Why do we think ETH outperforming BTC is good for the crypto market?

If ETH surpasses BTC, will this be good for the entire crypto market? What’s wrong with BTC being the top dog? Isn’t it great so far? If it’s good for crypto, why hasn’t it happened yet?

Written by: "Why the Flippening Is Good for Crypto" by Ryan Berckmans

Compiled by: TechFlow

The merger is over, Ethereum tokenomics has changed dramatically, and the supply of ETH has been significantly reduced.

Ethereum is generating more revenue and significantly improving its position in competition with BTC.

So, does this mean that ETH’s market cap will eventually surpass BTC’s?

Of course, people like me who own ETH want such a change to happen, but aside from our personal financial interests, is this good for crypto as a whole? What’s wrong with BTC being the No. 1? Isn’t it working great so far? If it’s good for crypto, why hasn’t it happened yet?

These questions are all intertwined and are perhaps best examined by delving into the details of BTC’s returns.

Reliability does not mean investability

BTC is the most trusted neutral asset. This is because the Bitcoin protocol is mature and will not change, and proof of work also substantially reduces risk due to its simplicity and proven track record.

Over the years, it has withstood dozens of failed attempts by some organizations to unilaterally modify Bitcoin’s underlying code and increase its node size. Regardless of Satoshi Nakamoto’s original intentions, BTC’s reliability has become its core intrinsic value proposition.

However, Bitcoin’s reliability does not mean that the asset will maintain its value or accrue value in terms of purchasing power or fiat currency.

In contrast, Bitcoin’s core design is not programmable, has no added value to holders, and its mining cost structure results in significant value leakage.

This is why, when it comes to Bitcoin, reliable is not the same as investable.

With this background, let’s start with historical returns to understand how BTC works.

What happened in 2016?

From 2013 to 2016, BTC returned about 6x if you bought low and sold high.

But if you bought BTC at the high in 2013 and sold it in 2016, you made nothing, zero.

After 2016, the situation is completely different. If you bought BTC in 2016 and held it until today, you made 20x to 40x. How about buying BTC at the low point in 2016 and selling it at the new high in 2021? You made 130x.

Some might protest, "Pre-2016 was the Dark Ages of crypto, it didn't matter then, we're just getting started."

Are you sure this explains everything?

What happened around 2016 that caused BTC to perform better in the years since? What changed in Bitcoin before or around 2016 that created huge returns?

In fact, Bitcoin itself has not changed. After all, immutability is the nature of Bitcoin and part of its first-class reliability.

Of course, the Lightning Network was launched after 2016, but it barely worked.

What else could have happened around 2016 to unlock Bitcoin’s potential? Or, was there something that BTC was nurturing that we couldn’t see and that matured in 2016?

None of these explanations make sense. The idea that Bitcoin somehow evolved or unlocked its potential around 2016 simply cannot be explained by the narrative and numbers we’ve seen over the past few years.

BTC takes advantage of Web3

So, what happened?

In my opinion, the fact that fits the historical narrative and data the most is that every major catalyst in the cryptocurrency market since 2016 has been driven by the promise or realization of Web3 applications, none of which Bitcoin supports.

In 2016, a small project called Ethereum began to achieve huge success in its effort to make a public blockchain function as a computer.

So far, BTC in its recent bull run has simply been surfing the huge wave of actual useful things created by the Ethereum community (and a few others).

At this point, Bitcoinists or crypto basket investors might reasonably counter: “Wait, if BTC is just a sideshow, why are investors buying it? BTC dominance is around 38% today.” “Are you kidding me? You think the $400 billion market cap is just a mistake?”

Yes, that is exactly what I am saying, and I will endeavor to prove it below.

This is why BTC is unsustainable as an investment, why it is possible for ETH to surpass BTC in market cap, and why this eventuality is good for crypto — because it will eliminate an uninvestable asset as a leader in our industry.

Unsustainable investment

Bitcoin fits the definition of an unsustainable investment pretty well.

