Ethereum – you’ve likely heard of it unless you’ve been living under a rock for the last 10 years. It was the first iteration of an open-source, decentralized blockchain network that also incorporated smart contract functionalities, meaning you could build and run various applications, protocols, and digital assets on top of its platform.
Fast forward to now, the Ethereum token is now the second largest crypto asset behind Bitcoin. The Ethereum Network has propelled it to being the largest smart contract platform at the forefront of a new economic and financial paradigm.
But what really is Ethereum: how does it work? How does it have any value outside of speculation? How is it different from Bitcoin? And what’s the connection between the Ethereum network and the Ethereum asset?
These are all valid questions and, in this report, we’re going to take a deep dive into all key aspects of Ethereum – including its ongoing evolution, how it works, and most importantly its fundamentals and economics.
How Ethereum Works and How It Has Developed
Ethereum was the first iteration of a blockchain with smart contract functionality. While we generally think of Ethereum as a blockchain, it’s actually so much more than a plain and simple blockchain protocol such as Bitcoin.
The Ethereum Platform is made up of 2 key components:
- The Ethereum Virtual Machine (EVM)
- The Ethereum Blockchain
The Ethereum Virtual Machine (EVM)
Ethereum Virtual Machine is a global virtual computer hosted on the Ethereum Network. This computer powers the Decentralized Applications (dApps) and Executes all Smart Contracts on the Ethereum network.
The EVM actually has its own programming language called solidity (which is the language for all smart contracts on Ethereum). The Ethereum virtual machine was so innovative that many other base layer platforms – such as Binance Smart Chain and Avalanche – use the EVM to power their own dApps and smart contracts.
The Ethereum Blockchain
Up until September of 2022, Ethereum was a proof of work consensus model meaning validators used computing power to compete in solving complex math problems in order to create new blocks.
As the Ethereum platform grew in popularity and usage, it started running into the issue of scalability. This meant there were so many users and applications utilizing the blockchain that it became slow and expensive.
This led to many new features and developments which are still taking place in order to help Ethereum eventually scale to 100’s of thousands of transactions per second while maintaining its robust security.
The biggest of these changes to date is the merge to the proof of stake consensus model, which happened in September 2022. This New mechanism makes Ethereum more energy efficient and theoretically more decentralized. Here’s how:
- Validators no longer need to expend hundreds of watts of energy.
- The barrier to entry is much lower since all a user needs now is enough Ethereum tokens and data availability on their computer in order to become a validator and earn ETH.
The other big development to help Ethereum scale was the rollout of layer2 sidechains (link) and rollups (link), which started to take place in 2019. These blockchains built on top of the main Ethereum blockchain added extensive capacity to the Ethereum ecosystem without compromising on security.
The Ethereum Network is still developing into its final form with updates expected in 2023 and 2024 that will transform Ethereum into a modular system. Once these are completed successfully, Ethereum will be an ecosystem of communicating chains that work in tandem to allow for millions of users while maintaining speed and robust security. The final product will be Ethereum 2.
The Ethereum Ecosystem
There’s a lot happening in the Ethereum ecosystem: from Stablecoins to DeFi, to gaming, to layer2s… The list goes on. All these innovations are utilizing the Ethereum platform to create a more efficient and cost-effective global economy and financial system.
Here are some of the protocols in the Ethereum ecosystem.
This is a look into more specifically the ecosystem of DeFi applications
On top of these apps already deployed on Ethereum, the number of new smart contracts being written and deployed on a daily basis is also continuing to rise, despite the bear market.
This constant rise in daily contract verification displays the ever-progressing strength of Ethereum’s innovative ecosystem of developers and applications, despite prices and hype around crypto having completely fallen off since 2021.
How Is Ethereum Different From Bitcoin?
People often want to compare Ethereum to Bitcoin, this is a mistake.
Bitcoin is a powerful and secure computing network underpinning a fully decentralized pier-to-pier cash system with a maximum # of assets that will ever be in circulation.
Furthermore, the Bitcoin protocol is completely static, meaning while the network is constantly updating, the code that was written and released to the world 14 years ago has never changed and never will change.
On the other hand, Ethereum is much more centralized from a developmental perspective, the Ethereum foundation is an actual team of developers that are building and launching updates and changes to the Ethereum Protocol. As stated earlier Ethereum is also much more of a platform with an entire infrastructure of Digital Finance protocols being built on top of it.
ETH vs BTC Tokenomics
BTC was never issued to the original developers of the Bitcoin protocol which made for a much more decentralized system – this is Bitcoin’s strong suit. Ethereum on the other hand could be classified as a security as it was initially issued by the Ethereum foundation and sold (more on that in a minute).
One may read this and think Ethereum is better than Bitcoin or vice versa, however, these differences are neither good nor bad. While many people like to compare Ethereum to Bitcoin, they simply are not the same thing, with the networks and assets that are built and optimized for very different purposes.
