ETHEREUM is finally Deflationary🔥 Supply, Fundamental, Technical Analysis (+Shanghai Upgrade)
It was highly anticipated, it didn’t happen after the merge, but now it is: The newest data shows, Ethereum is now finally deflationary! Not on a few single days, but actually over a couple of weeks now already. How much? What does this mean? And what to look out for, as, there is the Shanghai upgrade coming? I hope you are not afraid of data and charts, we are going to analyse the recent developments, simulate the impact, and form an outlook based on technical chart data merged with fundamentals.
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One thing upfront: We are no financial advisor!
Before looking at the Ethereum supply data, how much was emitted, how much burnt, let’s keep one thing in mind: Staking Ethereum currently yields a return of slightly above 5% per year, a little bit higher if you are a validator yourself, around 5% if you do it through one of the staking providers or centralized exchanges. What does that mean? If we have a look at the supply development now, we will be looking at an asset that is not only getting less and less over time, but also giving you another 5% APR. We will pick up this topic later on again in our fundamental analysis with some references to P/E ratio and dividend yields.
Now, let’s have a look at the supply data of Ethereum. I took the effort and downloaded the daily supply data from Etherscan and plotted them here in the chart so we can visualize them in different dimensions. As a first step, let’s understand the situation before the merge. You can see the 2 years before the merge, for which we see a supply increase of roughly 3.5% per year in a very linear way. Previous to these 2 years, the supply actually increased at a stronger rate, as the block rewards were significantly higher in absolute terms. And then the big event, the merge happened. For those of you who don’t know, at the merge the Ethereum mainnet was merged with the Beacon chain, which is proof-of-stake based vs. the previous proof-of-work consensus. After the merge, and with the new proof-of-stake set-up, Ethereums energy consumption was reduced by 99.95%. I don’t want to deep-dive into the technical details here, let’s rather have a look what happened to the supply and supply development of Ethereum.
With the merge at the 15th of September 2022, we indeed saw a sharp decline to the previous increase of total Ethereum supply. Let’s have a closer look what happened after the merge by zooming into this timeframe.
In the time from the merge until the end of 2022, we see that the total supply of Ethereum was pretty much flat, with still a slight increase of roughly 5.000 Eth, so the highly anticipated deflation in the ETH supply did not happen. Still, Ethereum went from a 3.5% annual supply increase to a only 0.1% increase per year. Now, within the first 2 month of the year, we see this deflationary pressure becoming much stronger, with an overall supply decrease of roughly 45.000 ETH or nearly 75 million USD. Extrapolating this for a whole year, we would look at a decrease of around 0.2% per year or at the current price roughly 500 million USD worth of ETH net burn. Let’s take this even one step further. What does this mean on a 5 year view?
With the old proof-of-work validation, in 5 years we would look at a total supply of around 140 million ETH, while extrapolating the 0.2% deflation on supply, we will be only looking at 119 million ETH, being 15% less supply.
Zooming out a little bit again from this data view, we can note, yes, the merge worked, and finally the anticipated result of Ethereum being deflationary is here. While it is only a small change between the first months after the merge and now in 2023, it is exactly that small step which pushed Ethereum from inflationary to deflationary. This is not the tipping point for the fundamentals behind Ethereum, but it is the tipping point for the narrative, and it is quite a strong one. Don’t get me wrong, I am not the biggest fan of easily pushed narratives, especially when they are paired with availability & recency bias, they can be dangerous in especially in trading, but my personal opinion is we have quite a strong one here. You have a deflationary token, the second largest and 2nd most famous token out there in whole crypto world, and, as said earlier, you get 5% return for holding and staking it. With increasing interest rates we may see 5% interest on our Dollars, Euros or whatever other currency as well soon again, but we will not hold a deflationary asset there, but a highly inflationary one. Before talking more on the outlook, the famous Shanghai upgrade, and technical analysis, I would like to do some analyses on these fundamentals of Ethereum we usually know from stock investments.