If we take a closer look at Bitcoin’s use of Proof of Work, it is hard to question the sustainability of Bitcoin in terms of value retention or accumulation.

Bitcoin fees are paid directly to miners, providing no value accumulation to BTC holders. This makes BTC non-income earning, especially considering the expensive cost of mining.

BTC’s annual inflation rate is about 2% before the halving in 2024. This sounds good, what’s wrong with only 2% inflation?

The problem is that due to the economics of mining, inflation (issuance) in PoW is the most direct capital consumption for BTC valuation. Coupled with the thin liquidity of spot prices, it means that miners selling BTC will greatly hurt BTC's market value.

In the medium term, on average, miners have to sell most of the BTC they earn, since they need to spend up to $1 in hardware and energy costs to compete for $1 of BTC. This is a huge problem for BTC (and it was for ETH before yesterday’s merger) because selling X% of supply hurts the market cap much more than X%.

According to some estimates, selling $1 of BTC could result in a loss of $5 to $20 in market value.

It’s an open secret in crypto that you can’t sell more than a fraction of the total supply at spot price, order books are thin, and liquidity is weak.

Therefore, not everyone can sell at today’s prices, and by definition miners are using up a scarce resource by continually selling.

This means that BTC miners may only sell 2% of the total supply each year, but they receive far more than 2% in net fiat inflows each year. Since BTC fees are low and all are paid to miners, there are two very important effects that may be overlooked by many BTC holders:

1. On average, someone has to buy a lot of BTC every day to keep the price flat. In 2021, about $46 million of net fiat inflows per day are needed to keep BTC at par. In other words, I have this huge investment for you, and we only need $46 million of new money from other people every day to avoid losing our principal...”

2. When a BTC investor gets a 50% return, or 5x, or 40x, those profits can only come from new entrants. There is no meaningful fee income accruing to holders, no meaningful applications on Bitcoin, and the price of BTC cannot maintain itself due to the cost of mining, so, by definition, anyone who buys BTC at the new high cannot make money on a sustainable basis.

Social imbalance

Who would intentionally buy an unsustainable long-term investment? Who would recommend buying it? How did we end up with BTC reaching $3 trillion in total cryptocurrency market cap last year with ~40% dominance?

From what I understand, a handful of different types of buyers may be responsible for driving capital into BTC, each with their own reasons, and most are unaware of the true risk profile of their investment, some of the types of investors are mentioned below:

1. The first category, new entrants buying BTC. For example, sophisticated hedgers, long-term institutional investors, ultra-high net worth individuals and retail investors turning to Web3. These new entrants appear in Web3 - statistically speaking, more during bull runs - they are excited, they know that cryptocurrencies are new and complex, and they reasonably allocate to a basket of top crypto assets in proportion.

Pro rata is an investing term that, in this case, means “I’m going to buy something in proportion to today’s market cap.” These new entrants are often the future lambs, the ones to be slaughtered for BTC as an unsustainable investment.

2. The second category, long-term investors buy BTC. These people may be crypto OGs who entered early, or crypto VCs with more connections and capital. These people buy BTC because they really don’t have and/or don’t want to have confidence in the direction of development of this field, and they don’t want people to think that their views are wrong. What’s worse is that these people are often authoritative figures who play an important role in helping to push new entrants to invest in BTC.

3. The third category, speculators buy BTC. They may sell all at the next new high. These are usually the smartest, savviest and/or hungriest of the crypto OGs, VCs and finance guys who are turning to Web3. However, they feel that for the greater good (often theirs), they must avoid being controversial and should work to promote Bitcoin.

They feel that if BTC crashes, it would mean huge losses for some of crypto’s largest and most powerful investors, which could hurt the entire space and their portfolios.

4. The fourth category, traders. They buy BTC and rotate profits into BTC as the de facto reserve currency for cryptocurrencies. Traders are simply following trends, and they know that in this current era, BTC performs better in bad times and worse in good times. Traders have a very short time horizon, and they simply use BTC as a base camp to play riskier games. In a way, traders are the most rational and/or least destructive of all BTC buyers.

