What drives the Ether–Bitcoin exchange rate (ETHBTC)?  A number of factors appear to influence movements in ether (ETH) relative to bitcoin (BTC) and they have to do with both macroeconomic factors as well as drivers closely related to the structure of the crypto markets themselves.  These factors include:

  1. The performance of technology stocks: higher tech stocks appear to benefit ETH relative to BTC.
  2. The U.S. dollar (USD): a stronger USD appears to be more negative for ETH than it is for BTC.
  3. ETHBTC may react more strongly to changes in BTC supply than it does to supply in ETH. 

To fully appreciate what drives the ETHBTC exchange rate, it’s helpful to begin with a few notes on how the two crypto assets relate to one another and how that relationship has evolved over time.  

The Ether-Bitcoin Trading Relationship

BTC and ETH dominate the crypto currency landscape, accounting for approximately 61% of the sector’s market cap.  Since December 2017 when BTC futures were launched, the correlation between the two crypto assets has been very high.  On a 30-day rolling basis, the correlation has ranged from +0.36 to nearly +1.  For the past year, it has hovered at around +0.85 (Figure 1).

Figure 1: ETH-BTC correlation has been more consistently positive since early 2018

Source: https://coinmarketcap.com/currencies/ethereum/historical-data/

Seen versus the USD, crypto assets are extremely volatile, though their level of volatility has come down over time.  Over the past year, BTC had a 42% annualized volatility of daily price movements.  ETH daily volatility has been around 59%.  As such, on days in which BTC rises, ETH tends to rise even more.  When BTC falls, ETH tends to fall to a greater degree. The high degree of correlation implies that ETHBTC should have less volatility than either BTC or ETH alone and this has been the case since the launch of BTC futures in late 2017.  During the past year, ETHBTC’s volatility has fallen to 30%, which is about one quarter less than BTCUSD’s and about one half ETHUSD’s (Figure 2).

Figure 2: ETH has been more volatile than either BTC or the ETHBTC exchange rate

Source: Coin Market Cap, CME Economic Research Calculations
[Details about CME’s Ether/Bitcoin Ratio Futures to be launched on July 31 here]

An overlayed chart of BTC and ETH prices shows that since 2021 their prices have been moving more closely together than they had in the past.  From 2017 to early 2021, BTC seems to behave as a leading indicator of ETH. For example, in late 2017, BTC, rallied and peaked ahead of ETH.  It happened again in 2020 (Figure 3).  

Figure 3: From 2017-2020 BTC often ran ahead of ETH but that seems to have stopped in 2021

Source: https://coinmarketcap.com/currencies/ethereum/historical-data/

In the three months after ETH futures were launched in February 2021, ETH soared 155% versus the USD while BTC rose by 30%, pushing the ETHBTC exchange rate 110% higher.  Since May 2021, however, ETHBTC exchange rate has been relatively stable, at least compared with the large swings that it experienced earlier in its history. Even so, it has still been moving in a significant range, from 0.052900 to 0.087200.  Previously, it had ranged from 0.016600 to 0.150000 (Figure 4).  However, its stability might not last: large changes have occurred to ETH and a significant change is coming to BTC in April 2024, both of which could impact prices going forward. 

Figure 4: ETHBTC had large swings until 2021 when it settled into a narrower range

Source: https://coinmarketcap.com/currencies/ethereum/historical-data/

Over the past two years (July 9, 2021 to July 9, 2023), BTC’s daily price movements explain 75% of the daily price movements in ETH, and ETH has a beta of 1.105 with respect to bitcoin.  This implies that on days when BTC moved by 1%, ETH would have moved, on average, by 1.105% in the same direction.  

Macroeconomic and Market Factors

ETHBTC shows near-zero correlation to movements in interest rate, gold and crude oil futures.  However, it has shown more interest in the fate of technology stocks and the USD.  Since May 2022, the one-year rolling correlation of ETHBTC with the tech-heavy Nasdaq 100 has been consistently around +0.2 and sometimes as high as +0.3.  It has a similar correlation with the S&P 500 Technology Select Sector futures. This suggests a modest but persistent positive correlation between the movements of technology stocks and the movements of ETH relative to BTC.  On days when tech stocks rally, ETHBTC tends to rise as ETH benefits more than BTC.

The USD appears to have the opposite effect.  On days when the Bloomberg Dollar Index (BBDXY), which measures the USD versus 10 major currencies, rises, ETHBTC tends to decline.  This tendency is not extremely strong, with a one-year rolling correlation that has usually been around -0.2 (Figure 5).  

