The Bitcoin vs Ethereum debate is passionately argued by maximalists for both sides. This article and video explains the fundamental differences in how they work, what makes them unique and why Ethereum carries more risk and potential reward.
- Bitcoin vs Ethereum [Video]
- Fundamental Differences
- First Mover Advantage
- Tokens Everywhere
- Decentralised Finance DeFi
- Lightning Network
- Scaling Blockchains
- Decentralisation & Consensus
- Supply & Economics
- Community & Development
- Risk Reward Curve
- Conclusion & Predictions
Bitcoin vs Ethereum [Video]
Fundamental Differences
In 2008 an anonymous developer using the pseudonym Satoshi Nakamoto released the Bitcoin whitepaper. It set out a proposal for “A Peer-to-Peer Electronic Cash System”. It wasn’t the first attempt at creating digital funds but it was revolutionary, seminal and ground breaking.
Ethereum was launched in 2015 by founder Vitalik Buterin and it initiated a new way to write programs known as smart contracts. Developers could write code to be executed across a decentralised, permissionless, trustless network of nodes.
How Bitcoin Works
To understand Bitcoin we first need to understand how blockchains work. A blockchain stacks blocks of data in numerical order one after the other. Each block contains a reference to the previous block and as the blockchain moves forward it becomes impossible to alter any data in an underlying block without adjusting everything on top of it.
The Bitcoin network is controlled and run by miners who earn newly minted Bitcoin rewards for securing the blockchain. They will take each block, add a random number and run a hashing algorithm on it repeatedly to try to find a value that meets a set target. The miner that finds a value that meets the target first announces to the network that the block has been solved and everyone moves on to the next one.
Each block contains a list of waiting transactions. The miners will all check that outgoing funds are available and have been signed for using a private & public key pair from the sender.
How Ethereum Works
The breakthrough with Ethereum was that each miner or node on a decentralised network could run a virtual machine executing 3rd party code known as smart contracts to update the persistent state of the network. Ethereum was a huge step forwards as they launched a global computer for the next generation of financial technology.
A smart contract can store and manipulate data on a blockchain. Here is a simple Solidity smart contract that stores the text “Hello World”.
contract ExampleContract {
string public myStateVariable = 'Hello World';
}This could can be deployed to the Ethereum network paying a small amount of ETH known as a gas fee to the miners. Once deployed anyone can interact with the smart contract from anywhere in the world by connecting to a node and making a transaction to the contract address.
First Mover Advantage
Bitcoin has a first mover advantage and it was seminal to everything that came later. Nothing will ever replace Bitcoin as the first cryptocurrency to gain adoption and prove digital assets work. This combined with the mystery around the founder and his coins creates a compelling narrative that is impossible to replicate.
For this reason I believe that in 10, 20 even a 100 years Bitcoin will still hold value. As central bank digital currencies get launched over the next decade it seems likely that the financial world will move across to digital assets and Bitcoin will always hold a claim to the coin that started it all.
Ethereum in contrast to this doesn’t have the same moat. It has a unique community, ecosystem and tool set which is years ahead of any “Ethereum Killer” rivals. However much like coding languages go in and out of fashion over the decades it seems plausible that developers might eventually move on to something else due to backwards compatibility requirements and the slower pace of development within the core code base.
At present I don’t think there are any real contenders to Ethereums smart contract network however it is worth monitoring the space as potential candidates such as Solana, Cardano and whatever comes next release competing products.
If I was to make an investment for my future grandchildren I would buy them Bitcoin over stocks, gold and any other cryptocurrencies.
Tokens Everywhere
Developers faced with this new global computer had a world of opportunity which degenerated into the ICO craze of 2017. Anyone could launch their own token in an attempt to create, store and add value. A lot of people including myself did and this created Ethereums first real product market fit.
Around half the assets listed on coinmarketcap are ERC20 tokens built on top of and running on the Ethereum network.
NFT’s were born on Ethereum around the same time which stored a unique data representation of an object such as a piece of art, punk or cryptokitty. Learn more about NFT’s here: Non Fungible Tokens
In the future it seems possible that all sorts of assets and tangible assets will be tokenised. Opportunities still exist for stocks, real estate, commodities, derivatives, and instruments resembling ETF’s.
Decentralised Finance DeFi
Compound launched a governance token in 2020 which lead the summer of DeFi. Liquidity was incentivised and bootstrapped with the distribution of tokens to vote on protocol changes in decentralised autonomous organisations DAO’s.
