Ethereum, the second-largest cryptocurrency platform in the world, has seen its currency plummet 36% this year. But some major crypto investors think it has more room to fall, and they’re betting aggressively against it.
New York-based Tetras Capital, a crypto hedge fund that launched last summer and is known for in-depth analyses of cryptocurrency prices, has shorted ether, borrowing the coins and hoping they tank so it can buy them back at a lower price. Tetras started shorting ether in May 2018, when the price ranged from $572 to $659. Ether currently hovers around $470.
Last week, Tetras published a 41-page report explaining its reasoning. Forbes estimates the six-person hedge fund has $30 million in assets under management. The ether short is one of its two high-conviction positions—the other is its bitcoin investment, says founding partner Alex Sunnarborg.
Timothy Young, a former entrepreneur who sold tech startup Socialcast for more than $100 million in 2011, is shorting ether through his San Francisco family office, Hidden Hand Capital. Hidden Hand has more than $100 million in crypto assets under management. And Bay Area hedge fund Neural Capital also has a short position, according to a person familiar with the matter.
Ethereum aims to be a global computing platform, but investors like Tetras and Hidden Hand are concerned that its $48 billion market cap isn’t justified, largely because the network can only handle about 15 transactions per second. By contrast, Visa can handle 24,000 transactions per second. “Ethereum has an incredible talent pool of developers,” Young says. “In the long term, I think they’ll solve a lot of scaling challenges. But in the short term, there’s a disconnect between the price and underlying technology.” Sunnarborg agrees, saying, “Just because something is a good idea doesn’t mean it’s a good investment.”
Ethereum isn’t controlled by a single company, and decentralized applications (DApps) run on top of it. None of these apps have more than 5,000 daily active users, yet the network is nearly at full capacity. Network congestion can cause the fees required to use the platform to skyrocket.
For example, to perform a simple step in the Ethereum-based game CryptoKitties, where users can create digital memorabilia, it might cost $3. Those costs rose higher than $20 at the end of 2017. “An application call can be roughly 1 million times as expensive on Ethereum as compared to a centralized service like AWS [Amazon Web Services],” Tetras wrote in its report.
Ethereum developers are working on several solutions to improve network capacity. The Tetras team thinks significant improvements are too far off. “The most optimistic estimates suggest that Ethereum’s Layer-2 and other broad scaling solutions will not be fully functional, tested, or capable of supporting the most popular DApps for roughly another two years,” Tetras’ report reads.
Jake Brukhman, founder of Brooklyn-based crypto asset manager CoinFund, disagrees. He has been holding ether since July 2015, and the asset has historically made up between 20% and 42% of his firm’s first fund. Among Ethereum’s nearer-term scaling solutions like “state channels,” which allow transactions to happen more quickly, off the Ethereum blockchain, “a ton of improvements are coming to market this year,” Brukhman says. “As a blockchain technology, Ethereum still remains the largest ecosystem of technologies, tools and developers.”
Some data suggests that few investors are closely monitoring Ethereum’s technological progress. Casper and Plasma are two technical updates that will help speed up Ethereum transactions. “Casper and Plasma publish their meetings, and they still have less than a few hundred views on YouTube,” Young says. “I don’t think most people are either taking the time or have the technical background to really understand.”
Other big-name investors are on the fence about ether. Kyle Samani, managing partner at Multicoin Capital, says he’s “seriously considering” shorting it, but is already betting against ripple and litecoin and isn’t ready to add more short exposure. Longtime crypto investor and CoinShares chief strategy officer Meltem Demirors is “neutral” on ether. “We are nowhere near a bear market yet,” she says, although she thinks demand for Ethereum-based tokens and applications is largely speculative. “In the absence of more Enterprise Ethereum Alliance announcements in 2018, I won’t look to add more exposure.”
Tetras goes into many other reasons for its short in its report. Other well-funded Ethereum competitors like EOS, Dfinity and Tezos have recently come online or are planning to launch later this year. “EOS just raised $4 billion, and you can pay teams to build applications,” Sunnarborg says. “I don’t think people with big bags [investments] are going to let that die.”
Tetras also thinks the ICO boom has driven ether’s price up, since many ICOs accepted only ether from interested investors. Those ICOs are at risk of a regulatory crackdown, “which will dry up most of ETH demand,” the report predicts.
Sunnarborg believes ether would need to become a better store-of-value asset to live up to its valuation. He sees bitcoin as the more likely winner as the top store-of-value crypto asset, due to “crucial characteristics, including: security, political and architectural centralization, monetary supply, regulation, and liquidity,” he says.
What would it take for Tetras to change its mind and exit its short? “If Vitalik and Vlad came out tomorrow and said, ‘In our sleep we developed the perfect sharding [scaling] solution,’ we might change our view,” Sunnarborg says.
Or if a regulatory ruling gave Ethereum a competitive advantage—for example, if other platforms like NEO or Dfinity were classified as securities—he would rethink the position. He doesn’t see the SEC’s recent statement that Ethereum isn’t a security as an indicator of a competitive advantage, because the ICOs that launched on top of Ethereum are still at risk of being deemed securities.