The rise of the Ethereum economy
The second-biggest cryptocurrency after Bitcoin is more than digital money — it’s the foundation of a multi-billion dollar economy. From DeFi to digital art, understand the forces at work behind the rise of Ethereum.
Published on March 2, 2021
On February 22, a surprisingly whimsical headline appeared in the New York Times’ business section:
If you were on the internet in 2011, you definitely know that cat. Indeed, Chris Torres, the originator of the internet-beloved “nyan cat” GIF (which features a pixel-art kitten blazing through space on a rainbow), had somehow sold his decade-old meme for nearly $600,000.
And Torres wasn’t alone in finding a way to sell the kind of digital content that would have previously been considered pretty much worthless — in part because anyone can copy and paste a digital file endlessly. In just the last couple of weeks:
A cool-looking lo-fi monkey — part of a series called Cryptopunks — sold for $1.5 million.
A series of 3D models for “impossible furniture,” like a table made out of bubble gum, garnered $450,000.
A single tweet from entrepreneur and Dallas Mavericks owner Mark Cuban went for $952.
All of these stories were really about the same thing — people buying a virtual, digital-world property for serious real-world sums of money.
This burgeoning market is made possible by a category of cryptoassets called NFTs. Short for “non-fungible token,” an NFT is essentially a certificate of authenticity that says your version of an endlessly copy-paste-able digital file (whether it’s an image, a video, a song, or virtually anything else) is the real one.
NFTs are mostly issued on the Ethereum blockchain — taking advantage of its “smart contract” functionality — and can generally be bought or sold on marketplaces dedicated to them. (While they’re getting huge buzz now, NFTs aren’t actually brand-new. You might recall the 2017 craze around Cryptokitties, a digital-cat-trading game.)
A NFT is a token just like Bitcoin is a token — and can generally be bought or sold via special exchanges that support the sales. But unlike Bitcoin, where every individual coin is virtually identical in characteristics, each NFT represents a specific digital property. (Hence the “non-fungible.”) They’ve been used to sell everything from celebrity ephemera and NBA “digital collectibles” to virtual real-estate and live clips from the dance-music star Deadmau5.
As they’ve become a surprisingly big business, with estimated sales of more than $100 million, NFTs have sparked philosophical debates around the meaning of ownership. Is collecting digital artifacts all that different from collecting rare sneakers, or vinyl records, or, for that matter, Picassos?
Which are fascinating questions, but they don’t even touch on a bigger story NFTs can help us understand. In that bigger story, the smart contract technology that has made it possible for artists, meme-makers, and musicians to sell their virtual wares is also fueling a new, decentralized alternative to the current financial system. In that alternative system, which is designed to economically empower individuals, capital will flow through open-source protocols that are faster, cheaper, more transparent, and available to all.
Call it Finance 2.0. And it’s already started to emerge if you know where to look.
Ethereum’s breakout year
Prior to the NFT craze, Bitcoin had gotten the lion's share of recent non-crypto-media headlines. But people already in the space tend to get even more excited when the topic of Ethereum comes up. And it’s not (mostly) because Ethereum is the second-biggest cryptocurrency by market capitalization after Bitcoin.
What casual observers tend not to understand about Ethereum is that it isn’t just another form of digital money. Ethereum’s blockchain was created to be a highly versatile decentralized computing platform — one which allows developers to build things like markets for digital art and which also runs “decentralized finance” (or DeFi) tools like Compound and Uniswap that have seen hundreds of billions of dollars in value flow through them.
Part of the Ethereum story is similar to the one you’ve been hearing about Bitcoin. Like Bitcoin, ETH (which is the Ethereum blockchain’s native cryptocurrency) has surged in price and popularity — climbing from the mid-$300 level to a high above $2000 in February.
Ethereum has also experienced record global search interest in recent months. (Bitcoin still lags behind its peak search era, which came during a flurry of mainstream coverage in late 2017 and early 2018.)
Another indicator of rising mainstream engagement? Reddit message boards dedicated to Ethereum (as well as crypto generally), have seen a surge in new subscribers in recent days:
A big reason why: the price of ETH. You might be surprised to learn ETH’s price has actually grown faster than Bitcoin since the beginning of the 2021 — in part driven by a flood of retail investors with extra time and discretionary income due to the COVID pandemic experimenting with new investment strategies. While the price of Bitcoin has appreciated by about 65% since the beginning of the year, ETH has appreciated by more than 112% — giving it a market capitalization of $177B (bigger than Morgan Stanley or Square).
Understanding the broader Ethereum economy
But surging market cap is just one part of the story. The really fascinating thing about Ethereum is that ETH’s value is merely the most visible part of the broader economy the Ethereum blockchain makes possible.
Think of ETH as being like the visible part of an iceberg. Because the Ethereum blockchain is so flexible, vast economic activity is happening just under the surface — in the form of Ethereum-powered crypto categories including DeFi, stablecoins, wrapped tokens, and NFTs.
Collectively, the Ethereum economy’s market cap — defined by the total market cap of the biggest ERC-20 tokens issued on top of the Ethereum blockchain — has soared in recent weeks to more than $250 billion (not including NFTs, because it’s hard to make apples-to-apples comparisons).
Stablecoins, which are designed to reduce volatility by having their value pegged to a reserve asset like the US dollar, are one of the most promising and rapidly-growing sectors of the ETH economy. They’ve been broadly adopted as a stable medium for making payments between exchanges.
As of February 2021, the total dollar value of stablecoins on the Ethereum blockchain has surpassed $30 billion:
A smaller, but also fast-growing component of the Ethereum economy are “wrapped tokens” which allow non-Ethereum native cryptocurrencies — especially Bitcoin — to be used on the Ethereum blockchain and easily interact with DeFi applications. As a result, the value of tokenized Bitcoin has increased substantially.
