Bankless: Ethereum will be the first profitable blockchain

Original title: The first profitable blockchain

Original author: Lucas Campbell, Bankless

Original translation: 0x9F, BlockBeats

Profit = Total Revenue – Total Expenses

Can this formula be applied to blockchain? Lucas Campbell, senior editor of Bankless, thinks it can, and he believes that a blockchain that cannot make a profit will not last long, but currently no blockchain has achieved profitability.

The merger of Ethereum gave him hope for blockchain to achieve profitability. Why does blockchain need to achieve profitability, and why did Ethereum achieve profitability first? BlockBeats translated Lucas Campbell's latest article on Bankless as follows:

“Apple sells iPhones, Facebook sells users’ attention, and blockchain sells blocks.”

— Ryan Sean Adams, Founder of Bankless

Blockchain business model

The value of the dollar benefits from the dominance of US hegemony.

The Visa network is valuable because it serves as the rails of the financial system, connecting billions of participants in economic activity. The problem, as crypto natives understand, is that they are not "secure" in a sociopolitical sense. These centralized institutions provide a "settlement" layer, but at the end of the day, the settlement layer is controlled by the centralized institution, whether it is a government or a corporation.

Blockchain offers a neutral alternative. The business of blockchain is to act as a secure settlement layer for value and remain neutral through decentralization. Blockchain does this by selling blocks - each block can only settle a limited number of transactions within a certain period of time. For example:

Bitcoin sells a block every 10 minutes, which can accommodate 1MB of transactions. Ethereum sells a block every 15 seconds, which can accommodate 80KB of transactions (equivalent to 4MB every 10 minutes).

Blockchain processes transactions and facilitates economic activities of users, including sending and receiving money, converting tokens, lending, collecting digital items, and anything else of programmable value.

From a business perspective, the product of blockchain is block space. The goal is to increase the value of block space and generate revenue from it.

So, what drives up the value of block space? Security.

Poor blockchain security means that transactions can be reversed or tampered with by attackers. Therefore, an insecure network is not a viable settlement layer for value, especially at a scale that processes tens of billions of dollars every day.

Source: Money Movers

The more secure the blockchain is, the more confident people will be in transaction settlement, and the demand for block space will increase. If a blockchain wants to become a global settlement layer, becoming secure becomes a top priority.

But security also comes at a cost to the blockchain. To do this, the blockchain uses token rewards to encourage people to allocate resources - usually computing power (PoW) or money (PoS) - to the network to ensure its security and freedom from attacks.

This makes security a major cost of blockchain.

Here we can deduce the core business model of the public chain. The blockchain earns revenue from transaction fees, while its cost is the security fee paid in token rewards. In simple terms:

Net Profit = Transaction Fee – Token Reward

Therefore, we can analyze a “successful blockchain business” by comparing how much a blockchain spends on security and how much it earns through transaction fees. If a blockchain’s security expenses exceed their revenue, they will be in deficit.

“Every L1 chain has to defend itself against attacks, and that costs money. You can raise funds in two ways:

1) Increase the money supply

2) Taxing block space sales

If the cost of inflation exceeds tax revenue, you are running a deficit, and deficits are unsustainable.”

As a crypto investor, what you can do is find the most profitable blockchain business and invest in it. The best blockchain can sell its blocks at the highest price because people are willing to pay for it. This means that as a settlement layer, its product has a market foothold.

People are willing to spend thousands of dollars on an iPhone because they believe it outperforms other phones. Last year, the iPhone accounted for less than 40% of the global smartphone market in terms of revenue, but more than 75% of the profits. Last year, the iPhone accounted for less than 40% of the global smartphone market in terms of revenue, but more than 75% of the profits.

The same is true for blockchains. As long as the blockchain provides the best product (secure economic opportunity), entities are willing to pay higher transaction fees for it.

The question is, who is the Apple of the blockchain industry?

What are the profitable blockchains?

The fact is, no blockchain is profitable today.

Right now, major blockchain networks are spending more token rewards than they earn in transaction fees. They are all running unsustainable businesses.

You can see this in the chart below.

Data source: CryptoFees & MoneyPrinter

Ethereum generates nearly $13 million in transaction fees every day, making it the most valuable blockchain from this perspective. However, on the other hand, in order to produce these blocks, the network issues $36 million in ETH to miners every day. As a result, Ethereum is currently operating at a loss of 64%.

Average daily profit margin over the past week

The closest blockchain to profitability is BNB Chain, as it earns $1.4 million in transaction fees per day while only issuing $1.74 million in token rewards. On the surface, you might think this is amazing.

“It’s time to imitate BNB.”