We have three aspects about Ethereum which I want to put in focus again. First, we have a slightly deflationary supply, second, we can get 5% return for staking it, and third, and this is very important, Ethereum is at the forefront, is an innovation-driver in one of the hottest industries out there with Web3 and the crypto market more broadly. We take a little bit of an unusual approach now and transform the fundamentals of Ethereum now into a stock price earning ratio analysis, and especially the third point is important to remember for this. It is also a bit unusual compared to what is our core at hoc-trade. We enable active traders to find and track their behavioral patterns in their very own trading data, by looking at their trading performance from completely new dimensions, such as how they react after a loss trade, tracking how fast they enter the market again afterwards, trying to revenge, and whether those revenge trades show a pattern of unusually bad performance (LINK TO DISCORD → Launching soon & you can get free + early access). But, also for daytraders and swingtraders, the following might be very interesting.
So what would the price earnings ratio of Ethereum be? If we assume the 5–5.2% staking rewards are your earnings + the 0.2% deflation of supply, we would be looking at earning of 5.2 to 5.4%. Dividing 1 by 5.3%, gives a price-earnings ratio of roughly 19. For the ones unfamiliar with typical price-earnings ratios of stocks, let’s have a small benchmark. As said previously, Ethereum is the leading coin after Bitcoin, is actively developing the product, and is located in a high growth industry, so we have to compare it to other leading companies in high growth industries. If we look at Nvidia, they have a PE ratio of around 100, Alibaba has 130, Tesla right now if 54, but is actually used to be in the hundreds as well, Salesforce currently has PE ratio of larger 600. So, looking at this, one could conclude, and all narratives on deflationary and so on aside just looking at the fundamentals, that Ethereum would be undervalued if believing Crypto & web3 are growth industries. Of course, take it with a grain of salt, and this is no financial advice. The analysis of course also has a limitation. On the earnings side, the 5% staking return are actually only paid to the people actively staking their Ethereum, and this is by far not everyone. We will have a look at how much is actually staked later when talking about the upcoming Shanghai upgrade, but even though it is only a part of the total ETH supply, we might frame it in another way. If earnings is not really earnings, then looking at it from a dividend perspective might be more applicable, because eventually what you are getting from staking could also be in the forms of dividends paid out by a company.
The 5.2 to 5.4% of staking + supply deflation would be a pretty good dividend not many of the large corporations out there pay. Let’s benchmark the 5.3% against large cap companies with some of the best dividend yields. Coca Cola currently pays you 3.1%, Ford 4.9%, Philip Morris 5.1%, AT&T 5.7%. There might be some even slightly higher ones, but the point is, Ethereum is actually in line, even among the leading dividend yields with 5.3% Usually, tech companies and others in high growth markets do not pay any dividend at all, and only companies in very stable industries, such as utilities, oil, etc. pay high dividends. So what would that mean? You could regard Ethereum as an asset, that gives you price exposure to one of the fastest growing industries out there and being a leader within that industry, and on top pays you a dividend in line with the top dividend yield companies out there. So, even though those two analyses are a bit unusual and are not 100% “clean”, I do think it is an interesting viewpoint on it and may help some of you to form your own judgement whether you consider Ethereum as undervalued or not.
OK, so I have thrown a lot of data at you, drawing some comparisons, but what does that actually mean now for Ethereum? Fundamentals and short term price action can be completely different, and we still have this big elephant in the room, the Shanghai upgrade. Let’s talk about this first before looking at the charts and some potential targets.
The Shanghai Upgrade, or Ethereum Improvement proposal 4895, consists of a few upgrades to Ethereum, but one of them stands out in terms of potential price action resulting from it. So far, Ethereum that is being staked as validator and receives those 5% return we have talked about a lot already, is currently locked, meaning it cannot be withdrawn. This was clear and communicated beforehand, so no surprise, but now with the Shanghai upgrade, this Ethereum will become withdrawable. So, the fear among many people is that a lot of ETH might be up for sale after the upgrade, leading to strong sell pressure. Let’s have a look how much Ethereum is currently staked in order to judge how big that sell pressure from the Shanghai upgrade may be.
