I've been on the sidelines watching cryptocurrencies for the past few years. One of the big turnoffs for me is that many cryptocurrencies seem to derive their value from hype instead of any real utility.
However, the more I learn about the sector, the more my view changes. That's mainly due to my growing understanding of Ethereum (CRYPTO: ETH). Here's why it's the one cryptocurrency that I might buy in 2022.
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Ethereum 101
Ethereum is more than a type of cryptocurrency. It's a blockchain technology platform for digital money, payments, and decentralized applications. The individual units, called ether, are the second largest cryptocurrency by market value behind Bitcoin (CRYPTO: BTC).
Vitalik Buterin, at the time a 19-year-old developer, proposed the idea of Ethereum in 2013. He suggested expanding the blockchain technology behind Bitcoin to more uses than just transactions. The platform launched two years later.
Since then, Ethereum has become one of the dominant blockchain platforms because of its wide range of functions. These include:
- Currency: Using a blockchain wallet, you can send and receive ether to pay for goods and services.
- Smart contracts: Digital contracts stored on the blockchain that automatically execute upon meeting predetermined terms and conditions.
- Digital apps (dApps): The Ethereum platform helps power apps that allow users to play games, invest, send money, and more.
- Non-fungible tokens (NFTs): Many NFTs use Ethereum technology to enable creators to buy and sell these digital goods.
- Decentralized finance (DeFi): Ethereum eliminates the need for government-controlled central banks to regulate currency.
The pros and cons of Ethereum
I think Ethereum has several major competitive advantages over other cryptocurrencies. First is its range of uses. It's not just another coin; it's an entire platform. It has become increasingly important in digital transactions as a result. That enables it to derive some value from more than the supply and demand of ether.
Another important benefit is its size and scale. It seems as if new cryptocurrencies are entering the market all the time to serve various purposes, including as a joke. However, as the second largest cryptocurrency behind Bitcoin, Ethereum's size and scale have given it credibility in the market.
However, there are some drawbacks to Ethereum. One of the biggest is volatility. Its price has bounced around significantly, driven in part by momentum trading:
Ethereum Price data by YCharts
That volatility makes it hard to use ether as a currency. You could sell an item for 1 ETH, thinking that's worth $4,000 only to have that value shrink by $1,000 in a matter of weeks.
Another issue with Ethereum is the costs. Transaction costs, known as gas fees, can be very high because of network congestion resulting from its popularity. Those fees also make it harder to use ether as a currency, since they make transactions more expensive.
Ethereum also uses a lot of computing power, causing it to consume a lot of energy. Given that carbon-emitting fossil fuels generate most of the world's electricity, it's contributing to climate change.
However, the platform is working to solve these issues by moving to a new validation system. This upgrade, Ethereum 2.0, should happen later this year. It promises to reduce Ethereum's power usage by 99.98% and increase its transaction processing capacity from 30 a second to as much as 100,000 a second. It could also enable making smart contracts even more sophisticated.
Ethereum stands out in the cryptocurrency market
I'm still on the fence about getting into cryptocurrencies. There's a lot of hype and volatility, which doesn't mesh with my investing style.
However, there's also a lot of promise, especially for the Ethereum platform. That's why it's the one that I might buy this year. I'm not ready yet; there's still much about it that I want to learn. And I'd like to see version 2.0 launch before I buy, since that would address some of the major issues with the platform.
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Matthew DiLallo has no position in any of the stocks mentioned. The Motley Fool owns and recommends Bitcoin and Ethereum. The Motley Fool has a disclosure policy.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
