Ether Explained - Chapter 6: Ethereum vs. Bitcoin (part 1)
Vontobel now offers investors access to the crypto currency «Ether». But what is Ether? And why has the second best-known crypto currency gained so much popularity in such a short time? In eight chapters, we want to give you high-quality knowledge about the exciting topic of «Ether».
1. A generalized approach vs. a special purpose
Bitcoin is designed to fulfil only one function: It is a new currency created to compete with fiat currencies. It offers a reliable monetary system that is free of unlimited inflation and government intervention.
Ethereum is evolving into a world computer; a blockchain based programming language that enables smart contracts and distributed applications with its token Ether. The Ethereum platform is the updated version of Bitcoin and is often described as Bitcoin 2.0 or Blockchain 2.0. It takes the existing blockchain platform and closes the gap where Bitcoin has failed or is unable to fix. The focus is on decentralising all aspects of the digital world.
2. The first Ether vs. the first Bitcoin: ICO vs. Mining
The first distribution for Bitcoin was done by mining, for Ethereum by an ICO. It is assumed that Bitcoin was mined exclusively by Satoshi Nakamoto in its early phase. It is estimated that Satoshi owns approximately 5% of the total supply, but some speculate that they may no longer be accessible.
Ethereum was distributed in the form of an ICO. Ether tokens were pre-sold in 2014 and Ether tokens worth more than USD 14 million were collected. The pre-sale contributors received 60 million Ethers, but a large chunk of 12 million Ethers went to the Ethereum Foundation. In comparison, Bitcoin had a fairer launch. The majority of the ICOs to pre-sale alternative coins take place via Ethereum to purchase the Ethereum-based tokens.
3. Different supply models: Maximum supply and growth of supply
An essential determinant of any currency price is its supply. The higher the growth rate of the money supply, the more inflationary pressure there would be on the currency. As standard currencies, cryptocurrencies also regulate the total money supply by controlling both the amount of money in circulation and the growth rate, without a central authority, central bank or government, but through a software algorithm. The supply of cryptocurrencies is predefined and publicly known to all market participants from the time of introduction.
Ethereum's supply model differs from Bitcoin's supply model. Bitcoin’s maximum supply will be limited to 21 million BTC in total, whereas the Ethereum platform has an unlimited supply but an annual maximum supply of 18 million ETH. Both, Bitcoin and Ether have a decreasing growth rate of supply: Bitcoins issuance is halved every 210,000 blocks, which is roughly every 4 years. Since 9 July 2016, the block reward is 12.5 Bitcoins. It is anticipated, that it will halve to 6.25 Bitcoins per block on 25 May 2020. Because Ethereum has an annual supply cap of coins its growth rate is slightly decreasing in relative terms.
Bitcoin has a deflationary supply style, while Ethereum has an inflationary supply style. This is because Bitcoin has a limited number of coins to be mined while the Ethereum platform produces and spends a lot of new Ether every day -- similar to the supply of fiat currencies. By increasing the amount of ETC, the coin steadily loses value. Anything else remains equal, the purchasing power of a deflationary currency will increase over time, while the relative value of an inflationary currency decreases. Bitcoin therefore stimulates saving and benefits early adopters who have bought it for less. Ethereum promotes spending and lowers entry costs for newcomers.
Currently, new blocks are mined in the Bitcoin network approximately every 10 minutes. In contrast, on the Ethereum platform, a new block is created every 15 seconds on average. On the Ethereum platform, 2-3 Ethers are assigned to the computer that created the block.
4. Consensus mechanism: Proof of Stake vs. Proof of Work
When a new transaction is recorded on the blockchain a new block on the shared ledger is created without needing a central authority. The settlement is therefore obtained through a consensus mechanism by other network members. Both Bitcoin and Ethereum are using the consensus mechanism Proof-of-Work (PoW) to validate the transactions recorded in the blockchain. But Ethereum plans in its roadmap to switch to Proof-of-Stake (PoS). The PoW has an incentive mechanism that motivates participants to invest in mining processing power by receiving transaction fees and newly minted coins while maintaining the entire system securely. PoW improves blockchain security by requiring network nodes to solve mathematical problems before they can verify a particular transaction. But finding a solution takes a considerable amount of processing power and electricity, consuming a large amount of real resources. Miners have to make expensive purchases and keep investing in the latest hardware. In addition, the mining community is getting smaller because more and more electricity and expensive hardware are needed. This fact contradicts the vision of decentralization and can lead to the danger of a takeover by a malicious community member who controls more than 51% of the network's computing power.
Because of these drawbacks, the Ethereum community will switch to PoS, also known as «Casper». With PoS you can mine the amount of Ether transactions, depending on how many Ethers he or she already has. Some believe that this could be a fairer system than PoW, because in theory anyone could become a miner helping to increase community participation and maintaining decentralization. It will also ensure a faster blockchain and lower electricity consumption. In addition, a 51% attack is more expensive, because if someone tries to attack the system, his/her deposit (stake) will be depleted. In PoW, the cost of attacking the community is just the cost of electricity. In PoS, however, the cost of attacking a community is the amount of the deposit and the cost of electricity. But some claim that the PoS would eventually only make the rich richer, members of the network would be encouraged to hoard coins, instead of using them in transactions.
5. Large developer community vs. first mover advantage
The network effect indicates that the overall value of a network is proportional to its number of users: the more popular the network, the more people will participate. This is noticeable not only in social media, but also in the cryptocurrency market. As the first cryptocurrency to be introduced in 2008, Bitcoin has a clear first mover advantage in terms of network effect over Ethereum, which was launched in 2015. Ethereum is much shorter in the market than Bitcoin and therefore has less press coverage.
As more and better information about Ethereum is published, it will be easier for developers to join and contribute to the system. Also, the Ethereum platform will most likely be stable over time, because most Blockchain tokens have been programmed with the Ethereum smart contracts. Additionally, Ethereum has far more developers than other blockchain communities. The size of the developer community is a critical indicator of which network will prevail in the long run. More and more established mid-sized to large companies and prominent venture capitalists have interest in supporting the Ethereum network. However, it should be noted that low quality ICOs also have the potential to negatively impact the platform.
6. True decentralization: Influential personality vs. few mining pools
Bitcoin is a completely decentralised system that is not controlled by a central authority that could be corrupted or attacked. Although the protocol is theoretically decentralized, in practice the Bitcoin network is controlled after a few years by a handful of mining pools which together control over 75% of the network. This would make the Bitcoin network vulnerable to a 51% attack, in which malevolent members try to control a majority of the power that validates transactions.
On the Ethereum platform, decentralized computer programs (DApps) can be executed via smart contracts. The DAO offers a decentralized and autonomous form of organization on its own blockchain. However, the actual decentralization of Ethereum can be questioned, as Buterin is seen as a leading figure whose opinions have a lot of influence in the crypto market. Thus, decisions of the market participants could be influenced from a central place.
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