Looking at the Ethereum website, we can see that currently roughly 17 million ETH are staked, and therefore locked. Based on a total supply of roughly 120 million, this means roughly 14% of all ETH are currently locked and become unlocked with the Shanghai upgrade. Of course, if all of this ETH would suddenly be sold, that would tank the price of ETH quite a lot, much more than 14% due to the missing market depth. However, this is quite unlikely, and we will also see an opposite effect. So far, if you were to buy Ethereum, stake it and lock it, you would not be able to withdraw it at any point, which probably kept quite a lot of people and especially institutions from doing so. Therefore, ETH also gains additional attractiveness to investors with the Shanghai upgrade. By now, probably quite a bit of the sell-off fear, as well as the boosted attractiveness to stake ETH is already priced in, and we did not see a big divergence between the ETH price development and the overall crypto market in the recent weeks and months.
As a last note on the Shanghai upgrade and before looking at some charts again to perform on outlook on ETH, we could also look at the peg from staked ETH to ETH, which has been pretty stable in the last couple of weeks and months. This can at least also give another indication, that the overall market is not expecting a huge sell-off for ETH. Overall, may we see higher volatility up until the Shanghai upgrade? Likely yes, and is some additional caution necessary, also probably yes, but do I personally, again no financial advice, count towards a huge sell-off? I rather tend to think no.
OK, as promised, let’s wrap up this video with a technical analysis on Ethereum, where does it stand, which price levels are important to watch, and what might be some potential price targets?
Before looking at the price chart of Ethereum, the more important chart might actually be the ETH dominance chart. This chart shows the market cap of Ethereum vs. the market cap of the whole crypto market. What we are essentially looking for here, is whether Ethereum may outperform the overall crypto market. I am showing you here the Eth dominance since 2018, with its high at roughly 26% and low at around 7% in 2019. Right now, we are in the range of 19–20% dominance. Zooming in a bit further, we see the two most important levels are here at roughly 17.5%, which is a strong support built through these 4 reversals, as well as the recent high at about 22.5% from December 2021. In the more recent past, the ETH dominance is mostly ranging between 21 and 17.5%. Zooming in even further, we see the dominant technical pattern is currently this triangle forming, of which we will soon see a breakout either to the top or bottom. If we see a breakout to the bottom, we may see some bounce back to the existing support at 17.5% dominance, then also paired with this longer term trend line coming in at a similar range. On the other hand, in a bullish breakout from the triangle, the recent high at 22.5% may be our target. From this chart, we would currently be a bit in a waiting position, very similar to the increased uncertainty due to the Shanghai upgrade, waiting for a clear technical signal in either direction.
Let’s have a look at the price of ETH next. Looking at the recent months, do we actually see a trend reversal here already? Not really… We see a local bottom here in June last year at around 890 USD, which hasn’t been challenged yet again. So, no lower low, but we also cannot witness a higher high yet, which would be required for a clean trend reversal. The recent high after that low from June last year is at 2000 USD. This makes 2000 USD our major watch-out point for the near future, a break of 2000 would be a strong bullish signal, while a break of 890 would be a strong bearish signal. With the current market price, not the greatest set-up from a return risk ratio point of view. Therefore, I would also here say patience is king right now, at least from a rather long-term swing trading perspective. If we see a break of the 2000 USD, we can well look further towards 3600 USD as the next strong resistance. Paired with the fundamental outlook as discussed earlier as well as the uncertainty from the Shanghai upgrade gone, there might be a strong case here for ETH going forward.
I hope you liked this analysis with a mix of recent development, fundamental analysis and outlook, as well as technical analysis! If you did, I’d very much appreciate if you leave a clap for the article and subscribe the channel. While ETH is one of the oldest assets in crypto and maybe less explosive, it’s definitely a super interesting one to follow with the potential for outperformance.
Thank you for reading, happy trades, stay humble, and see you in the next video.
All information in this article may not be up-to-date anymore while reading and should not considered to be financial advice!