Ethereum’s Tokenomics
Diving into the Tokenomics of the native asset on the Ethereum network, ETH.
As mentioned before ETH is not the same as BTC, it’s much closer to being a security, and Here’s why:
- It was sold by the developers of ETH in an Initial coin offering.
- A portion of ETH was issued to the Ethereum foundation which is the organization of developers behind the project.
- You can lock up ETH in the Ethereum protocol and earn a yield on it (staking).
- The Developers making changes to the network have control over the tokenomics of ETH. For example, an Ethereum update from 2021, made it so a portion of the fees are burned, meaning the amount of ETH in circulation is actually deflating as we speak.
This Chart shows the Tokenomics of the Initial Coin Offering (ICO) of the first 60,000 ETH, which took place in 2014.
The triple-halving phenomenon
What’s the triple halving, or even the halving for that matter?
What people in the crypto world refer to as the halving is Bitcoin’s halving of the total supply issuance every four years. For example, Bitcoin’s first halving took place in 2012 when it went from issuing 50 new BTC per block to 25 per block, in 2016 this number went from 25 to 12.5, and in the most recent halving in 2020 it went from 12.5 to 6.25 new BTC per block. This process will take place every 4 years until the last of the 21M BTC has been issued, in the year 2140 (assuming humans are still around).
So now we know the halving, but what’s the triple halving?
The Triple halving refers to the conjunction of 3 events that are taking place that will significantly decrease the amount of ETH in circulation.
The EIP-1599 Update
In 2021 Ethereum went from paying out all of the gas fees to validators, to burning a portion of them, increasing buy pressure.
We like to think of this burning of ETH as a stock buyback, because the protocol is automatically taking a portion of its revenue and eliminating those ETH Tokens from circulation, much like if a corporation uses profits to buy back stock which increases value for shareholders.
The Merge
The annual issuance of ETH before the merge to PoS was around 4.5%. Since the merge, under proof of stake, the annual ETH net issuance has dropped to about -0.008% leading to an increase in buy pressure. This reduction in supply could increase as the amount of activity on the network increases, because of the increase in the amount of gas fees being paid and burned.
ETH Staking
Before PoS validators provided computing power and energy to validate transactions. This meant their expenses (energy/computing costs) were in USD and they must sell their block rewards for USD in order to pay those expenses. Proof of Stake has removed this sell pressure, and in fact has reversed it, incentivizing validators to accrue more of the asset generating them rewards (ETH), and even re-staking those rewards to generate more.
This will theoretically remove $7.5 billion in sell pressure from the market, for reference the last Bitcoin halving removed about $4 billion in sell pressure from bitcoin. This does not account for the potentially increased hodling (holding on for dear life) of Ethereum by validators, which will remove more eth from the market.
So – after 9 years, network updates, huge growth, and now the triple halving – here’s what the ETH token allocation currently looks like.
As you can see in this chart, since the EIP1599 update in 2021, over 2,848,790 or 2% of the total supply of ETH has been burned, which keeps increasing by roughly 14,000 a week. This significantly offsets the amount of ETH issued to stakers as a reward for helping secure the network.
So what does this look like in the grand scheme of things? Here’s a look at the projected supply of Ethereum.
Currently since the update the total supply growth of ETH has been -1.05%
The current supply is 120.6 million and the projected total supply in 2025 is estimated at about 117.5 million.
It’s hard to be perfectly accurate with this because the amount of ETH burned on a daily basis is relative to the amount of revenue the Ethereum network brings in from fees.
All of these Tokenomics are looking pretty darn bullish for the long run, but tokenomics don’t mean nearly as much if anything, if there isn’t sufficient economic value being created by the network itself.
Network Data Evaluation and Analysis
Getting into the fundamentals of the Ethereum Network, the first thing we’ll dive into is Ethereum revenue. If you don’t understand how Ethereum really has any value as a network, you’ll love to see this part.
In its essence, Ethereum’s business model is to sell block space as well as run smart contracts and decentralized applications using its virtual computer (EVM).
Ethereum’s core value proposition is:
- Robust data security.
- Trustless peer-to-peer system via extensive decentralization.
- Being a part of an extensive ecosystem.
Ethereum generates revenue by charging fees for:
- Deploying a smart contract – which could be NFTs, an ICO, a conditional recurring transaction, etc. – or a decentralized application.
- Making transactions, whether it be through a decentralized application, or with another wallet.
The more people that are using the network, the more revenue is generated, and the more demand there is for ETH since it is the native asset used to pay fees. This is a double whammy from a value accrual standpoint for ETH holders.
If we were to look at Ethereum as a company, Ethereum has done exceedingly well. Even in 2022 despite the complete obliteration of the crypto space as a whole, Ethereum still brought in over $4 billion in fees – pretty much all of which is profit that goes back to holders and stakers through token burning and reward payouts.
(2023 revenue is projected based on last 30 days, it will likely end much higher then as it currently stands)
Ethereum’s current Price to earnings ratio based on previous annual earnings stands at about 45.4, for reference here are the current PE ratios for some of the largest U.S.-based tech companies.
