Ethereum: taking stock after ten years

Since the publication of the white paper back in 2013, Ethereum has been on a remarkable journey, starting with its IPO in 2014 and it subsequently establishing itself as one of the most important blockchain platforms with the official network launch in 2015. As a pioneer for smart contracts and decentralised applications, Ethereum has driven considerable innovation, including in connection with project financing through ICOs, on-chain culture through NFTs and financial infrastructure through DeFi.

However, Ethereum’s tenth birthday also provides an opportunity to contemplate its future and where its journey might take it next. What specific use cases are really fit for the future? Has Ethereum lost its position as digital base money to Bitcoin for good? And what impact will the increasing competition from alternative layer-1 blockchains like Solana have in the medium term?

A Hub for developers

Ethereum is and remains the blockchain with the most developers. According to the latest surveys, some 2,788 full-time developers are working on Ethereum, many more than are working on Solana (664), Bitcoin (358) and Cardano (217). Although the number of monthly active developers has declined since the summer of 2022, it still stands at a comparatively high level.

_{In June 2022, Ethereum had more than 12,000 active monthly developers (full and part-time), while today there are just under 9,000. The number of monthly contributions also remains well below the peak. Source: Developerreport.com}

In addition to the activity of the developers, the high number of researchers is a further aspect that stands out with Ethereum. Since 2019, the number of scientists working on Ethereum has increased by 1,500%. While some view this consolidated intelligence as a clear advantage for Ethereum, others warn that too many cooks could spoil the broth. What is undisputed, however, is that Ethereum, as an open, licence-free and decentralised network, still boasts the most brainpower.

Use cases for the real world?

But are these developers also developing useful applications on Ethereum? There are certainly critical voices in this regard. Although DeFi applications such as MakerDAO, Uniswap, Aave, Lido Finance and the like are now achieving considerable volumes and even generating regular income, a large part of this “economic” activity remains highly self-referential in nature.

One of the critics expressing this view is probably the most prominent co-founder of Ethereum, Vitalik Buterin himself. He describes this self-referentiality of many Ethereum use cases as reminiscent of an ouroboros – an image depicting a dragon biting its own tail. It thus refers to a cycle in which the applications chiefly operate within their own system without creating any real external benefit.

Even though there are certainly exceptions (e.g. BlackRock or Sony), as an external observer of Ethereum, even now in 2024 it is difficult to escape the impression that the primary use case of many Ethereum dApps is still not to provide successful services for non-crypto companies. Instead, these dApps primarily serve crypto platforms that focus on the trading, lending, borrowing and leveraging of crypto tokens. It is this that gives rise to the circular speculation that is criticised by Vitalik and others and which has no tangible reference to the real world.

As described in one of our most recent articles, we expect that this will change in the medium term. After all, Ethereum is increasingly becoming the basic infrastructure for the tokenisation of real assets of all kinds. As such, it is being integrated into the existing world, a development that should make Ethereum and its applications fit for the future.

The competition never sleeps

It goes without saying that Ethereum, which remains the biggest platform for smart contracts, is not only battling to achieve sustainable adaptation in the real world alongside non-crypto companies, but is also competing with many other layer-1 blockchains.

_{Total app capital (TAC) measures the capital and not the DeFi activity. Source: X}

At present, most of the application capital is on Ethereum. However, a comparison of different on-chain metrics reveals that other layer-1 blockchains have long since been able to keep pace with Ethereum in some areas. With 3.3 million daily active addresses for Solana and 2.1 million for Tron, these two blockchains are well ahead of Ethereum, which has only around 343,000 active addresses. Solana has also surpassed Ethereum several times in terms of DEX trading volume, while Tron stands out in terms of fees and collected revenue, mainly because a large share of global stablecoin transfers is processed via the Tron blockchain.

_{At the start of September, Tron generated USD 2.1 million in fees. Ethereum, by comparison, raised USD 1.8 million, while Solana generated almost USD 600,000. Source: Artemis}

Ethereum scales – but at what price?

A comparison of Ethereum with other layer-1 block chains that focusses exclusively on Ethereum is actually incomplete, as Ethereum is inextricably linked to a larger layer-2 ecosystem. Projects such as Arbitrum, Optimism and many other layer-2 blockchains make up an integral part of the Ethereum roadmap and therefore have to be viewed as a component of the overall Ethereum ecosystem. So if you count these scaling solutions as part of Ethereum and compare them to other layer blockchains, the overall Ethereum ecosystem is of course many times bigger.

