Weak capital influx, uncertain ETF prospects, ETH inflation rising after the Dencun upgrade, and the “Ethereum killers” breathing down its neck... Will Ethereum be able to take off in this cycle as it has in previous ones?

This bull market has so far been a one-coin show, with Bitcoin directing the overall crypto market. That’s not unusual at all, but if the past is anything to go by, at some point ether should make itself noticed by amplifying bitcoin price movements.

However, the second-largest cryptocurrency by market cap has been rather disappointing in this market cycle. While BTC gained 342% since the lows of January 2023 (now correcting -16%), ETH gained just 250% and corrected -27% since. Remarkably, during this period, bitcoin hit a new all-time high, while ether’s high $4,090 is still less than the $4,875 it reached in 2021.

Such underperformance raises questions about Ethereum’s potential and the current ETH market forces. Let’s look closer at the state of Ethereum.

Ether Capital Inflows

A key reason for Ethereum’s underperformance can be linked to its capital inflows.

While Bitcoin saw a significant new capital influx, thanks to the approval of spot ETFs in the US, Ethereum did not have such a catalyst.

Glassnode’s recent report shows that while bitcoin’s Short-Term-Holders Realized Cap is nearly on par with the last bull run peak, ether’s has barely lifted off the lows. This indicator, measuring the USD wealth held within coins moved in the past six months, suggests a markedly lackluster inflow of new capital to ether.

However, long-term holding patterns among Ethereum investors suggest an unwavering belief in its value proposition. The HODLers HODL, particularly the coins aged from 1 to 3 years. This would suggest that seasoned ETH investors are sitting back and waiting patiently for higher prices… and a possible Ethereum ETF approval.

Ethereum ETF prospects

After the SEC (U.S. Securities and Exchange Commission) approved Bitcoin spot ETFs, the industry’s attention shifted to the next regulatory frontier – Ethereum spot ETFs.

The firms currently awaiting the SEC’s response on this matter include BlackRock, Fidelity, VanEck, Invesco, Galaxy, Hashdex, Ark Invest, 21 Shares, and Grayscale. However, the chances their applications get approved are rather low, especially considering the SEC Chair Gary Gensler’s famous claim that all cryptocurrencies other than Bitcoin are securities.

As a sign of market’s gloom sentiment, Grayscale’s ETHE (Ethereum closed fund) shares have been trading at a substantial discount recently — ranging between 21% and 26% since March (data: Ycharts).

The first SEC decision on Ether spot ETF is expected by May 23^rd, when the commission will have to decide on VanEck’s application.

Dencun upgrade rekindles ETH inflation

Ethereum has been plagued by high transaction fees for a long time. To remedy that, its roadmap supposes an eventual transformation into a sharded system, where transaction data and processing are separated, allowing for higher transaction throughput and lower fees.

 Last month, the blockchain implemented the so-called Dencun upgrade containing “proto-danksharding” – a stepping stone toward full danksharding that would let layer-2 solutions on Ethereum store bulky transaction data off-chain. The upgrade implemented fee-reduction algorithms for layer-2 solutions, lowering the network fees. Indeed, median transaction fees are now  almost four times lower now than before the upgrade for the same level of network activity.

This overall positive improvement brought up an unexpected consequence – higher inflation. The Merge introduced a fee-burning mechanism back in 2022, where a higher network activity meant higher fees burned and hence lower ETH inflation. In fact, since the Merge ether has even become deflationary, burning 1.6 million ETH vs issuing 1.2 million ETH.

This trend is changing now. This CryptoQuant graph shows how the total amount of fees burned has decoupled from the network activity. The new supply of ETH is now growing at the fastest daily rate since the Merge as fees burned plummeted as a consequence of the Dencun upgrade. 

The increasing inflation takes away the “ultrasound money” narrative and makes ether less scarce, which also impacts its price action.

Ethereum killers

Increasing competition in the web3 domain impacts Ethereum too. With its fees still high and transaction throughput still low, the so-called “Ethereum killers” continue gaining ground, showing that the web3 narrative is still very much alive.

Solana is now the most dangerous competitor, attracting numerous web3 projects that need high scalability. With 71 million daily (non-vote) transactions, it beats Ethereum (1 million daily transactions) hands down. Also, with on-chain activity increasing fast, the skepticism about the sustainability of Solana’s low fees model is starting to dissipate. Indeed, Solana’s total daily gas fees are rising steadily and could even challenge Ethereum’s soon (data: Nansen).

Nevertheless, Ethereum remains the leader in DeFi (decentralized finance), with $104 billion of total value locked (TVL), or 66% of all TVL. Binance Smart Chain with 5.7% and Solana with 5.5% of TVL continue developing their own DeFi ecosystems, but they are still much smaller than Ethereum’s.

All in all, Ethereum’s position is visibly weaker than during the previous bull runs. The blockchain must speed up its own scalability improvements without relying too much on layer-2s. So far, the first tests of the danksharding technology that would significantly increase Ethereum’s transaction, is scheduled for January 2024. However, it is likely to be delayed, as almost all the other Ethereum upgrades have been. In the meantime, ether may still follow the overall crypto market uptrend, with possibly lower amplitude.