Bitcoin and Ethereum 101 For Advisors

Written by: Vaughn Kellerman, CFP® | HCM Wealth Advisors

In 2022, it has become a safe bet that the majority of Financial Advisors and the public have at least heard of Bitcoin and Ethereum. The range of opinions varies widely on these digital assets and the space itself: from a belief that this asset class is the future of finance to the other guardrail that Bitcoin, Ethereum, and any other project in the space is worthless and will go extinct. While the space itself is still very young, it continues to grow and as of this writing has a market cap of over 1 trillion dollars. Bitcoin and Ethereum continue to be the two major players, holding almost 600 billion dollars of the market cap. Advisors are continuing to report that they are being asked by clients more than ever before if now is the time to make an investment in one or both digital assets. While every client situation is unique and a blanket recommendation can never be made regarding investment in any area of the market, it is important to understand these two major players and the key differences between the two. With a basic understanding, Advisors will feel more confident that they can speak intelligently to their clients and prospects to help determine if investment in this area is something to explore further.

Before diving into the differences, let us first discuss some of the similarities between Bitcoin and Ethereum. First, both are considered digital currencies that are bought and sold via exchanges and are stored in what is known as digital asset wallets. Second, they are both built on the distributed ledger technology that is known as the blockchain. Put simply, the blockchain is a digital system where transactions are maintained and can be verified across a network. Finally, neither Bitcoin nor Ethereum are issued or controlled by central banks or any financial authority. They both rely on individual computers around the world, known as nodes, that download and use the software. Both have continued to appreciate against the dollar as more users of the networks grow and more use cases are invented.

Now let’s discuss what makes Bitcoin unique when you compare it to Ethereum and vice versa. Bitcoin is the first and only truly decentralized digital asset. There is no central authority that controls Bitcoin the software. In one of the most fascinating aspects of Bitcoin, its creator Satoshi Nakamoto, is fully anonymous who could be a single person or a group of people and disappeared from the project in 2011 after launching Bitcoin in 2009. Even the name itself is a pseudonym. Because there is no central authority, it is extremely difficult and almost impossible for the software’s core mechanics and rules to be changed. In fact, even if Nakamoto turned up and wanted to change the code, he/she/they would be unable to do so. Bitcoin uses a system called “Proof of Work” to secure the network, confirm transactions, eliminate the issue of double spending the same coins, and “mine” new bitcoins. Through the “mining” process, blocks of transactions are verified as accurate and added to the blockchain roughly every 10 minutes. As a reward for this work, miners are granted a specific number of coins that halves every 4 years. In the year 2140, the supply cap of bitcoin will max out at 21,000,000 coins.

Ethereum, while decentralized to an extent, does have a centralized authority that can change the software code and does have a known creator, Vitalik Buterin. Buterin created Ethereum in 2015. Around the time of this article, Ethereum will be switching from a Proof of Work system to Proof of Stake. Proof of Stake differs in that it sees users’ “stake” their ether coins to become a validator of the Ethereum network. As a validator, they confirm transactions that are entered on to the blockchain and are rewarded with coins. While this is a much less energy-intensive process than Proof of Work and allows for faster processing times, it essentially means that the largest holders of ether control the network. Finally, one of the biggest differences is that Ethereum does not have a supply cap and Buterin has stated that more ether will be created as needed.

Because these two digital assets have such key differences, it is important to discuss their differing goals as well. Bitcoin was created due in large part to the 2008 Global Financial Crisis and a lack of trust in the government’s handling of the situation. The goal for Bitcoin is to separate the control of money from governments or any other central authority. In Bitcoin’s perfect world, it would unseat the US dollar as THE global reserve asset. Because of its scarcity, among other factors, Bitcoin is commonly referred to as “digital gold” and an argument can be made that it is the soundest money ever created. Ethereum, on the other hand, was created not to compete with Bitcoin but to act as a platform to facilitate the creation of programmable smart contracts and applications using its own currency in the digital world. Ethereum can be thought of as a “decentralized internet of the world.”

In summary, as the digital asset space continues to grow, Bitcoin and Ethereum are likely to continue to be major players and will continue to get the attention of clients who may be looking to invest in this area. With a basic level of understanding here, Advisors will be able to answer client questions with more confidence and ensure that they continue to earn client’s trust through their ability to educate.

Related: 4 Keys to Staying on top of Long-Term Care planning in 22 & 23