Layer2 conquers the pool and Ethereum's throne as the "king of public chains" is more stable

I am increasingly convinced that Ethereum has the potential to create more value than alternative L1s for two main reasons:

• L2 adoption is growing rapidly

• L1 cannibalization is less than expected

In this post, I will briefly analyze the dynamic changes in the fundamentals of the Ethereum network.

ETH’s flat price swings belie its value accumulation.

• Ethereum price returns to growth track, driven by L2 growth and slight monetary tightening

• Despite the bear market, ETH has entered a deflationary state (inflation rate exceeded 4% before the merger)

• Despite cooling of network activity, ETH staked up 38% in 3 months

L1 Network Adoption

Ethereum’s ambition to scale the network via L2 Rollup is evident in on-chain data, as while L1 activity declined last year, ETH utilization increased and the network’s financials are booming.

Compared to a year ago, L1 active addresses fell 37% to 379,000, but active ERC-20 addresses increased 27%. Smart contracts locked up 31% of the total ETH supply (most of which came from staking), and the overall utilization of ETH has increased.

On-chain transaction value (in USD) is 30% lower than a year ago, while ETH price has increased by 8% over the same period. This drop is not surprising considering that on-chain transfers are now cheaper and faster on L2.

Despite the decline in network activity, investors are still actively hoarding coins. The number of non-zero balance addresses exceeds 100 million, and the number of wallet addresses containing at least 1 ETH exceeds 1.7 million.

Fee income growth outstrips price growth

From a two-year perspective, Ethereum network activity declined, with the Ethereum economy hitting bottom in the fourth quarter of 2022 and recovering at a rate consistent with the resumption of a new bull market cycle. As expected, the rapid growth of L2 cannibalized L1 network activity, but the impact on network finances was not as great as expected.

Although network fee revenue (in US dollars) is significantly lower than in 2021, it has increased threefold from the low point in the fourth quarter of 2022. L1 generates about $6 million in fee revenue per day, 80% of which is destroyed and the rest is paid to validators.

Ethereum L1 daily fee revenue (in USD) has risen 176% so far this year, while ETH prices have only risen 53%. The relationship between the two is instructive for the last bull run, when fees surpassed prices in 2020 after two years of decline (meaning that the increase in fees exceeded the increase in prices).

In the nation-state analogy, L1 provides infrastructure (roads, communications) and security (property rights) for special economic zones or city-states (L2) to build and compete for commercial capital (decentralized applications).

Operating in these locations means lower taxes (fees) and red tape from state agencies (ETH validators), which reduces friction in adoption, leading to cheaper and faster customer service.

L2 Network Adoption Metrics

Ethereum’s migration to L2 last year has proven to be a huge success, with hundreds of thousands of new users joining Web3 and L2 active addresses increasing by 245% in the past 12 months.

Growth in L2 fees ($600k/day on average) is helping to slow the cannibalization of L1 revenues, but more importantly, L2 is amplifying network effects.

Given the rapid rise in L2 adoption, L1 fees paid via Rollup could reach 20% of total fees by the end of the year and 50% within 3 years. In the disaggregated data, Rollup fees paid to L1 as a percentage of total fees have risen 2.8 times this year to just under 14%.

One consequence of L2’s growth is that NFT activity on L1 has dropped significantly as the L2 NFT market’s lower friction costs have won over users. The share of fees paid for NFTs has dropped by 80% and is currently just under 6%.

in conclusion

As the leading L1, Ethereum has performed very strongly. With the rapid expansion of L2, the extent of Ethereum's cannibalization is far less than we expected, and its moat is constantly deepening and widening.