Grayscale: How Ethereum maintains pricing power by executing scaling strategies

Source: Grayscale; Compilation: Wuzhu, bitchain vision

• The smart contract platform is the core infrastructure of decentralized applications and blockchain finance.Therefore, they are crucial to the public chain’s vision of providing a completely new architecture for financial markets and digital commerce.

• Grayscale Research believes that smart contract-based applications will accelerate their popularity in the next 1-2 years, partly due to changes in U.S. regulatory regulations and upcoming legislation.

• Ethereum is the largest smart contract platform, and its measurements include: (i) market capitalization; (ii) the size of the application ecosystem and developer community; and (iii) the value of on-chain assets.However, Ethereum has recently lagged behind competitors such as Solana in terms of fees and other on-chain activity metrics.

• We believe that even if some newer blockchains are beginning to gain popularity and occupy market share, Ethereum’s differentiated characteristics, including a culture that emphasizes decentralization, security and neutrality, will also help it continue to occupy a large share of users, developers and transaction fees in the cryptocurrency space of smart contract platform.Therefore, Ethereum should be regarded as an integral part of a diversified cryptocurrency portfolio.

• The outlook for smart contract platform fees is highly uncertain, partly because we don’t know how much pricing power a platform like Ethereum can maintain in the long run.However, Grayscale Research shows in this report how Ethereum can increase its total expenses from $1.7 billion annualized to more than $20 billion by implementing its scaling strategy.

Like Linux, Python, and some other open source software projects, Ethereum is arguably one of the most important open source software projects ever.Despite being less than 10 years old, the Ethereum network now has more than 11,000 nodes, processing between 35 and 40 million transactions per month, guaranteeing about $46 billion in transaction value, and benefiting from the support of more than 2,100 full-time developers.The broader Ethereum ecosystem composed of connected blockchains currently processes approximately 400 million transactions per month.[1]

Although Ethereum has a strong position in the cryptocurrency industry and launched its spot exchange-traded product (ETP) last year, its online token Ethereum (ETH) has a market capitalization far behind Bitcoin (BTC).In fact, the price ratio of ETH/BTC has fallen back to its level since mid-2020 (Figure 1).In terms of market cap, Ethereum’s market cap has increased by about $90 million since the end of 2022, while Bitcoin’s market cap has increased by about $1.35 trillion (i.e., about 15 times).[2] Ethereum has also performed worse than tokens from some other smart contract platforms, including Solana and Sui.

Figure 1: Ethereum has lagged behind Bitcoin for more than two years

The ongoing downturn has led some observers to question the prospects of Ethereum network activity and the value of Ethereum.Although there is uncertainty about the prospects of each crypto asset, we still believe thatEthereum should be seen as an integral part of a diversified crypto portfolio.

Ethereum and Bitcoin are not directly comparable.The Bitcoin network is a monetary system, and Bitcoin assets are mainly used as a medium of transactions and a means of store of value.Therefore, it belongs to the Grayscale Currency Crypto sector.Bitcoin’s relatively strong price returns reflect investors’ demand for its scarcity and censorship-resistant digital currency attributes.

By contrast, Ethereum is an application platform that provides practical features to users of these applications.Ethereum, along with Solana, Stacks, Sui and many other networks, belongs to the Grayscale Smart Contract Platform Encryption Section.Despite the bright prospects of smart contract technology, we have not seen large-scale adoption of decentralized applications based on smart contracts.While there are many early success stories—including the growth of stablecoin transactions—the current adoption rate is very low compared to the vision of smart contract platforms aiming to bring most traditional financial businesses to the chain.

Grayscale Research believes thatSmart contract-based applications will accelerate their popularity in the next 1-2 years, partly due to changes in U.S. regulatory regulations and upcoming legislation.The Trump administration has made changes to federal cryptocurrency policy, which will help the industry invest and thrive in the United States.[3] In addition, a bipartisan senator group proposed the Innovation Act for Guiding and Establishing the United States Stablecoin National (GENIUS).The bill is based on relevant efforts by the previous Congress to provide a comprehensive regulatory framework for the issuance of payment stablecoins.Clearer regulatory provisions will help increase investment and popularity of blockchain-based applications, thereby increasing on-chain activity (such as transactions and fees) and ultimately increasing the value of smart contract platform tokens.

