Out with the old, in with the new: it’s a story as old as time. In crypto parlance, it’s called "The Flippening"
The Flippening refers to the tipping point when the market cap of a new technology, (ETH), surpasses, or replaces, an older technology (BTC), due to its design advantages.
The possibility of a Flippening has featured in crypto-discourse for quite some time. If it were to happen, it would change perceptions that cryptocurrency’s primary use case is as a store of value, digital money or gold 2.0. Instead, it would, at least psychologically, signify the importance of smart-contracts and decentralized applications as blockchain-enabled innovations. It would also cement that, for now, the Ethereum “world computer” is the hub for this activity.
In terms of progress, Ethereum still has a way to go before it flips Bitcoin. At the time of writing, Bitcoin’s market cap is $407 billion, while Ethereum’s is $176.5 billion; a cool $230 billion deficit. However, certain indicators and events, both in the past and the future, indicate that this gap may well start to close.
This article will discuss the main factors that might contribute to:
One of the main driving factors of the discourse surrounding the flippening is The Merge and the transition to ETH 2.0.
The Merge represents Ethereum’s transition from a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) consensus mechanism.
Essentially, this means that Ethereum nodes will be able to reach consensus on the state of the Ethereum blockchain in a significantly more environmentally friendly way.
This is possible as unlike PoW, PoS blockchains do not rely on “mining” to reach consensus. Mining is a process whereby a decentralized network of computers running the Ethereum code compete to solve a hyper-complicated mathematical puzzle to ensure that transactions are valid and added correctly to the blockchain. Mining has significant hardware requirements and uses a lot of energy. Presently, a single Ethereum transaction uses the same amount of energy as an average US household uses in electricity over four days. PoS on the other hand, has no special hardware requirements.
Transitioning to PoS will make Ethereum 99% less energy-intensive and more attractive to builders.
Warehouses full of computers and mining equipment will be made redundant. As will arguments that Ethereum is bad for the environment.
In contrast, Bitcoin will continue to rely on a PoW consensus mechanism. Although Bitcoin can use green energy sources, and can even provide a solution to previously unsolvable environmental problems, it will always remain more energy intensive than Ethereum.
The transition to PoS also has a substantial impact on the supply and demand dynamics of Ethereum. PoW blockchains reward miners with the network’s native token. This acts as a financial incentive to mine. PoS blockchains have no miners. To secure a PoS blockchain, users stake the native token, in this case Ethereum, to validator nodes. To corrupt Ethereum PoS, an attacker must own over 51% of the staked Ethereum. With over 13 million Ethereum currently staked, this means an attacker would need over $12 billion.
As with Ethereum PoW, stakers will receive Ethereum as an incentive. However, there are no hardware requirements for stakers. The rewards do not need to be as substantial. As a result, the Merge is expected to slash Ethereum’s issuance from anywhere between 60–90%; a dramatic decrease in Ethereum’s rate of supply.
The Merge is one of the most anticipated events in crypto history.
This is partially driven by the fact that it has been continuously touted to happen at various points over the past few years. That said, if the most recent anticipated date for the Merge, and string of successful tests are anything to go by, it could happen as soon as next month.
The Merge is the first step in the transition into ETH 2.0. Another element of ETH 2.0 which will upgrade Ethereum’s ecosystem is the move to sharding, a process which splits the Ethereum blockchain into separate “sharded” chains. This will result in better transaction throughput and greater overall efficiency. Once sharding is implemented, Ethereum will be able to handle around 100,000 transactions per second. This is a significant improvement from the current 15.
The Merge will make Ethereum far more usable. With improvements in scalability comes a decline in gas fees. A drop in fees will make using Ethereum feasible for a far wider audience. Although fees are currently at a two year low, transacting on Ethereum is, at times, prohibitively expensive; at their peak in May 2021, a single Ethereum transaction cost an average of $197.
Essentially, ETH 2.0 will improve Ethereum’s scalability. This presents the opportunity for Ethereum to establish itself as a suitable back-end for a wider variety of high throughput use cases, such as blockchain gaming, which currently reside on other chains, or on Layer 2s.
Ethereum Improvement Proposal 1559, or EIP1559, is another recent Ethereum network upgrade which makes a flippening more likely. EIP1559 was significant as it altered Ethereum’s monetary policy by introducing the burning of a portion of transaction fees. Before EIP1559, Ethereum had no burning mechanisms embedded into its monetary policy.
When Ethereum is burnt, it is removed from circulation forever. Since gas increases with network usage, this means that the burn rate of Ethereum increases with it. As the same cannot be said for Ethereum’s issuance rate, it means that when the Ethereum network is busy, it is possible for the asset to actually become deflationary; its supply reduces. Since its introduction in August 2021, EIP1559 has already led to ~1.8% of the total ETH supply being burned. The basic laws of supply and demand indicate that this should prescribe more value to Ethereum & the Ethereum network.
