Under the rapid expansion of Layer 2, Ethereum has been less eroded than expected.
Original author: Jamie Coutts CMT, Bloomberg Intelligence cryptocurrency analyst
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I am increasingly convinced that Ethereum has the potential to create more value than alternative L1, mainly for two reasons:
L2 is adopted in rapid growth
L1 erosion is lower than expected
In this tweet, I will briefly analyze the dynamic changes in the fundamentals of the Ethereum network.
The smooth price fluctuations of ETH conceal its value accumulation.
Under the promotion of L2 growth and slight monetary tightening, the price of Ethereum has returned to a growth trajectory
Although it is a bear market, ETH has entered a deflationary state (the pre-merger inflation rate exceeds 4%)
Although network activity has cooled down, ETH staking has increased by 38% in the past 3 months
L1 network adoption
The ambition of Ethereum to extend the network through L2 Rollup is very obvious in the on-chain data. Although L1 activity declined last year, ETH utilization increased, and the network’s financial condition is also booming.
Compared with a year ago, the number of active L1 addresses has decreased by 37% to 379,000, but the number of active ERC-20 addresses has increased by 27%. Smart contracts lock up 31% of the total supply of ETH (most of which comes from staking), and the overall utilization rate of ETH has increased.
The on-chain transaction value (in USD) has decreased by 30% compared to a year ago, while the price of ETH has risen by 8%. Considering that on-chain transfers are now cheaper and faster on L2, this decline is not surprising.
Despite the decline in network activity, investors still show positive hoarding behavior. The number of non-zero balance addresses exceeds 100 million, and the number of wallet addresses containing at least 1 ETH exceeds 1.7 million.
Fee income growth exceeds price growth
From a two-year cycle perspective, Ethereum network activity has declined, and the Ethereum economy bottomed out in the fourth quarter of 2022 and recovered at the same speed as the new bull market cycle. As expected, the rapid growth of L2 has eroded the network activity of L1, but the impact on network finances is not as great as expected.
Although the network fee income (in USD) has decreased significantly compared to 2021, it has increased three times compared to the low point in the fourth quarter of 2022. L1 generates about $6 million in fee income per day, of which 80% is burned and the rest is paid to validators.
Since the beginning of this year, Ethereum L1’s daily fee income (in USD) has increased by 176%, while the price of ETH has only increased by 53%. The relationship between the two is inspiring, as fees exceeded prices (referring to the increase in fees exceeding the increase in prices) in the previous bull market after two years of decline in fees in 2020.
Using the analogy of a national state, L1 provides infrastructure (roads, communication) and security (property rights) for economic special zones or city-states (L2) to establish and compete for business capital (decentralized applications).
Operating in these places means lower taxes (fees) and the complexities of national institutions (ETH validators), reducing friction for applications and providing cheaper and faster customer service.
L2 Network Adoption Metrics
It has been proven that Ethereum’s migration to L2 last year was a great success. In the past 12 months, hundreds of thousands of new users have joined Web3, and L2 active addresses have increased by 245%.
The growth of L2 fees (an average of $600,000 per day) helps to slow down the erosion of L1 income, but more importantly, L2 is amplifying network effects.
Given the rapid increase in L2 adoption rates, by the end of the year, L1 fees paid through Rollup may account for 20% of total fees, and may reach 50% within 3 years. In classified data, the proportion of fees paid to L1 through Rollup this year has increased 2.8 times, slightly below 14%.
One consequence of L2 growth is a significant decrease in NFT activity on L1, as the lower friction costs of L2 NFT markets win users over. The proportion of fees paid for NFTs has decreased by 80%, currently slightly below 6%.
As a leading L1, Ethereum has performed very strongly. Under the rapid expansion of L2, Ethereum’s degree of erosion is much lower than our previous expectations, and its moat is continuously deepening and widening.