Bloomberg Analyst Layer 2 Siege Strategy Strengthens Ethereum’s King of Public Chains Throne

Author: Jamie Coutts CMT, Bloomberg Intelligence Cryptocurrency Analyst

Translation: Luffy, Foresight News

I am increasingly convinced that Ethereum has the potential to create more value than substitute L1, for two main reasons:

  • L2 is growing rapidly
  • L1 is being eroded less 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.

  • Driven by L2 growth and slight monetary tightening, the Ethereum price has returned to a growth trajectory
  • Despite being in a bear market, ETH has entered a deflationary state (pre-merge inflation rate exceeds 4%)
  • Despite the cooling of network activity, 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 evident in on-chain data. Although L1 activity declined last year, ETH utilization increased, and the network’s financial condition is also thriving.

Compared to 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 ETH supply (most of which comes from staking), and the overall ETH utilization has improved.

The on-chain transaction value (measured in USD) has decreased by 30% compared to a year ago, while the ETH price 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

Looking at the two-year cycle, Ethereum network activity has declined, and the Ethereum economy hit bottom in the fourth quarter of 2022 and rebounded at the same pace as the recovery of 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 significant as expected.

The revenue from network fees (in USD) has decreased significantly compared to 2021, but it has increased threefold compared to the lowest point in the fourth quarter of 2022. L1 generates approximately $6 million in revenue from fees per day, 80% of which is burned, and the rest is paid to validators.

Since the beginning of this year, Ethereum’s L1 daily fee revenue (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 nation-state, L1 provides infrastructure (roads, communications) and security (property rights) for economic special zones or city-states (L2) to establish and compete for commercial capital (decentralized applications).

Operating in these places means lower taxes (fees) and less bureaucracy from government 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 has been a huge 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 mitigate the erosion of L1 revenue, but more importantly, L2 is amplifying network effects.

Given the rapid rise in L2 adoption, by the end of the year, L1 fees paid through Rollup could account for 20% of total fees and reach 50% within 3 years. In categorized data, the proportion of fees paid to L1 through Rollup this year has increased 2.8 times, slightly below 14%.

One of the consequences of L2 growth is a significant decrease in NFT activity on L1, as the lower friction costs of L2 NFT markets attract users. The proportion of fees paid for NFTs has decreased by 80%, currently slightly below 6%.

Conclusion

As the leading L1, Ethereum has performed very strongly. Under the rapid expansion of L2, Ethereum’s level of erosion is much lower than our previous expectations, and its moat is continuously deepening and widening.

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