Will the rise of the Bitcoin ecosystem threaten the value of Ethereum?

作者 | Michael Nadeau &Token Terminal

Vernacular blockchain

Recently, the rapid rise of the Bitcoin ecosystem, because some routes may overlap with the Ethereum ecology, causing some crypto communities to worry, so will the rise of the Bitcoin ecosystem really weaken Ethereum?

It is undeniable that the current development of the Internet has brought us endless abundance. But it lacks two key elements:

• Internet users do not have digital property rights.
• The Internet does not have a trusted, neutral, shared, secure, permissionless global accounting system – to record the state of users and enable global trade on a shared ledger.

And these two points happen to be the core value proposition of blockchain, and the revolution of the Internet is on the way to come.

01, Ethereum’s construction reflects the construction of the Internet

Bitcoin is the first public blockchain. In the early days, if you wanted to take advantage of this new technological breakthrough to create a new application, you had to launch your own blockchain. For example, in the beginning, Namecoin (peer-to-peer naming system) was a fork of the Bitcoin network. This era of public blockchains is similar to the early days of the internet, where you had to host your own server to build a website.

Founded in 2015 as the “Geographic City of Public Blockchains,” Ethereum allows developers to build blockchain-based applications using shared infrastructure that is cheaper and more efficient. **

However, building applications for special use cases requires a lot of flexibility. Moving into L2 and application-specific blockchains has allowed people to start building execution services “on top of” Ethereum, which serves as the base layer of settlement infrastructure.

So Ethereum is becoming a “network of networks”. It’s like the internet. L2 looks very similar to Taobao services – enabling flexibility and scalability while maintaining a shared infrastructure. **

In addition, the enhanced scalability of L2 is being developed alongside zero-knowledge proofs, which bring privacy to public blockchains – just as HTTPS brings encryption to the internet, enabling e-commerce.

02, Ethereum’s business model

Investors should think of the Ethereum network as two different things:

ETH – The native token that powers the network and creates economic incentives for it to operate in a decentralized manner.

Ethereum – a computing network and accounting system that serves as the base layer infrastructure on which other businesses build their applications “on top”.

1) Data Overview

Non-zero addresses: The cumulative total has increased exponentially over the past 8 years. As of September 30, 2023, there were more than 107 million increases, up 26% from a year ago and up 4.9% from the previous quarter.

Active Addresses: In Q3, Ethereum’s average daily active addresses were around 400,000, down 4% from the previous quarter, and a similar decline was seen during the crypto trough last year, but as market conditions improved, new users began to pour in.

Average daily trading volume: In Q3, Ethereum’s average daily trading volume increased slightly, and network demand continued to outstrip supply, while L2 networks such as Optimism, Arbitrum, and Base are processing a larger percentage of transactions as the network scales, with transaction volume on L2 increasing by more than 3,438% over the past few years, highlighting the role of Moore’s Law in the Ethereum network.

Average number of developers: The average number of core developers working on Ethereum leveled off in Q3. According to Electric Capital’s developer report, the Ethereum ecosystem has more than 5,946 active developers, a 51% growth over the past two years, more than 3 times that of its closest competitor. Note that these numbers may be underestimated, as they do not reflect any contribution to the proprietary crypto business built on Ethereum.

Average Daily Gas Usage: Average gas usage, which serves as an indicator of block space demand on Ethereum L1, is similar to daily transaction volume, with a slight recent increase, and the gas limit has increased 5x since the network’s inception, with each increase to meet block space demand, and this relationship is expected to continue with the further development of L2 solutions and the expansion of Ethereum’s computing resources.

Average Transaction Fees:** Ethereum’s average transaction fees in Q3 were $4.85, down 46% from the previous quarter, indicating that the insufficient supply of block space at times of high demand led to a spike in fees, while the network achieved a surge in fees through L2 solutions and sidechains such as Arbitrum, Optimism, Base and Polygon) to leverage L2 applications with transaction costs ranging from 1 cent to 13 cents, and the implementation of the EIP4844 is expected to further reduce fees in the fourth quarter.