It came at a time of peak opportunity when Bitcoin was recovering from a market crash to $3k in March and everything profits were being redistributed across the risk curve in a search for yield.
DeFi, as the name suggests, provides decentralised financial products and services such as:
- Borrowing & lending with over-collateralised loans
- Trading via automated market makers
- Insurance products to hedge smart contract risk
- Derivative products such as options and perpetual futures
- Vaults which automate yield farming strategies
These are all built using smart contracts to run on the Ethereum virtual machine. More recently we saw alternative EVM compatible chains such as Binance Smart Chain and Polygon gain traction. In the future I believe a lot of the DeFi protocols and funds will migrate to layer 2 solutions such as Arbitrum and Optimism.
DeFi protocols form “lego bricks” which can be built on top of one another and integrated further by connecting smart contracts. This creates a economy within the Ethereum network which is closely integrated and valuable. The total value of locked funds (TVL) has grown dramatically over the last year with $50,000,000,000 USD currently committed to DeFi smart contracts.
Source: https://defipulse.com
Lightning Network
The lightning network was launched in 2018 at a time when a popular narrative was to create scaling systems that would enable everyday purchases such as buying a coffee to take place on the blockchain.
It was one of the first layer 2’s to be launched but it never took off. It’s limited acceptance and the fact no one wanted their purchases on a public blockchain meant that it ended up being a product that didn’t solve a problem. I only ever saw it used once at the blockchain cafe in Lisbon. Since then I’ve never used it or heard much about it.
There also haven’t been any new layer 2’s released for Bitcoin. The lightning network did everything it should technically but it never had the application that Ethereum had and Bitcoin’s narrative changed to a “a store of value” and “an institutional hedge against inflation” rather than peer-to-peer cash that the whitepaper originally intended.
Scaling Blockchains
The reason we need layer 2’s is because of the limitations on data and block sizes. The blockchain trilema states that the technology can be built on the foundations of scalability, security and decentralisation.
Bitcoin’s lightning network increased scalability at the cost of security and decentralisation. Ethereums layer 2 optimistic rollouts do the same.
Bitcoin produces one new block roughly every 10 minutes and there is a 1mb block size limit meaning that it can only process about 7 transactions per second. It simply doesn’t scale to the requirements of something like the Visa network which can carries out 1700 transactions per second on average.
Ethereum slightly improves on this but the colossal gas fees we have seen in recent years clearly demonstrates the existing network congestion and demand for scaling solutions.
Bitcoin has largely scaled via derivative products which now trade at higher volumes than the underlying spot markets. Perpetual futures in particular have become very popular with traders looking to gain or hedge exposure to the digital asset.
Ethereum has been talking about rolling out ETH2.0 for years but it is actually happening later this year and in early 2022. This will move the consensus algorithm from proof of work to proof of stake, introduce sharding and provide capacity for up to 100,000 transactions per second.
This combined with the layer 2 scaling solutions such as Arbitrum and Optimism will provide capacity on the Ethereum network for years to come.
Decentralisation & Consensus
Both Bitcoin and Ethereum currently use a proof of work consensus mechanism. Miners run a hashing algorithm over and over on the block with a random number added to find a target hash. This provides a lot of security and decentralisation because to carry out a 51% attack a malicious participant would need to acquire incomprehensible amounts of mining equipment, electrical power and facilities.
One criticism of blockchain technology in it’s current form is the excessive energy usage. I spoke about this here:
Bitcoin Mining Sustainability
Miners use specialist hardware known as ASIC devices racked up in huge server farms which consume huge amounts of electricity.
Ethereum is moving from proof of work to a proof of stake network. PoS is a consensus mechanism where token holders can bond their holdings and run a node to vote on the correct state of the blocks and network. This will provide a number of advantages including staking rewards providing a yield on the ETH token. I believe this may appeal to traditional finance as they can justify allocations based on the revenue generating asset which becomes more like a stock or bond.
Supply & Economics
Bitcoin’s supply is fixed at a hard limit of 21,000,000. There will never be more than 21m BTC in circulation and many of the early coins are considered lost. The current distribution is 6.25 BTC per block with the reward being halved every 4 years. The next halving is due in spring/summer 2024 (Bitcoin Halving Date). So far this has led to a consistent 4 year market cycle however there are some theories that cycles are speeding up and even that we are entering an Amazonesque up only super-cycle.
