Will the rise of Bitcoin weaken Ethereum? How will its value be reflected?

The Bitcoin ecosystem has risen rapidly recently. Since some routes may overlap with the Ethereum ecosystem, some crypto communities are worried. So will the rise of the Bitcoin ecosystem really weaken Ethereum? Not necessarily. Ethereum also has its own unique value.

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

• Internet users have no digital property rights.

• The Internet does not have a trusted neutral, shared, secure, permissionless global accounting system — to record the status of users and enable global trade on a shared ledger.

These two points happen to be the core value propositions of blockchain, and the Internet revolution is on the way.

Ethereum is built to mirror the way the internet is built

Bitcoin was the first public blockchain. In the early days, if you wanted to create a new application using this new technological breakthrough, you had to launch your own blockchain. For example, Namecoin (a peer-to-peer naming system) was originally a fork of the Bitcoin network. This era of public blockchains was similar to the early days of the Internet, where you had to host your own servers to build a website.
Ethereum was founded in 2015 as a “geo-city of public blockchains” that would allow developers to build blockchain-based applications using shared infrastructure more cheaply and efficiently.
However, building applications for specialized use cases requires a lot of flexibility. The move into L2 and application-specific blockchains has led to the start of building execution services “on top” of Ethereum, with Ethereum serving as the base layer settlement infrastructure.
Ethereum is thus becoming a “network of networks”. Just like the Internet. L2 looks very similar to the Taobao service - achieving flexibility and scalability while maintaining a shared infrastructure.
Additionally, enhanced scalability for L2 is being developed alongside zero-knowledge proofs, which bring privacy to public blockchains — just as HTTPS brought encryption to the internet, enabling e-commerce.  

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 for other businesses to build applications “on top”.

1) Data Overview

Non-zero addresses: The cumulative total has grown exponentially over the past 8 years. As of September 30, 2023, it has grown to more than 107 million, an increase of 26% from a year ago and 4.9% from the previous quarter.
Active addresses: In the third quarter, Ethereum’s average daily active addresses were approximately 400,000, down 4% from the previous quarter. A similar decline occurred during last year’s cryptocurrency trough, but as market conditions improved, new users began to pour in.
Average daily transaction volume: In the third quarter, Ethereum's average daily transaction volume increased slightly, and network demand continued to exceed supply. As the network scales, L2 networks (such as Optimism, Arbitrum, and Base) are processing a larger proportion of transactions. The transaction volume on L2 has increased by more than 3438% in 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 has leveled off in Q3. According to Electric Capital’s Developer Report, the Ethereum ecosystem has over 5,946 active developers, up 51% over the past two years and more than 3x its closest competitor. Note that these numbers are likely underestimates as they do not reflect any contributions to proprietary crypto businesses built on Ethereum.
Average Daily Gas Usage: Average Gas Usage, as an indicator of block space demand on Ethereum L1, similar to daily transactions, has increased slightly recently; since the network was founded, the Gas limit has increased 5 times, and each increase has been to meet block space demand. This relationship is expected to continue, further developing L2 solutions and expanding Ethereum's computing resources.

Average transaction fee : Ethereum's average transaction fee in the third quarter was $4.85, down 46% from the previous quarter, indicating that insufficient block space supply caused a surge in fees during times of high demand, while the network expanded through L2 solutions and side chains such as Arbitrum, Optimism, Base, and Polygon, and the transaction costs of applications utilizing L2 ranged from as low as 1 cent to 13 cents; the implementation of EIP4844 is expected to further reduce fees in the fourth quarter.
ETH Staking : The growth of ETH staking rate is critical to the healthy development of the Ethereum network. This indicator tracks the percentage of circulating ETH that is staked in the network. With the sharp increase in staking participation, ETH holders have gradually demonstrated long-term prospects. ETH is currently the only public blockchain network to achieve a positive actual equity rate (3.6%).
ETH Price: The crypto market is highly reflective, and ETH prices are closely correlated with on-chain indicators, showing dramatic annual fluctuations since 2015, such as the price bottom of $83.79 in 2018 and a 57-fold growth peak in 2021. A more in-depth valuation analysis will be provided later.
Daily Trading Volume: Trading volumes continued to decline in the third quarter, down 56% year-on-year, as Jane Street and Jump Trading scaled back their market-making operations in the U.S. market due to regulatory uncertainty, while retail investors lost interest in the space as the crypto winter continued.
TVL (USD): TVL in Ethereum DeFi applications is $3.9 billion, down 12% from the previous quarter, but still 5.8 times higher than its closest competitor; Another perspective of TVL is "assets under management". Currently, the proportion of ETH held in smart contracts has reached 32%, a record high, indicating the health of managed assets.
Unit Economics: Daily revenue per active address grew 87% in Q2 from the previous quarter, but fell 24.9% from the same period in 2022, showing that the growth in daily fees for active users is consistent with the growth in transaction fees, indicating that users are willing to pay higher fees when the network is congested due to the time value and sensitivity of on-chain transactions.
With L2 solutions, we are seeing user fees drop significantly. When this happens, transaction volumes are expected to grow exponentially.