Figure 5: Higher tech stocks tend to boost ETHBTC while a higher USD tends to depress it

Source: Bloomberg Professional (XETXBT, XET, XBT, NDX and BBDXY), CME Group Economic Research Calculations 

ETH and BTC’s differing responses may be grounded in how ETC and BTC are used and the different ways in which they are supplied to the market. For starters, ETH is much smaller than BTC with a market cap of $224 billion compared to BTC’s $586 billion as of July 11, 2023.  Additionally, the economics of creating ETH supply have always been very different from BTC’s:

  • BTC is limited to 21 million coins, of which 19.4 million already exist. 
  • BTC operates on an energy intensive proof of work (PoW) system, a competitive validation process that is used to confirm transactions and add new blocks to the blockchain.
  • ETH originally worked on a PoW model but switched to a much less energy intensive proof of stake (PoS) model in 2022 that uses randomly selected validators to confirm transactions. 
  • ETH has theoretically unlimited total supply, and up to 18 million coins could hypothetically be created each year. In actuality, about 4-12 million new ETH coins were created each year until 2022, when ETH shifted from a PoW to a PoS system. 
  • Since the PoS regime came into effect, the number of new ETH coins has begun to contract, whereas the number of new BTC coins has continued to rise by 335,000 per year (Figure 6).  BTC creation, however, is set to drop by half at the next halving, which will likely occur in April 2024, when the per-block reward falls from 6.25BTC to 3.125BTC.
  • BTC has basically no practical uses beyond being a highly volatile store of value and a possible hedge against the devaluation of fiat currencies.
  • Unlike BTC, ETH has practical applications as the currency of the Ethereum smart contract network. The Ethereum network’s promoters see it as a blockchain 2.0, an updated version of the bitcoin blockchain with an economics beyond being a store of value. 

Figure 6: The Total Number of Ether coins grew until the switch from PoW to PoS

The Economics of Ethereum Supply

Keeping these differences in mind, ETH supply doesn’t seem to drive prices.  Rather, under the PoW regime, ETH supply tended to increase when ETH rallied versus BTC, and its supply tended to fall when ETH prices fell relative to BTC.  In other words, ETH supply responded to price rather than drive it.  Since ETH shifted from a PoW to a PoS model, the number of ETH coins has started to shrink but with no noticeable, beneficial impact on ETH prices relative to those of BTC (Figure 7). 

Figure 7: Up until the 2022 switch to PoS, ETH new coin supply large reacted to ETHBTC

Bitcoin’s economics appears to drive the exchange rate

So, if ETH supply merely reacts to the change in its exchange rate with BTC, what is the main driver of the exchange rate itself?  The answer to this question appears to lie within bitcoin’s unique economics.  BTC has two features which makes it different from any other major financial asset:

  1. Its supply is perfectly inelastic.  No matter how high or low the price, the supply will follow the path preordained by its algorithm.
  2. The pre-ordained growth in supply halves every four years irrespective of demand conditions (Figure 8).  

Figure 8: Bitcoin supply is perfectly inelastic, which contributes to its high volatility.

Source: Bloomberg Professional (XBT), Blockchain.Info (supply), CME Economic Research Calculations

Bitcoin’s quadrennial halvings in 2010, 2014 and 2018 coincided with huge runups in price prior to the reduction in BTC supply growth, followed by enormous bear markets.  Going into the three previous halvings, the amount of revenue that miners demand for validating transactions on the bitcoin blockchain has tended to spike and these spikes have been followed by tremendous declines in bitcoin prices of between 70% and 93% (Figure 9).

Figure 9: Miners’ revenue and prices have tended to peak before halvings, followed by declines

Source: https://blockchain.info/charts/market-price?timespan=all
https://blockchain.info/charts/cost-per-transaction?timespan=all - "cost per transaction"

Additionally, the number of transactions per day on the bitcoin blockchain grew quickly between 2009 and 2013, then the pace slowed between 2013 and the end of 2017.  Then, between 2018 and 2021, the number of transactions barely grew at all although there has been a slight uptick since February 2022, when Russia invaded Ukraine and Western nations began placing additional sanctions on Russians individuals and entities.  BTC bull markets have tended to follow increases in the number of transactions per day – a proxy for BTC demand (Figure 10).

Figure 10: Transactions per day may be a proxy for demand and a harbinger of price moves

Source: https://blockchain.info/charts/market-price?timespan=all

So, what do BTC’s economics tell us about the ETHBTC exchange rate?  First, if ETH is both highly correlated with and more volatile than BTC, the ETHBTC exchange rate tends to rise when BTC rises and fall when BTC falls. 

Secondly, if the Russo-Ukrainian war and other factors have increased demand for BTC, it might eventually result in not only higher BTC prices but also even greater increases in ETH prices.  Finally, if BTC rallies ahead of its upcoming April 2024 halving as it did ahead of previous halvings, that might also help ETH prices to rise even further on a relative basis. 

That said, these possibilities are far from certain.  One thing is clear, demand growth for crypto assets, which was very strong during the first eight years of bitcoin’s existence, has tailed off during the past five years.  While bitcoin prices rocketed to new record highs ahead of previous halvings, there is no guarantee that it will do so this time, nor is there any guarantee that it would take ETH upwards along with it if it did. 

Finally, there is BTC and ETH’s relationship to the macroeconomy.  When the Federal Reserve and other central banks slashed rates to zero in 2020 and began quantitative easing of unprecedented size, BTC and ETH prices soared, with ETH outperforming.  Then, as inflation took root, central banks began raising rates and shrinking their balance sheets, which seems to have come at the detriment of crypto assets.  The process of monetary tightening doesn’t seem likely to let up soon but BTC and ETH did get a boost out of the collapse of several regional banks in March 2023.  Those events revived memories of the global financial crisis, the event that likely inspired BTC’s creation in the first place.

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All examples in this report are hypothetical interpretations of situations and are used for explanation purposes only. The views in this report reflect solely those of the author and not necessarily those of CME Group or its affiliated institutions. This report and the information herein should not be considered investment advice or the results of actual market experience.

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