Ether is finally outperforming bitcoin. Here's what's driving the crypto's rally.

By Frances YueInvestors are finally seeing signs of a potential comeback for ether after months of sluggish performance by the second-largest cryptocurrency, thanks to a recent upgrade to the Ethereum blockchain and renewed appetite from investors for risk assets.Ether (ETHUSD) was up 45% so far in May, on track for its best monthly performance since November, when it gained 47.8%, according to the Dow Jones Market Data. In comparison, bitcoin (BTCUSD) had gained 10.7% month to date, while solana (SOLUSD), one of ether's biggest competitors, had climbed 20.6% so far in May.That's a significant shift from earlier this year and last year, when ether lagged behind both bitcoin and solana. The token didn't attract as much institutional attention as bitcoin did, while the blockchain behind ether faced strong competition from rivals like the Solana platform.To be sure, ether still has a long way to catch up, as the crypto was trading 37% below its record high of $4,105.9 reached in November 2021. Bitcoin, by comparison, was trading only 5% below its own record high reached in January. Bitcoin was up 11.7% year to date, while ether was down 20.7% over the same period.The most important driver of ether's recent strength might be the completion of Ethereum's long-awaited Pectra upgrade last week, the blockchain's biggest overhaul since 2022, according to Alex Cheung, over-the-counter trader at crypto broker Abra Prime. The upgrade was supposed to improve user experience and lay the groundwork for future upgrades, allowing Ethereum to become cheaper and faster while handling a growing number of transactions.The crypto market seems to have received the Pectra upgrade well, based on market data. The ETH/BTC ratio stood at near five-year lows, at around 0.018, prior to the Pectra upgrade on May 7, but subsequently rose to as high as 0.025 on Tuesday, the loftiest level since March 9. Meanwhile, open interest in ether derivatives, or the total number of outstanding contracts, rose 21% to $25.8 billion on May 8, the day following the Pectra upgrade, showing an increase in market participation.What's more, the funding rates on ether perpetual contracts turned positive on almost all derivatives exchanges on May 7. Funding rates are periodic payments exchanged among traders on perpetual futures contracts. When funding rates turn positive, it means that traders holding long positions, or bets the price will go up, pay a premium to traders holding short positions - an indication of bullish sentiment.However, the changes brought by the Pectra upgrade may not be enough to power ether's turnaround, said Anthony Rousseau, head of brokerage solutions at TradeStation. Instead, ether's strength was more the result of traders piling into undervalued assets as risk-on sentiment returned to the market, he argued."That was more of a reversal-to-the-mean trade as capital flows to more depressed assets," Rousseau said.Progress in trade talks between the U.S. and China over the weekend led to a surge in appetite for assets perceived as risky across markets. Both stocks and crypto rallied on Monday, with the Nasdaq Composite COMP exiting a bear market, after the U.S. and China reached a deal to slash tariffs on each other for 90 days. Stocks were mostly higher Tuesday, with the S&P 500 SPX turning positive for the year after erasing steep losses suffered last month in the wake of President Donald Trump's rollout of sweeping tariffs on April 2.With such a backdrop, ether has attracted more attention, as the Ethereum blockchain still leads smart-contract activity among blockhains despite a sluggish ether price. Ethereum hosts around half of all smart-contract activity across all blockchains, with the total value locked on the platform standing at $63 billion, according to data from CoinGecko. Smart contracts use programs that automatically execute an agreement when its terms and conditions are met.Ether's outperformance also likely bodes well for other smaller cryptocurrencies."Historical data suggest that when ETH demonstrates relative strength against bitcoin, altcoins are likely to experience a period of outperformance," noted Joel Kruger, market strategist at LMAX Group. Altcoins typically refer to crypto tokens other than bitcoin.-Frances YueThis content was created by MarketWatch, which is operated by Dow Jones & Co. MarketWatch is published independently from Dow Jones Newswires and The Wall Street Journal.