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Ethereum has always dominated the decentralized finance (DeFi) market
Ethereum is the 2nd largest blockchain by market cap behind Bitcoin, and thus the largest smart contract blockchain, so it’s no surprise that Ethereum’s blockchain supports the largest portion of assets locked in DeFi protocols, with about $27b of assets locked. As shown in the pie chart below, this is several times the runner up Tron, which has $5.6b locked in DeFi protocols.
Ethereum has always enjoyed DeFi market dominance, with the graphic below from DefiLlama showing that Ethereum has always made up at least half of DeFi TVL. Today, Ethereum’s market share has plateaued just shy of 60%.
While the bear market depressed DeFi’s TVL in dollar terms, the number of ETH tokens locked in DeFi has remained between 15 million and 30 million since the end of the original ‘DeFi summer’ of 2020. This shows an ongoing demand for DeFi services from ETH holders.
Ethereum is a model for fair token distribution
As explained in a talk by Christine Kim at Devcon VI in 2022, over 83% of the initial Ethereum supply was distributed to participants in Ethereum’s 2014 initial coin offering (ICO). In total, 60 million ETH tokens were sold in 6,600 transactions, which at around 30 cents per token amounted to $18.3 million. There were no deals made with venture capital investors buying tokens at special valuations - everyone had one chance to purchase Ethereum before it launched and began trading on public markets. The table below shows how the distribution of the initial 72m ETH supply, and the current supply, which today at 122m is much larger after years of mining rewards have been generated.
Around half of the Ethereum Foundation’s initial allocation of ~12m tokens, (~16% of the initial supply) was quickly distributed to early project contributors. In the following year, the Foundation sold over half of their remaining 8% to fund their efforts. Over time, the Ethereum foundation sold more and more Ethereum, and by April of 2022 they disclosed holding less than 0.3% of the circulating supply (~365k ETH) - although this is now worth over $475m thanks to the price appreciation of ETH over the years.
For Ethereum holders, this is probably close to the ideal scenario: the Foundation is well-funded enough to support ecosystem development with grants, conferences, and other initiatives, and yet does not own enough of the circulating supply to impact the market. There are no early investors who hold tokens that have yet to unlock, the entire supply of Ethereum tokens is already circulating in the market.
Ethereum is a model for open-source, community driven development
While the Ethereum foundation plays an important role in Ethereum’s development, it is also careful not to overstep its bounds. Ethereum Foundation Executive Director Aya Miyaguchi referred to the Foundation’s role as ‘addition by subtraction’ in a speech during the opening ceremony of Devcon VI in October 2022, when she explained the Foundation’s tendency to support teams and spin out new projects rather than bring them in-house.
Indeed, most of Ethereum’s development is done by its strong community of researchers and developers. Community development efforts are organized according to a clear project management framework, with the possibility to propose and vote on changes to Ethereum and new features via Ethereum Improvement Proposals. (EIP) The drawback to this more democratic approach to development is slower speed, with Ethereum regularly drawing criticism for failing to adhere to a concrete roadmap for major upgrades like “The Merge” or “Shanghai”.
Now energy efficient via Proof of Stake, Ethereum is the most economically secure blockchain
While Ethereum still requires major upgrades like staking withdrawals, today’s Ethereum network is robust and secure. Originally a Proof-of-Work blockchain, secured by the energy consumption from ‘mining’ on graphic cards, Ethereum’s blockchain was successfully “merged” to Proof-of-Stake in the summer of 2022. This reduced the network’s global energy consumption by over 99%, as we’ve explained in a previous blog post, and paved the way for future scaling upgrades. Despite misconceptions that continue to lump Proof-of-stake blockchains like Ethereum together with Proof-of-Work blockchains like Bitcoin, the use of Ethereum and Ethereum-based DeFi applications is now environmentally friendly.
Now, with Proof of Stake, Ethereum is secured not by the economic value of its energy consumption, but by the economic value of tokens ‘staked’ with validators. With over 19 million ETH tokens staked, worth over $36b in total, Ethereum is the blockchain with the most value staked and therefore the most secure blockchain. As shown in the below chart, more Ethereum tokens are being staked all the time, making Ethereum increasingly harder to attack.
Ethereum’s blockchain secures and transfers the most value, and collects the most fees
The Ethereum blockchain moves tens of billions of dollars per day in its native token, which is several times the value transacted by the Bitcoin blockchain, despite Bitcoin’s larger market cap.
What’s even more impressive is the amount of non-ETH assets secured by the Ethereum blockchain, such as ERC-20 standard stablecoins. By 2020, the value of ERC-20 tokens secured by Ethereum had grown to half of the market cap of ETH, which is where it remains today, with roughly $90b of stablecoins secured on the Ethereum blockchain as of August of 2022.
Fees must be paid to use the Ethereum blockchain, regardless of the token being transacted or the DeFi protocol being used. Ethereum generates by far the most revenue of any blockchain - over $370m per month according to Token Terminal, as shown below.
The investment case for ETH is linked to the Ethereum blockchain’s usage
Now, after EIP-1559 was implemented in July of 2021 and The Merge was implemented in September 2022, Ethereum’s native token ETH has some very interesting economics, which create a unique investment case for the ETH token.
