Will Ethereum have its moment of glory? Will it be overthrown by SOL?

Author: Michael Nadeau, The Defi Report; Compiler: Tao Zhu, Golden Finance

ETH vs BTC

ETH/BTC continues to hit new lows. BTC's dominance has remained unabated - now back to 59.2%. The white box above shows that ETH/BTC was even lower at the same point in the 21 cycle. At the time, Bitcoin Maxi was rejoicing because BTC's dominance was 63%.

Of course, ETH continued to rise 5 times in the next five months - as BTC's dominance fell to 40%.

In some cases, if ETH/BTC goes back to .08 (as it did twice in the last cycle), this would take ETH to over $8.2k at current BTC levels.

We still think ETH will have its moments.

But I admit my conviction is waning.

What I keep thinking is that there are still a lot of ETH bigwigs. But I also see the community is a bit split. Just this week we saw several prominent members of the Ethereum community remove .eth from their X profiles.

This could just be noise or a bottom indicator. Meanwhile, you have an interesting setup between ETH and SOL right now:

• Ethereum has 3.2x the market cap of Solana, but has been vastly outpaced by Solana in terms of fundamentals, developer interest, and mindshare.

• ETH maxis are starting to question their loyalty to the chain.

• Solana continues to attract developer talent and launch new tokens (Trump memecoin, Pudgy Penguins memecoin)

If you take the long view, you can start to think about what Solana needs to do to disrupt Ethereum from here on out.For example, does Solana have to go up 3.2x? Or, what percentage of the Ethereum community will finally give in and swap some of their ETH holdings for SOL?

If it’s the latter, then the “disruption” could happen sooner than people expect. In this case, ETH would fall, while SOL would rise simultaneously.

We saw this last weekend when Trump launched the memecoin. As many investors swapped their existing memes for TRUMP, almost all other memes immediately fell.

As mentioned before, .eth’s condemnation of Ethereum may actually be the bottom.

Of course, this doesn’t mean there’s anything seriously wrong with ETH or Ethereum. As far as we can tell, the community is executing on its roadmap. There’s still a ton of innovation, developer talent, on-chain value, and network effects in Ethereum.

But you don’t have to take my word for it. You can research the on-chain fundamentals yourself…

On-Chain Fundamentals Update

In this section, I’ll cover some key on-chain metrics using some new data, and share some key takeaways for each.

L1 Fees

Base Fee

Key Points:

Base fees (destroyed) rose in Q4 (up 135% from Q3) for the first time in 2022. However, the base fee in 2024 has dropped by 42% compared to 2023.

Uniswap, Tether, MEV Bot, Circle, and Banana Gun (Telegram Trading Bot) are currently the top five contracts consuming the most gas on L1.

The top-ranked contracts reveal the main uses of cryptocurrencies at present: 1) speculative trading of assets, 2) stablecoins.

Priority Fees

Key Points:

Priority fees (paid to ETH validators and stakers) rose 8% in Q4, but are down 21% from Q1. For the year, priority fees are down 26%.

Priority fees were lower in Q4 than in Q1, which is surprising. This means that there was less speculation on L1 in Q4 (after the election) than at the beginning of the year (before the ETF announcement).

We think there are two main reasons for this: 1) users are moving to L2, and 2) users are moving to Solana.

L1 vs. L2 Transactions

Speaking of L2. Part of the reason Ethereum L1 struggled so much last year was the EIP4844 network upgrade — which introduced a new data type called a “blob” on Ethereum. These “blobs” allow L2 to store transaction data on L1 at a very low cost.

This results in 1) cheaper L2 fees and 2) no L1 congestion — since L2 transactions no longer compete with regular L1 transactions. Less L1 congestion = lower priority fees.

But let’s look at user activity at the L2 level. As we noted, users are moving to L2 (short term bearish, long term bullish ETH) and Solana (short term + long term bearish ETH).

Key Points:

Currently, the top L2 has 10x the number of transactions than Ethereum L1. A year ago, it was 3x. Two years ago, it was 1x.

The power law is playing out at Layer 2. Base controlled 64% of transaction activity among the top L2s in December. Arbitrum was second with 18%. OP had 7%. Six months ago, Base had 42%, while Arbitrum had 27% and OP had 9%.

