Ethereum fundamental analysis

Four or five years ago, during the previous manic Bitcoin cycle, after a steep increase of its rate, it peaked at 1200 dollars, subsequently dropping to 150 dollars after over a year-long steady decline. Later, its price ranged between 200 and 300 dollars.

These figures are very similar to this year’s performance of Etherum (ETH), the cryptocurrency with the second biggest market capitalization. In January, its price was over 1400 dollars, yet in September it reached lows of 170 dollars. Currently, it’s hovering around 220-230 dollars.

Therefore, Ether has now produced a decline of 80-90%, similar to the performance of Bitcoin when the bubble of the first manic cycle burst. Is it threatened by a similar fate and extended ranging over the months to come? Or will its price continue to drop? In the case of Bitcoin, in early 2015 I provided atimely reasoning that its decline had most likely come to an end. Can the same reasoning be applied to Ether? Actually, I do think so. Let’s see why.

A state of equilibrium

On Ether’s market, great speculative forces can be mobilized for both its sale and purchase. These are characteristically prone to rapid and unpredictable changes. We do not intend to provide a prediction of these factors. However, the supply side has an easily analyzable component with a decisive behavior that becomes definitive under calmer market conditions, once the speculative forces have settled down. After last year’s craze and the equally great panic, there’s a good chance that we’ve just entered such a period. The above-indicated factor on the supply side is none other than the newly marketed Ether created by miners.

In order to say anything on the matter, we must first clarify the economics of mining. Let us consider the following simplified model: Ether miners purchase gadgets (e.g. graphics cards) required for mining, hook them up to the net and start running the mining software. The gadgets use up a lot of electricity. However, in exchange, miners end up with newly created ether. They earn 3 ether for every newly mined block.

During calm market periods, the majority of earned cryptocurrencies will surely be converted to conventional money. This is used, in turn, to pay the electricity bill, which is the greatest and continuous overhead cost, yet they must also cover the purchase price of the gadgets. They end up with some profit, which – as we’re dealing with a cryptocurrency – is typically kept in ether. Thus the entire operational costs of the Ethereum network – which mainly consists of the aggregate electricity bill of the network – appears as a supply of ether on the market. Ultimately, this is covered from the net cash-flow appearing on the market thanks to the miners, by those who are willing to spend dollars and euros on new Ether.

Manic conditions on the market and in mining

The market was mostly in this state of equilibrium around October-November 2017, with Ether’s price moving in a relatively narrow range around 300 dollars. However, in late November there was a sudden and incredibly steep increase of money entering the market, which meant that as if by magic, everyone wanted to buy Ether, which resulted in a frenzied rally. How did miners react to this? As Ether mining suddenly became an incredibly profitable activity, naturally they also introduced rapid developments. Of course! They raced to hook up more and more devices to the network.

However, this quickly led to a shortage of gadgets. Therefore, they couldn’t be deployed as rapidly as justified by the price of ether. We live in a world in which capital flows faster than physical items. This is more clearly illustrated by the following graph. The increase in the price of ether shifted gears in the month of December, which was closely mirrored by the network’s mining capacity. The latter is measured by the number of hashing attempts per second (hash rate). I don’t wish to go into the details of what exactly hashes are; what matters is that mining fundamentally consists of calculating hashes. The more hashes are calculated, the greater the computational power of the network is and the higher the electricity bill.

Panic on the market, whilst the mining craze continues

However, the skyrocketing Ether began plummeting in mid-January, while the hash rate continued its steep increase for nearly two more months. Thus despite growing electricity costs, deploying new mining gadgets was easily worthwhile even when the price of ether was long declining. However, to cover their increasing electricity bills, miners had to dump Ether on the market in ever greater value. The ever-increasing total value of ether for sale aggravated the drop in price. This led to a positive feedback loop in which the price drop boosted the pressure to sell, generating an even greater price drop or, if you will, a descending spiral.

Break-even point

There came a point sometime in March, when the increase in hash rate came to a standstill. Despite the enormous price drop, the ether earnings of miners still easily covered their electricity bills. However, they no longer hoped to recover the additional capital costs of new mining machines, so they ceased their installation. However, they continued to utilize existing machines. In economics, this is referred to as the break-even point.