But the nuance is that chains like Binance can be completely excluded from profitability comparisons of L1 blockchains.

The reason is:

As mentioned earlier, block space becomes valuable when there is certainty in transaction settlement. And this certainty costs money.

BNB Chain is guarded by only 21 validators. This is a closed and regulated entity. In other words, the centralized BNB Chain benefits from not paying for security. These 21 validators can easily collude to make transactions irrelevant, causing the blockchain to be much less valuable than an extremely decentralized and censorship-resistant network.

If BNB Chain really pays for high security, the cost will definitely be higher. In comparison, Bitcoin spends $34.75 million in token rewards on 1 million miners every day, while Ethereum spends $36 million on 276,000 validator nodes to ensure the security of the beacon chain (before the merger!!).

It’s also worth highlighting that there have been reports that BNB Chain has been affected by money laundering and spam transactions, and has disproportionately reported higher revenues. (Of course there have been rebuttals to these claims, and it’s hard to tell the truth).

But the fact is that, with the exception of Ethereum and BNB Chain, almost all major L1s are operating at losses of around 90% or even worse.

Each L1 has built an impressive scalable infrastructure layer while issuing billions of dollars in token rewards each year to ensure the security of blocks - but what about the demand for blocks?

Again, this is a trade-off. It’s much cheaper to transact on Avalanche or Solana than on Bitcoin or Ethereum, but that’s a trade-off, and these chains don’t have enough revenue to offset their expenses.

How do you assess product demand: Product sales revenue.

How do you assess blockchain demand: Revenue from block space sales.

Revenue is the true measure of demand for block space, not the number of blocks sold.

What about Bitcoin?

Despite a decade of decreasing token rewards (Bitcoin halving three times), the Bitcoin network is still operating at a 98% loss rate. Although the network plans to effectively rely on transaction fees by the end of this decade (after the fifth halving, more than 95% of BTC will be mined), the network is not even close to the break-even point. Token rewards are approaching zero, but the network only pays for security, which is worth our close attention next.

The harsh reality is that building a profitable blockchain business is hard.

Even Ethereum, which has the most valuable blocks, cannot make a profit in its current state, and Bitcoin is in even worse shape, on par with other L1s.

How is this possible at this point?

As a technology, it’s still early days for blockchain. Massive adoption has yet to arrive, and the technology itself still has a lot of room for optimization, so it makes sense that blockchains are not profitable right now—they’re still on their own.

This is very similar to the dot-com companies of the 90s. Amazon was founded in 1994, but it didn't become profitable until 2001, when it reported $5 million in profit on $1 billion in revenue.

It took seven years for the now trillion-dollar company to barely become profitable.

Bitcoin has been around for 12 years, and Ethereum will celebrate its 7th anniversary this July, which is like the year 2000 for blockchain.

This begs the question…will blockchain become profitable in the same timeframe as Amazon?

The road to profitability

So, what is the path for blockchain to achieve profitability?

There are two main levers:

1. Increase transaction income

2. Reduce security expenses

1. Increase transaction income

The main way blockchains increase transaction revenue is by increasing block utility — increasing the value of what can be done within each block . This can be achieved by building valuable applications that increase the utility of the network.

For example, on Ethereum, anyone can trade $1 million in ETH for $1 million in DAI on Uniswap. This may be of great value to some people. They are happy to pay a $10 transaction fee to settle this trade. In fact, perhaps they are willing to pay up to $1,000 in transaction fees. Even in times of stress and volatility, they are willing to pay $10,000 to have their trade processed instantly. A rational person is willing to pay a slightly higher price for a block than the value they can extract from that block.

As the application layer becomes more active, blocks become more valuable because applications such as DeFi, NFT, etc. create economic opportunities within the block.

Blockspace revenue is almost directly correlated to the number of valuable applications on the network and the opportunities they hold.

This is even more evident when we look at Bitcoin. Bitcoin really only has one application - transferring BTC. As such, it struggles to generate significant blockspace revenue, as shown by its -98% profit margin.

One use case can only generate so much revenue.

With the help of smart contract platform, an unlimited number of applications can be built, making the block space revenue scale far beyond a limited application blockchain

This is happening, with multiple smart contract platforms surpassing Bitcoin in transaction fee revenue, including several Ethereum applications. The market is willing to pay more to convert tokens on Ethereum than to transfer Bitcoin.

The key point is that blockspace revenue increases with blockspace utility — having more options. Blockspace utility scales with more tokens, more applications, and a more vibrant ecosystem.

All of this depends on the decentralization and security of the network.

As mentioned before, if transactions can be reversed or censored, block space is less valuable and fewer applications will take root in such a network.

