Cryptocurrency has had mixed performance in recent weeks with Ethereum doing particularly bad - going down around $125 (35%) since June. The other two major coins held up better. Bitcoin (COIN) gained 5% and Litcoin now trades at roughly the same price it traded for at the end of June.
Ethereum's downside risk is due to asset-specific negative pressures. These pressures will cause Ethereum to continue underperforming its peers over the long-term so Ethereum should be avoided.
Unloading the ICO Cash
Ethereum is built with blockchain technology and expands the functionality of the technology by being programmable. Because Ethereum is programmable, it can be used to create decentralized applications called Daaps. The funding for these projects is also decentralized. Instead of going through traditional means like an IPO - these blockchain startups raise money through a crowd-sale called an initial coin offering or ICO.
To participate in the offering, interested investors send a predetermined amount of Ethereum to the organization in return for tokens which they expect to then trade after the project goes live.
The problem is that hundreds of millions worth of Ethereum has been sent to these ICOs, and these organizations are now sitting on an enormous amount of digital wealth. The liquidation of this Ethereum will dilute the market for Ethereum and put downward pressure on prices.
A Double-Edged Sword
Initial Coin Offerings are funded with Ethereum so they boost demand for Ethereum temporarily. Investors who want to invest in the ICO must first buy Ethereum and send that Ethereum to the ICO. However, once the Ethereum has been sent to the ICO, it will be eventually liquidated back into fiat.
The event is a net neutral for people who owned Ethereum before the ICO, but a net negative for investors who buy Ethereum after the ICO. There have been dozens of ICOs in the past, and millions of dollars worth of Ethereum ready to be released back into the market, making this a bad time to invest in Ethereum.
Competition from new crypto currencies
While the danger of Ethereum-based tokens is obvious, the threat of completely new platforms is another huge risk -specifically, a new digital asset called Tezos. Tezos recently IPOed for $232 million, and it aims to fill a similar role as Ethereum and its creators claim that it has a better (more decentralized) governance structure.
The worst part is that Tezos was primarily funded with Bitcoin and Ethereum, meaning that the cash raised in the Tezos ICO came directly from the market cap of the other two cryptocurrencies.
Tezos will fill a similar role to Ethereum and may even have significant advantages over Ethereum. According to Forbes magazine, the Tezos ICO is only the beginning. There are many other companies planning to IPO in the coming months. These ICOs can hurt Ethereum by diverting investment funds.
The higher they rise the harder they fall. Ethereum's spectacular rise is looking likely to be met with an even more dramatic collapse. Decentralized applications will probably be the downfall of Ethereum because they create a massive downward pressure as they unload their funding for fiat. On top of this, Ethereum will face significant demand from cryptocurrencies that are not built on its platform. Brand new coins like Tezos, will compete with Ethereum and steal its market share.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.