Some fluctuation remained in the hash rate, yet this was of negligible scale compared to previous events. It’s safe to say that the radical increase in the electricity costs of the Ethereum network came to a halt and was stabilized at a relatively constant level. Consequently, miners no longer had to flood the market with an ever-increasing value of Ether. Thus the descending spiral was broken and this definitely played a role in the fact, that shortly after this took place, the price of Ether doubled during a bear market rally in April.

Shutdown point

However, the bear market didn’t come to an end. The reason for this was that miners aren’t the only sellers, and sellers still had an advantage over buyers and kept pushing the price curve down. The next major standing was lost in early September when the price dropped from 300 to around 200 dollars over the course of a few days. For some miners, this was too much to handle. The mined ether was no longer enough to cover their electricity bills, so there was no sense in continuing the mining and they shut down their devices. This was clearly mirrored in the hash rate of the network, which reduced by approx. 10% directly after the fatal drop in price. Less effective miners ceased production after their income was unable to recover even their variable costs. This is referred to as the shutdown point.

Achieving the shutdown point also meant that the network’s electricity bill was decreasing. This was great news, as the remaining miners only had to bring a lower value of Ether to the market. This doesn’t necessarily mean that the drop in price came to an end, yet it certainly increased the likelihood. Moreover, if the price level continues to drop, more miners would shut down their operations, thus further reducing the electricity bill of the network and the value of newly mined ether on the market. This creates a negative feedback loop and the continued drop in price actually reduces the pressure on sellers.

However, unfortunately, negative feedback also has an upward effect. If the price heads in that direction, more miners would deploy their devices, which would lead to growing electricity costs and increased pressure on sellers. In last December, all the money of the world was being used to buy ether and the huge demand overcame the restraints of growing electricity bills, yet similarly manic periods are unlikely in the near future.


In summary, there is a clearly increased likelihood that the price drop of ether has come to an end, whilst a major increase in price is unlikely. Due to the negative feedback loop the market has been experiencing since September, we can look forward to reduced volatility.


Naturally, it’s possible that for some reason, the speculative forces of the market will dominate again, in which case the above-mentioned negative feedback would not apply. Similarly, there is a possibility that some unmanageable, fundamental design fault of Ethereum might be revealed or the legal regulatory environment might become suddenly hostile, in which case negative feedback would have no impact and the price would plummet.

The planned Ethereum hard fork expected over the coming months could have an opposite effect. Currently, it’s running the Byzantium version, which will shortly be replaced by Constantinople. The significance in change for us is that the emission of ether will be reduced and the reward for miners will fall from 3 to 2 ethers per block. As this change only effects supply, in itself, it will not reduce the electricity bill or the net cash-flow to the market, therefore it has a price-increasing effect. Naturally, it’s possible that the market has already priced this event in advance and will have no subsequent impact.

In relation to the above, the question might arise as to how is it possible that the price is lower than last November’s levels, yet the network’s hash rate is much higher. Thus the electricity bill is seemingly much higher than during last year’s state of equilibrium, whilst the income of miners is lower. This contradiction is resolved by two factors, one of a technological and the other of an economic nature.

On one hand, miners use increasingly efficient equipment capable of achieving more hashing attempts using the same amount of electricity. Thus the hash rate increase can stem from the increased effectiveness of the hardware, which doesn’t necessarily entail a higher electricity bill. Fortunately, all of this results in a slower growth trend in the hash rate which doesn’t influence the short term conclusions based on the more obvious changes of the exchange rate outlined above.

In order to understand the economic reasons, we must notice the asymmetry in the recoupment of mining compared to the conditions from last year. At the time, a miner might have reasoned that the possibility of increased capacity could only arise if the projected revenue would at least cover the costs, thus the electricity bill and the hardware costs.

However, the network is now characterized by unutilized capacity, which we know from the sudden drop in the hash rate from early September this year. The shelves of miners are now lined with decommissioned devices, which they have no need to purchase again. These can be deployed on short notice if the price of Ether increases ever slightly. It’s now sufficient for the projected revenue to cover the electricity bill. This implies that currently, miners would tolerate a higher electricity bill at a price level similar to the one observed last November.

As the corollary of the two above-mentioned – technological and economic – effects, despite the higher hash rate, due to the improved efficiency, the electricity bill of the network might be lower than that implied from the price level of ether from last November, yet not as low as justified by the development of the technology itself.

Finally, I wish to add that miners also obtain some revenue from Ethereum users, paying transaction fees for running their smart contracts. However, this results in revenues that are negligible compared to newly-created Ether. Thus, this factor was not considered in the analysis.