Ethereum (CCC:ETH) is a decentralized, open-source blockchain. After the impressive run-up in bitcoin, Ethereum is getting lots of investor interest, too. The cryptocurrency is trading at levels not seen since last September. Where it’s heading next is unpredictable.
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Cryptocurrency has a history of trading at extraordinary peaks only to dip sharply weeks later. Should readers speculate on the digital currency at these prices or avoid it for now?
Ethereum Prices Slipped Last Week
Ethereum fell sharply as expected after miners booked profits. The second-largest cryptocurrency by market capitalization traded at an all-time high of around $1,440. After breaking a record not seen since Jan. 13, 2018, miners locked-in prices. The drop usually happens after reaching a peak. For example, bitcoin fell when holders worried that they would not see the $41,962.36 peak set on Jan. 7.
Since speculators do not know the reasons for the cryptocurrency bidding at new highs earlier this year, the volatility creates more headaches than opportunities. Still, asset managers like Blackrock (NYSE:BLK) are letting two of its funds invest in bitcoin futures. Sequoia Holdings said on Jan. 21 that it started offering its staff the option of getting paid partly in cryptocurrencies.
Having only two big names publicly announce the use of bitcoin or Ethereum is a positive development for the digital currency. But it is not enough. Cryptocurrency will need dozens of bigger firms announcing their support. Until then, it will have limited appeal to people. The restricted liquidity will lead to ongoing price volatility. Plus, it will create a wide bid-ask spread and add commission costs when the digital currency gets exchanged for real currency.
Hedge Against Inflation
The U.S. abandoned the gold standard in 1933 and then the remnants of the system in 1973. Fiat money then replaced the gold standard. Last year, the Federal Reserve pumped out money to the banking system and aggressively bought the corporate debt. Since nothing is free, investors are potentially acquiring cryptocurrency as a hedge against inflation and higher interest rates.
So far, investors are expecting a zero-interest-rate environment. This would suggest that no one expects any inflation. With neutral interest rates ahead and no inflation, the increase in the value of Ethereum is a mystery. Conversely, some believe Ethereum’s technical advantages will set the stage for a breakout this year.
Ethereum: Better Than Bitcoin?
Ethereum offers buyers better control over payments to sellers. For example, when a buyer initiates an escrow transaction, the Ether is locked in a smart contract. Once the buyer confirms that the seller fulfilled the obligation, the buyer may release the funds to the seller.
Transaction fees are also minimal. At EscrowMyEther, sellers pay only a small percentage Escrow fee, plus a 0.25% developer fee. Buyers, on the other hand, do not have to pay any fees.
When Ethereum traded at an all-time high, the cryptocurrency experienced network difficulties, and hashrates hit new levels. This signals the coin’s robustness. Despite the expected volatility ahead, the long-term prospects are strong. Supporters are willing to mine Ethereum during volatile valuations.
Weighing the Risks
Buying cryptocurrency does not come without risks. News of hacks of a digital exchange led to complete loss of the currency at hand or the inability to cash out. Bitcoin and Ethereum are too big and widely mined to face those risks. Still, news of smaller cryptocurrency hacks could hurt their value.
Holders may want to diversify their crypto token holdings with smaller cryptos besides Ethereum. Selling ETH would put pressure on its daily value.
The currency is relatively new to most people. As participants enter the exchange, expect volatility to continue. Ether will likely swing wildly in the near term. For new investors in this market, holding a currency other than fiat currency is worthwhile. A rise in the value of Ether will reward those willing to diversify into cryptocurrency.
On the date of publication, Chris Lau did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Chris Lau is a contributing author for InvestorPlace.com and numerous other financial sites. Chris has over 20 years of investing experience in the stock market and runs the Do-It-Yourself Value Investing Marketplace on Seeking Alpha. He shares his stock picks so readers get original insight that helps improve investment returns.