We expect the door to large institutions entering the crypto space to open, and many will choose to build their own L2s. Given the current power law, it will be interesting to see how this plays out. Will institutions launch their own general purpose L2? Build on Unichain? Build on the OP stack? Time will tell.

But what does all this mean for value accrual on Ethereum L1s? After all, if L2 is successful, shouldn’t this drive demand for ETH (users on L2 need ETH to transact) + increase settlement/accounting fees paid to Ethereum L1?

Let’s see what the data says…

L2 Fees Paid to L1

Publishing Costs

The above chart shows us the cost paid by L2 to publish data to Ethereum L1.

Key Points:

The EIP 4844 upgrade happened in March. The chart shows us the impact: On March 10, L2s collectively paid 577 ETH to publish data to L1. Yesterday, they collectively paid 3.6 ETH (a 99.5% drop) to publish data to L1.

Ethereum subverted itself with EIP4844 so that the network could scale. If it wants to recoup these fees, we need to see a surge in L2s and new use cases — which could ultimately fill the massive new supply provided by technical upgrades that favor L2s.

Blob Fees

Note that L2 pays two types of fees to L1: 1) call data/publishing fees, 2) "blob" fees. Both should be considered "revenue costs" for L2. Call data fees are more expensive than "blob" fees, which is a change brought about by EIP4844.

Key Points:

In the above figure, we can see that as L2 transitions from traditional "call data" and accelerates, blob fees are also increasing. Peak activity occurred on 1/6. But only 75 ETH was paid to L1 ($277k).

At 1/6, it would take 16.06 million transactions on L2 to generate $277k in blob fees ($0.017 per transaction).

At its peak in 21 cycles, Ethereum’s L1 fees were ~$70m/day. For blob fees to return to that level, we’d need to see L2 transactions increase to 4,117,647,058/day.

L2 User Fees

Switch to paying user fees to L2 (instead of paying L2 fees to L1).

Key Points:

We can see that L2 fees have also dropped significantly due to EIP 4844.

Just before the upgrade was implemented, total daily user fees on L2 peaked at around $5 million. Now, they are around $1 million per day in fees.

With the recent increase in blob fees paid to L1, L2's on-chain profit margin is currently around 85% (initially increased to 99%).

Base dominates the L2 space and currently accounts for an average of 70-80% of all L2 fees. Arbitrum is in second place, with OP in third place in terms of user fees. L2 user fees as a percentage of L1 user fees Key points: Despite L2 having 10x the volume of Ethereum L1 transactions, L2 transaction fees currently only account for 9% of L1 fees - suggesting that demand for L1 block space continues despite much higher transaction fees.

Earlier this year, L2 fees as a percentage of L1 peaked at 24%. In the future, we expect more than 90% of Ethereum L1 fees to come from L2.

Ethereum L1: Smart Contracts with More Than 500 Interactions per Day

Key Points:

Ethereum L1 has about 75 contracts with more than 500 unique wallet interactions per day.

The leading contracts are Uniswap, Tether, Circle, MEV Robot, Banana Gun, top L2, and top DeFi projects.

Key Points:

The top L2s have about 5 times more smart contracts with more than 500 daily independent interactions than Ethereum L1.

Base once again dominates the L2 space. It has about 55% of smart contracts with more than 500 daily independent interactions. Arbitrum is second with about 20% market share.

Native ETH in L2

Key points:

Native ETH (excluding staked or wrapped ETH) peaked at 3.6 million in July. It has now dropped to 3.25 million (2.7% of the circulating supply).

Base leads with 1.23 million ETH. Arbitrum has 1.03 million ETH (the above chart tells us that a large amount of ETH on Arbitrum has flowed to Base), and OP has 542,000 ETH. This equates to 86% market share.

We are surprised that 2.7% of ETH migrated to L2. This suggests that users still don’t trust the L2 bridge — as 97.3% of ETH is currently on L1 (a small amount is now in ETFs).

If we include staked ETH and wrapped ETH, the amount of ETH on L2 increases to 4.3M.

