Ethereum’s value capture dilemma

Author: 0xEdwardyw Source: tokeninsight

Ethereum’s price performance has been disappointing over the past year. Despite the overall growth of the Ethereum ecosystem, ETH has struggled to keep pace with its competitors in terms of price appreciation. As an indicator of ETH’s relative strength, the ETH/BTC ratio has declined significantly, with the ratio falling by more than 32% over the past year.

The disappointing price performance has raised concerns among investors, especially given Ethereum’s central role in the decentralized finance (DeFi) and smart contract space. Slowing price growth has fueled debate about ETH’s long-term value capture potential, especially in the face of increasing competition from other Layer 1 blockchains and the complexity brought by Layer 2 scaling solutions.

This article will introduce several key issues faced by Ethereum that may have contributed to its recent poor price performance.

Second-layer solutions lead to reduced demand for ETH

Ethereum’s second-layer solutions, such as rollups, emerged as a solution to alleviate congestion on the Ethereum mainnet. By processing transactions off-chain and then uploading them back to the main chain in batches, these solutions provide faster and cheaper transactions, significantly improving the user experience. However, this shift poses potential challenges to Ethereum’s value capture.

As more transactions are processed on second-layer solutions, the fees and economic activity that would otherwise benefit the Ethereum mainnet are increasingly Be redirected. This shift could lead to less demand for ETH as users interact more with second-layer networks like Arbitrum and Optimism rather than using the Ethereum base layer. The economic incentives driving the value of ETH may weaken, potentially impacting its price and utility as a primary asset within the ecosystem.

Although Ethereum can serve as a data availability (DA) layer for these second-layer protocols, the fees and value captured by ETH are still significantly lower than if these transactions occurred directly On one level. While the DA role is crucial, it does not fully compensate for the reduced value of direct transactions on the Ethereum mainnet.

Gas fees dropped significantly

In July and August 2024, Ethereum Experienced significant gas cost declines, reaching levels not seen in more than five years. This trend can be primarily attributed to the continued impact of the Dencun upgrade and increased interactive activity on second-tier solutions.

By mid-August, Ethereum’s gas fees had dropped to as low as 0.6 gwei, with low-priority transactions recording only 1 gwei or less. This is down more than 95% from the high of 83 gwei observed during the network’s active period in March 2024.

The Dencun upgrade implemented in March 2024 played a key role in reducing the transaction costs of the second layer network. The most notable aspect of Dencun's upgrade is the introduction of proto-danksharding. This mechanism allows Ethereum to utilize a new type of temporary data called "blobs" to more efficiently process Layer 2 (L2) transaction data. These blobs are purged from the blockchain after a set period, significantly reducing the storage costs associated with L2 transactions.

ETH supply increase

The significant drop in Gas fees has also affected the amount of ETH burned, which is Determined by the EIP-1559 mechanism. EIP-1559 establishes a base fee for each transaction, which is the minimum gas price required for a transaction to be included in a block. This base fee will be dynamically adjusted based on the network's demand for block space, increasing when the block is full and decreasing when the block is underutilized. The base fee is burned, permanently removing ETH from circulation. This mechanism introduces deflationary pressure on ETH, reducing the total supply over time if the amount burned exceeds the issuance of staking rewards. However, if there is insufficient demand for ETH to pay gas fees, issuance from staking rewards may cause the total ETH supply to increase.

As less ETH is burned, the total supply of Ethereum has been increasing over the past few months, rising from approximately 120 million ETH in March to over 100,000 ETH in August. About 120.3 million. If demand fails to keep pace, increased supply could put downward pressure on ETH prices.

Layer 2 interoperability and complexity issues

Ethereum moves toward a second layer solution The push has created interoperability issues and increased complexity for developers, making it more difficult for users to have a seamless experience compared to other layer networks such as Solana.

Each second-tier solution — such as Arbitrum, Optimism, and zkSync — operates as an independent environment with its own set of rules and standards. This fragmentation means assets and data cannot move seamlessly between these different second-layer networks, creating silos within the Ethereum ecosystem. Developers must build or integrate complex cross-chain mechanisms to achieve interoperability between these layers, which can be time-consuming and error-prone.

There are now 64 second-layer, 18 third-layer, and 81 second- and third-layer projects that are about to enter Ethereum. Since different L2s run in isolated environments, it becomes difficult for decentralized applications (dApps) and users to interact seamlessly between these networks.

Additionally, multiple second-layer solutions significantly increase the complexity of building and deploying decentralized applications (dApps). Developers must decide which layer 2 network to build on, weighing factors such as user base, transaction costs and technical specifications. Furthermore, maintaining dApps on multiple second layers increases development and maintenance efforts, as each second layer may have different tools, APIs, and performance characteristics.

These interoperability and complexity issues not only affect developers, but also have a knock-on effect on user experience. Users may find it confusing to navigate between different layer 2 networks, each with their own wallets, transaction processes, and fees. This fragmented experience hinders adoption and reduces the seamless experience Ethereum aims to provide.

Does ETH have a currency premium?

Monetary premium is the additional value of an asset above its intrinsic or utility value, usually because it is viewed as a store of value, medium of exchange, or unit of account. Ethereum has long been considered to have a currency premium, which has contributed to its status as the second-largest cryptocurrency by market capitalization.

For Ethereum, the currency premium stems from several factors:

• < p style="text-align: left;">Utility in the ecosystem: Ethereum is the foundation for a host of decentralized applications (dApps), decentralized finance (DeFi) platforms, and non-fungible tokens (NFTs) pillar. The need to use ETH to pay for gas and participate in on-chain activities extends its value beyond mere technical functionality.

• Perception of store of value: due to Ethereum’s widespread use, large market capitalization, and belief in the long-term growth of the Ethereum network , some investors view ETH as a store of value similar to Bitcoin. This perception adds a monetary premium to ETH.

• Staking and Earning Potential: ETH holders can earn rewards by staking their tokens, which further improves Its value proposition adds to its monetary premium.

However, unlike Bitcoin, which has a hard cap of 21 million, Ethereum does not have a fixed supply limit. Critics argue that this lack of a cap undermines ETH's ability to serve as a reliable store of value, and that its supply could increase over time, causing value to be diluted. According to EIP-1559, when demand for ETH is high, ETH becomes a deflationary asset because part of the gas fees is burned. But when demand drops, ETH becomes an inflationary asset, which weakens its value proposition as a store of value.

In addition, Ethereum is often seen as more focused on becoming a "world computer" rather than just a monetary asset. This multifaceted role, while providing utility, may undermine its perception as a simple and reliable store of value, in contrast to Bitcoin's focus on being "digital gold."

The core question revolves around what exactly is Ethereum’s value proposition. If Ethereum’s primary goal is to function as the world’s computer, it needs to move transactions to second-layer solutions for faster processing and lower transaction costs. However, this shift will inevitably transfer some value to second-layer protocols, weakening the value accumulation of ETH as an asset. The challenge is balancing the need for scalability with the desire to maintain and increase the value of ETH.

To maintain its status as "Ultra Sound Money", Ethereum must ensure that second-layer solutions provide users with low-cost transactions without detracting from its native The value of the asset. This delicate balance is crucial for ETH to continue to maintain its currency premium.