2. Reduce security expenses

Increasing the utility of block space can't be forced by incentives to a large extent. You need developers, applications, and users. In the long run, you can only incentivize users to use it.

Therefore, the main way for blockchain to achieve sustainable development will be to reduce token rewards and reduce network expenses over time.

When you reduce token rewards, the biggest cost is that you spend less on security. Unless the price rises, once the network reduces token rewards, the incentive for validators/miners to operate will be weakened and the network will become less secure. This is not always the case, but as long as the network needs are not balanced, this risk will occur.

Blockchains must face the trade-off between token rewards and block size. Many Alt L1 chains have chosen larger blocks to support more total transactions and make the fees for individual transactions lower. Increasing the block space supply would make it cheaper, and so far it has proven difficult to generate significant revenue for blockchains.

Furthermore, increasing throughput on the base layer tends to create a more centralized system, undermining the confidence base for the premium on the chain’s native currency.

The blockchain must balance the supply of block space and the subsequent issuance of tokens. Producing blocks faster and larger blocks means greater network throughput, and more coins must be issued to ensure security at this scale.

If you want a bigger scale, you have to spend more on security.

You can see the effects of this in the inflation of smart contract chains.

Ethereum: 4.20% inflation rate

Solana: 9.15% inflation rate

Avalanche: 26.6% inflation

Important note: Ethereum is currently proof of work, which is a resource-intensive security mechanism. Ethereum will switch to PoS later this year, and the new issuance of ETH will be reduced by 90%, and the annual inflation rate of Ethereum will be reduced to 0.4%.

A quick note about L2

L2 can play an important role in increasing the net revenue of the blockchain.

According to CryptoFees.info, Ethereum L2 generates $50,000 to $100,000 in revenue per day by selling block space. This is L2’s native revenue, collected by L2 operators (and may be democratized through L2’s native tokens in the future).

Importantly, L2 has a demand for the block space of Ethereum L1. L2 must consume the block space of L1 to "settle" with the blockchain mainnet. Arbitrum, Polyon, and Optimism are prominently listed in UltraSound.Money's ETH burning rankings.

The core of L2 is that they do not need to issue tokens to pay for security. They inherit their security from L1 where settlement occurs. This makes deploying L2 trivial because many difficult parts of blockchain sustainability are solved by leveraging the resources of L1.

L2s operate like solar panels for economic activity. They offer low fees to users and bundle user transactions into a package that is deployed to L1 in batches. This is where L2 usage can translate into L1 block space demand, and why a vibrant L2 ecosystem is good for L1 transaction fees.

The cool thing about Ethereum’s scalability roadmap is that it sells block space to other blockchains (L2) rather than users. Although some users find Ethereum’s gas fees unbearable, L2 blockchains don’t feel much about L1’s gas fees. And as more and more users come, they will have greater demand for block space.

The first profitable blockchain is coming

By merging, Ethereum is the first blockchain to embark on a path of economic sustainability. Later this year, perhaps in June or July, the network will switch to a PoS consensus mechanism, reducing the issuance of ETH by 90%.

The interesting part about the Ethereum merger is that it is not just a pure issuance reduction.

While improving security efficiency, the way the "security budget" is used has undergone a fundamental change. Given the shift in consensus algorithms and the improvements they bring, PoS will make Ethereum more secure while reducing token issuance.

As the network reduces 90% of its token issuance, Ethereum will distribute less than $4 million of ETH to stakers every day. It should be noted that Ethereum's transaction fees will not decrease with the merger.

This means that later this year, the network will distribute $4 million in token rewards per day while generating $13 million in revenue, making a net profit of $9 million and a profit margin of 72%.

Ethereum, the first profitable blockchain!

One of them stands out from the crowd

It is worth emphasizing that ETH has also completed the triple-point asset theory with the merger and has completely transitioned into an interest-bearing asset.

All transaction fees generated by the network will flow to ETH holders through EIP 1559 (buybacks) and staking (dividends). As a result, ETH staking yields will soar to double-digit APYs. As investors compete to absorb these yields, demand for the asset is boosted, while the network gains more security from the increased staking.

Ethereum is poised to become the first profitable blockchain.

And this will happen in months, not years. As we’ve written before, this is not yet reflected in prices.

Will other blockchains follow Ethereum?

A lot of that depends on how well they sell their products.

How much is the market willing to pay for their blocks? When the token rewards dry up, will anyone still buy? When transaction fees increase, will anyone still buy?

Since L2 does not need to pay billions of dollars in security fees every year through token rewards, how will L1 compete with L2 for profits?

We will find out in the months and years ahead.

In the long run, profitability is the key to survival.