2) Business Model

Although Ethereum’s economic and market structure is decentralized, its business model is simple, charging a small amount of computing/settlement fees. As the application expands, the network becomes more and more profitable. The following is a detailed analysis of Ethereum’s financial situation.
Total Revenue: Ethereum's transaction fees refer to the total fees paid by users on the network. It is expected that applications will pay fees on behalf of users in the future, covering peer-to-peer payments, DeFi loans, trading platform transactions, gaming experiences, NFT minting, and any other operations that utilize the Ethereum blockchain. Applications using the 2 solution will ultimately settle data for transactions on the Ethereum base layer. Although revenue in the third quarter fell 47% from the second quarter, the network still achieved profitability.
Revenue Cost: This line item represents the amount paid to supply parties (validators) who provide services to the network by approving transactions and ensuring network security, of which 80% of user fees are burned during the quarter, and the remaining 20% ​​represents priority fees and MEV costs.
Token Incentives: Token incentives represent the block subsidies paid by the network to validators. After the "merger" in 2022, Ethereum's security fees were drastically reduced by 87%, bringing the network into profitability and providing compensation for user fees to validators and passive holders.
There are different opinions on token incentives. The general view is that it is a kind of "fee" paid by the network to the validator, but its essence is different from the traditional fees because the validator does not directly pay the reward. This concept may be difficult to quantify accurately under the current circumstances.
Blockspace Profitability: From an on-chain perspective, Ethereum’s net revenue was $78.7 million this quarter, down 81% from the second quarter. Despite the decrease, Ethereum remains the only profitable public blockchain as user fees exceed fees from network token incentives.

Relative Valuation: “GDP” Analysis

One way to compare the valuation of Ethereum to other L1 networks is to use a “GDP” analysis. In this case, we will quantify and forecast the economic opportunity or GDP of the network. The GDP of a blockchain network is the sum of all revenues generated by applications built on L1.
From this perspective, we view L1 blockchains as “nations” 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 currency (paying taxes, buying goods, consuming services, storing value, etc.)
In a public blockchain network, L1’s native token is the currency of the network. The property rights and legal system within a public blockchain network derive from its consensus mechanism, decentralization, security, community, and value. Similar to a country, the strength of a currency is related to the economy/GDP supported by the L1 infrastructure and the token demand for accessing services within the network.
According to data extracted from Token Terminal, Ethereum’s “GDP” for the past year was $2.6 billion. We break down annual revenue by industry as follows:

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

Comparing ETH demand to USD demand

To expand on the concept of ETH as a currency, we analyzed the strength of a currency relative to other currencies. The dollar has established a strong position in the world due to structural needs such as oil trade demand and taxation, showing the relative strength of currencies. Dollars themselves have 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 with ETH. If users want to send stablecoins across borders, they need some ETH. To use DeFi services, payments need to be made with ETH. To play on-chain games, users must have some ETH. To mint or buy NFTs, you better have some ETH. In addition, if you want to protect the Ethereum network and earn returns, you need to hold some ETH.

We’re even now seeing ETH used to provide economic security for additional layers of the tech stack via the Eigen Layer — an emerging “re-hypothecation” solution that’s creating more demand for ETH.

In summary, we see similarities between ETH and traditional currencies such as the US dollar . If Ethereum can continue to expand its global network effect, we believe that users and businesses will have a strong demand to hold the asset given the requirements to access services within the network.

The next cycle is coming

There are three main drivers of the crypto cycle:

• Global Liquidity/Business Cycle: Interest Rates and Monetary Policy

• Innovation cycle: infrastructure and application development

• Bitcoin Halving: The date when the issuance of new Bitcoins is halved (in this cycle we go from 900 Bitcoins per day to 450)

Using Bitcoin as a benchmark, we observe remarkable consistency in timing and price action over the past three cycles:

Retracement percentage of each cycle peak: about 80%

Time to cycle bottom: 1 year from peak

Time to recapture all-time high: 2 years

Moreover, each cycle coincides almost perfectly with the cyclical changes in the business cycle as measured by the ISM Manufacturers PMI, which also coincides 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 is expected to occur in April 2024.

