Ethereum is rising faster than Bitcoin – is it a good investment?

Ethereum is well known in the cryptocurrency world but lacks the star status of Bitcoin among mainstream investors.

It is second to Bitcoin in terms of market value, at £220bn compared with Bitcoin’s £520bn. Like Bitcoin its price has been knocked from an all-time high, and fell yesterday after China's central central bank warned financial firms about accepting cryptocurrencies as payment.

But it has recovered some of that ground and is rising faster than Bitcoin this year, up 269pc versus 35pc.

One Ethereum token now costs $2,690 (£1,900). But what exactly is it, will its price keep rising, and should investors buy some?

What is it?

Ethereum is a cryptocurrency, like Bitcoin, which runs on its own "blockchain", an online ledger which tracks the transfer of information.

It was created by Vitalik Buterin in 2013, a developer who was just 19 at the time. His vision was for a decentralised payment network, with its own cryptographic currency, that allows anonymous payments to be sent across the internet without the need for a bank or other third party.

As the second-biggest cryptocurrency after Bitcoin, Ethereum has inevitably drawn comparisons to it. Its rapid rise has also led to claims of a bubble. But advocates say Ethereum has several advantages over Bitcoin that make it more useful.

The first is that Ethereum allows for "blocks", the records of cryptocurrency transactions, that can be created much more quickly than Bitcoin. While Bitcoin has been more widely adopted by online retailers and even some physical stores, Ethereum's fans believe its efficiency makes it better for transactions, rather than storing value.

But the major advantage of Ethereum is that the technology allows for third party applications, not just the currency, to run on the network. Bitcoin's appeal lies in money that is not controlled by any one party and does not have to run through a central server, but Ethereum allows not just money, but all sorts of other things to run on the network.

Storing files on a cloud storage service like Dropbox means the user is trusting Dropbox to take care of it, but on a decentralised storage network, they are placing their faith in fellow users who have an interest in maintaining it.

A number of apps are being built on Ethereum, and the network is also being used by start-ups to raise money with initial coin offerings, which exchange Ethereum or other currencies for special "tokens" that grant access to a service.

Why is the price rising?

The price of Ethereum is linked to the price of Bitcoin, as there is an overlap between those buying both. When cryptocurrency buyers are optimistic, that will be reflected in price rises for a number of different currencies. When they are pessimistic, they will dump many of them as well.

However, there have been a number of events specific to Ethereum that have led investors to bid up prices this year.

For example, this month there was a change in the way Ethereum is used in transactions, known at the Ethereum Improvement Proposal 1559.

David Derhy, of cryptocurrency exchange eToro, said currently users paid a fee to a cryptocurrency "miner" for a transaction to be included in a block, but under the new proposals fees would be sent to the network instead, in a new charging structure called a "basefee".

Miners will only be given an optional tip by users, with the basefee set by an algorithm and thus easier for users to understand and check if they are paying a fair fee or not.

"The market is already welcoming the moves. Ethereum and Bitcoin prices have both rebounded this week amid the news, as well as because of the latest expectations of further government stimulus," he said.

Another big development this year was that Christie’s, the auction house, announced it would accept Ethereum as a form of payment for a piece of digital artwork, known as a non-fungible token, or NFT.

It said while plans to accept Ethereum were restricted to this single lot, it recognised the growing importance of cryptocurrencies as a global form of payment.

Should you invest?

The same arguments for buying or avoiding Bitcoin can be applied to Ethereum. Sceptics argue that cryptocurrencies have no intrinsic value, could face regulatory hurdles which would block people from buying them, and are too volatile to ever become a reliable store of value or medium of exchange.

Fans counter that trust in cryptocurrencies is built on their "incorruptible" blockchain ledgers and limited supply of coins, which provide a sound store of value in a world of fiscal stimulus and money printing, which will ultimately lead to inflation. Therefore, over long periods, the value of digital assets will keep rising, they argue.

What is certain is that any cryptocurrency investment is likely to be volatile, so it is not for investors that might need to cash out over short periods. Digital assets should also be held as part of a balanced portfolio which contains mainstream assets like stocks and bonds. For example, Ruffer, the investment manager, invested 2.5pc of its portfolios in Bitcoin.

That said, Mr Derhy was positive about the potential this year for Ethereum and said it could stay over $2,000 because of the changes being made to its fee structure.

How to invest?

Ethereum is available on most cryptocurrency exchanges. The largest include Coinbase, eToro and Binance.

Binance and eToro do not charge transaction fees on Ethereum, however there are fees for withdrawing the coins from the exchange.

Coinbase has different fee tiers, with transactions under $10 (£7) costing £1 and a £3 charge on deals between $50 and $250. Any purchase over $250 carries a 1.49pc fee for British customers.

Investors also have to pay a spread – the difference between the buying and selling price – which tends to come in at around 0.5pc.