Disclaimer

Overview

Over the last year, crypto-asset markets have run wild on the thesis that value accrues to the “infrastructure layer of blockchains”. We now see nearly every project in the space define themselves as the blockchain infrastructure for XYZ industry, and the valuations of nearly all the tokens native to these networks have skyrocketed as a result.

Entrepreneurs are flocking to build decentralized communities, blockchains, and tokens where they are not only unnecessary but, in some cases, detrimental to the system they are meant to underpin. Uncertainty around regulation and value capture is orders of magnitude higher in the crypto-asset space than with traditional equity investments, yet, almost absurdly, crypto-asset valuations have ascended higher in comparison.

Ethereum and its native asset, Ether (ETH), sit at the center of this mania.

The recent decline in ETH’s price suggests that the speculation that drove it to new heights over the past year is exhausting. Just as ETH benefited from irrational exuberance, it will inevitably suffer further as the market sobers up.

We believe that ETH’s current price is still significantly overvalued; still significantly decoupled from the Ethereum network’s current and near-term technological state. Our research has led us to believe that the market and technology is still far too immature to justify current valuations. This nascent asset class has taken off due to speculative narratives, and we believe that the current marketplace is not sophisticated enough to properly evaluate risks or general economic concerns.

On the surface, some of the Ethereum ecosystem’s key performance indicators (KPIs) have been promising. As of July 2018, ETH’s market cap was roughly $45 billion. Ethereum currently supports thousands of ERC20 tokens (35 of which are worth greater than $100 million) and over 1,500 decentralized application (DApp) projects. The Ethereum network currently processes roughly 750k transactions per day.

The network is seeing some genuine demand, but we believe that this demand is far from sufficient to justify ETH’s price. When there is an expectation that a crypto-asset can achieve/exceed a trillion dollar market cap, the asset must become some reserve store of value (SoV). We believe ETH lacks the crucial characteristics required for a dominant SoV, and we see a low probability of ETH taking the reign from the current crypto-asset leader, BTC — let alone from incumbent globally dominant assets like the USD and Gold.

Whatever the probability, ETH’s chance at becoming a reserve SoV in the future will depend heavily on it being tremendously successful at one of its main use cases:

A decentralized application platform

A capital raising platform

Upon digging deeper, we currently see Ethereum struggling at both:

The platform has severe issues on technical and decentralization

fronts (both architecturally and politically) that will persist both over the short and long term. These issues question its value proposition over cheaper, more efficient, less risky application platforms.

fronts (both architecturally and politically) that will persist both over the short and long term. These issues question its value proposition over cheaper, more efficient, less risky application platforms. The commoditization of capital raising is already eating away at the main source of genuine ETH demand. Additionally, (incoming) regulation surrounding ICOs will severely curtail this demand.

While Ethereum’s current “brand name” edge may continue for some time, it has yet to solidify any functional competitive advantages.

Understanding the imminence of key catalysts, Tetras began building an ETH short position in May 2018. Although we do believe a naked short was justified, the primary motivation for this short position was to hedge a core long position in BTC. As mentioned in all our updates since the start of the year, we believe the next, sustained crypto bull market will be led by BTC.

Shorting ETH is an ideal strategy for hedging out overall crypto market risk because:

ETH has minimal “breaking news risk” that can move the price unexpectedly

ETH is the asset and Ethereum is the ecosystem we understand best behind Bitcoin

ETH has a mature enough market to facilitate reasonable borrow terms

We believe the coming months will be extremely telling for Ethereum’s future. Network strain (from DApp usage), competition (from alternative DApp platforms), and regulation (towards ICOs) will test the speculative hype and price of ETH.