CoinEx Academy: What Is the Difference between Ethereum and Bitcoin?

There have always been naysayers who are bearish about Bitcoin, saying it will be overtaken by Ethereum. However, despite the passive voices, Bitcoin has long held a pivotal and unshakable position in the cryptocurrency market, ranking first in market capitalization. As of August 12, 2021, Bitcoin’s market cap has reached $838 billion, while Ethereum’s hovered around $363 billion, less than half of Bitcoin’s figure. With that, why do the objectors believe that Ethereum will become the top store of value? What is Ethereum and how is it different from Bitcoin? What’s the difference in our investment strategies for holding the two currencies?

01

What is Ethereum?

Ethereum is defined as a decentralized, open-source blockchain with smart contract functionality that opens access to cryptocurrency and data-friendly services for every user.

Its founder Vitalik Buterin, at the age of 17, came into contact with Bitcoin because of his father’s introduction. Two years later, he dropped out of school and started his own business. His original intention was to improve Bitcoin. But to his disappointment, after an in-depth study in the cryptocurrency market, he found that what everyone cared most about was the investment of digital currency, or to put it more bluntly, speculation in the crypto market. Many of the new cryptocurrencies were born from just simple modifications of the Bitcoin source code and then listed on the network for profit, whereas no one paid attention to the underlying technology. To this end, after a detailed analysis of the advantages and disadvantages of the Bitcoin system, Vitalik proposed to build a new blockchain as a decentralized application platform.

At the end of 2013, Vitalik Buterin released the Ethereum White Paper: A Next Generation Smart Contract & Decentralized Application Platform. Ethereum’s application architecture was so popular that Vitalik Buterin raised 31,000 bitcoins ($18 million at the time) in the Initial Coin Offering in 2014. The Buterin team then formed a non-profit company, Ethereum Foundation, and started to develop Ethereum until June 2015, when the first Ethereum was released.

02

What’s the difference between Ethereum and Bitcoin? Or, what is Ethereum’s upgrade over Bitcoin?

1)The difference in the overall aims

Bitcoin is defined as a “peer-to-peer electronic cash system”, that is, the “currency” initially set for decentralization. Because of the constant total amount, it has now become a store of value and a scarce asset. Its biggest breakthrough is using blockchain technology to realize value expression and value transfer without any third-party intermediaries, making a leap from the “Internet of Information” to the “Internet of Value”.

On the other hand, Ethereum is a Turing-complete system that offers functions such as smart contracts and decentralized applications programming, so it is positioned to be the “World Computer” and a global open-source infrastructure platform.

Here’s a simple analogy:

Suppose that Party A and Party B are making a transaction, and Party A needs to pay Party B ten dollars. At this point, the Bitcoin platform can complete the payment to Party B without the guarantee of central institutions such as banks. On the Ethereum platform, Party A can specify that the money will be paid if Party B completes a task. To execute more complex smart contracts, Party A can also further develop decentralized programs on Ethereum.

2)The difference in the consensus mechanism

Before the London hard fork upgrade on August 6, both Ethereum and Bitcoin followed a consensus mechanism called the Proof of Work (PoW). However, this mechanism has a fatal disadvantage — the extremely low transaction processing efficiency that leads to network congestion. At that time, Bitcoin had a TPS of approximately 7, whereas Ethereum, in contrast, could handle roughly twice that amount, but still too slow for its aim to become the world computer.

Because of this, after the London upgrade, Ethereum officially changed the PoW mechanism to the PoS mechanism. Of course, the number of Ethereum miners is so huge that it will take quite a while to complete the transition of mechanism. So Ethereum is currently adopting a hybrid PoW+PoS consensus mechanism for the interim period.

The difference in consensus mechanisms leads to different currency issuance mechanisms. The issuance of Bitcoin is a process of obtaining Bitcoin rewards. Everyone obtains the block packaging right by competing for the right of accounting via hash calculation, and gets Bitcoin rewards upon successful packaging, which is exactly the issuance of Bitcoin. In the case of Ethereum, upon the introduction of the PoS mechanism, users gain interest automatically generated by the system after staking Ethereum, which represents the way Ethereum is issued. But there is a threshold. Only when Ethereum users have 32 ETH can they become a validator to start stake mining and enjoy interest.

So here comes the question. Since the issuance of Ethereum is the process of stake mining on tokens, does it mean the more tokens you hold, the more profit you will make? Is the Ethereum network becoming increasingly centralized, deviating from the original vision of decentralized application?