After initially taking the lead, Ethereum now faces fierce competition from other smart contract platforms, and it needs to execute ambitious development plans to succeed.But Ethereum also has some differentiated features that we expect are particularly important for financial use cases—including a large on-chain pool and design choices that emphasize decentralization and neutrality.Therefore, we expect Ethereum to occupy a considerable share of future on-chain activity, which in turn will drive the value of Ethereum.

Everything is a “computer”

Ethereum is the first major smart contract platform blockchain.Like Bitcoin, the Ethereum blockchain can be used to send and receive transactions.However, with the addition of smart contracts, Ethereum can also run decentralized applications.These applications can be any kind, from decentralized lending platforms to identity solutions to video games.[4] Since Ethereum acts as the infrastructure for applications, it can be regarded as a software-based computer, sometimes referred to as a “world computer.”

Today, Ethereum hosts thousands of applications and is the most valuable asset in our smart contract platform cryptocurrency sector.Ethereum has more on-chain assets (such as stablecoins and tokenized assets) than other leading smart contract blockchains, but its on-chain activity lags behind some other blockchains recently (Figure 2).Solana is the second-ranked network with higher active addresses, transaction volume and fees over the past 30 days, but its market cap is only 30% of Ethereum.

Figure 2: Ethereum is the smart contract platform with the largest market value

The investment philosophy of smart contract platforms is that new applications will bring more users, more transactions, and ultimately increase the fees of the underlying agreement.We estimate that the transaction volume of smart contract platforms has grown from about 20 transactions per second (TPS) five years ago to about 1,200 transactions today, with an annualized growth rate of about 130% (Figure 3).By comparison, Visa Network processed approximately 7,400 transactions in the 12 months ended September 30, 2024.[5] If the share of smart contract blockchains in digital payments can continue to grow, and can establish competitive barriers and maintain pricing power, this will lead to an increase in fee income and may push up the token price.

Figure 3: Smart Contract Blockchain processes approximately 1,200 transactions per second

According to the FTSE/Grayscale Smart Contract Platform Cryptocurrency Industry Index (Figure 4), Ethereum’s performance is basically consistent with its similar currencies.The market segment currently contains 70 tokens with a total market value of US$428 billion.[6] Since the beginning of 2024, the smart contract platform index has fallen by 22%, while Ethereum’s price has fallen by 18%.By comparison, Solana’s price rose 18% and Bitcoin’s price rose 90%.

Figure 4: Ethereum’s performance is roughly consistent with its market performance

How to make money on Ethereum

Ethereum monetizes network activity through transaction fees (i.e., “Gas fees”), which are the fees required to execute transactions or interact with smart contracts.Unlike Solana and many other blockchains, activity in the Ethereum ecosystem occurs simultaneously on the Ethereum mainnet Layer 1 (L1) and a series of Layer 2 (L2) networks.Ethereum plans to scale to millions of users in this way, because Layer 1 itself cannot fully scale capacity without sacrificing decentralization.If this hierarchical structure can operate in a coordinated manner, it should be able to provide users with high throughput and low-cost Layer 2 transaction options, while retaining Layer 1’s security and decentralization.However, the migration of the activity to Layer 2 affects the level of fee allocation across the network, which we will explain below.

The Gas fees for Ethereum Layer1 and Layer2 networks differ in structure, reflecting their different roles in protocol scaling strategies.The Ethereum Layer1 fee model contains three different components: [7]

• Gas Unit:Fixed calculated costs for certain operations (e.g., ETH transfers require 21,000 Gas).

• Basic fees:The payment amount for all transactions is in Gwei per unit of Gas (1 Gwei equals one billionth of ETH).The basic expenses will be adjusted through algorithms according to the needs of each block.

• Priority Fees (“tip”):Optional fees for priority execution of transactions.

For example, a transfer of 1 ETH (requires 21,000 gas) is 10 gwei and a tip of 2 gwei, which is:

=21,000*(10+2)=252,000 gwei or 0.000252 ETH

Trading fees add value to token holders through mechanisms similar to stock market dividends and buybacks.The priority fee is paid to the validator as part of the pledge reward, similar to a dividend.The base fee will be destroyed to reduce the supply of ETH and reward all token holders, similar to a buyback.(Figure 5)

Chart 5: Fees are allocated to token holders through pledge rewards and destruction

The Layer 2 networks such as Arbitrum One and Base also charge transaction fees.Because they rely on the Ethereum Layer 1 network for final settlement and security, Layer 2 is able to charge lower transaction fees and process more transactions per second.However, Layer 2 will transfer some of the fees to Layer 1 as payment for settlement and security services.Last year, Ethereum underwent a hard fork (network update) called Dencun, aiming to expand the Layer 2 ecosystem.The Dencun upgrade introduces blob[8] transactions, a way to let Layer 2 publish data to Layer 1 at a low cost.This upgrade has significantly increased the number of users and transactions on Layer 2 (Figure 6).