As we explained in a previous tweet thread, EIP-1559 splits Ethereum transaction fees into a "base fee", which is set by the protocol and burned, and a "tip" (aka "priority fee") which paid to the validator to incentivize inclusion of the transaction in the next block. This means that depending on the level of the blockchain’s usage and thus the base fee, some amount of ETH is being burned on an ongoing basis.
An important effect of the Ethereum Merge in September of 2022 was to reduce the block reward issuance of new Ethereum from ~13,000 ETH/day (paid to Proof-of-Work miners) to ~1,600 ETH/day (paid to Proof-of-Stake validators). Since the Merge, this rate of new issuance has roughly equaled the rate of ETH burning from EIP-1559, causing the total supply of ETH to stop growing as it has in the past, as shown below in the chart from YCharts.
The base fee is set by the Ethereum protocol in proportion to the current usage of the blockchain. If usage increases, so does the base fee, and thus the rate at which ETH is burned. Therefore, there exists a level of usage of Ethereum whereby more ETH is burned more rapidly than it is issued, making the total supply of ETH decrease over time. This decrease of the total supply makes ETH deflationary, or “ultra-sound money,” and it has already taken place in November of 2022, at one point the supply of ETH was decreasing by over 6,000 ETH per day, as shown on ultrasound.money.
If the supply of ETH is dropping, ETH becomes more scarce, and each ETH token should theoretically be worth more money. Thus, the effect of EIP-1559 and The Merge make the ETH token a way to “bet on” the increased usage of the Ethereum blockchain going forward. What excites ETH investors is the realization that ETH’s supply has stopped growing, even as the current bear market has significantly reduced the amount of fees being burned. During the bull market of 2021, between 5,000 and 15,000 ETH was burned each day, far above the post-Merge issuance of 1,600 ETH that came into effect in September 2022.
If there is another period of heightened activity on the Ethereum blockchain and thus heightened fee burning, the supply of ETH is likely to decrease at a rate never seen before.
L2 activity has surpassed L1 activity
During the last bull market, the limits of Ethereum’s scalability came again into focus, with activities like swapping tokens costing upward of $30 per transaction. While there do exist plans for increasing scalability on Ethereum’s blockchain, other features like staking withdrawals have taken priority for the time being.
In the mean time, Ethereum’s community has embraced “layer 2” (L2) solutions like rollups as a path toward scalability. Rollups are smart contacts that can be thought of as separate silos or bubbles in which transactions take place, before the entire batch of transactions is “rolled up” into Ethereum’s main chain. The transactions within the rollup are verified as true, usually with either “zero knowledge” (ZK) proofs or “optimistic” proofs. While it’s still the early days, there are already many layer 2 scaling solutions for Ethereum, and about 4.6m ETH tokens (almost 4% of all ETH) are locked in layer 2 smart contracts. Because of the increased scalability and transaction throughput of layer 2s, users pay much lower transaction fees for activities like sending or swapping tokens. In October of 2022, the activity on layer 2 solutions began to exceed activity on the Ethereum layer 1 on a regular basis, according to l2beat.com.
Challenges remain around scalability, decentralization, MEV
While Ethereum has made significant progress, challenges remain. The historical lack of staking withdrawals catalyzed the growth of liquid staking, where “winner take all” effects have resulted in almost 30% of all staked ETH within the Lido protocol - not an ideal scenario for decentralization. (Another 12% is staked by Coinbase) This issue is exacerbated by the censorship resistance debate coming out of the Tornado Cash episode, as we explained in a tweet thread. This has been even further exacerbated by the evolution of MEV on Ethereum and the separation between block builders (relays) and block proposers (validators): many blocks being produced on Ethereum are “OFAC compliant”, leaving out transactions that have interacted with Tornado Cash.
Other challenges, summarized by Ethsunshine.com in the graphic below, include increasing Ethereum’s client diversity and reducing the concentration of validators within certain countries and hosting providers.
Conclusion: Ethereum’s is a ‘must-have’ within the Ultimate wallet
At Ultimate, we are believers in a multi-chain future, where thoughtfully designed wallets abstract complexity away from the user. In order to offer low fees and fast transactions to our initial users, we chose to build on Solana first, but it was only a matter of time before we launched our Ethereum integration.
Ethereum’s blockchain is home to the majority of the DeFi market’s TVL, $100b of stablecoins, and produces tens of millions of dollars in transaction fees every month. The burn from those transaction fees has halted the growth of the total ETH supply, and ETH is likely to become deflationary in the next bull run. Layer 2 solutions like Arbitrum and Optimism offer improved scalability, and a capable community of developers is empowered by the Ethereum Foundation to make real contributions to the ecosystem.
But even on well-established Ethereum, we see room for improvement with mobile wallets. Our wallet Ultimate is available on iOS and Android, across Ethereum, Solana, Arbitrum, Optimism, and Polygon, with more chains to come!
Ultimate is a multi-chain, fully non-custodial wallet that makes the DeFi and dex trading accessible to the masses. With features like real time prices, candlestick charts, and zero-fee-added swaps on 10k+ tokens on all your favorite chains, leave your centralized exchange behind forever, and say hi to DeFi. Available at get.ultimate.app