Is This Really The Resurrection of Ethereum Classic?

In a matter of two weeks, Ethereum Classic has rallied over 150%, adding $3B dollars to its market cap, from its July market cap of just $2B. This begs the question of what caused this rally and whether it is sustainable. So, let’s take a deep dive into Ethereum Classic.

On June 2016, “The DAO”, a decentralized venture fund built on Ethereum, wherein token holders can vote on project proposals, was hacked by exploiting a smart contract bug that drained about $60 million of its total $150 million in funds. 

A proposed plan was to fork Ethereum to reverse the theft and return the money to The DAO, but the Ethereum community was split over the decision. The pro fork group argued for a bailout to save the DAO and other projects that have been affected by it. The anti fork group argued that the attack was not the result of a defect in the blockchain’s core protocol, hence a fork to save DAO will challenge the immutability of blockchains and give the perception that final settlements on blockchain can be reversed if people will it. They argued for adhering to a strict “code is law” principle. 

On 15th July 2016, on-chain vote regarding the fork took place at a short notice. Only 5.5% of the total Ethereum holders turned out for vote, of which 87% voted in favour of the fork and 13% voted against it. 

The hard fork was completed on 20th July, 2016. But, a group of developers decided to keep building on the original chain that was left behind, which came to be known as Ethereum Classic.

Ethereum Classic fundamentally differs in its ideology from Ethereum. The community follows a strict “code is law” principle, writing on its website “applications run exactly as programmed without downtime, censorship or third party interference”, which is not surprising considering the fact that it was the same hardcore believers in the original Ethereum’s vision that resurrected Ethereum Classic.

As for the use cases, the proponents say it can function as a store of value like gold or Bitcoin since its coin supply is capped, though a look at its value over the years doesn’t give one much confidence. The second use case is smart contract functionality that allows developers to build applications on top of it. 

Ethereum Classic also has a deeper focus on security (though it has been hacked many times) over scalability, therefore targeting low volume but large value settlements. This resulted in a chain that is more immutable than Ethereum, but less so than Bitcoin. More programmable than Bitcoin but less so than Ethereum. 

Therefore, it is placed somewhere in the middle between Bitcoin, with its coin capping and store of value and Ethereum with its smart contract functionality. 

But it also creates a problem, which Harvard Professor on business strategy Michael Porter calls as “getting stuck in the middle” – where a product doesn’t offer its own distinct advantage. For example, here in this case, people who want a store of value might opt for Bitcoin and those who want to build applications will choose Ethereum.  

Proving the theory, till now Ethereum Classic hasn’t achieved much success as a store of value. People who want that in a cryptocurrency still prefer Bitcoin.

On the application side too it hasn’t received much traction. The total value locked is at just $237K, according to data from Defi Llama, compared to Ethereum’s $40B, Tron’s $5.8B and Binance Smart Chain’s $5.7B. 

The top application built on Ethereum Classic is HebeSwap, a decentralized exchange for swapping ERC-20 tokens, with just 212K value locked, contributing to 90% of the total value locked in the chain. The remaining value is contributed by “ETC Swap”, another decentralized exchange forked from Uniswap, at 24.6K value locked.

This is a far cry compared to applications built on other L1 and L2 chains with similar valuations. Avalanche has 242 applications built on top of it, Polygon has 282 and Fantom has 254. 

Another problem with Ethereum Classic is its security. For a chain that has sacrificed scalability for security, a series of hacks that happened a couple of years ago, has dented its reputation. Its low and volatile hashrate makes it vulnerable to 51% attacks. 

In 2019, it witnessed a double spend attack of more than a million dollars that prompted Coinbase to stop trading the coin for a while .  

In August 2020, just within a month, it saw three 51% attacks leading to millions of ETC being stolen.  Though the development community has implemented a finality algorithm called MESS, short for Modified Exponential Subjective Scoring in October 2020 to make 51% attacks more costlier, critics say it doesn’t provide robust security against such attacks. 

So what is causing the sudden increase in its coin prices? 

Part of the reason is Ethereum’s upcoming merge, in which Ethereum moves to a proof-of-stake consensus from the current proof-of-work this September, which makes mining obsolete and it is speculated that miners will migrate to Ethereum Classic. The speculation is further fueled after AntPool, the 11th largest ethereum mining pool, announced $10 million in further development of Ethereum Classic. 

Antpool is an affiliate of Bitmain, a Beijing based company that makes cryptocurrency mining hardware. 

Little more than a year ago when the mining revenues were at its peak, Bitmain announced its Etherum miner and started selling them in July 2022, at $10k per unit.

The problem though for Bitmain is that after Ethereum’s proposed merge, there won’t be any need for mining. The “Difficulty Bomb” update on Ethereum significantly increases mining computation that will disincentivize mining. 

This creates a dilemma for miners, whether to liquidate their hardware or to move to other proof of work chains such as Ethereum Classic, since Bitcoin is not suitable as it needs ASIC for efficient mining whereas GPU is used for Ethereum.

Ethereum mining was a $19B industry according to Messari, a crypto currency research firm, and miner revenue hit a peak of $2.4B in May 2021 but since then it declined to 74% to  $620M in July 2022 according to the data from The Block. 

If miners do not move to other proof of work chains and instead liquidate their hardware, it isn’t going to be good for Bitmain’s and Antpool’s business. Hence, they have an incentive to promote other proof of work chains like Ethereum Classic. 

Because if ETC price increase through funding and promotional efforts, block rewards for miners increases,thus incentivising more miners to join the network. This in-turn increases security, which gives confidence for developers to build on the chain and investors to invest in the coin, leading to more transactions and mining requirements, which leads to more sales and revenue for Bitmain and Antpool. 

But in reality, materialising such a scenario is easier said than done. One reason being Ethereum Classic getting stuck in the middle as mentioned earlier and other being the increased competition, as Ethereum and other chains have already garnered a large user base and strong network effects. Adding to their woes, governments have started cracking down on energy inefficient proof-of-work chains. New York and EU’s proposed ban on proof-of-work chains highlights the regulatory risk that can affect the chain in the long term. Lastly, it’s still a speculation that miners will choose Ethereum Classic, as they could very easily fork the existing Ethereum chain with proof of work consensus. Recently, Justin Sun of Tron announced donations to community and developers to build on a proof of work Ethereum.

So for Ethereum Classic’s rally to last longer, its fundamentals should improve. As Ben Graham once said about stock markets, “In the short run the market is a voting machine, but in the long run it is a weighing machine”.This holds true for crypto markets as well.