Where should the value in the Ethereum ecosystem lie? In other words, what should be greater? The aggregate market cap of utility tokens built on the Ethereum network or the market cap of Ether?
Where should the value of the Ethereum Ecosystem Lie?
This is the question I have been pondering for while now and in this article I will discuss my thoughts. This is just my take on a rarely discussed topic and I welcome any and all ideas you might have to further this discussion. The answer to this question will determine whether we, as investors, should be holding more of our portfolio of ERC20 tokens relative to ETH.
The EVM
The Ethereum virtual machine(EVM) acts as the the underlying computational engine for smart contracts to be executed on. One of the main arguments for the tremendous potential of ETH as an investment is that there will be a huge ecosystem of useful projects built to utilise the EVM. Every time a smart contract executes, a small amount of ETH will be needed to “pay” for its execution. As more people use these decentralised apps, the more demand there will be for ETH to execute these smart contracts and therefore increase the value of ETH will increase. Similarly as more people use these Dapps, the more value their utility tokens should hold.
This seems to be a completely reasonable argument. As the utility in the ecosystem increases, so should the value of ETH and the utility token providing the customer with the useful service. But how will this extra value be distributed? Should more of it go to the collective owners of the utility token or to the underlying Ethereum network?
Could we compare it to AWS?
My approach to tackling this problem is to think of the EVM as a utility, like Amazon Web Services, and the utility tokens as representing the companies that are built on top of this service. Anyone with a good Dapp idea can code up a set of economic rules and run their smart contract on the EVM. Just like anyone with a traditional tech idea can code up an application and pay AWS to host and run their application.
I know this is not a perfect comparison but for the purposes of demonstrating the possible economic forces at play here, I think this is an interesting starting point.
Amazon, at the time of writing, has a market cap of just over $450bn, and a SIC Investment Research report in May this year estimates that the AWS component is worth $190bn. Using this estimate, we can put a market cap of Amazon ex AWS at roughly $260bn. We can think of AWS as a utility that business use to build their added value on top of. Even just looking at Amazon’s own use of AWS, the AWS utility is able to support a $260bn business. Then, add on all the other thousands of businesses that use AWS we can quickly see that the AWS utility, valued at $190bn, is able to support trillions of USD in business value.
If we now draw a parallel with the Ethereum network we can start making some interesting arguements. The underlying EVM offers a lot less in terms of functionality that the AWS ecosystem. Storage will require use of SiaCoin or Filecoin. Computationally intensive tasks will require the use of the Golem token. And as the other utility projects release production ready components, the Ethereum ecosystem will begin to resemble a decentralised AWS that provides the full Web 3.0 tech stack that will drive the decentralised revolution forward. But should the value of that ecosystem really end up mostly in ETH?
What all this means?
ETH is the connective tissue in the ecosystem but to store TBs of data or perform intense computational tasks, this utility value should be held by utility tokens. And once the Web 3.0 tech stack is built, the network of Dapps that people will use should also hold most of the extra utility value that they create.
As of right now ETH has a market cap of around $27bn but the cumulative market cap of the top 82 ETH tokens is only $6.4bn. One could argue that the large market cap of ETH is a premium that reflects the huge future potential of the utility tokens that can be built on this network. But isn’t that an argument to have a much greater % of our crypto portfolio in tokens rather than ETH itself?
Furthermore, looking at AWS’s relationship with the businesses it supports, AWS relies on a huge customer base, representing trillions of USD in value, to support its $190bn valuation. It seems logical that the aggregate value of the utility tokens in the Ethereum ecosystem will also need to be many multiples of the market cap of ETH in order to support the ETH market cap. If we make a rather speculative(but I think conservative) assumption that the utility token ecosystem needs to be 10X the market cap of ETH to support any particular ETH market cap, a current valuation of $27bn in ETH predicts that the aggregate value of utility tokens should be around $270bn.
Now this is my high level analysis of the situation and I am extremely interested in hearing your thoughts. For those that believe in the future of the Ethereum network and who have a large portion of your investments in ETH, I hope this piece has made you think about your asset allocation between ETH and ERC20 tokens. For those that are bearish this space, this may be a justification for ETH being overvalued.
In conclusion:
I believe that within the Ethereum eco system the value will lie with the utility tokens rather than the underlying ETH token
I have liken this to how AWS, a $190bn portion of the Amazon company, supports thousands of businesses that operate on top of its infrastructure and represent trillions of dollars of value
ETH is currently valued at $27bn whereas the top 82 tokens have a combined market cap of only $6.4bn (at time of writing)
If my hypothesis plays out, the combined market cap of utility tokens will grow to be multiples of the market cap of ETH in the future
Therefore there should be much greater upside in utility tokens relative to ETH
NB: I realise that this is a very brief discussion of a multifaceted but very interesting topic. There are clearly many more forces at work here and I hope that this piece can stimulate more ideas on how we can analyse the economic landscape of the Ethereum ecosystem.
Disclaimer: THIS IS NOT INVESTMENT ADVICE. Please seek professional advice for your personal investments.