Figure 6: Ethereum L2 layer activity growth significantly

However, the introduction of blob transactions also affects the fee level and allocation of the entire network.Most importantly, the blob transaction reduces the fees paid by Layer-2 to Layer-1 (Figure 7).This led some observers to believe that Layer-2 is the “parasite” of Ethereum.Because in the short term, Layer-2’s success comes at the expense of Layer-1.But if Layer-2 can benefit from staying in the Ethereum ecosystem—such as security and other network effects—then a huge Layer-2 ecosystem will ultimately bring greater value to the Ethereum network and ETH in the long run.

Figure 7: Ethereum L2 pays less to L1

Future upgrades will continue to expand the L1 and L2 layers.The Pectra upgrade is scheduled to take place in April 2025 and will combine enhanced capabilities from Prague (execution layer) and Electra (consensus layer).In terms of scalability, Ethereum improvement proposal 7691 optimizes blob storage with the goal of 6 blobs per block, doubles the blob capacity of Dencun.Looking ahead, Ethereum’s expansion potential may increase significantly with the implementation of the concept of “full Danksharding” (see Figure 8).[9] This upgrade will simultaneously expand the number of blobs per block and the size of each blob, thereby greatly increasing the upper limit of TPS.Figure 8 shows that Pectra and full Danksharding may affect transaction capacity at Ethereum L2 layer.

Figure 8: Ethereum upgrade will significantly increase L2 capacity in the future

The prospect of Ethereum fees

The outlook for smart contract platform fees is highly uncertain, partly because the technology is still in its early stages and we are not sure how much pricing power a platform like Ethereum can maintain over the long term.Smart contract platforms compete with each other and also compete with centralized systems.To maintain pricing power for the long term, they need to provide differentiated features to prevent users from moving to cheaper (centralized or decentralized) alternatives.Although the Ethereum blockchain is slower and more costly than many competitors, Grayscale Research believes its unique advantages—including high-value on-chain assets and the emphasis on decentralization and security—will help increase adoption and network effects, and ultimately provide Ethereum with some pricing power over time.

Figure 9 shows an example of how Ethereum can increase fees by increasing capacity and maintaining pricing power.We assume that the average transaction fee for Layer-1 is $5.00, while the average transaction fee since 2019 is $6.30.[10]In the long run, Layer 1 will probably be mainly used for high-value transactions and transactions with high security requirements.For Layer 2, we assume that the average transaction fee is $0.05, which is similar to recent experience.We further assume that Ethereum Layer 1 processes 100 transactions per second, while Ethereum Layer 2 processes 25,000 transactions per second.These are hypothetical TPS predictions, guided by the Ethereum expansion roadmap, and assuming that the overall demand for smart contract-based applications has increased significantly, will be achievable within the next 3-5 years.[11]

According to these assumptions,Total transaction fees for Ethereum Layer 1 will grow from an annualized growth rate of approximately $1.7 billion to over $20 billion in the past six months(Figure 9).Although the prospects for transaction fees are highly uncertain, if Ethereum can implement its scaling strategy and maintain a certain pricing power, it should technically be able to significantly increase transaction fees revenue.To monitor progress, investors should consider tracking fundamental variables in this simplified model—i.e., the TPS for Layer 1 and Layer 2 and the average execution fee for Layer 1 and Layer 2.[12]

Figure 9: Ethereum fee revenue can grow with capacity expansion and pricing power

Making a big cake

In the last cryptocurrency bull market, Bitcoin and Ethereum initially rose simultaneously.However, by 2021, Ethereum’s price has risen faster, eventually achieving a price return of about twice that of Bitcoin during the market peak from early 2019 to November 2021 (Figure 10).Some cryptocurrency investors may have been ready for a similar pattern in the current cycle—Ethereum will significantly outperform other cryptocurrencies as the cycle matures—but they are disappointed by its recent weak performance.