**ETHStaking:**The growth of ETH pledge rate is critical to the health of the Ethereum network, which tracks the percentage of ETH in circulation that is staked in the network, and ETH holders are gradually showing a long-term outlook as staking participation rises dramatically, and ETH is currently the only public blockchain network to achieve a positive real equity ratio (3.6%).

ETH price: The crypto market is extremely reflective, with ETH price closely correlated with on-chain indicators, demonstrating sharp annual volatility since 2015, such as the price bottom of $83.79 in 2018 and the peak of 57x growth in 2021, with more in-depth valuation analysis provided below.

Daily trading volume: Trading volumes continued to decline in Q3, down 56% year-over-year, while Jane Street and Jump Trading’s market-making operations in the U.S. market shrank due to regulatory uncertainty and retail investors lost interest in the space as the crypto winter continued.

TVL (USD) :* Ethereum DeFi applications had a TVL of $3.9 billion, down 12% from the previous quarter, but still 5.8 times higher than its closest competitor, and TVL has a record high of 32% of ETH held in smart contracts, indicating the health of assets under management.

Unit economics: Daily revenue per active address increased 87% in Q2 from the previous quarter, but decreased by 24.9% from the same period in '22, showing that the increase in daily fees for active users is in line with the increase in transaction fees, indicating that users are willing to pay higher fees when the network is congested because of the time value and sensitivity of on-chain transactions.

With the L2 solution, we’ve seen a significant drop in user fees. When this happens, the trading volume is expected to grow exponentially.

2) Business Model

Although Ethereum’s economic and market structure is decentralized, its business model is simple, it charges a small calculation/settlement fee, and as its applications expand, the network becomes more and more profitable, and Ethereum’s finances are analyzed in detail.

Total revenue: Ethereum’s transaction fees refer to the total fees paid by users on the network, and it is expected that in the future applications will pay fees on behalf of users, covering peer-to-peer payments, DeFi loans, exchange platform transactions, gaming experiences, NFT minting, and any other operations that leverage the Ethereum blockchain, while applications using the 2 solution will eventually settle transactions with data for the Ethereum base layer, and the network is still profitable despite a 47% decrease in revenue in the third quarter compared to the second quarter.

Cost of Revenue: This line item represents the amount paid to the supply side (validator) who serves the network by approving transactions and ensuring network security, with 80% of user fees burned during the quarter and the remaining 20% representing priority fees and MEV costs.

Token Incentives: Token incentives represent the block subsidy paid by the network to validators, and after the 2022 “Merge”, Ethereum’s security fees were significantly reduced by 87%, bringing the network into a profitable state, compensating validators and passive holders for user fees.

There are different views on token incentives, with the general view that it is a “fee” paid by the network to validators, but its essence is different from the traditional sense of fees, as validators do not pay this reward directly, a concept that may be difficult to quantify precisely in the current situation.

Block Space Profitability: From an on-chain perspective, Ethereum’s net revenue for the quarter was $78.7 million, down 81% from Q2, and despite the reduction, Ethereum remains the only profitable public blockchain as user fees exceed fees for network token incentives.

03. Relative Valuation: “GDP” Analysis

One way to compare the valuations of Ethereum with other L1 networks is to use a “GDP” analysis. In this case, we will quantify and predict the economic opportunity or GDP of the network. The GDP of a blockchain network is the sum of all the revenue generated by applications built on top of L1.

From this perspective, we see L1 blockchains as “countries” rather than networks or companies. The strength of a country’s currency depends on its economy/GDP, property rights and legal system (the country’s infrastructure) and the demand for the currency (paying taxes, purchasing goods, consuming services, storing value, etc.). ）

In a public blockchain network, L1’s native token is the network’s currency. The property rights and legal system within a public blockchain network derive from its consensus mechanism, decentralization, security, community, and value. Similar to countries, the strength of a currency is related to the economy/GDP supported by the L1 infrastructure and the demand for tokens to access services within the network.

