jakiro
Source: Grayscale; Compilation: Tao Zhu, Bitchain Vision
After the SEC approved a spot Ethereum exchange-traded product, some investors may want to learn more about the second-largest crypto asset.[1] Grayscale Research expects that new products may give more investors an idea of smart contracts and decentralized applications, thus understanding the potential of public blockchains to change digital commerce.Below we have compiled 10 common questions investors may ask about Ethereum, whether they want to understand the basics or deepen their understanding of the network and its ecosystem.
Q: What is the main difference between Bitcoin and Ethereum?How is Ethereum different from other assets in the cryptocurrency space of smart contract platform?
A: Bitcoin’s main purpose is currently used as a store of value, while Ethereum’s main purpose is to serve as a platform for decentralized applications.
In 2009, Bitcoin became the first public blockchain and the first investable blockchain token.Today, Bitcoin can be regarded as an asset and digital alternative to gold.In 2015, Ethereum applied the concept of public blockchain to smart contracts (self-executable computer code), creating a completely new category in the crypto asset class with a completely different use case than Bitcoin.
Ethereum can be compared to the decentralized version of the Apple App Store because it provides the basic platform for the construction of applications.These decentralized applications (dApps) range from financial applications to games to identity tools.Compared to Bitcoin, Ethereum currently allows for higher transaction throughput, lower average block time, and roughly the same user transaction fee level (Figure 1).
Chart 1: Comparison of Bitcoin and Ethereum
Since the main use cases of Ethereum and Bitcoin are completely different, they belong to different market segments in the framework of the Grayscale cryptocurrency industry.Bitcoin belongs to the currency cryptocurrency industry, while Ethereum belongs to the smart contract platform cryptocurrency industry, and there are many other industries.Ethereum is ahead of other assets in the industry in terms of basic metrics such as market cap, total locked value (TVL), and expense income (Figure 2).
Figure 2: Basic information of smart contract platforms with market value rankings
Q: How much will the supply of Ethereum (ETH) [2] increase, and what determines the issuance rate?
A: Since the transition to Proof of Stake (PoS) in 2022, the supply of ETH has remained largely unchanged.The issuance rate is determined by block rewards and transaction fees.
In 2022, Ethereum underwent a major upgrade, known as a “merger”, which included the transition from a Proof of Work (PoW) to a Proof of Stake (PoS) consensus mechanism.Before the merger, Ethereum supply has almost not changed since the merger and the shift to PoS (Figure 3).Like Bitcoin, limited ETH supply growth supports its value as a scarce digital asset.
Figure 3: ETH supply has remained largely unchanged since September 2022
ETH issuance is affected by block rewards and transaction fees.Block rewards are newly minted ETH assigned to validators, which contribute to inflation.Transaction fees or gas fees include a basic fee (deflation) and a priority fee (as a reward for validators) (the impact on inflation is neutral).
Q: What is the “gas” on the Ethereum network?What is Ethereum network fee income?How does it bring value to token holders?
Answer: Transaction fees on Ethereum are called “gas” and can be regarded as network revenue.Token holders earn revenue through mechanisms similar to equity dividends and buybacks.
Ethereum network fee income comes from gas, i.e. fees paid in ETH, used to execute transactions and use applications on the Ethereum network.Gas is necessary to help regulate network usage: without some type of transaction cost, the network can be overwhelmed by spam transactions.
Gas fees consist of two parts: basic fees and tips.Similar to stock buybacks, the basic expenses are “burned”.Remove the ETH supply from circulation.In this way, the increase in transaction volume can help all token holders benefit.Similar to equity dividends, tips are allocated to validators as rewards.However, the difference in this case is that validators help protect the network by processing transactions and maintaining the blockchain (Figure 4).
Figure 4: Ethereum supply dynamics achieved through destruction and staking
Gas fees are crucial to the operation of the Ethereum network because they provide financial incentives for validators and stakeholders to participate in cybersecurity.By directly linking network usage to the value of ETH, network fee income plays a key role in Ethereum’s value accumulation mechanism, benefiting token holders, validators and the entire network ecosystem.
Q: How attractive is Ethereum to developers built on the web?What is the largest application on Ethereum?
A: Ethereum is attractive to developers because of network effects and network security.Most of the largest decentralized applications (dApps) today have financial use cases.
Ethereum is attractive to developers who develop on its network for many reasons.First, Ethereum benefits from a larger network effect compared to other chains in the crypto space of Grayscale smart contract platform.Ethereum is leading the way in application count (around 4,700 decentralized applications in total) and has the largest developer community (about 580 developers per week), demonstrating the power of application interoperability and innovation.environment.[4] Ethereum also leads its competitors with a $54 billion TVL, a key indicator of ecosystem liquidity (Figure 5).[5] These advantages put Ethereum in a particularly advantageous position in retaining and attracting new developers.
