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Everything You Need to Know About Ethereum

By Sean Williams - Dec 20, 2017 at 8:08AM

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From catalysts to concerns, here's your one-stop guide to all things Ethereum.

Cryptocurrencies have been unstoppable this year. When the calendar does finally change to 2018, this year could go down as the single greatest year of gains for any asset group that investors have ever seen.

Cryptocurrencies take center stage in 2017

When the year began, the aggregate value of all cryptocurrencies combined was $17.7 billion. As of Dec. 17, the more than 1,300 tradable cryptocurrencies had a combined market cap of $594 billion. For you math-phobic people, that's a return of more than 3,200%, which has taken the S&P 500 decades to deliver to investors. In fact, many of the largest cryptocurrencies have left even the best-performing stocks in the dust this year -- so much so that a side-by-side chart comparison between a virtual currency and a traditional equity makes the return of the equity look like a flat line.

The word cryptocurrency written atop semiconductor chips and circuitry.

Image source: Getty Images.

Bitcoin is often credited as being the driving force behind the march higher in digital currency, and with good reason. It's the world's most popular digital currency with merchants, and was also the first tradable cryptocurrency. It also doesn't hurt that bitcoin comprises nearly 55% of the aforementioned $594 billion market cap. It has a ton of influence over the movement of virtual currencies.

However, the bizarre truth is that bitcoin has drastically underperformed its peers in 2017. Though its coin has rallied to nearly $20,000 after beginning the year at $967, many of the top 10 cryptocurrencies by market cap have gains of 6,000% to over 10,000% year to date. Virtual currencies not named "bitcoin" is where the interest and action has been all year. And arguably at the top of the list of most popular non-bitcoin cryptocurrencies is Ethereum.

Everything you need to know about Ethereum

Even though Ethereum is the second largest cryptocurrency by market cap at $69 billion, most folks have absolutely no clue what is, or have never even heard about it. A somewhat recent survey from student loan refinancing marketplace LendEDU found that just 31.6% of respondents were even aware of Ethereum. 

A person holding a physical gold Ethereum token.

Image source: Getty Images.

So, what is Ethereum? It, like most cryptocurrencies, shares the same basic traits as bitcoin. It has underlying blockchain technology with a tethered token, which in this case is known as "Ether." Ether is the token investors are purchasing, and what's gone from $7.98 at the beginning of the year to $719.71 as of Dec. 17. That's good enough for a better than 8,900% return. Yeah, not too shabby.

But with regard to Ethereum, virtually none of the buzz is about the payment facilitation potential of Ether. In fact, with the exception of online home-goods retailer Overstock.com, you'd struggle to find any brand-name merchants that accept Ether tokens as a form of payment. Instead, nearly all focus is on the underlying blockchain.

Blockchain is the digital and decentralized ledger that records transactions without the need for a financial intermediary, which in most cases is a bank. The advantages of blockchain technology are aplenty, but there are three standout components. First, is the potential for smaller transaction fees as a result of having no third-party involved. Secondly, the decentralization of blockchain ensures that there's no central hub cybercriminals could attack. And finally, the fact that miners are working to proof transactions 24 hours a day, seven days a week, means they could be settled considerably quicker than with current databases.

Here's what separates Ethereum from the pack

But unlike most blockchains, Ethereum's has an added component that's particularly attractive to enterprise clients: smart contracts. These protocols help to verify, facilitate, or enforce the negotiation of a contract in an efficient and secure manner.

A person touching an encrypted block among a blockchain with their finger on a digital screen.

Image source: Getty Images.

In plainer English, Ethereum's smart contracts function like that of bitcoin's blockchain, but without the restrictive currency-only nature of bitcoin. On top of managing agreements between users, Ethereum's smart contracts can function as multi-signature accounts that allow money to be spent when a required percentage of people agree, or they can be used to store information about an application. They aren't limited to the financial services sector, which could be a big boon to Ethereum's blockchain in the months and years to come. 

The buzz surrounding Ethereum is backed up by the sheer number of partners and big names it's collected to test out its blockchain. The Enterprise Ethereum Alliance currently has 200 organizations testing a version of Ethereum's blockchain in demos, pilot, and small-scale programs. This includes some very big names in the banking sector, such as JPMorgan Chase, Credit Suisse, Scotiabank, and Mastercard. But it also includes non-financial companies, like Cisco Systems and oil and gas giant BP ( BP -0.55% ). In particular, BP might be able to utilize Ethereum's blockchain technology in its energy trading platforms, refining its ability to boost margins by accelerating the verification and settlement of trading transactions. 

Here's what should concern Ethereum's investors

Despite these positives, Ethereum is far from perfect. Like pretty much every other cryptocurrency on the planet, it's suffering from a case of "FOMO," which stands for "fear of missing out." Investors have watched Ether tokens rise by more than 8,900% over the past 11 1/2 months, and they simply don't want to be left on the sidelines while everyone else is making money. FOMO is often a short-lived euphoric phenomenon that can turn on a dime.

A risk dial turned to its maximum setting.

Image source: Getty Images.

But there's more to worry about beyond emotional concerns. For example, it's unclear what role these Ether tokens will play in the future. Though transaction fees are paid in Ether tokens, most merchants couldn't care less about accepting Ether, and the Ethereum Foundation certainly isn't promoting it as a burgeoning payment option. That lack of visibility with merchants could be a hindrance.

In addition, even though it's had great success in attracting enterprise clients for testing, there are no guarantees that (1) Ethereum has the preferred blockchain among businesses, or that (2) blockchain uptake will be immediately put into play. The barrier to entry in developing blockchain is exceptionally low, with time, money, and a team to code being all that's needed to enter the space. Further, investors have a long history of overestimating the adoption of new technologies like blockchain. This isn't to say it won't be a game-changer, but perhaps nowhere near on the timeline that investors are expecting.

Lastly, buying into cryptocurrencies like Ethereum gives the investor no direct "ownership" in anything, other than a virtual token. You don't actually own a percentage of the blockchain technology, which is where the real value is. This makes placing a "fair" valuation on Ethereum almost impossible.

Is Ethereum right for you? Now that you understand what it is, its benefits, and risks, you can weigh in.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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