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The years-in-the-making, systemwide upgrade to the ethereum blockchain is set to roll out on Wednesday, marking one of the crypto sector's most historic events to date. Leading up to the overhaul, investors have been jumping into ether, the native token to ethereum.
\"We believe post-merge the bull case for ethereum is going to be a lot stronger for a number of reasons,\" said Katie Talati, head of research at asset management firm Arca. The main factor, she says, is that supply is going to come way down, creating scarcity.
The hallmark of ethereum's big makeover is that it will take a lot less energy to verify transactions, which has long been a major problem for the crypto industry. The proof-of-stake model, which is replacing the proof-of-work model, requires validators on the network to put up their ether tokens, or \"stake\" them, essentially pulling them out of circulation for an extended period of time, in order to secure the network.
With the upgrade, ethereum won't become faster, cheaper or more scalable. One developer even told CNBC that if the user experience feels the same, that will be one sign that the merge was a total success.
Ethereum has set itself apart from rival chains, as more of an operating system for the industry. The vast majority of apps are built on top of ethereum, and the merge is the first in a series of planned upgrades that should ultimately result in faster and cheaper transactions.
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Importantly, ethereum is also escaping the bearish sentiment affecting the stock market. Risk assets like stocks are struggling in response to persistently high inflation in the US and the worrying news that price rises have become embedded in the broader economy. For example, the wage-price spiral is now in effect, and inflation slowed only slightly to 6.4% in January of 2023 from 6.5% in December, less than market forecasts of 6.2%.
The macro backdrop for ethereum is bearish. We analyse various on-chain/flow metrics for ethereum, which are neutral. Overall, we are neutral to bearish on ETH in the short term. Therefore, if you have a two-to-four-week horizon, now may not be a good time to buy ethereum.
Furthermore, the correlation of ethereum to NASDAQ started to increase sharply just as US interest rates started to rise. This is a common occurrence throughout history. When the liquidity tap turns off, usually by central banks raising rates, the correlation between diverse assets shoots up. This time appears no different.
One exercise is to see how low prices could get were the NASDAQ to suffer a 2000-style crash. After all, the ethereum and NASDAQ correlation was around 80% until recently. So where the NASDAQ goes, ethereum follows.
Back in 2000, the NASDAQ suffered a 78% drawdown. Currently, the NASDAQ is in a 30% drawdown. A repeat of the 2000-style drawdown would put the NASDAQ at 3,500. So where would crypto be if NASDAQ were trading at this level We estimate a regression between ethereum/bitcoin returns and NASDAQ returns from 2020 onwards. Based on this relationship, we find:
Should the currently restrictive environment of rising interest rates and recession risks subside, we could see ethereum return to its all-time high of $4,379 or even beyond. However, we caution that this scenario is unlikely in the short term and, like with any investment, it is impossible to say with certainty how high ethereum will go.
On the flip side, overregulation could stifle innovation by increasing censorship. The ongoing regulatory backdrop will be key to monitor. Lastly, on ethereum specifically, there is the much-anticipated merge. We previously covered its potential implications. The punchline was that it should be bullish for ethereum.
We think ethereum is a worthwhile long-term investment. However, we also note that ethereum is extremely volatile. That means it experiences large price movements over short periods. Before you invest in ETH, you must understand the risks involved: you could lose all or a large portion of your investment. Never invest money that you cannot afford to lose.
However, to invest in cryptocurrency, we must first understand it. Crypto tokens are unlike any traditional asset class. And they are all different. Just because you understand bitcoin, does not mean you know how ethereum works. Our video on bitcoin and ethereum fundamentals can help you understand how ethereum prices fluctuate and how to assess trends in important ethereum metrics. And the video below explains other cryptocurrencies that might put ethereum at risk.
Your exposure to ethereum needs to be appropriately sized so that you can survive 50% to 80% drawdowns. Drawdowns provide good entry levels for exposure, but we would not go max long in an environment of rising central bank rates and falling global growth momentum.
For trading ethereum over the next two to four weeks, we are neutral to bearish. That means we expect stable to falling prices. For 2022-3 in general, we think recession risks pose a risk to ETH and so now might not be the best time to buy ethereum if you have a medium-term outlook. We think ethereum is a good long-term investment for the next one to three years and are bullish overall. That means we expect prices to rise in the long term.
As with all investments, the value of ethereum can rise as well as fall. While it is unlikely that ethereum will suffer a complete loss of value, investors must be prepared to suffer drawdowns of between 50% and 80%. We recommend small allocations and diversification of your portfolio. Never invest what you cannot afford to lose.
Traditional wisdom says you should buy low and sell high. But whether you should sell ethereum depends on your investment horizon, risk appetite and financial goals. Although some website speculate that certain days of the week are better or worse then others for selling ethereum, we believe that any decision to buy or sell should be based on analysis of crypto fundamentals.
We think a small allocation to ETH makes sense in the long term. However, we caution against investing in ethereum too heavily as cryptocurrencies are extremely volatile and often subject to large downturns.
Ethereum has been running on two different blockchains since April 2022. One operates using proof-of-work, like bitcoin. The other is a test chain what uses proof-of-stake. The merge is an upcoming event where these two blockchains will combine, ending proof-of-work. It is expected to happen in Q3/Q4 2022, and it will eliminate the energy-intensive mining required in proof-of-work. Guest author Nikhil Shamapant explains more about the ethereum merge and what it could mean for ETH price in 2023 in his recent article. 59ce067264