One of the key reasons that Bitcoin (BTC 2.49%) has performed so well, topping $107,000 at one point last year, and been more resilient than the rest of the crypto sector is because investors view the token as a potential inflation hedge. Only 21 million Bitcoin tokens can ever be mined and there are already 19.8 million in circulation, making the world's largest cryptocurrency a finite asset with similar dynamics to gold. Now, ARK Invest CEO Cathie Wood has said she believes Ethereum (ETH 3.99%) has begun to develop some unique characteristics of its own that could potentially position it as the crypto-equivalent of U.S. Treasury bills. If Wood is right, that could prove to be a major catalyst for Ethereum.
Proof of stake
Toward the end of 2022, Ethereum shifted from a proof-of-work protocol to a proof-of-stake consensus mechanism to govern its network. As networks like Bitcoin and Ethereum grew in popularity, the process of validating and mining new tokens became quite energy intensive, consuming ever more computing power. The alternative approach involves Ethereum holders "staking" their tokens -- locking them up for a certain period -- for a chance to validate new transactions. Validators are chosen randomly, winning the right to mint new blocks and being rewarded in new tokens for doing so. Those with more staked tokens have a higher chance of getting chosen.
Many investors now stake on Ethereum's network and earn fees for locking up their tokens. It's this trend where Wood sees a correlation with U.S. Treasury bills. Not only can investors in the Ethereum network earn yields on their tokens, but the tokens are also frequently used as collateral in digital asset transactions.
There are still many differences, of course, between the two asset types. For instance, most bonds have fixed maturities once issued, but Ethereum owners can continue to earn rewards until they choose to stop staking their holdings. While bonds are backed by the U.S. government, staked Ethereum is backed by the security of the network and the value of Ethereum tokens.
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Ethereum also presents some advantages over traditional bonds. The network cannot default on staked Ethereum as a government or company could because that staked Ethereum is not debt, but a way to govern the network itself. However, staked Ethereum as an asset does have similar risks to bonds. It can suffer from inflation, for example. If new Ethereum issuance surpasses the burn rate (some tokens are burned in each transaction), that leads to higher supply, which lowers the net yield. The other big difference is that while bonds are viewed as low-risk instruments, the yield on staked Ethereum can fluctuate quite a bit because the amount of Ethereum being staked changes, which impacts the rewards that stakers on average can earn. Other factors like transaction volume can impact the yield as well.
Wood and ARK also predict that Ethereum staking will become an important benchmark for the crypto sector, especially for those in the business of allocating capital to early-stage digital assets. ARK suggests that simply holding and staking Ethereum can deliver average staking yields of 4%. Investors would have to generate compelling returns from their investments to beat staked Ethereum when you look at the trade-off of compounding versus waiting for private investments to eventually pay out. In this manner, Ethereum's staking yield would essentially represent a risk premium similar to U.S. Treasury yields.
An early concept
The ARK white paper on this topic presents some interesting ideas that I had never contemplated before. It makes some points I agree with, but others look like more of a stretch right now. However, if the "crypto T-bill" concept catches on, it could serve as a catalyst for Ethereum in the same way that the "digital gold" premise did for Bitcoin, so investors should be on the lookout for its growing acceptance. Ultimately, I think Ethereum is one of the few cryptocurrencies that can be held as a long-term asset. If anything, Wood and ARK's research shows just how compelling Ethereum's network and its potential utility are.
