Ethereum: Why We Have Yet to See the ETH Rally

On May 10th, Ethereum (ETH) hit an all time high, punctuating a run up in price that nearly matched the frenzied rally Bitcoin experienced in 2020. Through conversations with some of the biggest institutions, I see more room for growth, as Ethereum undergirds the infrastructure of a rapidly growing crypto ecosystem: DeFi.

While consumers, through a desire for higher yield and easily accessible financial products, first initiated Decentralize Finance (DeFi), we are now seeing DeFi applications push the entire blockchain marketplace to new heights both on Wall Street and Main Street. Today, not only are large financial institutions building the infrastructure to invest in Bitcoin, they are expanding into Ethereum with the belief that the demand for this digital asset will continue to grow as the applications built on top of them expand.

How did we get here?

In working with institutional investors, we have been at the forefront of the diversification from traditional asset classes into crypto. A year ago, the only entities doing this were crypto-native. Over the past few months, the narrative has shifted dramatically with large volumes, mainly in Bitcoin, coming from traditional financial institutions and Fortune 500 company balance sheets. The reasons behind this trend are numerous, but typically center around inflation hedging, geopolitical risk hedging and dampened expected returns coming from traditional asset classes.

Returning 15%, 2020 was a banner year for the S&P 500. While impressive on an absolute basis, that return pales in comparison to the staggering 300% return that Bitcoin had in that same year. These high, less-correlated returns are enticing to institutional investors and causing them to explore where that level of growth may come next. For some, that answer remains Bitcoin, but many believe the next leg of growth is in DeFi.

Why DeFi?

On March 12th, 2020, the entire DeFi sector had just under $1 billion in total value locked (TVL). Today, that number sits at $61B. This 61x increase in TVL was partially driven by price appreciation, but was more significantly catalyzed by the belief in a system that enables basic financial services, such as borrowing, lending and asset management, on permissionless protocols that are not subject to the whims of a central party, such as a bank.

Currently, DeFi is being led by what are commonly referred to as DeFi Blue Chips. Examples of these include Compound (COMP) and Uniswap (UNI). With Compound, users, in exchange for interest income, are able to lend tokens to token pools from which borrowers can take out collateralized loans. On Uniswap, users contribute their tokens to liquidity pools that traders utilize to exchange tokens in. These liquidity providers earn a portion of trading revenues. Respectively, Compound and Uniswap have $7.52B and $6.61B in TVL. These are just two examples of a rapidly growing DeFi universe that is white hot with innovation.

The Role of Stablecoins

The rate of expansion in DeFi would not be possible without the proliferation of stablecoins. While originally brought to market to give users some of the benefits of crypto, such as fast settlement and seamless transactions, without the volatility that has characterized the asset class, the role they have played in DeFi cannot be understated.

Stablecoins have served as the connective tissue between users and various DeFi protocols. Users are very easily able to move tokens from wallet-to-protocol and protocol-to-protocol with speed and confidence in value. Further, they allow users to more effectively use DeFi. For example, if taking a loan out from Compound, a user will have to post collateral. If collateral falls below specific thresholds, the collateral is liquidated. In using a stablecoin, there is more certainty in collateralization relative to using a volatile asset such as ETH. The benefits of stablecoins are not limited to lending and borrowing protocols, rather they are felt throughout the entire DeFi ecosystem.

As stablecoins continue to enable positive DeFi interactions, there will be a virtuous cycle of user retention and user attraction. This is being clearly proven out with the massive increase in stablecoin supply this year. As of January 2021, stablecoin supply, consisting of tokens such as USDT, USDC, BUSD and Dai, totaled some $30 billion. Today, that number sits closer to $100 billion and the rate-of-change continues to point north. While some of these tokens will be used for simple transactions, many will be used in DeFi.

So what’s next for DeFi? And what should we expect?

DeFi is clearly the most powerful and tangible use case of crypto we’ve seen thus far outside of Bitcoin and it is still in its infancy. The promise of decentralized, permissionless and censorship-resistant protocols has moved from being a theoretical exercise to a real one. As we move forward, we expect more: more protocols, more TVL, more use cases and more innovation. Traditional finance, who have had a tight grasp on financial services for millennia, stand to be disrupted in a big way. Importantly, consumers - retail and institutional alike - stand to benefit from a more open system that is built for and by the community.

In this next leg forward, we anticipate ETH to capture this value expansion, which fuels our belief that ETH is positioned well for more growth.