Figure 5: Ethereum leads competitors in TVL (a key indicator of liquidity)
Ethereum is also an industry leader in cybersecurity, which we believe helps win the trust of users and developers.The theoretical cost of attacking the Ethereum network is prohibitive.For example, to control 51% of the network to perform a majority of attacks requires a lot of computing power and financial resources, so such attacks are not economically feasible.[6] An extensive network of decentralized nodes further helps enhance network security by ensuring redundancy and eliminating single points of failure.
The use cases for decentralized applications on Ethereum range from finance/tokenization to gaming and NFT.Applications built on Ethereum based on metrics such as user, fees, and TVL include Lido and Uniswap.Lido is a liquid staking solution that enables users to stake their ETH while maintaining liquidity by issuing derivative tokens (stETH).Uniswap is a decentralized exchange that enables peer-to-peer trading of various crypto assets without intermediaries.Both use Ethereum as the settlement layer, aiming to execute secure and decentralized transactions.
Q: Ethereum is a modular blockchain design. What does this mean?
A: Ethereum’s modular design means that different types of blockchain infrastructure (multiple software “layers”) work together to provide an end user experience.
Blockchain can be considered as a digital infrastructure.Just like infrastructure in the physical world, they also experience congestion.For example, in May 2022, congestion on the Ethereum network increased, resulting in an average daily gas fee of $196 for a single transaction.[7] When network congestion increases, gas fees can also rise, which can squeeze many types of network activity.Therefore, Ethereum pursues a modular (or layered) design philosophy where different types of blockchain infrastructure work together to provide an end-user experience.
Ethereum’s modular design divides the network into specialized parts such as execution (processing transactions), data availability (storing transaction data) and consensus (to ensure all transactions are valid).This approach allows targeted innovation and updates without damaging the entire network, allowing Ethereum to solve its scalability challenges while still keeping its network secure.
This design contrasts with Solana’s monolithic approach, where each feature (execution, data availability, and consensus) is processed in a single layer to optimize speed, efficiency, and consistency.
Q: What is Ethereum Layer 2?How do they connect to the Ethereum mainnet?
Answer: Ethereum Layer 2 is an expansion solution built on Ethereum that can execute transactions at a lower cost.
Since Ethereum adopts a modular design, it can separate transaction execution from transaction settlement.Therefore, Ethereum Layer 2 processes transactions, batches them together, and then sends the compressed version back to the main network (Ethereum main network or Layer 1) for settlement.Through this batch process, Layer 2 can provide users with higher throughput and lower costs compared to transactions executed on the main chain, while still relying on Ethereum’s network security.
Today, there are a wide variety of Layer 2 extension solutions, including Optimistic Rollups (such as Optimism and Arbitrum) and ZK Rollups (such as Starknet and ZkSync).From the perspective of blockchain activity, the Layer 2 network has significantly expanded the Ethereum ecosystem;Layer 2 now accounts for about two-thirds of the total activity of the Ethereum ecosystem (Figure 6).
Figure 6: Ethereum Layer 2 activity increases significantly
Layer 2 adoption can be attributed to Ethereum’s recent Dencun upgrade.With this upgrade in March 2024, Ethereum has significantly reduced its data costs by providing Layer 2 with specified storage space on the main network.This allows Layer 2 to reduce its transaction fees, and in some cases, Ethereum Layer 2 can be as affordable and accessible as Solana.
Q: How to reach a consensus on Ethereum and how to measure network security?
Answer: Ethereum reached a consensus through a proof of stake algorithm.Cybersecurity can be measured in different ways, including the value of staking ETH and the number of validators.
Initially, Ethereum reached a consensus through proof of work, similar to Bitcoin.However, in 2022, Ethereum will transition to the PoS network through a “merger” upgrade.The upgrade aims to improve network efficiency and scalability while reducing energy consumption by 99%.[8]
The PoS consensus used by Ethereum is different from PoW, which chooses who has the right to confirm the next block based on the value of the staked token, rather than through competition among miners.In the PoS consensus mechanism, the validator must stake in increments of 32 ETH to be eligible to confirm the block to receive the reward.[9]
Ethereum network security can be measured by the total amount of ETH staked on the network, and is currently worth $112 billion (Figure 7).This represents the economic commitment of the entire ecosystem to cybersecurity (also known as Ethereum’s security budget).Another measure is the number of validators, currently around 1 million, which reflects the decentralization of the Ethereum network.[10]
Figure 7: Cybersecurity measured by validator and staking value
Q: How is the ownership distribution of ETH holders?
Answer: As of mid-July 2024, ETH ownership can be divided into the following different categories: pledged ETH (27%), ETH in smart contracts (11%), dormant ETH (6%), and ETH held in ETP (~3%), ETH in vault bills (0.7%), and ETH used as gas per year (0.7%).For more details, see Figure 8.
Grayscale Research believes thatApproximately 17% of ETH supply can be classified as idle or relatively lack of liquidity.According to data analytics platform Allium, this includes about 6% of the ETH supply that has not moved in over five years, as well as about ‘locking’ in various smart contracts such as bridges, packed ETH and various other applications.11% ETH supply.In addition, 27% of ETH supply is pledged.
