Ethereum (ETH), the world's second-most valuable cryptocurrency, appears to be having a strong year at first glance. It has gained 57% and seems to be building momentum as the year comes to a close. Over the past month alone, it has climbed more than 20%.
However, context is essential. Currently, Ethereum is significantly underperforming the broader cryptocurrency market. Bitcoin (BTC), for instance, has surged an impressive 112% this year. Other leading cryptocurrencies have also posted triple-digit gains in 2023. This underperformance complicates the decision-making process for potential investors, making Ethereum look like a market laggard. If you're considering an investment, here’s what you should understand.
Why Is Ethereum Underperforming?
What makes Ethereum's situation particularly puzzling is the difficulty in pinpointing the exact reasons for its underperformance relative to Bitcoin and other major cryptocurrencies. Entering 2023, Ethereum seemed to be riding a wave of positive momentum following The Merge. This event was widely celebrated as one of the most significant technical achievements in the blockchain space. The Merge fundamentally changed Ethereum's blockchain infrastructure, aiming to reduce transaction fees, increase processing speeds, and enhance overall efficiency.
Yet, several challenges have emerged this year. Overall activity on the Ethereum blockchain has declined, which is not a positive indicator for future growth. For example, Bitcoin recently surpassed Ethereum in 24-hour non-fungible token (NFT) sales volume for the first time—a sector Ethereum has traditionally dominated. Additionally, Total Value Locked (TVL), a key metric for blockchain activity, recently hit a 12-month low, suggesting a potential weakening of Ethereum's position in decentralized finance (DeFi). These may be short-term fluctuations, but they are concerning nonetheless.
Regulatory concerns have also played a role, particularly those related to staking activities on Ethereum's new proof-of-stake blockchain. The primary worry is that the SEC's crackdown on major cryptocurrency exchanges for their staking offerings, as seen earlier this year, could eventually diminish Ethereum's appeal as an investment.
Furthermore, The Merge has not delivered the transformative impact many expected, especially regarding transaction fees and processing speeds. For instance, fees for relatively simple actions, like purchasing an NFT, can still run into hundreds of dollars. The main Ethereum blockchain can still only handle 20 to 30 transactions per second, far below the once-promised one million transactions per second.
Ethereum vs. Bitcoin
Perhaps the most straightforward explanation is that investor attention is currently hyper-focused on Bitcoin. Nearly everyone is anticipating the imminent launch of the first-ever spot Bitcoin exchange-traded fund (ETF) and its potential implications for the broader crypto market. In this context, Ethereum seems to have taken a backseat.
As a result, the historically strong correlation between Ethereum and Bitcoin appears to be weakening. Until mid-March, the correlation between the two was nearly 0.95, indicating an almost perfect performance match. However, the 90-day correlation has since dropped to around 0.8.
Ethereum vs. Other Altcoins
Moreover, several other cryptocurrencies are outperforming Ethereum. Solana (SOL), often considered Ethereum's primary rival in the Layer-1 blockchain space, is up a remarkable 325% year-to-date. Despite its own regulatory and technical challenges, investors have largely overlooked these issues due to Solana's perceived growth potential. Innovations like Solana's "crypto phone" have generated significant excitement.
These shifting perceptions are influencing institutional money flows. Large institutional investors appear to be reallocating funds from Ethereum to Solana. According to CoinShares, which tracks inflows and outflows for various cryptocurrencies, Solana has seen net positive inflows in 28 of the 32 weeks this year. In contrast, Ethereum has experienced outflows, leading CoinShares to label Solana as "the altcoin of choice" for institutional investors.
Can Ethereum Bounce Back?
Ultimately, the decision to invest in Ethereum depends on your view of its long-term growth prospects. Ethereum remains the clear leader in nearly every niche and sector of the blockchain world. It is also one of the few cryptocurrencies that seems to enjoy implicit support from federal regulators. Notably, SEC Chair Gary Gensler has avoided classifying Ethereum as a "security." Analysts have not entirely given up on Ethereum either; Standard Chartered Bank, for example, recently set an ambitious price target of $8,000.
Moving forward, it will be crucial to monitor how Ethereum responds to competitive threats from Solana and other Layer-1 blockchains. This factor could significantly influence Ethereum's long-term growth trajectory. If Ethereum fails to keep pace with these rivals, it may impact investment decisions considerably.
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Frequently Asked Questions
What is causing Ethereum's current underperformance?
Ethereum's underperformance can be attributed to several factors, including reduced on-chain activity, regulatory concerns around staking, and heightened investor focus on Bitcoin due to the anticipated spot ETF. Additionally, competitors like Solana are gaining market share.
How does Ethereum's transaction speed compare to its promises?
Ethereum's main blockchain currently processes 20 to 30 transactions per second, which is significantly lower than the one million transactions per second once promised. High transaction fees for basic actions also remain a concern.
Is Ethereum still a good long-term investment?
Ethereum remains a leader in the blockchain space with strong institutional support and regulatory clarity. However, investors should monitor its ability to innovate and compete with rivals like Solana to assess its long-term potential.
What are the main risks of investing in Ethereum?
Key risks include regulatory uncertainty, especially regarding staking, intense competition from other Layer-1 blockchains, and potential declines in network activity and developer engagement.
How is institutional investment shifting between Ethereum and Solana?
Data from CoinShares indicates that Solana has seen net positive institutional inflows for most of the year, while Ethereum has experienced outflows. This suggests a trend of institutional preference toward Solana currently.
Could Ethereum regain its leading position?
Ethereum could rebound by addressing its scalability issues, reducing fees, and maintaining its dominant role in key sectors like DeFi and NFTs. However, this depends on its execution and ability to fend off competitive threats.