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Written by Erik Weijers 4 months ago

Bitcoin and Ethereum: what are the differences?

In crypto, it's still Bitcoin and the pack. Of that pack, Ethereum is the frontrunner. Both Bitcoin and Ethereum are already on the balance sheets of reputable institutions - although this is more common with Bitcoin. However, the fundamental differences between the projects are large. That's fine. After all, it gives them both a purpose.

In short, what are Bitcoin (BTC) and Ethereum (ETH) used for?

  • Bitcoin is used as hard money or 'digital gold'. People, businesses and governments buy BTC to store their assets and to be protected from government-induced inflation and confiscation.
  • Ethereum is used as a software development platform on which all kinds of (mainly) financial applications are built. Think of decentralized trading platforms and NFT markets. To run those applications, the currency Ether is needed, which creates a demand for ETH.

You might think: why do we need Bitcoin and Ethereum? After all, we already have money and we already have software on which to build applications. The answer is that Bitcoin and Ethereum are based on cryptography and blockchain technology. As a result, the ownership of the digital assets lies with the person who has the private keys. As such, there is no (or: hardly any) counterparty risk: no bank or government that can go bankrupt or that, when all is said and done, owns your assets. This aspect of unwavering ownership is especially highly developed in Bitcoin.

Now let's look at the differences between Bitcoin and Ethereum: origin, power structure, volatility, competition and price projections.

Origins

The difference between Bitcoin and Ethereum starts with its origins. Bitcoin was originally (2009) a fundamentally different project from all other crypto that followed. Precisely because the conditions under which Bitcoin emerged cannot be copied, Bitcoin cannot be successfully copied or replaced. It began in 2009 as an experimental peer-to-peer payment system. The launch of the Bitcoin blockchain began with 0 Bitcoin in circulation. The coins had no price for the first year and a half: it was purely a volunteer project of people who believed in a better financial system.

Compare that to Ethereum, where the team of founders did a so-called pre-mine and sold the first load of Ether on the market. That was in 2014. That's how they funded their project. The idealism was no less there, but the expectations of financial gain must have been different. For that reason, it still lingers that Ether is a security according to US law. They have escaped that classification but many other similar crypto projects still fear lawsuits - not that this would be the end of such a project, but still. Bitcoin does not have these issues.

Who has the power?

A joke in Bitcoin circles is 'Bitcoin's CEO declined to comment'. This is cited when a government agency has once again made a negative comment about, say, energy consumption. Just to show that Bitcoin is a decentralized network with no board, shareholders or PR team. It is a network, a protocol, a bit similar to how TCP/IP (data transmission on the Internet) or SMTP (mail traffic) are protocols. It is true that the parties involved in Bitcoin - developers, miners, and node runners - can make changes to the source code. But none of those parties have enough power to impose their will. This creates stability - but the downside is that development is slow.

Contrast that with Ethereum. Strictly speaking it has no CEO. But there is a prominent founder at the helm: Vitalik Buterin. He and his team have a big say in major updates. Some decisions are very far-reaching, such as the infamous decision to split the blockchain (transaction history) after a hack in 2016. In the process, the hacked version of the blockchain was invalidated by decree and transactions were reversed. It shows that when all is said and done, Ethereum tends to be a corporate entity rather than a decentralized protocol. We write "tends" because the power structure is still more decentralized than in a publicly traded company.

Incidentally, such centralization was still an issue in Bitcoin's first year. Then it was founder Satoshi Nakamoto who made changes like a 'benevolent dictator' would. So Bitcoiners should be careful not to blow their own trumpet on this issue.

How changeable are they?

Bitcoin as a protocol is set in stone in many fundamental ways. The fact that there will never be more than 21 million Bitcoins in circulation is fixed by protocol. The odds of that changing are about as high as the odds of Genesis disappearing as the first book of the Bible. Many owners find this certainty reassuring, of course.

Compare that to Ethereum: there, the process of issuing money is still being tinkered with. It is an experimental process and there is no guarantee that the parameters will not be changed many more times. This provides flexibility to respond to what the market wants. The downside is that it is not inconceivable that "the money press" will one day be turned on as it often is in the traditional financial system.

