether has reached an average price of $ 2,000 and an issuance of 13,500 Ethers per day. This means that with Ether at $ 2,000 / Ether, the market needed an injection of $ 27 million a day just to keep the price stable at $ 2,000.
Daily issue x Price per Ether = Daily investment necessary to keep the price of Ether stable - (currently needed: 13,500 Ethers x $ 4,100 = 55.35 million dollars)
So what will happen when the daily issuance of new Ethers drops 90% after the transition to Proof of Stake? Well, suppose that $ 55.35 million continues to be injected daily into Ethers purchases. The new daily issuance is 1,350 Ether per day. What would be the fair price of Ether where it should hold?
$ 55.35 million / 1,350 new daily Ethers = $ 41,000 per Ether
After transitioning to proof of stake, the price of Ether will grow at least at an average rate of 8% per month.
Anyone who has been trained with us at formacioneninversion.com knows that we usually set objective prices that based on our study give us an almost 100% probability of success. Knowing that Ether could be worth $ 41,000 / Ether, we will go for a price that the market may consider expensive at any given time, with $ 20,000 / Ether being an acceptable price that we believe can be easily reached in the long term after upgrade to Ether 2.0.
As is normal, we ourselves try to refute our hypothesis. The fact that the number of people who have joined the Ethereum community has increased in such a disproportionate way suggests that it is highly unlikely that Ether will be worth less than $ 1,000 again (except Black Swan). for the moment they are in our favor, we cannot ignore the trend that has already been created, the NFT-mania, the Metaverse, the DeFi ecosystem, the “Ultra Sound Money” movement against central banks and fiat currency, the movement that values the “Triple Halving” of Ether (EIP-1559, PoS and ETH2.0), etc… The market is currently channeling 55.35 million dollars a day just to keep the price of Ether stable, and has continued to do so for the last Market crash of almost 30%. From the perspective of beToken Capital, this event is sufficient to establish that we are facing an asset that qualifies with the necessary characteristics to be considered a real Reserve of Value.
There will be those who ask: what about the Ethers that the miners produce and still keep unsold? They are generating Ethers for a price below the market price. This establishes the premise that we could also be wrong about the need for real capital that Ether needs to be stable every day, and the lack of supply in some cases and the excess in others, will give us an average price in the long term that we can consider As a reference to determine if Ether is expensive or cheap, even so, not selling the Ethers generated from mining is considered a great opportunity cost for miners. Since Proof of Work (PoW) mining is a fairly low profit margin business, the cost of producing new Ethers may not be much lower than the actual market price Famous investor and analyst Raoul Pal (founder of Real Vision) also predicts $ 20,000 per Ether in this market cycle (marked before the next Bitcoin Halving), but believes that the transition to PoS will be an event that will be more than discounted by the market ("buy the rumor, sell the news").
Even so, we consider that Ether, under current conditions, may not have the ability to reach $ 20,000 / Ether and remain stable at that price, especially since the market is not yet sophisticated enough to set the price at a certain point. price, and as always, we must expect moments of very strong FUD. Reaching $ 20,000 for Ether we do not think it is a difficult event to achieve, but keeping the price stable there is another matter, since it will depend on the capital flows that enter to buy Ethereum for a prolonged period of time, once the Proof of Participation.
The last all-time highs that we have reached will serve as a reference for the expectations of the next cycle. We can be sure that any all-time highs we reach in this cycle will be surpassed in the next. This is the huge conviction for a large portion of cryptocurrency hodlers and is most likely the reason why the price correction for Bitcoin and other cryptos after China's May 2021 ban was not as pronounced as it could be expected.
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