The ratio in the chart above divides the price of Ether by the price of Bitcoin and represents the amount of Bitcoin it takes to buy 1 Ether. When the ratio rises, Ether is outperforming Bitcoin - and when it falls, Ether is underperforming.
Ether is the second-largest cryptocurrency by market capitalization after Bitcoin. It is the currency of the Ethereum blockchain and is often referred to as the "fuel" of the decentralized applications ("dapps") that are running on the network. Ethereum is the most popular blockchain for running smart contracts and dapps. In fact, as of May 2023, 158 out of the top 200 tokens (as measured by market capitalization) are located on the Ethereum blockchain. They include stablecoins, DeFi projects and tokens of decentralized exchanges.
Bitcoin operates on a consensus mechanism called Proof-of-Work (PoW), where miners compete to solve complex mathematical puzzles to validate transactions and add new blocks to the blockchain. Miners are rewarded with newly minted bitcoins for their computational efforts.
In a network upgrade called The Merge, on September 15th 2022, Ethereum transitioned from PoW to a more eco-friendly consensus mechanism known as Proof-of-Stake (PoS). Under PoS, validators (rather than miners) are selected based on the amount of cryptocurrency they hold and "stake" in the network to validate transactions and create new blocks. This shift to PoS reduces energy consumption and promotes a more efficient and environmentally friendly approach to securing the Ethereum network.
Whereas Bitcoin has a maximum total supply of 21 million BTC, the situation with ETH is a bit more complicated. Apart from the consensus mechanism, the Merge upgrade has also impacted the Ether supply dynamics. From the date of the Merge until May 2023 the total supply of ETH has been shrinking at a rate of 0.29% per year and it peaked on July 7th 2022 at 120,532,870.5 ETH.
The chart above displays the 1-year rolling correlation coefficient between the price of Ether and the price of Bitcoin. A correlation coefficient of +1 indicates a perfect positive correlation, meaning that the two cryptocurrencies moved in the same direction during the specified time window. Conversely, a correlation coefficient of -1 indicates that they moved in opposite directions.
Diversification is the practice of spreading investments across different asset classes to reduce risk. In his book Principles, Ray Dalio called diversification the “Holy Grail of Investing”. He realized that with fifteen to twenty uncorrelated return streams, he could dramatically reduce the risks without reducing the expected returns.
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