ETH Staking

Key Points:

After peaking at 35M (29% of circulating supply), total ETH staked declined in Q4. It currently stands at 34.17M.

Over the past few years, Ethereum staking yields have fallen from 5.5% to about 3%. The decline is due to 1) more stakers and 2) lower user fees.

If fees continue to increase, and total ETH staked levels off, we may see ETH’s staking yield start to move higher.

This may surprise you, but in terms of total economic security, Ethereum has $110,984,160,000 in value secured. Solana has $961,818,000,000 — primarily because SOL has a much higher percentage staked than ETH on Ethereum. Ethereum’s lead as the more secure and decentralized network is fading as the network’s fundamentals fade.

ETH ETF

Key Points:

The ETH ETF currently holds 3.65 million ETH ($11.8 billion). This is 3% of the circulating supply (more than L2's current holdings). For reference, the BTC ETF holds 5.8% of the supply ($121 billion).

In terms of net flows, the ETH ETF currently has $3.2 billion. BTC has $37 billion in net flows.

Given that ETH accounts for about 20% of BTC's market cap, we believe that flows may tilt toward ETH later in the cycle, as ETH currently only accounts for 9.7% of BTC ETF holdings.

The ETH ETF does not currently return returns to holders, but we expect this to change. When this happens, the ETH ETF may become more attractive to investors than BTC.

Inflation Rate

Key Points:

After deflation in 2023, ETH supply grew by 0.10% in 2024.

The network was deflationary in Q1 but switched to inflation in Q2-Q4 after the implementation of EIP4844 in March.

The highest inflation levels were seen in Q3 (0.11%) and Q4 (0.11%).

Given the challenges faced throughout the year, our view of Ethereum being almost deflationary in 24 is quite optimistic.

ETH vs SOL

We will conduct a full data-driven analysis in an upcoming report, so I will not go into detail here. But I want to talk about the most important metric when comparing Ethereum and Solana right now:

DEX Volume

Key Points:

Over the past month, Solana’s DEX volume was $220 billion, while Ethereum + L2s’ volume was $172 billion.

On Saturday (the first day of trading for the Trump memecoin), Solana’s volume was $36 billion. This is 3x the all-time high for Ethereum + L2s.

For reference, Nasdaq does ~$200-400 billion in volume per day.

We believe that DEX volume is the most important metric to track at this stage of crypto adoption. Why? Ultimately, we believe trading of all financial assets will move to public blockchains.

For Solana, the open question is whether institutions like BlackRock will trust it as a place to hold tokenized stocks, bonds, private assets, etc.

Qualitative Analysis

Finally, I wanted to share some of my thoughts on the Ethereum Foundation, the community, and overall leadership.

• I am increasingly concerned about Vitalik as a leader. This is not a knock on Vitalik and everything he has built. It's just that Ethereum needs to position itself for the business/institutional community now. Rather than the cypherpunk crowd. It feels like the next phase requires new leadership.

• The Enterprise Ethereum Alliance should be able to help with this. This is where Paul Brody (Head of Blockchain at E&Y) and leaders from Microsoft, Fidelity, JPMorgan, Intel, Oracle, etc. are at. Ethereum needs to see this group step up and act as the BD for institutional use cases.

• The Ethereum Foundation recently released its 2024 report. It covers both internal and external spending… a microcosm of where Ethereum is today.

• It’s clear that Solana is moving faster. Has a more aligned community. Is focused on its end-users (not ideology). And has a technically superior L1 architecture. But that doesn’t mean Solana won’t run into scaling issues that will require an L2. That’s already happening.

In summary, Ethereum upended itself in 2024 with the EIP4844 network upgrade. And shortly thereafter, it lost momentum.

That being said, Ethereum is still moving forward steadily. It’s executing on its roadmap. We are seeing bright spots across the ecosystem, but especially on Base. In some ways, Ethereum feels like it is turning into a value play. The challenge is that crypto markets don’t run on value. Therefore, Ethereum needs a major catalyst. We think this could come in the form of a major announcement from a large TradFi player building an L2 using the playbook laid out by Coinbase.

Will this be enough to turn things around?

In the long run, will any of us remember EIP4844 and the failure of .eth in 2024?

Time will tell.