As the cryptocurrency with the largest market cap and many of the loudest supporters, Bitcoin dominates headlines and mindshare of cryptocurrencies and digital assets more broadly. For this reason, Bitcoin’s investment narrative is sometimes associated with digital assets.

There are, however, important distinctions between different types of blockchains (transaction ledgers maintained by a decentralized network) and the economic properties of assets represented on those blockchains.

This article compares the two largest digital assets by market cap, Bitcoin and Ether, along with their associated native blockchains. Bitcoin (BTC) is the native asset of the Bitcoin Blockchain, while the native asset of the Ethereum Blockchain is denoted as Ether (ETH).

The investment narrative for Bitcoin has evolved over the years. Generally, it relates to Bitcoin acting as a decentralized and censorship-resistant payment scheme and store of value, an inflation hedge, or an uncorrelated asset that can enhance risk-adjusted portfolio returns.

Value appreciation for Bitcoin is reliant on increasing global demand to own the asset and growing consensus around its narrative. Given Bitcoin’s pre-defined inflation rate and fixed long-term supply of 21 million, increasing demand to own the asset would, in theory, contribute to higher prices over time. The price of Bitcoin is not supported by underlying cash flows or a corresponding intrinsic value; the investment thesis is speculative, like gold.

Ether, by contrast, should be considered in a different light than Bitcoin, with its narrative driven by unique economic properties and use cases. The Ethereum Blockchain earns fees associated with user transactions, and these fees programmatically return value to holders of Ether, the blockchain’s native asset—how this works is discussed in more depth below. This Bitcoin/Ether comparison also provides insights into the variety of digital assets that exist today, each with unique economic properties.

The Ethereum Blockchain offers a broad spectrum of use cases

The Bitcoin Blockchain acts as a decentralized ledger for one asset, Bitcoin. It proves ownership of this asset and enables the secure transfer of Bitcoin between network addresses (which can be thought of as user wallets, or accounts).

The Ethereum Blockchain, by contrast, acts as a decentralized ledger for not just Ether, but also a virtually unlimited array of other assets created by network participants, each with distinct properties. The Ethereum Blockchain proves ownership of assets represented on the blockchain and enables their secure transfer between network addresses. It also functions as a decentralized operating system capable of hosting smart contract applications that define rules for the interaction of assets on the blockchain.

Examples of meaningful assets represented on Ethereum Blockchain include stablecoins, non-fungible tokens (NFTs), and decentralized finance (DeFi) tokens. Stablecoins typically represent U.S. dollars on the blockchain, with tokens backed 1:1 by bank deposits and treasuries (e.g., USD Coin issued by Circle). Stablecoins currently represent a value of roughly US$100 billion on the Ethereum Blockchain.¹ NFTs are tokens representing ownership of a unique asset; NFTs have been used for digital art and collectibles, proof of membership/ticketing, and even real-world assets such as real estate. DeFi tokens often represent governance rights over smart contract applications and sometimes represent some form of economic interest in fees generated by these applications.

Smart contract applications that exist today are in their infancy, experimental, lacking in regulatory clarity, and evolving rapidly. Smart contract applications on the Ethereum Blockchain have included digital asset exchanges, NFT sales platforms, and other financial services such as money markets (collateralized lending) and derivatives. Uniswap, the leading smart contract digital asset exchange on the Ethereum Blockchain, generated hundreds of billions in trading volume in 2021.²

The wide variety of assets on the Ethereum Blockchain and a growing number of applications have the potential to deliver value to Ether, the blockchain’s native asset. An increasing number of new use cases and growing use of existing applications drive demand to transact on the blockchain, ultimately driving higher fees paid to the network.

Ethereum’s economic model

Every transaction that occurs on the Ethereum Blockchain requires users to pay a network fee. Depending on their complexity, some transactions cost more than others, with simple transfers of Ether from one address to another at the low end and the use of smart contract applications (e.g., asset swaps on decentralized exchanges, NFT purchases) at the higher end.

Ethereum’s fee market utilizes an auction mechanism whereby participants bid for their transaction to be included in the next block of transactions (a limited number of transactions can be executed per second). The limited supply of transaction space significantly drives up the average fees paid during periods of high demand, as was seen in the fourth quarter of 2021 when high levels of speculative trading in various assets took place on the Ethereum Blockchain.

Fees to transact on the Ethereum Blockchain must be paid in its native token, Ether. The total fees paid during 2021 amounted to US$9.9 billion,³ a substantial increase from US$0.6 billion in 2020 due to a considerable increase in user adoption and heightened speculative activity.

Source: Author’s calculations based on data exported from Messari.