Ethereum introduced smart-contracts to the blockchain; it is the first smart-contract layer 1. Its Ethereum Virtual Machine (EVM) enables the execution of smart-contracts and, as a result, the programming of decentralized applications. The first mover advantage in this instance is striking.
In terms of the total-value-locked (TVL) in DeFi applications across different blockchains, although its dominance has been weakening, Ethereum still commands a 57.85% market share. Furthermore, a number of alternative chains competing for second place are either Ethereum layer 2s (Polygon, Optimism & Arbitrum) or conform to Ethereum’s EVM solidity smart contract standard (BSC, Avalanche C-Chain, Cronos).
As a result, the market share of the whole Ethereum ecosystem (discounting EVM-compatible chains) is closer to 64%.
As for NFTs, if you examine the top 15 NFT collections in terms of all-time trading volume, the vast majority of projects are on Ethereum.
One might argue that Ethereum only leads in all-time trading volumes as it was the first blockchain to host NFTs. It had a head start. However, assessing more recent trading volume data shows that the majority of high volume NFT projects are still on Ethereum.
In fact, around 84% of the secondary NFT sales volume was on Ethereum in Q1 2022.
The main arguments made against the flippening (beyond those made by avid Bitcoin maximalists) center around the recent Taproot upgrade, which brings smart-contract functionality to Bitcoin. This enables decentralized applications to be built on the Bitcoin blockchain, which had a use case previously limited to payment transactions. And the Lightning Network, which operates as a second layer on top of Bitcoin that enables significantly greater efficiency and throughput. This could enable microtransactions on Bitcoin which beforehand were not possible due to cost and time inefficiencies. This would add weight to the case that Bitcoin is a suitable medium of exchange and alternative to with fiat currencies.
While these upgrades have the potential to significantly improve the Bitcoin network, they’re both in their nascency. Taproot enabled smart contracts and decentralized applications (dApps) on Bitcoin. However, building dApps from scratch on a new network takes time. At the time of publication, there are no dApps live on the Bitcoin network. Thus, whether Bitcoin can compete as a smart-contract blockchain remains to be seen. The lack of a virtual machine potentially suggests otherwise.
As for the Lightning Network, it has the potential to improve Bitcoin’s scalability by several orders of magnitude. The Lightning Network is capable of handling 1,000,000 transactions per second, compared to Bitcoin’s seven transactions per second. It also makes transacting on Bitcoin far cheaper, enabling microtransactions on the Bitcoin network, which could facilitate the adoption of Bitcoin as a currency. In fact, in theory, the Lightning Network would even be able to out-compete existing payment infrastructure like Visa, which can only handle tens of thousands of transactions per second. However, while it enhances Bitcoin’s usability — a major hurdle for Bitcoin’s adoption — and competitiveness as payment infrastructure, it too is yet to be rolled out at scale.
Despite all the bullish catalysts, Ethereum still has a way to go before it flips Bitcoins market cap. Currently Ethereum’s market cap is 46% the size of Bitcoins. This is not the closest it has been to overtaking Bitcoin’s market cap by some margin.
That said, when taking the lows of the recent crypto crash as a price point, Ethereum has significantly outperformed Bitcoin, recovering 118%, compared to Bitcoin’s less impressive 38% at the time of writing. Ethereum’s outperformance extends beyond just crypto markets, with the graph below highlighting how the asset has significantly outperformed other major markets both within and outside the cryptosphere.
Other indicators tell the same story. Premiums on futures are more expensive for Ethereum compared to Bitcoin; 10% against 7%. Interest in ETH-based options recently surpassed that for BTC-based options, for the first time ever. In Q2 of 2022, Ethereum had a greater trading volume than Bitcoin. Again, this is the first time this has happened.
The balance of Ethereum on centralized exchanges has dropped from 21.7 million to 20.6 million since the beginning of July, solidifying the idea that the market believes ETH will go up. This is because Ethereum moving off exchanges signifies that market participants are moving from liquid form on a centralized exchange (CEX) to illiquid in cold storage. This indicates that buyers expect Ethereum to go up in value and feel comfortable with illiquidity. As further evidence for this, Ethereum held on CEX’s such as coinbase hit a four year low in July, further showcasing demand for the asset.
The number of active addresses on Ethereum has also been slowly closing in on Bitcoin. Ethereum active addresses hit a new all time high in 2022, with over 1.1 million addresses making a transaction on July 27th.
The Flippening seems well on its way to becoming a reality. Ethereum pioneered smart contract technology, but in many cases developers have chosen to build on other blockchains, often citing scalability and environmental concerns as the reason for doing so. Following the Merge, many blockchains will no longer have these advantages over Ethereum, and if they do, they will be significantly less pronounced. If the Merge does take place in September, which seems increasingly likely, it will be one of the most significant events in crypto history. We await the upgrade with bated breath.
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