Ethereum does not have a fixed hard limit but it does have EIP 1559 which is due to be rolled out on the 4th August 2021. Currently miners earn transaction fees and block rewards. The EIP 1559 rollout will cause transaction fees to be burned. It’s estimated that this will balance and even surmount the block rewards causing Ethereum to become a deflationary asset. The circulating supply will be reduced as transaction fees are burned.
Ethereum 2.0 will redirect block rewards from miners who have overheads in electrical and operation costs to stakers who are essentially investors. At this time Ethereum will experience the Tripple Halvening Event where supply will be reduced from 4.3% to 0.43%. I expect this will have a positive impact on the price over the long term as there will be less selling pressure from the distribution of block rewards. The block rewards will be going to people who are already hodling ETH rather than mining enterprises that need to sell to pay their bills.
Community & Development
Bitcoin has a strong community of die hard maximalists that live and breath BTC.
The network is ultimately controlled by the miners who have the power to vote for changes to the code base. Bitcoin core has always been backwards compatible with previous versions and this principle is held in high regard by the devs and miners. The majority of Bitcoin mining hardware is produced by Bitmain, a Chinese manufacturer who has been criticised for having too much influence over the network amid centralisation concerns.
Ethereum grew quickly and a strong community emerged around the protocol. Ethereum is more developer driven whereas Bitcoin is miner driven. I can’t ever imagine EIP1559 transaction fee changes getting passed through on Bitcoin because the miners would never stand for it. In contrast to this Ethereum mining is coming to an end and the miners have known this for a number of years as the network migrates to proof of stake. Vitalik has a lot of influence as the original creator and he handles himself very well in a crazy genius type of way.
The ethereum community have built some amazing tools for users and devs alike.
- Metamask – A digital wallet for storing funds and interacting with front-end interfaces that connect to smart contracts.
- Infura – A publicly available node for developers to connect to the network using a API key.
- Etherscan – A impressively reliable and feature rich blockchain explorer
- Truffle – a suite of tools for developing smart contracts
Ethereum development has slowed to a snails pace. It sometimes seems that they will have arrange a meeting in 6 months time to discuss changes that may or may not be rolled out in a few years time. Bitcoin takes this to a whole new level and semi-significant changes are an annual event at best.
Risk Reward Curve
Bitcoin is a highly volatile asset that can drop 30%+ in USD value over a few hours. Ethereum is even more volatile and is further along the risk curve.
In previous bull markets Ethereum tends to do well as a lot of the innovation that speculators and investors are looking at is built on Ethereum. Gas prices go through the roof and Bitcoin dominance drops like a stone.
In bear markets money flows back to Bitcoin from altcoins in a flight to relative safety. Lower liquidity alts get crushed and Bitcoin dominance goes straight up again.
There are also lower time frame surges in Bitcoin dominance. One example was when Bitcoin broke $20k resistance around the turn of the year. All eyes were on Bitcoin and it outperformed just about everything else for a few weeks. Once it settled down and the initial “Bitcoin melting eye balls” phase is over Ethereum catches up and then more some.
I’d recommend checking the charts for both BTC.D (Bitcoin dominance) and ETH/BTC as obvious price levels and areas are often respected and can act as pivot points.
Conclusion & Predictions
My investment thesis is built on the idea that Ethereum will outperform Bitcoin over a long enough period. I actually believe that there’s a significant chance we see a flippening, when Ethereum’s market cap exceeds Bitcoin’s in the next few years.
I can see Bitcoin being used as an exceptional store of value once the market matures and volatility reduces. Bitcoin transfers will be rare much like we use bank wire transfers today.
Ethereum will be the foundation of everything else. It will be blockchain developers tool of choice for building on. There’s room for growth in DeFi, tokenised stocks, NFT’s, derivatives and decentralised trading. More and more funds will be injected into DeFi protocols as traditional finance becomes aware, builds trust and searches for yield on Ethereum.
I believe that BTC, ETH and other assets will eventually compete directly with central bank digital currencies. I can foresee mobile apps where digital assets can be swapped and staked to earn yields using DeFi on the back-end. Funds will be instantly transferred to a local currency on payment via a pre-paid card like Monzo/Revolut or via a non-contact payment using Google/Apple pay.
It’s clear there’s a place for both Bitcoin and Ethereum in most digital asset portfolios. Allocation percentages should vary according to the individuals conviction and market conditions.
I hope this analysis of Bitcoin vs Ethereum has been of interest and helps build an understanding of the two largest cryptocurrencies.