Following the implementation of a network upgrade called “EIP-1559” in August 2021, most fees paid to use the Ethereum Blockchain are now “burned.” This means that the Ether used to pay transaction fees is removed from the total supply at the time of the transaction (note: a small portion of fees are not burned, but instead paid as a “tip” directly to miners). The automatic supply reduction from the burning of transaction fees is like a publicly traded company returning value to shareholders via share repurchases.

Similarly, Ether is exposed to ongoing supply inflation required by the Ethereum Blockchain to compensate the group of participants (often referred to as miners) who maintain the decentralized network. This supply inflation is essential for the security of the decentralized network, as network participants must have continued economic incentives to maintain the transaction ledger. Total supply inflation amounted to 4.9 million Ether in 2021 (US$13.6 billion at the average ETH price of US$2,780 in 2021).³

Ether is the asset that is ultimately exposed to the economic value created (or lost) by the Ethereum Blockchain. In business terms, fees paid to the Ethereum Blockchain can be considered revenue for the network, and supply inflation considered an expense. In summary, Ether holders accrue value from fees generated by the network due to the fee burn mechanism, while experiencing the dilutive impact of supply inflation used to compensate miners.

“The Merge” further adjusts Ether’s economic properties

A network upgrade to the Ethereum Blockchain called “The Merge” is planned for September 2022. This upgrade is important because it will change the group of individuals compensated for maintaining the Ethereum Blockchain. The upgrade will reduce the supply issuance rate by an estimated 50 to 90 percent⁴ and the network’s energy consumption by an estimated 99.95 percent.⁵ This is possible due to the Ethereum Blockchain’s planned shift to “proof-of-stake,” which has substantially lower operational costs for participants who maintain the network.

Today, Ethereum is a “proof-of-work” blockchain like Bitcoin, meaning the group of individuals who maintain the network compete for the right to append the next block of transactions to the decentralized ledger by expending energy (computing power). For this service, they are rewarded with a share of the network’s new supply issuance. Following The Merge, participants will be randomly selected to append the next block of transactions based on the amount of capital (Ether) they have “staked” in the network. (“Staking” is essentially posting collateral as a promise of being a good actor in maintaining the decentralized ledger; malicious actors can be penalized by having their staked Ether revoked.)

Following The Merge, the group of individuals who are rewarded with new supply issuance will be Ether holders, as staking a minimum of 32 Ether is required to participate in maintaining the decentralized ledger. This change is substantial, as Ether holders who decide to stake will not experience the dilutive impact of new issuance yet will continue to receive value distribution from the network’s fee revenue. Stakers would receive an amount above the issuance dilution impact, as not all Ether is staked. Thinking in business terms, participants who stake their Ether and help maintain the blockchain experience the benefits of revenue generated by the network without experiencing the network’s associated expenses in the form of dilution.

A new form of asset

Ether is a very different asset than Bitcoin, a nuance that is not often discussed in mainstream media. Bitcoin’s investment thesis relies on a growing shared belief in its narrative to drive increasing demand for the asset over time. Ether shares this to a degree and is considered a competing digital money by some. However, Ether also has the potential to produce positive cash flows when fee revenue generated by the network exceeds issuance expenses. This will be particularly true following The Merge, given the expected reduction to the Ethereum Blockchain’s supply issuance rate (i.e., expense reduction).

Ether is an asset that resembles something closer to equity, whereby owners of the asset accrue value from the growing use of the Ethereum Blockchain. The Ethereum Blockchain is selling transaction space on its decentralized ledger, where revenues are generated from user transaction fees, and expenses (new issuance) are paid out to a group of participants who maintain the network. Staking adds an entirely new concept, which resembles a dividend but requires active participation in the network to earn this reward, rather than being equally distributed to all holders.

Today, there is a lack of clear and thoughtful categorization of the new forms of assets emerging within the digital asset space. More research is required to understand how these assets should be valued and considered within a diversified portfolio. Investment professionals should look beyond broad generalizations, instead seeking to understand the economic properties of each asset. 

¹ Dune analytics. Stablecoins. Accessed July 23, 2022 . (Data sourced directly from the Ethereum Blockchain.)

² Cameron Thompson. “DeFi Trading Hub Uniswap Surpasses $1T in Lifetime Volume.” Coindesk, May 24, 2022.

³ Data exported from Messari database, a leading crypto asset data provider, on July 30, 2022.

⁴Olga Kharif. “Ethereum’s Coming ‘Merge’ Could Make or Break Crypto.” Bloomberg, April 6, 2022.

⁵ Ethereum Foundation. “Ethereum Energy Consumption.” Ethereum Foundation, July 25, 2022.

This article was written by guest contributor David Filion, CFA.