Second only to Bitcoin in terms of market cap, Ethereum (ETH) is a smart-contract blockchain protocol that delivers a secure and decentralized environment for hosting applications across a wide range of users. It has been central to the DeFi boom in 2020, the NFT explosion in 2021, and will maintain that position during the metaverse boom that is currently projected to occur in 2022.
Instead of a gold-like store of value feature unique to Bitcoin (BTC), investing in Ethereum’s native token ETH represents a technology bet on the wider crypto ecosystem and its sophisticated applications. As more innovative platforms launch, more capital is invested in altcoins. This is a major reason that explains why ETH outperformed BTC in 2021. This is despite the 90-day correlation coefficient of Bitcoin and Ether staying at 0.84, meaning the two assets moved in lockstep most of the time.
Competing Layer 1 tokens
As far as wider technology bets go, the most established player is Ethereum but astronomically high transaction costs remain an obstacle for the average user. Minting an NFT on Ethereum can easily set you back USD $60 to $200, depending on network congestion. Then there is also the possibility that the transaction fails, meaning the fee is permanently lost without anything to show for.
High transaction costs have been a huge driver for investors to seek alternatives to Ethereum, resulting in sizable gains in 2021 for some Layer 1 protocols. Intensifying development, significant funding, and growing utility have resulted in a market rotation out of BTC and into the tokens of platforms such as Terra, Avalanche, Flow, Binance Smart Chain, Fantom, and Solana. However, Ethereum still holds the top position with over 60% of Total Value Locked across all chains.
Most analysts predict that in 2022, Layer 1 tokens will continue to perform well as added utility and usage will help to drive prices higher. Even if the whole market tanks for macroeconomic reasons, Layer 1 tokens are still widely considered as the best measure of overall utility in the crypto space.
More than likely, that scenario includes Ethereum as one of the top performers in its category. Many large institutional investors and corporations are increasing their allocation to digital assets, and the first port of call after Bitcoin is still Ethereum for most. The protocol has established itself firmly as a reliable platform, and when you’re moving millions between dApps, a quick $60 transaction fee does not affect your bottom line so much. Perhaps after a substantial Ethereum initiation into DeFi will some of these investors go deeper down the rabbit hole and explore the Layer 1 alternatives.
Upgrades to the Ethereum network
So what’s on the roadmap for the Ethereum protocol in 2022? Last year, we finally saw the highly anticipated upgrade to the network under Ethereum 2.0, the London Hard Fork. This year, we expect to see the so-called Merge, integrating with the Beacon Chain and swapping out the current proof-of-work (PoW) consensus mechanism with a more eco-friendly, efficient, and secure proof-of-stake (PoS) consensus mechanism. When the Merge occurs, the current PoW consensus mechanism on Ethereum will be fully abolished and all blocks on Ethereum will be produced via PoS.
The underlying improvements and the foundation a proof-of-stake consensus mechanism lays out will allow Ethereum to achieve:
- Lower energy consumption as the PoS consensus layer rids the network of miners and replaces them with validators. This enables the network to run with significantly lower energy consumption, with the Ethereum Foundation predicting it will use 99.95% less energy than the network does currently.
- Ethereum’s current execution layer will be ported over to the incoming proof-of-stake consensus layer and supported by the clients that are currently in charge of Ethereum 1.0.
- Moving to the PoS model also lowers the barrier to entry to participate in the validator network as you would no longer need expensive hardware to create blocks. More nodes in the network will increase the immunity to centralization, paving the way to increased decentralization and scalability.
Whether transaction fees will go down remains unknown. On the one hand, under PoS, the network will have the capability to implement sharding and other scalability-focused upgrades to lower transaction costs. On the other hand, new users and entities may join the Ethereum network and increase the current demand for blockspace.