Grayscale Research: Reasons for ETH’s poor performance in 2023

Source: Grayscale; Compiled by: Songxue, Golden Finance

• Ethernet in 2023 Bitcoin has performed strongly, but has underperformed relative to Bitcoin and some other smart contract blockchain tokens. We believe this reflectsBitcoin-specific positives this year and a slower recovery in Ethereum on-chain activity.

• Although the increase is not as high as that of Bitcoin, Ethereum has outperformed traditional asset classes this year on an absolute return and risk-adjusted basis. The development of the Ethereum L2 ecosystem may attract new users and support the token’s valuation in 2024.

While the asset is up 82%, you can hardly call it “underperforming,” but that’s exactly where Ethereum will be in 2023 The case of Ethereum (ETH). The second-largest crypto asset has produced strong returns (and relatively low price volatility) this year, but still has less room to appreciate than Bitcoin (BTC), which is expected to grow by 162% this year[2]. The ETH/BTC price ratio has declined throughout the year, reaching its lowest level since mid-2021 (Chart 1) [3]. Grayscale Research believes there are several reasons for ETH’s poor performance in 2023.

Chart 1: The ETH/BTC price ratio shows a downward trend in 2023

First of all, this year Several Bitcoin-specific positives are included, including potential spot Bitcoin ETF progress and instability at regional U.S. banks, highlighting Bitcoin’s role as an alternative digital currency system. These developments appear to have driven inflows into Bitcoin-focused crypto investment products throughout the year, which may help drive its greater price returns. For example, Grayscale Research estimates that net inflows into Bitcoin-focused crypto trading products (including futures-based products in the United States and spot products overseas) will total approximately $2 billion in 2023. In comparison, net inflows into Ethereum-focused trading products during the same period were only $24 million (Chart 2)[4].

Chart 2: Bitcoin-specific positives appear to be driving greater ETP inflows

Second, most smart contract platform tokens have gained less than Bitcoin this year, while ETH has largely been in line with this peer group. As shown in Figure 3, the FTSE Grayscale Smart Contract Platform Crypto Sector Index rose by approximately 94% in 2023, only slightly higher than ETH [5]. Ethereum outperformed other cryptocurrencies in the year to October, but other coins have caught up recently (clear outperformers include AVAX and SOL). Overall, ETH ranks in the middle of the 40 tokens in the smart contract platform crypto space[6].

Chart 3: Ethereum performance is consistent with smart contract platform crypto industry

Third, Certain categories of on-chain activity have been slower to resume on the Ethereum mainnet compared to other blockchains. For example, Solana’s NFT transaction volume has grown faster (about 15 times) since the beginning of the quarter, while in comparison, Ethereum’s NFT transaction volume has only grown about 2 times[7 ]. Bitcoin’s digital collectibles transactions have also increased significantly due to the rise of Ordinals (Exhibit 4); in late December, Bitcoin’s daily fees even surpassed Ethereum due to the large number of Ordinals transactions [8]. While Grayscale Research remains positive about Ethereum’s NFT ecosystem, Solana and Bitcoin have recently captured market share in this area of ​​on-chain activity[9].

Chart 4: Increasing NFT activity on Bitcoin and Solana

From a broader perspective, Although Ethereum has lagged Bitcoin and certain other cryptoassets this year, it has largely outperformed traditional asset classes from an absolute value and volatility-adjusted perspective (Chart 5). So while its price is up “only” 82% this year, in our view this rebound should be seen as evidence of a broader recovery in the crypto market.

Exhibit 5: Ethereum’s risk-adjusted returns outperform traditional asset classes

While other blockchains are in the spotlight in 2023, the future of Ethereum looks bright. Most importantly, The Ethereum blockchain has historically benefited from the deepest network effects in the industry and has the most decentralized applications (DApps), the most developers, and the highest revenue[10]. Ethereum is pursuing a “modular” development approach, in which the ecosystem of Layer 2 blockchains will be built on top of Layer 1 chains to enable the expansion of activities. This effort is still ongoing, but a step will be taken next year with EIP-4844[11], which will make it 10-100 times cheaper for Layer 2 scaling solutions to confirm transactions on-chain to Ethereum[12] . This will help reduce costs for Ethereum Layer 2 users.

If Ethereum can attract more users to its growing Layer 2 ecosystem, it has the potential to Return to center stage in 2024.

A low-cost “monolithic” blockchain like Solana can provide an engaging experience for new users, especially if coupled with well-designed wallets and other ecosystem applications used with the program. In contrast, Ethereum’s modular landscape may be more difficult to speculate as users will need to actively bridge assets between the mainnet and its Layer 2. However, the development of these networks is still in its early stages, and it is unclear which blockchain design choices will find the best product/market fit and accumulate the most value for their native tokens over time. Once end users primarily interact with applications and blockchain infrastructure runs in the background, Ethereum's current user experience challenges will become less relevant, and Ethereum's other features, such as its reliable decentralization, may Attract developers and ultimately support the token’s valuation. For investors unsure of how competition among smart contract platforms will evolve, it may be worth exploring diversifying into this crypto sector.

Notes:

[1] Based on data as of December 18, 2023, Ethereum’s weekly price volatility in 2023 It is about 45% year-on-year, about half the historical average. Source: Bloomberg, Grayscale Investments.

[2] ETH and BTC price source: Bloomberg reports as of December 20, 2023.

[3] As of December 20, 2023, the ETH/BTC price ratio is 0.0502.

[4] As of December 20, 2023.

[5] As of December 2023, ETH represents approximately 20% of the index’s weight.

[6] Based on quarterly rebalancing of index constituents prior to December 19, 2023.

[7] Based on 7-day moving average volume as of December 15, 2023. Source: Allium.

[8] Source: Coin Metrics.

[9] As of December 2023, Ethereum’s share of daily NFT trading volume was approximately 40%, down from approximately 90% prior to Q4 2023. Source: Allium, Grayscale Investments.

[10] Source: DApp Radar, Electric Capital Developer Report, Token Terminal. Until December 2023.

[11] "EIP" is an Ethereum improvement proposal. EIP-4844 is a proposed upgrade to Ethereum that aims to significantly improve network efficiency and scalability by introducing a new transaction type to process large amounts of data at a lower cost.

[12] Source: Coinbase, as of December 2023.