Figure 10: Ethereum ultimately outperformed Bitcoin in the last cryptocurrency cycle

Grayscale Research believes that the poor performance of Ethereum is a healthy signal that the cryptocurrency market is focused on fundamentals.In our analytical framework,The cryptocurrency market mainly distinguishes smart contract platforms based on fees.[13] Although fees are not exactly the same way among different blockchains convert to token value, they are usually passed on to token holders, and fees are arguably the most direct comparable metric for measuring blockchain activity.

In the cryptocurrency space of smart contract platform, Ethereum and Solana have relatively high fees and market capitalization (Figure 11).Since the end of 2023, Solana’s fee revenue and market share in the cryptocurrency sector of smart contract platform have increased, while Ethereum’s fee revenue and market capitalization have decreased.In other words, the market has properly repriced the relative value of Ethereum and Solana due to changes in fundamentals.In the simple framework shown in Figure 11, Solana’s price moves up and to the right, and it now appears that the valuation is roughly reasonable (“has grown to its valuation level”).By contrast, Ethereum’s price moves down and left, and now its valuation may be higher than its expense income.

Figure 11: Ethereum is underperforming Solana due to weaker fee growth

These subtle differences in competitive positions are important, but their importance is far less than the potential growth of the entire category.The popularity of all smart contract platforms is in an early stage.For example, Ethereum currently has only about 7 million monthly active users, while Facebook parent company Meta Platforms reported that as of December 2024, its app had 3.35 billion “daily active users”.[14] With the increase in penetration rate, smart contract platforms are expected to benefit from the compound network effect.Increased participation will not only drive the increase in transaction volume and fee revenue, but will also accelerate developer activities, liquidity depth, and interoperability across ecosystems.This cycle of popularity and practicality can amplify the acquisition of value across the category.

The ultimate winning networks are likely those that receive the highest transaction fees over time and their native tokens have good structural supply and demand conditions (e.g., due to limited supply growth and structural demand as collateral assets or payment mediums).Solana, Sui and some other smart contract platforms will stand out from competitors with high throughput, low transaction costs and generally excellent user experience.Ethereum stands out with its huge and diverse application and developer ecosystem, a large amount of on-chain capital, and a culture that prioritizes decentralization, security and neutrality.We expect these features to continue to attract a large number of users to join the Ethereum ecosystem and believe that Ethereum will occupy a significant share of the economic activity of the smart contract platform blockchain in the future.

Comments

[1] Source: Nodewatch.io, Artemis, DeFi Llama, Electric Capital, Grayscale Investments.All data are as of March 17, 2025 except the number of developers as of November 2024.The total ecosystem transaction volume covers the following L2: Base, Arbitrum One, OP Mainnet, ZKsync Era, Starknet, Blast, Linea, Scroll and World Chain.

[2] Source: Artemis, Grayscale Investments.Data as of March 17, 2025.

[3] For more information, see Grayscale.com’s January 2025: U.S. Crypto Policy Reshaping is in Progress and February 2025: Progress, Dilemma and Opportunities.‍‌‍‌‌‌‌‌‌‌‌‍‌‍‌

[4] For more background information, see “The Current Situation of Ethereum and Layer 1 Blockchain: The Story of User Owning a City” (Part 1 and Part 2), Grayscale.com

[5] Source: Visa 2024 Annual Report, Grayscale Investments.Visa processed 233.8 billion transactions, about 7400 per second in its fiscal year.

[6] Source: FTSE Russell Index, Artemis, Grayscale Investments.Data as of March 17, 2025.

[7] Market News: Merger, September 24, 2022, Grayscale.com.

[8] Ethereum Blob is a temporary data storage unit (retention time is about 18 days), which the Layer 2 network uses to efficiently batch process off-chain transaction data while taking advantage of Ethereum’s security, which can reduce fees by about 90% compared to permanent on-chain storage.

[9] Danksharding, Ethereum Roadmap, Ethereum.org.

[10] Source: Coin Metrics, Grayscale Investments.Data as of March 15, 2025.

[11] The TPS hypothesis is not the theoretical maximum.

[12] Layer 2’s operating margin, i.e. the share of execution expenses retained by Layer, may also change in the future, but this is beyond the scope of this report’s discussion.

[13] In this report, we exclude discussion of “currency premium” (if any) in token valuation.See “The War of Value of Smart Contract Platforms”, Grayscale.com.

[14] Source: Token Terminal; Meta Reports 2024 Fourth Quarter and Full Year Results, Meta Investor Relations.