In a report explaining the principles of Ethereum to investors, Morgan Stanley warned that the blockchain tech underlying most of the world’s “decentralized finance” systems today could lose dominance to rising competitors owing to the network’s high costs and volatility.
Ethereum’s “high transaction fees create scalability problems and threaten user demand,” Morgan Stanley wrote in a January report titled Cryptocurrency 201: What Is Ethereum? “High costs make Ethereum too expensive for small-value transactions.”
Unlike Bitcoin, which is primarily used as a store of value or as an alternative currency for direct exchange, the Ethereum blockchain is used as the foundational tech for building “decentralized” platforms. Non-fungible tokens (NFTs) are primarily stored and traded on the Ethereum network, and metaverse spaces like Decentraland are built on Ethereum tech, too.
But because Ethereum is used as a building platform, rather than just for the trade of a single cryptocurrency, the blockchain carries a significant amount of data—much more than Bitcoin, which is just used for processing transactions. Carrying extra data increases the cost of running Ethereum, and those costs will increase as Ethereum grows.
“Over time, Ethereum’s storage demand, unless changed, will likely outstrip its resources,” Morgan Stanley says.
Ethereum’s developers have attempted to address these issue. The network’s founder, Vitalik Buterin, has promised for years that Ethereum will shift from a “proof of work” method of validation to a “proof of stake” model, which he says could reduce Ethereum’s energy consumption by 99% and cut costs.
But moving Ethereum to a proof of stake model has proved difficult, and the transition has been plagued by months of delays. Ethereum zealots are optimistic the transition will be complete in the first half of this year but, meanwhile, Ethereum alternatives are gaining ground on the incumbent.
“Among several others, prominent Ethereum competitors include Binance, Solana, and Cardano,” Morgan Stanley writes. Each network, just like Ethereum, facilitates the creation of “smart contracts”—digital agreements that are written into the network’s code and automatically fulfilled—but do so at different price points than Ethereum.
Solana, Morgan Stanley says, “is designed to allow faster, cheaper smart contract transactions” than Ethereum offers, while the other two have achieved a scale that places them as likely competitors. But despite flagging some networks as alternatives to Ethereum, the bank warns that the very principle of using blockchain tech as the basis for trade might be untenable itself, because maintaining the network requires a constant increase in the number of “transactions” on the network, which in turn increases costs.
According to Morgan Stanley, “It may be that no blockchain is scalable enough for smart contract applications.”
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