Eth, in a perfect sense, is a medium of exchange controlled by no monopolistic or oligopolistic body. In this regard, eth could become a primary means of carrying out any digital transaction while knowing that the underlying value of the currency you hold today will have the same value (or marginally deflated value) over many tomorrows.
The controlled issuance of new eth provides a predictable level of inflation. In theory, this should allow eth to maintain a store of value because the expected deflationary price effects of eth’s issuance are generally known. However, the use of eth as an investment vehicle has disturbed issuance-based inflation trends. As speculative investments in eth have grown over time, the result has been extreme price inflation (even ignoring the 2018 speculative bubble), thereby decreasing the utility of eth as a means to store value or to transact. This rapid price growth is coupled with persistently high volatility levels, as speculative trading has impacted day-to-day pricing.
Figure 2 shows the daily price volatility of eth. Even as eth’s market cap has grown to that of a small country’s money supply, the impact of currency speculators can be seen in the persistence of volatility over the last two years. How do we know this impact is from speculators, you ask? The network is not yet a fully functional currency market, so the drivers for volatility could be:
Lack of supply. Demand exceeds supply.
Self-dealing trades. Round-tripping.
Too much supply. Supply exceeds demand.
Liquidity issues — Large bid-offer spreads.
The reality is that people in the eth marketplace are either collectors of tokens or sellers of tokens. There may or may not be a transaction involved in the trade of tokens, and more often than not, there probably is not a good or service traded for the currency, so speculation must be driving the ups and downs. It is improbable that the price swings are due to bid-offer spreads because it is unlikely that eth market participants have immediate liquidity needs and, therefore, will sell at a discount to convert to fiat.
Of course, when we see the above, coupled with the daily Reddit stream of contributors saying that the eth price will “moon soon,” so “buy now,” we recoil as what is currently happening could effectively defeat the premise of eth.
Figures 3&4 illustrate what a reasonably healthy level of currency price volatility relative to a reference currency is. Canadian dollar daily volatility relative to the US dollar and the Euro rarely strays outside of the ±1% band. Between the same period, eth price volatility ranged from +40/-20%.
So what does this all mean?
Firstly, if you are not converting eth to a fiat currency and back again, it means nothing at all! Perfect in a world where we are all-in on a single digital currency.
Secondly, maybe it’s not a fair comparison. Eth has a market capital valuation of around 43 billion USD (October 19, 2020) and has achieved this in only five years. Comparing it to Canada and the EU maybe isn’t appropriate given their M2 valuations of 1.5 trillion and 15.7 trillion USD, respectively. That alone should reduce volatility, should it not?
Countries with similar M2 market capitalizations to Eth, we are the realm of countries such as the Guatemalan Quetzel (36B$), Kazakhstan Tenge (42B$ — very nice!). When we analyze their daily volatility what do we see?
Well, Figure 5 for Quetzal and Figure 6 for the Tenge show that volatility generally remains controlled within a pretty tight band. Ok, we tried to sneak one past you. The Quetzal is pegged to the USD and is controlled to hold a steady value to the USD. But the Tenge is free-floating.
So, volatility is a problem that eth must solve if it is to act as a currency. Who would want to purchase a good or service today with eth if it means you could be paying as much as 20% more than you should (or 20% less — sure, that would be ok but not for the seller!)? The answer is no one.
Couple eth’s daily volatility with reasonably rapid inflation, and you have a “currency” with only marginal utility. Perhaps, as we are in the early stages of eth development (staking not yet online) and limited adoption, using eth as an investment vehicle may stabilize (or decrease), thereby reverting to a system where only issuance-based inflation remains.
Eth perhaps was never meant to be a currency. Then what is it to be? A store of value to secure a digital transaction ecosystem (i.e. a form of collateral or creditworthiness)? With these descriptions, eth almost starts to resemble central or merchant banks underpinning the ecosystem. That is not the desired outcome of a decentralized currency.
Does eth need to be pegged to a currency or a basket of currencies? Hmm, that sounds familiar…
Stablecoins are commercialized corporate versions of digital fiat currencies. Sure, you have the stability as a means of transaction, but you are still hostage to a government body printing money and eroding the value of your currency over time.
A stablecoin based upon a basket of fiat currencies? Remember libra? The libra was
Facebook et al’s version of a stable 3rd party digital currency based upon a basket of global currencies. In theory, this would provide more stability as it was envisioned to be proportionately currency weighted and, therefore, less subject to the whims of one particular government printing fiat until the printing presses ran out of ink. It is a good approach. Unfortunately, while many people don’t love or trust their governments, they are not surprisingly less enamoured with a global conglomerate taking control of a digital currency (and the transactional data that goes with it). Who would have thought that to be a concern? Sleepy governments and their regulators rose mightily to the occasion when they got a sense of global companies reaching into their purse!
In summary, we meant to provide commentary on the state of utility for eth and an illustration that there is a long way to build the ecosystem and make eth a utile currency. We remain enthusiastic supporters, but cryptocurrencies such as eth and bitcoin as alternative investments do not help the business case. If eth takes over the world, then none of this may matter. If eth evolves to a global transaction currency, then speculation must fall to the level of providing marginal liquidity, or the project is likely to fail.
Let’s hope we figure it out.