Why has Ethereum outperformed Bitcoin since the merger?

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Key Takeaways Since the merger went live in September, Ether has significantly underperformed Bitcoin, despite Ethereum’s supply plummeting after the merger. More Ether is also being staked since the Shapella upgrade in April. falling supply Regulatory repression and heightened institutional interest in Bitcoin appear to be behind the divergence, writes our head of research

One of the most interesting trends to watch within crypto is the ETH/BTC chart. In other words, how the two biggest cryptocurrencies in the world are performing against each other. Now, ten months after the Ethereum merger, it’s a good time to reanalyze the relationship.

The merger completely transformed Ethereum, switching the network to a proof-of-stake mechanism rather than the proof-of-work mechanism it was on before. On the other hand, Bitcoin remains (and always will be) a proof-of-work blockchain.

This means that the fundamentals underlying the Ethereum network have reversed. This is perhaps most noticeable when plotting the total supply of ETH in circulation. The September 2022 live merger sticks out like a sore thumb, with supply contracting (slightly) from that date.

Zooming into the post-merger period in the following chart shows the contraction. Supply has been declining at an average rate of 0.15% per month. Prior to the Merger, supply was growing at 0.41% per month.

Additionally, the supply of liquid ether has contracted even more than the charts above show. As for the total value of Ether staked, the trend was relatively stable since the opening of the staking contract in November 2020. This trend more or less continued when the merger went live in September 2022 However, as seen in the following chart, the amount of Ether staked notably increased in April this year when the Shapella upgrade went live.

This upgrade from Shapella, also known as Shanghai, finally allowed staked Ether to be sold off, with some early stakers having locked their tokens since the fourth quarter of 2020. Despite fears that this would lead to a large amount of Ether flooding the market and denting the price, the opposite happened. With the indefinite lockdown restriction no longer a factor, staked Ether rose noticeably, with a much steeper trend over the ensuing three months.

But how did this structural break on the supply side affect Ether’s performance against Bitcoin? Less supply equals higher price, right? Well, actually no. Almost a penny away from the meltdown going live, ETH has fallen against Bitcoin, as I’ve plotted on the chart below (the black line indicates the meltdown in September).

The reason, of course, is that price is governed by supply and demand, rather than supply. And while supply has contracted, the demand side of the equation has not held up – at least relative to Bitcoin.

Ether underperforms Bitcoin

Two months after the merger, FTX collapsed, sending the entire crypto sector into a tailspin. As is customary in times of falling prices, Bitcoin fell less than the rest of the market. So, Ether falling against Bitcoin following the crash is not surprising.

However, so far in 2023, the crypto market has been on fire, with token prices accelerating across the board as macroeconomic sentiment has softened amid falling inflation. The Nasdaq jumped 32% in the first six months of the year, its best semi-annual return since 1983. And yet, despite the crypto market on that wave, Ether fell again against Bitcoin, which looks set to go. against the trend.

The reason for this is probably regulation. The big regulatory crackdown in the US has been brutal on crypto, but Bitcoin hasn’t been as squarely in the crosshairs as much of the market. This has led Bitcoin’s dominance to its highest level in two years, now accounting for over 50% of the cryptocurrency’s total market capitalization. It opened the year at 42% (it was also around that level at the time of the Ethereum merger in September).

This comes amid sentiment that Bitcoin could carve out its own niche in the space. This is the view that many in the space have long held (and the sworn mantra of a Bitcoin maximalist), but the difference now is that the law seems to be moving closer to the same view. I’ll let Coinbase CEO Brian Armstrong put it more succinctly than me:

“We go back to 2021, we wanted to become a public company, we described everything about our business, the assets we list on our platform, how we do staking. The SEC at that time allowed us to become a public company”.

“A totally different tone started happening (about a year ago),” Armstrong continued. “We kind of got this information from the SEC that, in fact, everything other than Bitcoin is a security.”

Although Ether was not on the list of tokens announced by the SEC that included securities, a list that included other popular cryptos such as MATIC, SOL and ATOM, it was not immune. Seen more or less in a gray area, Ether nevertheless suffered from regulatory blows that followed. While last week’s XRP decision is positive for the space, and there will be many more twists to come, it still feels like Bitcoin has separated itself from the crowd.

The multitude of Bitcoin ETFs submitted for approval by some of the world’s largest asset managers, including Blackrock, further reinforces this view. Repeatedly denied to date, the presence of big names supporting Bitcoin in this stifling US legal environment is another boon for the orange coin. And while one might (rightly) speculate that a Bitcoin ETF would make an Ether ETF more likely, there’s no denying that Bitcoin has a head start in the race.

This led to a situation in 2023 where Bitcoin outperformed Ether, which seems surprising as the latter has tended to outperform the former during previous periods of price expansion. But it is always important to remember how brief the trading history of Ether and Bitcoin is. Ether was only launched in 2015, and it took a few more years before it was trading with true liquidity. So, relying on past performance should always be done with a pinch of salt. Moreover, the crypto market has never experienced a macro environment like this.

Finally, any hope that the merger would accelerate Ether into the stratosphere may have overlooked the price of the upgrade. It had been in the works for a long time, repeatedly delayed before it came and went.

Overall, this has led Ether to lag behind Bitcoin, with the latter increasing its dominance not just over Ether, but the crypto market as a whole. Things are changing fast in crypto, and Bitcoin has weathered turbulent waters better than altcoins in recent months, mostly due to the legal climate.

Again, looking at the price action, Ether investors can’t be too upset – despite Ether’s second place, it’s still up 57% so far this year. It could be worse, even if they backed the wrong horse.

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