According to data pulled from Token Terminal, Ethereum’s “GDP” over the past year was $2.6 billion. Our breakdown of annual revenue by industry is as follows:**

Ethereum currently leads its competitors in terms of “GDP” and TVL ($39 billion). As the network expands with L2 solutions, we expect the economic opportunity (or GDP) to grow exponentially in the coming years through the net new use cases that will be enabled by enhanced throughput and zero-knowledge privacy solutions (“broadband” + “privacy”).

Compare ETH demand to USD demand

To expand on the concept of ETH as a currency, we analyzed the strength of one currency relative to others. **The U.S. dollar has established a strong position globally due to structural demands such as oil trade and tax revenues, demonstrating the relative strength of the currency. The dollar itself has no utility, but we need them to get what we want. **

We see the same pattern in Ethereum. In order to access the network, computing resources must be paid for in ETH. If a user wants to send stablecoins across borders, they need some ETH. To use DeFi services, payments need to be made in ETH. To play on-chain games, users must have some ETH. To mint or buy NFTs, you’d better have some ETH. Also, if you want to secure the Ethereum network and earn yields, you’ll need to hold some ETH.

We’re even now seeing ETH being used to provide economic security for an additional layer of the tech stack through Eigen Layer – an emerging “re-staking” solution that creates more demand for ETH.

All in all, we see similarities between ETH and traditional currencies like the US dollar. If Ethereum can continue to expand its global network effect, we believe there will be a strong demand from users and businesses to hold the asset, given the requirement to access services within the network.

04, the arrival of the next cycle

There are three main drivers of the crypto cycle:**

• Global Liquidity/Business Cycle: Interest Rates and Monetary Policy
• Innovation cycle: development of infrastructure and applications
• Bitcoin Halving: The date of the halving of new Bitcoin issuance (in this cycle, we went from issuing 900 BTC per day to 450)

Using Bitcoin as a benchmark, we have observed significant consistency in time and price action over the past three cycles:**

Percentage drawdown per cycle peak: Approximately 80%

Time from the end of the cycle: 1 year from the peak

Time to regain all-time highs: 2 years

In addition, each cycle is almost exactly aligned with the cyclical changes in the business cycle as measured by the ISM Manufacturer PMI, which is also consistent with the global liquidity cycle.

Looking ahead, we believe all three factors are likely to align again as we prepare for the next Bitcoin halving, which will occur in April 2024.

05. On-chain gas consumption by year

The above gas consumption data illustrates the development of Ethereum as a computing infrastructure. Notably, we can see the introduction of DeFi in 2017, stablecoins as payments and collateral in 2019, NFTs in 2020, and bridges in 2021, all of which eased Ethereum’s congestion at the time.

In the future, we expect the majority of Ethereum’s gas consumption to come from L2 solutions, which will drive explosive growth for new use cases as costs are compressed.

06. Competition between modular and integrated blockchains

As we know, Ethereum is maturing and evolving as a “network of networks” or “modular” technology stack – where settlement (L1) and execution (L2) are separate but interconnected.

In contrast, Solana (ranked third) runs in monolithic or integrated architectures. In this architecture, settlement and execution are put together.

We think both Ethereum and Solana have the opportunity to thrive, and some have likened them to Android and iOS. In this case, Ethereum is more like Android, which values modularity and runs on many different devices made by hundreds of manufacturers around the world. The flexibility and expressiveness of Android enables hardware developers to make anything from smartphones to TVs without having to invest in building a custom operating system.

Solana is more like iOS in that it can provide users and developers with a more integrated experience with the complexity required to seamlessly connect different L2 networks. As a unified network, Solana has lower transaction costs and higher throughput than Ethereum and EVM operating systems. This allows developers to focus on delivering applications with a single, high-performance platform without having to deal with the complexities associated with transaction speed or interoperability between different networks. It also eliminates the hassle of bridging assets or dealing with inconsistent wallets, making the user’s experience more seamless.

However, we believe there is room for alternative architectures such as Solana. We believe that the two can go hand in hand.

