At first glance, Ethereum (ETH 0.01%), the world's second-most valuable cryptocurrency, seems to be having a banner year. Ethereum is up 57% and appears to be gaining momentum heading into the final weeks of the year. Over the past 30 days, Ethereum is up more than 20%.
But context matters, and right now, Ethereum is badly underperforming the crypto market. Bitcoin (BTC -1.86%), for example, is up a spectacular 112% this year. And other top cryptocurrencies are similarly posting triple-digit gains in 2023. All of this has complicated the decision-making calculus around Ethereum, which now looks like a market laggard. If you are thinking about buying Ethereum, this is what you need to know.
Why is Ethereum underperforming?
What's particularly puzzling about Ethereum this year is that it's just so hard to pinpoint exactly why it's underperforming Bitcoin and other top cryptos. Heading into 2023, Ethereum seemed to be riding a wave of momentum after pulling off The Merge, which was widely hailed as one of the greatest technical achievements ever in the blockchain world. As a result of The Merge, Ethereum changed its overall blockchain infrastructure, all with the goal of reducing transaction fees, boosting transaction processing speeds, and improving overall efficiency.
Image source: Getty Images.
But a number of issues have popped up throughout this year. For one, overall activity on the Ethereum blockchain seems to be down and that's not a good sign for future growth. Case in point: Bitcoin recently passed Ethereum for the first time ever in terms of 24-hour non-fungible token (NFT) sales volume, an area Ethereum has always dominated. And Total Value Locked (TVL), which measures activity on the blockchain, also recently reached a 12-month low, a potential sign of Ethereum's weakening position in decentralized finance. These might just be short-term blips on the radar, but they are still concerning.
There have been regulatory concerns, too, such as those related to staking activity on Ethereum's brand-new proof-of-stake blockchain. The primary concern is that the SEC's willingness to go after major cryptocurrency exchanges for their staking activity, as we saw earlier this year, will eventually erode the attractiveness of Ethereum as an investment option.
Moreover, The Merge is not having the sort of breakthrough impact it was supposed to have, as measured by transaction fees and transaction processing speeds. For example, transaction fees for relatively straightforward activities, such as buying a new NFT, can sometimes run into the hundreds of dollars. And the main Ethereum blockchain can still only handle 20 to 30 transactions per second, a far cry from the 1 million transactions per second promised years ago.
Ethereum vs. Bitcoin
Perhaps the best explanation, though, might be that investors are almost single-mindedly focused on Bitcoin at the moment. Just about everyone seems to be looking ahead to the imminent launch of the first-ever spot Bitcoin exchange-traded fund (ETF), and what that could mean for the broader crypto market. Ethereum almost feels like an afterthought right now.
Perhaps as a result, the longtime strong correlation between Ethereum and Bitcoin appears to be weakening. Until mid-March, the correlation between Bitcoin and Ethereum was nearly 0.95. That's almost a perfect 1-to-1 match in terms of performance. But now the 90-day correlation between the two has dipped to the 0.8 level.
Ethereum vs. other altcoins
In addition, many other cryptos appear to be passing Ethereum right now. That's of particular concern in the case of Solana (SOL -4.46%), which is arguably Ethereum's greatest rival right now in the Layer-1 blockchain space. Solana is up a stunning 325% year to date. While Solana has its own fair share of regulatory and technical issues, investors have largely been willing to shrug them off due to Solana's perceived growth prospects. Solana's new "crypto phone" is just one of the most exciting projects.
These shifting investor perceptions of Ethereum are having an impact on institutional money flows. Quite simply, large institutional investors appear to be taking their money out of Ethereum and moving it into Solana. In 28 of 32 weeks this year, Solana has seen net positive inflows, according to CoinShares, which tracks inflows and outflows into different cryptocurrencies. In contrast, Ethereum has seen outflows. And that has led to CoinShares calling Solana "the altcoin of choice" for institutional investors right now.
Can Ethereum bounce back?
At the end of the day, the decision whether or not to invest in Ethereum comes down to your view of its long-term growth prospects. Ethereum is still the clear leader in just about every niche or sector of the blockchain world and it's one of the few cryptos that seems to have the implicit support of federal regulators. Notably, SEC Chair Gary Gensler has always stopped short of calling Ethereum a "security." And it's not like analysts have completely given up on Ethereum. Standard Chartered Bank, for example, just put out an aggressive $8,000 price target for Ethereum.
Going forward, I'm keeping a close eye on how Ethereum fends off the threat from rival Solana. This one factor could end up having the greatest impact on Ethereum's long-term growth prospects. If Ethereum is unable to keep up with Solana and other Layer-1 blockchains, that could have a huge impact on my decision of whether or not to invest in Ethereum going forward.
