Cryptocurrency Analyst
Summary: It is typical to hear that cryptocurrencies do not generate value for the holders, except for a potential increase in the price of a given cryptocurrency. Yet, contrary to this popular belief, some cryptocurrencies may give additional returns similar to dividends or buyback programs of equities, although the fluctuations in cryptocurrencies are rather large right now compared to the dividend-like returns.
Cryptocurrencies are often criticized for not providing any financial benefits to their holders in contrast to holding equities, where holders benefit from dividends and buybacks to reduce outstanding shares by effecting a buyback program.
Not only do the majority of cryptocurrencies not provide financial benefits to holders, but they also often dilute the very same holders, as they issue new coins to miners and stakers to incentivize them to verify transactions. A regular holder of Bitcoin as well as other proof-of-work cryptocurrencies will be diluted over time. In terms of Bitcoin, 1.7% of the supply is presently issued annually to miners. For proof-of-stake frameworks such as Ethereum, regular holders are also diluted by a similar mechanism – unless the holders decide to stake their coins.
In proof-of-stake, to compensate stakers with rewards without simultaneously diluting them, transaction fees are absolutely crucial. In the past 30 days, Ethereum has generated $69.71mn from transaction fees, which are particularly burnt and paid to stakers. Since adopting a proof-of-stake framework on September 15th this year known as the Ethereum merge, Ether holders have been able to earn an annual reward of up to 7% by staking their Ether. The reward is derived from newly issued Ether and the unburnt transaction fees.
Although the network issues new Ether to stakers, since it also burns the majority of transaction fees, the supply has largely been constant since the Ethereum merge. So, the rewards to stakers have not come at the expense of dilution but rather due to transaction fees. It is important to notice that stakers lock up Ether for the foreseeable future and risk being slashed, meaning the network can ultimately take all their Ether in case the staker acts dishonestly. The latter occurs relatively rarely. Likewise, stakers have ongoing expenses to verify transactions, but they are estimated to be below 10% of the rewards. At present, around 15.6mn Ether are presently staked out of a total supply of 120mn.
Again, if you do not stake Ether, you will not receive a direct reward. Yet, the supply may turn negative, if burnt fees exceeds newly-issued Ether. This occurs in times of high demand for Ethereum-based transactions. If the high demand for transactions in 2021 is to be repeated in the future, we are likely to see an annual negative supply growth of up to 1%. This would benefit all holders of Ether, not just those who are staking it.
ENS has $43mn on its book
It is not only native blockchains to possibly generate yield. Here, we also find tokens, in other words, protocols based on, for instance, Ethereum. We stay within the ecosystem of the latter, namely Ethereum Name Service or ENS in short. ENS is the decentralized protocol for registering domain names on Ethereum. Like ordinary domain names, there is a small recurring cost to keep ownership of an ENS domain. Last month, ENS generated a revenue of $1.7mn, while its all-time high was in May of this year at nearly $10 million. Although the revenue is almost as volatile as crypto prices, it implies that protocols can generate revenue too.
After paying expenses to further develop and market the protocol, the revenue of ENS is paid to the treasury of the DAO (decentralized autonomous organizations) of ENS. This is the treasury that the holders of the ENS token control, and they decide what to do with it. At present, ENS has over 35,000 Ether in its treasury, worth over $40 million. At a fully diluted market capitalization of the ENS token of $1.3 billion, having a treasury of over $40 million is relatively insignificant, but it shows that a DAO can generate revenue, have a treasury, and potentially compensate holders in the future. To compensate holders, a DAO may use its treasury to buy back and burn its native token to potentially increase the price of its token, as the decentralized stablecoin MakerDAO has done.
It should not be a surprise for any that crypto prices are greatly volatile. So, as long as this is the case, the perception of dividend-like return is likely to be negligible to traditional investors. In our view, when your potential downside is as high as e.g., 90% on the asset itself, you do not appreciate the potential 4% you receive in annual staking rewards. To make matters worse, the staking reward is denominated in the respective cryptocurrency, so the real yield of staking is perfectly correlated to the asset, so if the asset tumbles by 50%, the staking reward does so as well. This is contrary to a traditional dividend paid in cash.
Not only are the prices volatile, but as stressed by both Ethereum and ENS, their respective revenues are highly volatile, effectively causing the potential reward to be volatile. One day, Ethereum may burn more Ether than it issues, but the next day it may burn much less than its issuance rate. As long as the use cases for cryptocurrencies are purely speculative, the volatility in prices nor revenues will decrease. This makes it difficult to predict and manage the potential value generated by these cryptocurrencies. The volatility, however, will first decrease sufficiently the day crypto is used in more genuine use cases. The latter may lead the broader market to recognize that cryptocurrencies can create a constant real yield. However, there is no guarantee that these use cases will ever emerge.
The examples mentioned herein are not endorsements of the individual projects, but rather show that, in our view, various cryptocurrencies may generate dividend-like returns, somewhat similar to equities.
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