Gas consumption on the chain in each year

The above Gas consumption data shows the development of Ethereum as a computing infrastructure. It is worth noting that we can see that the introduction of DeFi in 2017, the introduction of stablecoins as payment and collateral in 2019, the introduction of NFTs in 2020, and the introduction of bridges in 2021 have all eased the congestion of Ethereum at the time.

In the future, we expect the majority of Ethereum’s gas consumption to come from L2 solutions, which will drive an explosion of new use cases as costs compress.

The competition between modular and integrated blockchain

Ethereum, as we know it, is maturing and evolving as a “network of networks” or “modular” technology stack — where settlement (L1) and execution (L2) are separate yet connected.
In contrast, Solana (ranked third) operates in a monolithic or integrated architecture where settlement and execution are brought together.
We think both Ethereum and Solana have a chance 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. Android’s flexibility and expressiveness enable 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 a more integrated experience for users and developers, seamlessly connecting the complexities required for different L2 networks. As a unified network, Solana has lower transaction costs and higher throughput than Ethereum and the EVM operating system. This allows developers to focus on delivering applications with a single high-performance platform without having to deal with the complexities associated with transaction speeds or interoperability between different networks. It also eliminates the hassles of bridging assets or dealing with inconsistent wallets, making the user experience more seamless.

However, we think there is room for alternative architectures like Solana. We think both can coexist.

Catalysts and drivers for Ethereum adoption

In the short term (2-3 years), we see scalability, privacy solutions, and regulatory clarity facilitating adoption. In the long term, Ethereum has several tailwinds supporting network adoption this decade:
1) Open source technology: The Ethereum network is the center of the web3 movement. As a leader in open source technology, it has created new standards, driving the next generation of the Internet through composability and decentralization, and benefiting from a broad network of talent and rapid iteration in innovation and development.

2) Demographics: The world’s largest demographic shift is currently shaping the future of the United States and other countries, as the last of the baby boomers retire and the mindsets and career paths of the younger generation increasingly change the overall landscape.

3) Global distribution of wallets: As web3 products and services improve, we believe adoption is 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. The token distribution mechanism guides the distribution of value, giving users, creators and suppliers more value and achieving more equal ownership distribution.

5) Internet Culture: We haven’t forgotten that Bitcoin has no CEO, no board room, no sales or marketing team, and no “roadmap.” Yet Bitcoin reached a $1 trillion valuation faster than any company in history. This also brings potential conviction to networks like Ethereum and other web3 networks.

6) Lack of trust in institutions: According to Gallup polls, the United States currently has a low level of trust in organized religion, the Supreme Court, public schools, newspapers, Congress, television news, the presidency, the police, the World Bank, the International Monetary Fund, NATO, the European Union, the World Trade Organization, and other global institutions that were established after World War II. History shows that decades of relative stability can be followed by dramatic changes in just a decade.

7) Macroeconomics: History also shows the existence of long-term debt cycles, which are currently in their final stages, foreshadowing the possibility of geopolitical turmoil. Such periods could trigger rapid social change and bring new opportunities for web3 and the Ethereum network.

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 EIP-4844, heralds a significant increase in transaction throughput, enabling Ethereum to usher in wider applications and a better user experience, which may push its user base to 1 billion in the next few years.

9) Financial innovation: The Internet has disrupted almost every business model imaginable. However, the business model of the financial services industry remains relatively unchanged. Public blockchains are seen as a driving force for financial system reform, especially the privacy-based L2 called Nightfall launched by EY on Ethereum, which is expected to become a catalyst for institutions to migrate to public blockchains.

10) New Internet-native business models: As we have introduced 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.

in conclusion

In 2021, the total cryptocurrency market cap reached $3 trillion. Despite volatility in the space, we believe that cryptocurrencies are in a long-term, exponential adoption cycle. Therefore, if the industry follows past growth patterns, the total market cap could reach $10 trillion during the next adoption cycle. Based on simple logic and historical data, more than 50% of this number could return to Bitcoin and Ethereum (currently 68.1% of the cryptocurrency market). If we assume Ethereum captures $1-2.5 trillion, then the price would be in the $8,300 - $20,800 range during the next adoption cycle.

After all, Ethereum demonstrates strong network effects, clear revenue generation/outward distribution of value, and high-quality token economics “after merger.” The core team has demonstrated the ability to execute its roadmap, and the Ethereum ecosystem/community is the strongest we have ever 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 representing a call option on web3. The S&P 500 rotates in new companies. Ethereum rotates in 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 grew with internet adoption.