When Reddit met DeFi
So what’s been driving all this recent activity? A lot of it, of course, is related to the broader boom in crypto. But an interesting constituent class that’s worth taking a closer look at are the internet-fluent “memestock” investors of Reddit — who were inspired by frustrating experiences with the traditional financial system to seek out less-centralized alternatives.
These decentralized tools (also referred to as “DeFi” or “Finance 2.0”) allow for investing, trading, yield-bearing savings, new kinds of “flash” loans and much more. According to a Fabian Schär, a University of Basel professor and researcher, Ethereum-powered DeFi applications have “the potential to create a truly open, transparent, and immutable financial infrastructure.”
If you’re just getting your bearings, the DeFi landscape is broadly made up of three categories of apps — which together aim to become speedier, more efficient alternatives to the inefficient, slow, and often expensive pipes that capital flows through in the current financial system.
Decentralized exchanges like Uniswap and Sushiswap allow users to trade tokens without an intermediary.
Savings and loans protocols like Compound and Aave allow users to borrow and lend tokens without an intermediary.
Oracles like Chainlink aim to feed real-world data to DeFi applications.
For the Reddit-based traders whose trust in Finance 1.0’s plumbing was left shaken, DeFi was a natural home — and because these very-online investors were already furiously exchanging tips and strategies, they were able to help each other explore complex new protocols. (It doesn’t hurt that group is comfortable with risk, given that DeFi markets can be highly volatile.)
At least one prominent voice began evangelizing DeFi directly to Reddit’s most active stock traders. In an AMA hosted by the wallstreetbets subreddit, Mark Cuban shared his belief that DeFi would make “markets much more efficient, transparent and available to the small investor.”
And Cuban wasn’t alone. In a stream with U.S. representative Alexandra Ocasio-Cortez, Reddit co-founder Alexis Ohanian made his own case for DeFi: “No one’s gonna wake up in a week and be like let’s all go back to how it was,” he said. “The collective public cannot unsee this, and so I think that there’s going to be more and more energy to find decentralized solutions. There is so much energy to rally behind something that isn’t capable of having the game rigged.”
In part as a result of this new attention, the total DeFi market had risen above $40 billion as of February 2021. In one strong indicator of how quickly these tools have gained popularity, the biggest decentralized exchange, Uniswap, has seen $100 billion in volume since it launched in May 2020.
Monthly volume across all decentralized exchanges broke the $50 billion mark in January:
Institutional adoption of Ethereum
The Ethereum economy has also caught the attention of major financial institutions. In large part due to stablecoins’ popularity as a non-volatile method of sending value between exchanges and DeFi protocols, the Ethereum blockchain has become one of the most popular vehicles for U.S. dollar payments.
In 2020, Ethereum processed $874 billion worth of dollar payments, rivalling major consumer-facing systems like Zelle ($307 billion) and Paypal ($963 billion) although it remains far below the volume processed by central bank payment systems such as Fedwire ($840 trillion).
In December 2020, Visa announced that it is connecting its global payments network of 60 million merchants to the U.S. Dollar Coin (USDC) stablecoin. (USDC is backed by a consortium including Coinbase and Circle.)
Paypal also recently enabled limited ETH trading for its vast U.S. user base — and is planning to extend that functionality to all 325 million global users. “We all know the current financial system is antiquated, and we can envision a future where transactions are completed in seconds, not days,” said CEO Daniel Schulman in a 2021 earning call. “We are significantly investing in our new crypto, blockchain, and digital currencies business unit in order to help shape this more inclusive future."
Meanwhile, institutional investors are starting to move into Ethereum. The Grayscale Ethereum Trust (which allows investors to gain Ethereum exposure via traditional brokerages) has grown substantially over the past year. The fund now holds 3 million ETH at a value greater than $4 billion.
CME futures, another vehicle for institutional Ethereum exposure, recently went live and traded over $33 million on its first day. And in December 2020, Connecticut-based hedge fund One River Asset Management revealed commitments that would “bring its holdings of Bitcoin and Ether to about $1 billion as of early 2021.”
Ethereum is evolving
When Ethereum was created in 2014, the founding team was well aware that the blockchain had a fundamental shortcoming that would eventually need to be fixed. Because it uses a “consensus mechanism” called Proof of Work, transaction times can slow down and fees can rise when blockchain traffic increases.
The sheer number of transactions that DeFi and the other smart-contract-powered tools we’ve covered in this article, have resulted in scalability bottlenecks. As a result, the network has become increasingly expensive to use. As of February 2021 each transaction cost around $10 in ETH “gas” fees. (Confused? A big section of our new Ethereum explainer is devoted to this topic.)
But major solutions are on the horizon. The nonprofit Ethereum Foundation officially partnered with Reddit to seek solutions and new use-cases for the technology. In August 2020, nearly two dozen developer teams submitted Ethereum-scaling proposals to Reddit. Projects such as Optimism and rollups can potentially help the blockchain process hundreds of thousands of transactions per second (although each solution presents unique challenges).
Meanwhile, the Ethereum community has begun the long-planned transition to a faster, cheaper, and theoretically even more secure Ethereum 2.0 (or ETH2) blockchain.
The ETH2 blockchain, which uses a consensus mechanism called Proof of Stake, should vastly increase capacity. It began rolling out in December 2020, and as of February 2021, over 3 million ETH are staked in the ETH 2.0 contract. And at the end of this multiyear upgrade, the Ethereum economy should be one big step closer to fulfilling its potential of making financial transactions of all kinds faster, cheaper, and more accessible.