Transition to Proof-of-stake

Bitcoin and Ethereum started out as a Proof-of-work (PoW) protocol, which is to say that energy consumption secures the network: energy is the cornerstone of the consensus mechanism on what constitutes valid transactions. There is hardly a chance that Bitcoin will any time soon switch to a consensus mechanism other than PoW. No matter what the environmental lobby tries. Ethereum, however, is already close to switching to Proof-of-stake. That's more like a shareholder model, where it's not the miners who get paid but owners of ETH who 'stake' (lock in) their ETH in exchange for staking rewards 'dividends'. The advantage is the much lower energy consumption of proof-of-stake compared to proof-of-work. The possible danger is the centralization of power in the hands of those who own the majority of ETH.

The move to Proof-of-stake highlights another issue with Ethereum, which is that PoS is much more complex software-wise and therefore more vulnerable. The programming language in which Ethereum is written is "Turing-complete," meaning that you can run any computation imaginable on it. This flexibility/complexity also brings with it a risk, namely that unforeseen vulnerabilities to hacks may emerge.

What competition do they face?

Bitcoin has always had pretenders to the throne. In the early years, these were near-copies or forks that tried to distinguish themselves from Bitcoin in a few ways, such as the size of the blocks (Bitcoin Cash). Those forks never really took off. That is why, by now, it has been sort of established that Bitcoin remains the only player in its niche of hard money. It was the first - a fact that cannot be copied. It has the network effect of users, developers and miners. And it has the brand name - all things that are hard to replicate.

Ethereum has never been a direct competitor to Bitcoin in that way: it is a completely different project and is built as a Turing-complete blockchain. That is, Ethereum has a huge range of conceivable applications. Bitcoin, on the other hand, is limited to one thing: being hard money. This does mean, though, that Ethereum is fishing in a pond where many competitors are lurking to claim market share. It does have a lead in the world of smart contract platform blockchains, but it remains to be seen how permanent that is.

Price expectation

Bitcoin is rightfully called digital gold: it has many of the characteristics of gold (scarcity, immutability, being unseizable), but abstracted and tailored for the digital world. If Bitcoin were to have a similar total market value to gold, it would mean a total market value of about $12 trillion (about $500,000 per Bitcoin).

For Ethereum, such a benchmark is less easy to determine. Precisely because it is a platform on which basically anything is possible: this makes the total addressable market so enormous. Currently, the economic activity on Ethereum comes from applications in Decentralized Finance (lending and trading platforms) and NFT marketplaces (digital art). Those two markets alone currently give Ethereum a total market value in the order of a few hundred billion dollars. Is Ethereum going to deliver on its promise of being the number one platform on which many financial transactions and applications (from stock trading to insurance) will take place? If so, its current value is a sliver of what it could be.

Disclaimer: It is important to realize that both crypto projects - although already dinosaurs within the crypto world - are still speculative. It is not yet clear how usage will develop in the coming years and how laws and regulations will evolve. So both remain high-risk investments - despite clearly being the most solid projects within crypto.

Adoption curve

The price of crypto coins is strongly related to usage. To determine whether something is a good investment, it is advisable to look not too much at the daily charts but at the fundamentals. Is the number of users / addresses / apps / stores where you can pay with it increasing?

The biggest jumps in user numbers (adoption) and price are made in the first few years after launch. Since Bitcoin has been around longer than Ethereum, this perhaps means that there is a bit less of an upside in the price. BTC has already weathered two additional bull and bear markets, and its price - though still volatile - is somewhat more stable than Ethereum's. So perhaps Ethereum has more upside. It is even not inconceivable that ETH could overtake BTC in terms of total market value. On the other hand, with Ethereum the risk of something going wrong is also higher. As mentioned, Ethereum's software is much more complex, governance is less decentralized, and competition is greater.

Conclusion

Bitcoin and Ethereum are fundamentally different beasts. We list the differences we discussed above.

Bitcoin

Ethereum

Purpose (niche)

Hard money/digital gold

Platform for financial (and other) applications

Consensus mechanism

Proof-of-work

Proof-of-stake (soon)

Programmability (number of possible applications)

Low

High

Risk of software vulnerabilities

Low

Average

Possible growth total market cap

Average

High

Competition in its niche

Low

High

Which project do you believe in more? Do you envision a world where both exist? Based on these and other investment decisions, you can determine whether and to what extent to include BTC and ETH in your portfolio.

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