5. The fifth category, BTC nativists. These are die-hard fans of BTC who believe that BTC is the most reliable currency in the history of the world. They not only believe that BTC has first-class reliability, but also believe that this reliability will inevitably translate into an excellent long-term investment and/or the best cryptocurrency investment to date on a risk-adjusted basis.

Of these five types of BTC buyers, only the BTC nativists have any hope of sticking around after BTC dominance collapses. Overall, Bitcoin buyers are playing one of the biggest speculative games in modern finance, and only the speculators have any idea of ​​the nature of this game.

Admittedly, this breakdown of the types of BTC buyers is overly simplistic, but I think it’s useful. BTC nativists and skeptics may have gained confidence after reading this:

“Since you say BTC is doomed to fail as an investment vehicle, why hasn’t ETH already beaten BTC?”

It’s because: numbers, that’s why.

Historically, ETH miners have been paid much more than Bitcoin miners. If the two chains swapped cost structures, i.e. if BTC miners made as much money as ETH miners and vice versa, or if the merger had happened two years ago, I think ETH's market cap would have surpassed BTC.

Let’s explore these numbers…

Standing on the heavy shoulders of giants

If miner selling is important — and it is, as noted above — then it’s also important that ETH miners have been paid anywhere from 2.5x to over 4x as much as BTC miners (normalized by market cap) over the past few years:

Last year, BTC miners were paid $16.6 billion, while ETH miners were paid $18.4 billion.

Conversely, if we swapped the cost structures of Bitcoin and Ethereum last year, ETH miners would have made and sold about $6 billion, while BTC miners would have made and sold about $50 billion.

This is a key point, so let me say it again: Ethereum miners earned and sold $1.8 billion more in ETH than Bitcoin miners sold in BTC last year. If we imagine reversing the cost structure between the two chains, BTC miners earned and sold about $44 billion more in BTC than Ethereum miners sold in ETH in 2021 alone.

To demonstrate this: in 2021, Ethereum is so expensive to run compared to Bitcoin that if the situation were reversed, Bitcoin would need an additional ~$45.8 billion in net fiat inflows (i.e. new buyers of BTC) to keep the market cap of both chains essentially the same as it is today, all else being equal.

These extremely large numbers — especially the fact that ETH has greater selling pressure from miners relative to its market cap — are a key driver of why the takeover has yet to happen.

There is no eternal king

What happens next?

Ethereum moved to PoS from merged staking, eliminating miner dumping. We are now on the path to positive revenue, scaling with L2, and Web3 adoption around the world.

Ethereum has become a positive-sum, productive economy.

In the next few years, due to the reasons mentioned above, I think there is a 99% probability that ETH will surpass BTC, and the 1% is unknown uncertainties, such as aliens appearing and forcing us to use BTC as the only global currency.

ETH’s profitability, low cost of verification, huge growth of dApps, and the favorable atmosphere brought by credible neutrality will bring our industry into a post-BTC era.

The Fall of Rome

That day will be explosive and spectacular.

Of course, we may only be briefly above it. But zooming in on time, this is a one-way transition for BTC into a cryptocurrency investment antique.

Unfortunately, cryptocurrency and Web3 investors could lose a lot from both a slow decline and a violent crash of BTC.

Today, the probability of surpassing is close to 50%.

As ETH slowly rises against BTC, we will encounter a breakthrough point, and then the surpass ratio will jump from 70% to 100%, or 80% to 120%, or any final result, in one day, bidding farewell to the BTC era.

What’s Good for Cryptocurrency: A New Era of Health

I guess that eventually, years from now, we all, including most BTC owners today, will look back and see how naive it was to think that BTC could always remain number one.

The fate of BTC will undergo earth-shaking changes and finally become a living fossil in the crypto world. Only after ETH becomes the first, the real healthy era of cryptocurrency will begin.

An era of environmentally friendly, streamlined cost structures, profits from valuable applications, Web3 will develop to global ubiquity, and Ethereum will become the global settlement layer - an era of fair competition for all mankind.