A year filled with highs and lows for cryptocurrency is ending with surprising winners — neither of which are Bitcoin (BTC-USD), Dogecoin (DOGE-USD) and Shiba Inu (SHIB-INU), the three digital coins that grabbed most of the headlines in 2021.
Ether (ETH-USD) was one of the year's biggest winners, more than quadrupling Bitcoin as an investment. Despite heavy investor buzz and new exchange-traded funds, the leading cryptocurrency spiked to a fresh record near $69,000 — only to retreat in dramatic fashion this month, and is currently languishing below $50,000.
As of Friday, Bitcoin has added over 60% year to date, and ETH is up 410%, according to Yahoo Finance/Coinbase data.
"Ultimately, I do think there's a little bit of a sentiment letdown right now in cryptocurrency," DailyFX analyst Chris Vecchio told Yahoo Finance on Friday. "I'd be very surprised if Dogecoin and Shiba Inu have a good year unless someone like Elon Musk is pumping them on Twitter."
Meanwhile, several smaller cryptocurrencies are fueling a new generation of blockchain protocols, challenging Ether.
Cardano's native cryptocurrency, ADA (ADA-USD) jumped a whopping 657%, and the price of Solana (SOL1-USD) leapt over 9,258.2%, according to Yahoo Finance/Coinbase data. Meanwhile, Polygon (MATIC-USD) and Terra (LUNA-USD) both eclipsed SOL with staggering price gains topping 13,000% each.
As the cryptocurrency ether fuels Ethereum, each of these less known cryptocurrencies offers something similar for their own protocols, most of all to pay transaction fees.
Similar to how Tesla (TSLA) has a market capitalization that dwarfs more established auto companies producing more vehicles, the outperformance of these newer tokens comes with "the expectation for growth," Gil Luria, technology strategist with D.A. Davidson Companies, told Yahoo Finance.
Despite crypto's current drawdown, and the belief that the digital currency trade has gotten overcrowded, Luria and others remain bullish, with increasing demand and competition for smart contracts compatible layer-1 protocols (like Ethereum) driving 2022 growth.
'New cloud wars'
Spurred by demand for two of this year’s hottest crypto frontiers, decentralized finance (DeFi) and non-fungible tokens (NFTs), transaction fees on Ethereum have spiked to high — sometimes outrageous — levels.
Soaring costs are a barrier to retail investors, as well as developers aiming to build enterprise-grade applications, like a streaming platform or video game.
That's why Luria and others analysts believe smaller protocols will "gain [market] share at Ethereum’s expense" by soaking up its unmet demand for investors and developers.
Akin to the fierce competition between the world’s major tech giants like Microsoft, Amazon and Google (MSFT, AMZN, GOOG) over the last decade, the D.A. Davidson team is billing this crypto competition as “the new cloud wars.”
It's the latest version of the “scaling wars," a topic crypto developers and investors have debated for years. Bitcoin acts primarily as a decentralized ledger for money rather than a smart contract platform like Ethereum.
Mauricio Di Bartolomeo co-founder and chief strategy officer of crypto lender, Ledn, called the latter "clogged" given high fees and surging demand. "It's like where Bitcoin was in 2017 where transaction fees were outrageous," he told Yahoo Finance in an interview.
Currently, Bitcoin processes about 7 transactions per second (TPS) at a cost of $3.34 per transaction. Ethereum can do 15, but at an average cost of $20 to $40 per transaction. For context, Visa is capable of 24,000 TPS with fees ranging from 1.4 to 2.4%.
"Anything over a dollar is too much," Baxter Hines, chief investment officer of Honeycomb Digital Investments, told Yahoo Finance — and a tough sell for anyone using an enterprise-scale blockchain application.
The competition to effectively scale is taking several different forms, designed to improve network speed, decentralization and security. This 3-part "trilemma" — a term coined by Ethereum creator, Vitalik Buterin — entails that all three can't be achieved at once.
To improve scale, Ethereum began implementation of its ETH 2.0 upgrade in August. The fee-improving part of the upgrade - a transaction innovation called "sharding" - isn't estimated to finish until 2023.
Kevin Woicki, Co-founder of Gitcoin, a developer fundraising application and DAO (decentralized autonomous organization) explained Ethereum's strategy is to become a “blockchain of blockchains," where most scaling is streamlined by second-layer applications and providers like Polygon.
Woicki said investors concerned about Ethereum losing market share should weigh whether the protocol's current transaction fee problem can overshadow its hefty network effects.
“Smart contract platforms are all about being able to build financial applications like legos. Every new lego added on Ethereum makes it better to build on the network. If I walk into an Ethereum hackathon, I am able to build something in a weekend that 10 years ago would have taken a bank $30 million and a staff of thousands of developers to build,” Woicki told Yahoo Finance.
For 2022, a lot of the high-value applications will be built on Ethereum. The more forward-looking, ambitious and lower value stuff will get built on other chains because Ethereum has become so expensive.Gil Luria, D.A. Davidson
Solana is another emerging contender, as its design allows for faster and cheaper transactions. Still in beta, its protocol processes currently 2,682 transactions per second (TPS), with average costs adding up to fractions of a penny. However, Solana's white paper states "up to 710k TPS is possible."
A report from The Block Research reveals Solana's other biggest advantage is fund raising. Amid the DeFi and NFT boom this year, Ethereum-based projects took 26% of the total funds raised; Solana took second place, with 73 deals (9%) of total deal flow.
And better fundraising is imperative to building a richer network faster because it can attract more developers.
“Our primary customer isn’t the end user. It’s the devs, the engineers, the app developers—they’re trying to build the next generation of applications,” Anatoly Yakenvenko Co-founder and CTO for Solana Labs, the company that built Solana, told Yahoo Finance.
Yet there are concerns surrounding validators, i.e. protocols that verify blockchain transactions. The top 19 control a 33% stake of the network according to Solana beach, meaning together they could halt the network, or censor transactions.
And because its still in its infancy, Solana's comparatively low number of validators makes it easier to jam the network with Denial-of-service (DDOS) attacks. In September, one such attack shutdown Solana for 17-hours, and sent the token reeling. The protocol is exploring a "validator delegation strategy" to mitigate the problem.
"We're still in the earliest inning," D.A. Davidson's Luria said. "For 2022, a lot of the high-value applications will be built on Ethereum. The more forward-looking, ambitious and lower value stuff will get built on other chains because Ethereum has become so expensive."
In Messari's 2022 trend report, CEO Ryan Selkis dubbed the new crypto units "ethereum killers" that "all have the money to compete aggressively... Either way, these assets are tethered to ETH."
David Hollerith covers cryptocurrency for Yahoo Finance. Follow him @dshollers.
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