Amazon: 89.68
Google: 19.16
Tesla: 44.49
Microsoft: 26.7
Netflix: 36.97
In the Financial tech sector many of the largest companies, such as Sofi and Block, actually have negative PE ratios currently, meaning the companies aren’t even profitable. This makes Ethereum look like a superior asset to own in the financial innovations space because it, in fact, has stronger fundamentals than stocks in the same industry, not to mention it’s on the cutting edge of innovation in the industry which = much more upside potential.
So where is all of this revenue coming from?
These are the top 9 revenue-generating assets and protocols on the Network in the last year and a half roughly.
One trend to note is that a significant portion of Ethereum revenue comes from NFT transactions, which lines up Ethereum for an even stronger and more sustainable comeback of the NFT market will be a huge revenue generator. Ideally, the next big wave of NFTs will be (in the majority) real use cases as opposed to wild speculation such as the last NFT market bubble.
Revenue, while great, is mostly a byproduct of the other fundamental stat that we believe is the real kicker when looking at evaluating Ethereum or any blockchain for that matter. That stat is users.
Like with any network, what we really want to watch is user growth.
Currently, daily active addresses have fallen a bit over the last year or so, as expected, which explains the loss in revenue. That being said, daily active users are still far above the levels of the previous crypto bear market and are positive from 2020 which is what we’re really looking for.
Metcalfe’s Law
So we’ve looked at PE ratio, ETH tokenomics, all of which look relatively strong. The next way to evaluate blockchains that we’ll look at was actually created as a way to value the original networks such as the phone and ethernet. This valuation model is called Metcalfe’s law.
Metcalfe’s Law was developed as a way to explain the value of entire networks of “compatible communicating devices” such as phones, ethernet, fax machines etc… The theory is that for every compatible device added to the network, the number of unique connections grows.
Applying this model to blockchains proves to be extremely accurate historically, and looking at it in the context of the last few years it also gives us an idea of when the price could be over or undervalued based on a significant widening of the correlation between the two.
A perfect example of this is the 2021 market. You can clearly see that Ethereum was overvalued in the second half of 2022, which in hindsight we know to be true due to the amount of hidden leverage there was in the DeFi ecosystem that was also propping up ETH.
The total correlation coefficient of Metcalfe’s law and ETHs market cap is .85
The total correlation coefficient of the Natural Log of the two is even higher at .95 here’s a look at that chart.
The other Key fundamentals that show network economic value are Total Value Locked (TVL) and Total Value Secured (TVS)
Total Value Locked shows the amount of value locked in protocols on the Ethereum network. Currently, Ethereum has almost $28 Billion dollars in value locked in protocols on the network resulting in a 6.3 price to TVL ratio.
Total Value Secured is an even better representation of economic value, this is total asset value being secured by the Ethereum network.
The Ethereum Network is currently securing $450 Billion of value, almost $100 billion of which is Bitcoin, USD, and Gold equivalent assets.
Future Expectations that will Affect Ethereum
Stablecoin Activity
- 2022 Fidelity and BlackRock, who manage collectively around $14T in wealth, invested in a $400 million funding round into Fintech company and USDC issuer circle.
- Blackrock has also become a strategic partner with circle.
- According to a letter from prof of legal studies at Wharton, Kevin Werbach, to the federal reserve, regarding crypto regulation, Circle projected that USDC total assets would be $190B in FY2023.
- Current total stablecoin supply, according to data from the block, is $137B.
- Current total supply on ethereum, according to the block, is $99B.
- According to Business Insider, the total stablecoin market is projected to be $1T in 2025.
Our Outlook
We believe that a huge yet not as well known usage inflow for Ethereum, especially in the shorter term, will be the massive increase in stablecoin asset values and volumes.
With a reported projection of 10x increase in stablecoin values in the next few years and much of that volume likely being in the Ethereum ecosystem, we are very bullish on this source of user growth and revenue for Ethereum, especially since the largest institutions in the world are already positioning themselves for this to happen.
Regulation
Piggybacking off stablecoin increased values and volumes, regulation will also have an impact on moving this market forward.
Coming stablecoin regulations will enhance trust allowing institutions and individuals to increase usage of stablecoins for more efficient and cost-effective settlements and participation in the decentralized finance landscape.
The other regulation that we’re looking forward to will be the coming crypto asset regulations, which will likely get signed into law after a stablecoin bill gets passed.
Unfortunately, the United States has not been overly friendly to crypto since the collapse of FTX. This may delay positive action in getting regulation passed, however we still believe there will be regulation passed, slow as it may be.
Meanwhile many other countries are working on fostering crypto friendly environments, so the issues in the United States aren’t overly concerning in our view.
The coming regulations of the broader crypto asset class will better classify and regulate digital assets enabling user and investor trust in digital assets and DeFi, this will significantly increase usage and investment into the space.