Ethereum's $58 Billion Problem Could Get Worse

Ethereum (CRYPTO: ETH) is in danger of being overtaken by a $58 billion threat. There isn't much that it can do immediately to mitigate this threat. And it's getting bigger.

Here's what you need to know and how to adapt your investment strategy accordingly.

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There's a valuation problem here

One of the key metrics used to determine the valuation of any chain's native token is the total value staked on the chain. The more total value staked, the more capital there is that's on the chain and seeking a yield in exchange for keeping those funds locked there for a predetermined period of time. The yield delivered to staked capital is thus another important attribute, as it indicates the relative rewards that investors demand for taking the risk of locking up their funds on a chain when they could be deploying them elsewhere.

As of midday April 29, there was $62 billion in value staked on Ethereum, with an annual reward rate (the annualized interest rate for staking) of close to 3%. Given that Ethereum's market cap is $216 billion, about 29% of the chain's value is tied up to provide a yield via staking.

In contrast, Solana, (CRYPTO: SOL) despite having a much smaller market cap of $77 billion, has $58 billion in value staked on its chain, and it delivers a yield of 8.3%. For brief periods in late April, its total value staked was even higher than Ethereum's. That's a big problem for Ethereum on multiple fronts, and it won't be going away anytime soon.

Solana is a smaller chain, but investors are parking nearly as much capital there as they are on Ethereum, and getting much higher returns for doing so. That either implies that Ethereum is overvalued right now, or that Solana is undervalued -- or perhaps both. Generally speaking, capital will migrate from one chain to another when it can get better returns for the same amount of risk, and the outflows tend to be faster when one of the assets involved is overvalued. The sum of value staked on Solana is thus likely to grow, and that growth is likely to be siphoned from Ethereum, which would reduce its price significantly.

But the yield gap is just one element of Ethereum's precarious competitive position relative to Solana. The Ethereum chain is also much more expensive and much slower to use than its rival, which is one of the main factors contributing to its underperformance. Plus, during the past three years, Solana's price is up by 51% while Ethereum is down by 38%, which is sure to damp investor sentiment for it quite a bit, even if past performance doesn't predict the coin's future movements.

Valuation isn't destiny, but don't ignore it

Ethereum isn't doomed to see its market cap fall further just because Solana's staked value is approaching and perhaps soon to exceed its own, nor because its yield is lower.

The chain's ecosystem is also significant to its valuation, and Ethereum's is the single largest cryptocurrency ecosystem that exists, covering most major segments with an extensive number of projects in each. If the coin's value does go up, it will more likely be a result of the ecosystem's projects performing well than a result of more capital being staked on the chain. Exciting applications simply make for a more compelling pitch to investors than a reliable but small yield; most investors don't hold cryptocurrency with the goal of getting a return that's similar to what's available from far safer financial instruments like U.S. Treasuries -- they're looking for growth.

This is yet another factor supporting the bear thesis for Ethereum right now. There isn't much incentive for investors to lock up their capital for long periods to get a small return that's denominated in coins that have, at least for the past few years, lost a lot of their value. Nor is there much incentive to keep capital parked on the chain in the form of stablecoins when it's cheaper to manage and hold elsewhere, like on Solana.

In short, the staking value situation is a harbinger of more tough times to come for Ethereum. It is therefore also a sign that the crypto is an excessively risky purchase right now, making it unsuitable for most investors. And, in case it wasn't clear, it would not be wise to stake your Ether right now because it could lock you into deep capital losses in exchange for a meager yield.

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Alex Carchidi has positions in Ethereum and Solana. The Motley Fool has positions in and recommends Ethereum and Solana. The Motley Fool has a disclosure policy.