The many layer 2s have actually increased the scalability of Ethereum. Updates such as the Dencun upgrade, which was implemented in March, have successfully reduced the transaction costs in the Ethereum layer-2 networks. In some cases, expectations have even been exceeded. The transaction fees in the layer-2 networks have dropped by a factor of ten or more. Prior to the introduction of Dencun, fees in layer-2 blockchains typically stood at between USD 0.10 and USD 0.30 per transaction. Following the upgrade, it has been shown that these fees for many scaling solutions are now less than USD 0.01.

The decline in layer-2 transaction fees has therefore given rise to increased activity in these networks, with both the number of daily transactions and the number of active users having increased (see Figure 4). In total, there are already 73 layer-2 solutions, with a further 83 in development.

_{90% of all Ethereum transactions now take place on L2 blockchains. Source: L2beat.com}

However, the increased level of scalability provided by layer-2 technologies has also taken its toll: demand for Ether as a transaction currency in the Ethereum network has fallen markedly. This drop in demand has resulted in a fall in transaction fees for Ethereum. And with this decline, the amount of Ether burned via the burn mechanism introduced with EIP-1559 has also decreased.

The drop in the amount of Ether being burnt at this time is so significant that it cannot compensate for the amount of new Ether currently being created, meaning that Ethereum now finds itself in inflationary territory once more. For example, on an annualised basis, Ethereum’s inflation stands at around 0.7% and thus only a few basis points beneath Bitcoin’s current rate of inflation. While it is true that this level of inflation is still orders of magnitude lower than those of layer-1 blockchains such as Solana, Avalanche and the like, non-stakers are currently no longer compensated via the burn mechanism. Ethereum is thus no longer the ultra-solid money that the Ethereum community propagated just a few years ago.

Caution despite Ethereum ETFs

The current deterioration of tokenomics, especially in light of the deflationary downtrend of Ether, is likely to be one of the main reasons why some investors have adopted a critical stance towards the crypto asset and its price has stalled. This fact is also unlikely to have escaped the attention of traditional investors. After all, Ethereum is repeatedly referred to as a “tech play”. Those who invest in Ether are placing their bets on the future of a decentralised, open and licence-free app store for blockchain applications.

At the same time, however, this exciting narrative also means that Ethereum is increasingly being assessed according to traditional valuation metrics such as the price/sales ratio (PSR). If you compare the PSR of Ethereum with those of the major tech giants, it becomes clear that Ethereum currently appears overvalued. While Ethereum has a PSR of almost 800, Apple's PSR stands at 8.78, Microsoft’s at 12.4 and Nvidia's at 33.2. In light of these figures, it comes as no surprise that traditional investors are showing little interest in Ethereum ETFs at the current price. It of course doesn't help that they don't have a staking component.

However, Ethereum ETFs have not been completely without success to date. The iShares Ethereum Trust ETF, for example, is one of this year’s ten most successful ETFs and already manages in excess of USD 1 billion. Nevertheless, capital flows across all Ethereum ETFs are negative with a current net outflow of USD 562 million, a fact that can primarily be attributed to the considerable outflows from the Grayscale product (ETHE).

_{An overview of Ethereum ETF money flows during the past two weeks (as at 5 September 2024). Source: Farside}

What next?

The growth, attention and trading volume that Ethereum has achieved during the past decade are impressive. It is also inevitable that such a complex system with so many different moving parts will always find itself faced with challenges.

One way in which Ether could become more attractive again as an asset and, at the same time, ensure its multi-layer scalability would be through a closer financial link with its layer-2 blockchains. The Ethereum Foundation, for example, could launch a DAO-led consortium that ensures that value-adding layer-2 solutions pay higher fees to the Ethereum network. A further possibility would be to optimise the fee market that connects layer 2s with Ethereum from an economic perspective and make it more profitable.

It is precisely these challenges that make Ethereum one of the most fascinating phenomena in the blockchain world – and a project whose future still holds a great deal of potential.

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Editorial deadline: 10 September 2024

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