07. Catalysts and drivers for the adoption of Ethereum

In the short term (2-3 years), we see scalability, privacy solutions, and regulatory clarity driving adoption. In the long run, Ethereum has several favorable factors supporting network adoption during this decade:

1. Open Source Technology: The Ethereum network is at the center of the Web3 movement, and as a leader in open source technology, it has created new standards, driven the next generation of the Internet through its composability and decentralization, and benefited from an extensive talent network and rapid iteration in innovation and development.

2. Demographics: The world’s largest demographic shifts are shaping the future of the U.S. and beyond, and as the last baby boomers retire, younger generations are increasingly changing the landscape in terms of perceptions and career paths.

3. Global distribution of wallets: As web3 products and services improve, we believe that adoption rates are likely to scale non-linearly due to the open-source nature of the technology and the fact that anyone with a smartphone can participate. It is estimated that 83% of the world’s population owns a smartphone today (up from 49% six years ago).

4. Outward distribution of tokens and value: Crypto networks such as Ethereum lay the foundation for new business models, and the token distribution mechanism guides the distribution of value, giving more value to users, creators, and supply sides, and achieving a more equal distribution of ownership.

5. Internet Culture: We haven’t forgotten that Bitcoin doesn’t have a CEO, no boardroom. There is no sales or marketing team, and there is no “roadmap”. However, Bitcoin is valued at $1 trillion faster than any company in history. This also brings underlying beliefs to networks like Ethereum and others.

6. Lack of trust in institutions: According to Gallup polls, the current global institutions in the United States, such as organized religion, the Supreme Court, public schools, newspapers, Congress, television news, the president, the police, the World Bank, the International Monetary Fund, NATO, the European Union, the World Trade Organization, and others, were all established after World War II. **History shows that decades of relative stability can change dramatically in just a decade. **

7. Macroeconomics: History also indicates the existence of long-term debt cycles, which are currently at the end of the phase, heralding the possibility of geopolitical upheaval, a period that could trigger rapid social change and new opportunities for the Web3 and Ethereum networks.

8. L2 scaling solutions: Ethereum’s settlement network is still slow and expensive, but the growth of L2 scaling networks such as Arbitrum, Optimism, Base, and Polygon, as well as the upcoming launch of EIP-4844, bodes well for a significant increase in transaction throughput, leading to wider adoption and a better user experience for Ethereum, potentially driving its user base to 1 billion in the coming years.

9. Financial Innovation: The Internet has disrupted almost every business model imaginable. But the business model of the financial services industry is relatively unchanged. Public blockchains are seen as a driving force for financial system reform, and in particular, EY’s launch of privacy-based L2 on Ethereum, called Nightfall, is expected to be a catalyst for institutions to migrate to public blockchains.

10. New Internet-Native Business Models: As we covered in this article, Ethereum has enabled many new Internet-native business models by introducing user-controlled data, smart contracts, peer-to-peer interactions, and a global accounting ledger.

08, Conclusion

**In 2021, the total crypto market capitalization reached $3 trillion. Despite the volatility in the space, we believe cryptocurrencies are in a long-term, exponential adoption cycle. As a result, if the industry follows past growth patterns, the total market capitalization could reach $10 trillion in the next adoption cycle. According to simple logic and historical data, more than 50% of this figure could regress to Bitcoin and Ethereum (68.1% of the current cryptocurrency market). If we assume that Ethereum captures $1-2.5 trillion, then in the next adoption cycle, the price will be in the range of $8300 - $20800.

After all, Ethereum demonstrates strong network effects, clear revenue generation/value distribution, and a high-quality “post-merge” token economy. The core team has demonstrated the ability to execute its roadmap, and the Ethereum ecosystem/community is the most powerful we’ve seen in a smart contract platform.

We believe ETH represents the best risk-adjusted return potential in the crypto ecosystem today. Investors can think of ETH as an index fund that represents web3 call options. The S&P 500 rotates among new companies. Ethereum rotates new L2s, applications, and protocols. Given Ethereum’s strong network effects, we believe ETH’s value is likely to grow with web3 adoption, similar to how Google, Amazon, and Apple have grown with internet adoption.

本文节选自《The Ethereum Investment Framework》

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原文作者：Michael Nadeau & Token Terminal

Compilation: Firefire