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The 2 Biggest Risks for Ethereum and Ripple

Sean Williams, The Motley Fool

Though probably long overdue, the cryptocurrency correction has finally arrived. In a roughly 30-day span following Jan. 7, the combined market cap of cryptocurrencies plunged by 67%. Despite this drop, followed by a modest rebound from their recent lows, cryptocurrencies have still run circles around traditional equities since the beginning of 2017, with an aggregate market cap gain in virtual currencies of 2,100%.

Ethereum and Ripple emerge from bitcoin's shadow

Principal to that strong performance have been Ethereum and Ripple, the two major digital currencies that have emerged from bitcoin's shadow to captivate investors' attention. In 2017, Ethereum, the second largest cryptocurrency by market cap, surged almost 9,400%, while Ripple ended the year more than 35,500% higher. Though bitcoin is often credited with leading the cryptocurrency rally, 2017 was more about cryptos like Ethereum and Ripple than bitcoin.

Messy stacks of physical silver and gold Ethereum coins.

Image source: Getty Images.

Key to the strong performances of Ethereum and Ripple are their underlying blockchains. For those unfamiliar, blockchain technology is the digital, distributed, and decentralized ledger that underpins virtual currencies and is responsible for recording all transactions without the need for a financial intermediary, like a bank.

It's believed that blockchain will bring a number of key advantages to the table for enterprises. This includes potentially lower transaction fees, considerably faster transaction settlement times, and a safer means of transferring money from one point to another, relative to the current banking system.

What's made Ethereum so special

Ethereum's blockchain has essentially been the basis of evolution for countless blockchain projects in recent years. It was the first notable blockchain to offer non-currency solutions. In other words, it gave businesses the chance to move beyond the confines of using blockchain just to transfer money, and allowed them to consider aspects like supply chain management and device management. Not surprisingly, the Enterprise Ethereum Alliance, formed in February 2017, now has 200 organizations testing a version of Ethereum's blockchain in various industries and capacities. There simply isn't a larger open-source blockchain being tested out there. 

The heart of Ethereum's lure is its smart contract protocols. Smart contracts help to facilitate, verify, or enforce the negotiation of a contract. Their purpose is to get rid of paper contracts, which are prone to inefficiencies, and allow businesses to fully customize the scope of what can be done with a contract. These protocols could dictate when money can be spent within an operating account, or allow Internet of Things devices to order parts when they break.

A physical silver and gold Ripple coin.

Image source: Getty Images.

Why Ripple has made waves

On the other hand, Ripple has made its presence felt by solely focusing its attention on financial institutions. Ripple's blockchain is unique for both its speed and transaction fees. A recently published analysis from HowMuch.net that examined the maximum number of transactions per second for a handful of cryptocurrencies found Ripple's 1,500 per second to be the fastest. Though it trailed Visa by a wide margin (24,000 transactions per second), Ripple's network purportedly has the ability to scale and become even faster. Also, Ripple's transactions cost just a fraction of a penny, which is bound to make its blockchain an attractive alternative for banks. 

Ripple currently has five brand-name partners testing out its technology in real-world and small-scale projects. Perhaps the best known of these partnerships was its November announcement with American Express (NYSE: AXP) and Banco Santander (NYSE: SAN). American Express users sending non-card payments to U.K. Santander accounts via AmEx's FX International Payment network will have those payments processed through Ripple's blockchain. What had resulted in a multiday wait for settlement is expected to settle almost instantly, and for a fraction of a cent in costs.

The two biggest risks for Ethereum and Ripple

However, these hot cryptocurrencies aren't without risks. Despite having partners seemingly lining up to test their blockchain technology, Ethereum and Ripple share two common risks that could derail them.

A risk dial turned to the maximum setting.

Image source: Getty Images.

1. Blockchain technology fails to launch in the real world

Unquestionably, the biggest risk facing Ethereum and Ripple involves just how quickly enterprises incorporate blockchain into real-world applications.

While there's seemingly endless buzz from the tech community about what blockchain can do for financial services, retail, logistics, and tech industries, we also have to remember that blockchain has been around for nearly a decade, and it's only now moving into demos and small-scale projects. Investors have, time and again, overestimated how quickly new technology will be adopted, and that could very well be the case with blockchain.

In no particular instance with Ripple or Ethereum have we seen a business pushing for a large-scale test. In fact, practically every application has been for small-scale projects or extremely narrow real-world applications.

It should be pointed out, too, that blockchain isn't necessarily compatible with existing networks in some industries. Rather than incorporate blockchain, some industries could be forced to essentially start from scratch. That's a costly and time-consuming venture for a technology that remains untested on a larger scale.

Long story short: If businesses don't welcome blockchain with open arms very soon, Ethereum's and Ripple's valuation could suffer.

A businessman looking at an encrypted blockchain on a digital screen.

Image source: Getty Images.

2. The barrier to entry in cryptocurrencies remains low

The other concern for Ethereum and Ripple is that the barrier to entry for cryptocurrencies is exceptionally low. In fact, more than 600 new cryptocurrencies have come to market just since this past July, many of which have their own blockchain technology.

All it takes to develop blockchain and a tethered cryptocurrency is time, money, and a team that understands how to code. This essentially means that currently developing blockchains could take the best aspects of Ethereum or Ripple, and then add their own proprietary changes. In effect, the most intriguing blockchains of today could just as easily be kicked to the curb by superior technology tomorrow. That could make it tough for businesses to go all-in on a particular blockchain technology if something better could just as easily come along.

While I remain steadfast in my belief that Ethereum deserves to be the world's most valuable cryptocurrency, I also suspect that both Ethereum and Ripple could face more valuation pressure in the months to come.

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Sean Williams has no position in any of the stocks or cryptocurrencies mentioned. The Motley Fool owns shares of and recommends Visa, but has no position in any cryptocurrencies mentioned. The Motley Fool recommends American Express. The Motley Fool has a disclosure policy.