One and a half years ago, Superblog readers were presented with an investment opportunity that is worth 25 times more today in dollar terms. And that despite the fact that it nearly halved over the past month. The chart for ether, Ethereum’s own currency, looks like this:
What is ether? What is the source of its value? How is it better and different than bitcoin? How did we get here and what can we expect for the future? These are the questions I am attempting to answer below. I am no longer providing an introduction to Ethereum; I have already done that in the previous two parts, here and here.
In summer 2014, as part of the largest crowdfunding campaign the world had ever seen, the owners of the Ethereum project held an advance sale of ether, the currency of the system they were looking to implement. Investors pooled over 18 million dollars worth of bitcoins, in exchange for which they received a pledge on the payment of about 60 million items of ether.
This was a real venture investment. A promising project with the prospect of losing the investment. The technology that was to be developed did not exist at the time, and there was no guarantee that the system, which was viable in theory, could also be implemented.
Nevertheless, the investment decision was by no means a difficult one for me to make. As I previously argued, Ethereum’s world computer provides just as many possibilities as the PC. Thus, two years ago prospective investors were in a situation akin to making a decision in 1975 on whether it was a good idea to buy into the royalties of the PC. All depends on the price, of course. Yet, if it had been possible to buy into the royalties of the PC, it is difficult to conceive of a price at which such a purchase would subsequently have turned out to be a bad move. In the Ethereum case, there was a fair chance for the entire project to end up as a failure. We have no way of knowing what the future will bring; however, the ether’s price movements so far have not been a cause for disappointment.
In fact, ether is not royalty, it has useful value. Ethereum’s world computer is run by the community of miners. In exchange for offering computing capacity, miners are given ethers, in one of two ways. For one thing, they get the newly generated ethers. On the other hand, Ethereum users pay some ethers for miners so that they are willing to run the smart contracts. That is, the currency has value because anyone who wants to enter into a smart contract in Ethereum will need to acquire ethers. In this way, during the circulation of the currency, miners sell it to users, who then spend it on running their smart contracts, returning it to miners. Again, ether is not royalty, but similarly to royalties, its value is commensurate with the success of the underlying product. As ethers are limited in number and the speed of their circulation is not unlimited, the more parties use Ethereum, the more a single ether will be worth.
The creators of Ethereum had no ambition to create a better decentralised currency than bitcoin. Initially, they planned to construct their system on a bitcoin basis, but realised that it would have involved too many technical constraints and compromises. They reckoned it was better to start off with a clean slate. So, together with Ethereum, they created ether, which they prefer to consider as fuel driving the trust machine, as a kind of virtual oil, rather than as currency.
In its most liquid markets, ether is traded for bitcoin. Based on the above argument, these markets do not provide a platform for the exchange of virtual currencies, but for the purchase of virtual oil for virtual currency. Despite all intentions, however, there is no way to prevent the user community from using ether as tender or to store value.
Following months of delay, Ethereum’s Frontier version was completed by summer 2015, and was finally launched on 30 July by generating its genesis block. The genesis block can be seen as the first page of the virtual general ledger, which is where investors’ 60 million ethers were booked. Additionally, as indicated in advance, the Swiss non-profit foundation developing Ethereum also booked 12 million ethers for itself. Ultimately part of this amount will be given to programmers, who can claim a part of their pay in ether. Some of it will be kept as a reserve for further developments. In the months following its launch, one ether traded at around one dollar.
However, programming work did not stop at that point. Apart from troubleshooting, additional developments and versions were scheduled. Yet, despite the large amount of money pooled initially, the foundation’s resources were depleting. The delay of the project also meant that it cost considerably more to launch Ethereum than originally planned. To make things worse, the rate of the bitcoin depreciated sharply, and the foundation had kept a major portion of its reserves in bitcoin.
The situation deteriorated to a point that a significant part of the programmers were made redundant, while those remaining had their pay reduced. This is how the foundation tried to push the project past a few more milestones. By the beginning of the year, the foundation’s balance only showed some cash and about 2 million ethers, which, at the then price of one dollar each, would only have lasted for a few months’ more work.
Fortunately, the tide turned soon. One the one hand, the bitcoin’s long-knownscaling issues were again brought to the center of attention in January. At the same time, rumours got around about Ethereum’s next version, nicknamed ‘Homestead’, being released soon. And unlike Frontier, this version would be recognised as secure, and would no longer be regarded as a trial version running in production, which could at any time throw an error with the potential of rocking the system to its core. Consequently, as shown in the chart, and the possibility of which I had pointed out in advance, in February the ether’s price exploded. Suddenly the foundation’s remaining capital catapulted from the million dollar magnitude into tens of millions,enabling years of development to come.
And there is plenty of work to do. Although Homestead was indeed released on Pi day (14 March), the developer team continues to work on additional versions. The names have been around for a good while, only the associated programs need to be written. Work is underway, with Metropolis slated for release this year, to be followed by Serenity.
One of the key questions concerning future movements in the ether’s price is the development of supply, i.e. the rate at which new ethers will be generated following the initial 72 million. New ethers are given to miners at 5 for each block. Blocks, representing the pages in bitcoin’s virtual general ledger, are generated every 10 minutes, while in the case of Ethereum the cycle is only 15 seconds. At that rate, just under 1 million ethers are generated each month.
New bitcoins are generated at a decelerating rate which will be reduced to zero over time. It is known that ultimately a total of 21 million bitcoins will exist. Ethereum’s developers follow a different model. Each year a constant quantity of ethers are issued, corresponding to a gradually smaller portion of the increasing total. In the longer term, due to ethers being permanently withdrawn from circulation as a result of lost and forgotten passwords, corrupted files and deaths, actual supply is expected to be constant.
Currently about 11 million ethers are generated each year. Somewhat in contrast, plans are to reduce this figure radically. However, this will involve a single intervention linked to a technological upgrade rather than some arbitrary measure. Currently both bitcoins and ethers are mined using a so-called proof of work (PoW) algorithm. The technical details are not relevant for our purposes; the point is that the method wastes a terrible amount of energy. Mining computers perform a huge amount of unnecessary computing, guzzling electricity in the process. Ethereum’s developers set a relatively high current rate for the issue of ethers in order to motivate a number of people sufficient for the reliable operation of the system to operate mining computers expensively.
At a later stage, Ethereum’s programmers are planning to transition mining to a workable proof of stake (PoS) algorithm. In theory, this is much cheaper to run, but needs plenty of refining as yet. If developments go the right way, mining will transition to the PoS algorithm sometime next year, accompanied by a radical deceleration in ether generation. The precise rate of that will be set so as to motivate quite a sufficient number of people to run mining computers. It is known to be a fragment the current rate of issue.
That is, the ‘ether press’ in full swing today will shift to a lower gear. Consequently, if Ethereum will indeed be used by many people, further appreciation is to be expected in the price of ether, since the virtual oil, unlike real oil, will not glut the world. Ether investors have high hopes that they will be spared a virtual shale oil revolution.
I wish to thank Ethereum programmer Dániel Nagy for the interviews.