To both improve efficiency and achieve decentralization by utilizing the PoS mechanism, Ethereum has worked out a solution: if users stake more than 32 ETH for mining, there will be no revenues generated from the extra part. Therefore, if users are to make full use of the currency, they need to distribute the excess to other accounts. Going further, Ethereum 2.0 randomly selects validators among these stake mining nodes through technical means (that is, to randomly assign accounting rights), reducing the probability of large-scale control of nodes by deep-pocketed currency holders. In addition, the 128 validators randomly selected will obtain rewards by generating new blocks as a committee. New validators will be selected by the beacon chain every 64 blocks. By regularly and randomly selecting validators, Ethereum prevents collusion among malicious nodes to the greatest extent.

In this way, Ethereum’s POS mechanism will not be inferior to the POW mechanism in terms of security and decentralization. More importantly, the upgraded system will be environmentally friendly, consuming much fewer resources than the PoW mechanism.

3)The difference in the miner’s income

The incomes of Bitcoin and Ethereum miners are both made up of mining rewards and transaction fees. The transaction fees of Bitcoin equal 0.1% of the transfer amount, but that of Ethereum can be generated through many more ways, such as token sending, contracts execution, and Ether transfer. For whatever you do on the block, you need to pay miners transaction fees.

However, Ethereum’s transaction fees didn’t surpass Bitcoin’s until 2020, when, according to data from Coinmetrics, the cumulative transaction fees of Ethereum reached $276 million, almost twice that of Bitcoin ($146 million).

Why is that?

It was the explosion of DeFi and NFT in 2020 that multiplied the transaction fees of Ethereum, partly contributed by the increase in transaction fees caused by the congestion of the Ethereum network and the resulting improvement in transaction confirmation efficiency. But this can prove that Ethereum miners have a more friendly ecosystem of earning profits. For Bitcoin miners, with the rise of the currency price, the number of transactions drops (because the transaction fee rises with the currency price). When there are fewer transactions and all bitcoins have been issued (the miners have nothing to dig), the income of miners will be slashed, making it impossible to encourage accounting. At that time, people will doubt whether or not Bitcoin can develop in a positive cycle.

By contrast, Ethereum miners can earn not only the mining rewards and transaction fees but also the fees from decentralized applications in the Ethereum ecosystem. In other words, the more prosperous the Ethereum ecosystem is, the higher the miner revenue. Even though the miner’s transaction fees will be reduced by 10–20% briefly after the Ethereum London upgrade, the ecosystem will grow better, so will the income of Ethereum miners. The Ethereum miner’s revenue model outdoes that of Bitcoin miners, doesn’t it?

03

Finally, the market valuations of Bitcoin and Ethereum are completely different. That is, investors must understand the different logic of holding the two coins.

Bitcoin was originally set as a globally circulating, decentralized currency with a constant total amount. But the rising transaction fees have made global circulation impossible. Bitcoin can only be anchored as a store of value. Becoming an alternative to gold is probably the best prospect for Bitcoin.

But Ethereum is a whole different game. Its market demand keeps growing and diversifying:

1) Ethereum can be used as a store of value. As Ethereum has moved to the proof-of-stake (PoS) consensus mechanism, users can earn interest on their staked coins (i.e. staking).

2) Ethereum can be used as a payment currency. Consumers can spend Ethereum in the Ethereum ecosystem to buy and sell digital assets like artwork (NFT), game assets, and insurance.

3) Enterprises can develop decentralized applications on Ethereum. Creative monetization can become a new driver for business development.

…..

In a word, the Ethereum upgrades have enabled currency issuance, currency circulation, payment transfer, deposit interest (staking), DeFi lending, semi-financial applications like “employment contracts”, and “self-enforcing bounties for solutions to problems”, both financial and non-financial functions.

As for the valuation of Ethereum, some argue that Ethereum is a commodity for the digital world, a payment network, a non-sovereign store of value, or even a digital state. Because it has citizens (wallets and users), currencies (ETH), companies (DAOs and Dapps), financial markets (DeFi), and the ability to form relationships with other digital states (bridges between different chains). This is why people always believe that Ethereum will overtake Bitcoin one day.

Ethereum excels in so many ways, but why the price and market value of Bitcoin is still way higher than those of Ethereum?

There are some probable explanations: Bitcoin, the earliest digital currency, boasts the most consensus; Bitcoin’s deflation is established, the technology to realize the store-of-value blueprint is stable; while Ethereum’s deflation just started after the London hard fork; and whether Ethereum can be used as a store of value depends on the Ethereum ecosystem. To maintain the ecosystem, ongoing breakthroughs are needed in Ethereum’s underlying technology, which is much more difficult than that for Bitcoin.

Can Ethereum overtake Bitcoin in the future? Let’s wait and see.

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