In addition to these categories, gas ETH used for online transactions is $2.7 billion per year.[11] This represents an additional 0.7% supply at current ETH price.There are also many agreements that hold a large amount of ETH in their vaults, including the Ethereum Foundation ($1 billion worth of ETH), Mantle (about $750 million ETH), and Golem (about $519 million ETH).[12] Overall, ETH in the protocol library accounts for approximately 0.7% of the supply.Finally, 3.4 million ETH (about 3% of the total supply) has been stored in ETH ETP.
Overall, these categories account for nearly 50% of the ETH supply (Figure 8), although categories overlap partially (e.g., ETH in the protocol library may be staked).
Figure 8: Pledged ETH accounts for a large proportion of the total ETH supply
Q: How much money is likely to flow into the US Ethereum ETP?
A: Grayscale Research estimates that the funds flowing into the U.S. Ethereum ETP may be about 25%-30% of Bitcoin ETP assets, or $3.5 billion to $4 billion in the first four months.
Outside the United States, both Bitcoin and Ethereum Exchange Trading Products (ETPs) have been listed, with assets in Ethereum ETP accounting for approximately 25%-30% of Bitcoin ETP assets (Figure 9).On this basis, Grayscale Research’s working assumption is that the net inflow of spot Ethereum ETP listed in the United States will reach 25%-30% of the net inflow of spot Bitcoin ETP so far, that is, about 3.5 billion in the first four months or soto US$4 billion (25%-30% of the net inflow of spot Bitcoin ETP since January).
Figure 9: Outside the United States, Ethereum ETP asset management scale accounts for 25%-30% of Bitcoin ETP asset management scale
Ethereum has a market capitalization of about one-third (33%) of Bitcoin’s market capitalization, so our assumptions mean that Ethereum’s net inflows may be slightly smaller in proportion to market capitalization.While we believe this is a reasonable working assumption, the estimates are uncertain, and there is a risk of higher or lower net inflows of spot Ethereum ETP listed in the United States.In the U.S. market, ETH futures-based ETP accounts for only about 5% of ETP assets based on BTC futures, although we believe this does not represent the relative demand for ETH ETP.
Q: What opportunities and challenges does Ethereum network face in the future?
Answer: Ethereum benefits from strong network effects and liquidity advantages.At the same time, it also faces certain challenges, including Layer 2 centralization and increasingly fierce competition from other smart contract platforms.
Ethereum benefits from several fundamental positives.Most importantly, Ethereum’s network effects and liquidity advantages make it conducive to retaining and attracting new developers, applications and users.Ethereum also generates the most network fee revenue of its kind (over $2 billion in 2023), demonstrating Ethereum’s maturity, its ability to monetize its user base, and its ability to attract validators and cybersecurity stakers.Advantages.Overall, Ethereum has the largest cybersecurity budget at 33 million ETH (currently worth $112 billion).This is especially important for use cases that require high-level security, such as stablecoins and tokenized financial assets.
Ethereum ETP can increase institutions’ willingness to hold ETH as an asset and adopt technology on the Ethereum blockchain.We have seen advancements in this regard, as the list of Wall Street companies that have built tokenized funds now includes Goldman Sachs and BlackRock, which is developing its BUIDL fund on Ethereum.[14]In addition to traditional finance, spot approval of Ethereum ETP may have an impact on the wider retail investors’ awareness of Ethereum, inflows of ETH assets, and adoption of the Ethereum network.
Meanwhile, Ethereum faces some challenges.For example, most Layer 2s are currently centralized.To fully realize its potential as a truly license-free decentralized ecosystem, Ethereum Layer 2 will need to be gradually decentralized over time.Additionally, network expense revenue from the Ethereum mainnet has recently declined as network activity transitions to Layer 2.This highlights the importance of Ethereum continuing to increase its expense revenue.This can be achieved through i) modest growth in Layer 1 activity, paying higher transaction costs, or ii) significant growth in Layer 2 activity, paying lower transaction costs.
Ethereum is facing increasingly fierce competition in the field of smart contract platform encryption.In order to maintain dominance in a highly competitive market segment, Ethereum will need to leverage its advantages to attract more users and increase expense revenue.
References
[1]CoinMarketCap as of July 22, 2024
[2]“ETH” refers to the native token on the Ethereum blockchain
[3]Coin Metrics
[4]Dapp RadarandArtemis
[5]Defi Llama
[6]Breaking BFT: Quantifying the Cost to Attack Bitcoin and Ethereum
[7]Bitinfocharts
[8]Forbes
[9]Ethereum.orgas of July 9th, 2024
[10]Beaconcha.in
[11]This reflects the amount of Ethereum used as gas in the transaction.This value is priced in ETH (see Figure 8).
[12]Defi Llama, as of 7/18/2024
[13]Artemis, as of July 22, 2024
[14]Coindesk
