Why Tether flipping Ethereum is a pivotal moment for crypto

​Last week, Tether’s USDT briefly passed Ethereum’s ether (ETH) by market capitalization for the first time in history before ETH was able to take back the number-two spot on the crypto charts. Although the move was temporary, it was not random and had been predicted by many. It followed years of centralized stablecoin growth that has increasingly defined the practical use of Ethereum and other crypto rails focused on so-called “decentralized” finance (DeFi).

According to data from DefiLlama, the total stablecoin market capitalization grew from less than $5 billion in January 2020 to a little over $180 billion by early 2022. At the time of this writing, the total stablecoin market cap sits at roughly $316 billion, with USDT alone accounting for roughly 59% of that.

While stablecoins have seen massive growth, ETH is currently sitting far below its all-time high near $4,946; it’s currently trading roughly 66% below that level. Of course, the picture of what’s really happening looks clearer (and worse) in Bitcoin terms. The ETH/BTC exchange rate is now around 0.026, well below the 0.08 area it reached in late 2021 during the peak of Ethereum DeFi hysteria. Notably, the 2021 ETH/BTC peak was also well below the exchange rate’s peak reached in the 2017 cycle before that, indicating a trend over multiple cycles.

What happened to “ultrasound money?”

This comparison to Bitcoin specifically is notable because Ethereum was supposed to be the network where DeFi, non-fungible tokens (NFTs), and general web3 activity (along with a changed monetary policy) transformed its native cryptocurrency into “ultrasound money” and eventually challenged Bitcoin’s monetary premium. Instead, the biggest and most durable growth area has been centrally-issued dollars moving across public and semi-public crypto databases. When combined with blockchain infrastructure developments like Coinbase’s Base and Circle’s Arc, the lesson may be that the market does not care as much about a decentralized base layer for DeFi as Ethereum supporters assumed, especially when everything is already centralized around stablecoins anyway.

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During the 2021 hype cycle around web3, Ethereum was the main venue. The network had the developers, the liquidity, the applications, and the cultural momentum. Gas fees were high because blockspace demand was high. EIP-1559 had just introduced fee burning, and The Merge was framed as the next step toward a more monetary ether asset. The “flippening” of Bitcoin was also not just a meme on crypto Twitter. Bloomberg Intelligence’s Mike McGlone posted on X that “there appears little can stop the process of Ethereum flippening.” Additionally, Silicon Valley venture capitalist Garry Tan shared his belief that ETH is ultrasound money during an interview with CNBC.

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However, even during that time, a large portion of the actual activity on Ethereum was built around centralized stablecoins such as Tether’s USDT and Circle’s USDC. These are not decentralized assets. They are liabilities of companies that operate within the traditional financial system, hold reserves, deal with banks, and respond to law enforcement (as the Iranian regime recently found out). In a May 2021 Cryptonews article, I argued that Ethereum’s reliance on stablecoins created an identity problem for the network. If regulated dollar tokens are the main product, the case for using a public blockchain becomes less obvious. And theoretically, cheaper, more centralized competitors could offer the same end-user experience with fewer ideological constraints.

The bullish Ethereum argument was that all of this activity from stablecoins and other tokens would create structural demand for ETH. However, if users mainly wanted to use dollars on Ethereum, it was not clear to myselft and other “toxic Bitcoin maximalists” why ETH should be a long-term winner. And now, this bullish argument for ETH appears to be on life support, no matter how much ETH Tom Lee buys for digital asset treasury company Bitmine.

The writing is on the wall

The general thesis laid out by myself and others five years ago has played out in a fairly straightforward way. Ethereum supporters often dismissed Solana as too centralized early on in its development, but Solana has continued to capture market attention and trading activity, especially around memecoins and retail-friendly applications. Tron is an even more uncomfortable example for Ethereum bulls. It is not taken seriously by many people in crypto due to its centralization and association with the controversial Justin Sun, yet data from The Block shows there’s more USDT issued on Tron than Ethereum. For real end users, cheaper and faster USDT transfers are more important than decentralization theater. That said, roughly half of the greater stablecoin market cap is still deployed on Ethereum.

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Regulated financial institutions are taking things one step further by building out blockchain infrastructure that is heavily affiliated with and centralized around specific stablecoins or crypto exchanges. Coinbase collects all of the sequencer fees from Base, its Ethereum layer-two network. Circle has developed its own layer-one blockchain, Arc, where USDC is central to settlement. These are not the sorts of cypherpunk projects trying to minimize trusted intermediaries that Ethereum enthusiasts envisioned in the early days of the network’s existence. They are regulated financial companies building payment and settlement infrastructure around their own products. In many ways, the non-Bitcoin aspects of crypto have devolved into traditional fintech.

Tether flipping Ethereum, even briefly, is a clean expression of this shift in crypto. It is also not a coincidence that this happened around the same period that longtime Ethereum bulls started publicly revisiting their views. For example, Bankless co-founder David Hoffman recently said he had exited his ether position, arguing that Ethereum may succeed without ether capturing as much value as he originally expected.

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Instead of ETH becoming ultrasound money and flipping Bitcoin, Ethereum users increasingly chose USDT and USDC as the preferred currencies. At the same time, Bitcoin itself benefits more directly from Tether’s growth than ETH does, as Tether holds Bitcoin as part of its reserves and accumulates more on a regular basis.

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The question for those still confused about Ethereum’s current position is simple: if Tether has spent years building on Ethereum and other networks, why does it hold Bitcoin as a reserve asset rather than ETH or any other native token from the chains that carry its stablecoin traffic? Perhaps it’s because Tether, much like Circle with Arc, is also involved with alternative, USDT-focused layer-one blockchains. Why does Coinbase, one of the earliest and strongest advocates for Ethereum, hold much more Bitcoin than ETH on its balance sheet? Thinking about these questions should be helpful in separating signal from noise in terms of what’s going on with crypto right now.