Original title: The Battle for Value in Smart Contract Platforms

Original source: Grayscale

Original translation: Yanan, BitpushNews

· In the cryptocurrency field of smart contract platforms, there is a value accumulation mechanism called the "flywheel effect". This mechanism, like a snowball, closely links transaction fees and network usage with the value of tokens, the security of the network, and the degree of decentralization.

· Different smart contract platforms adopt different strategies for fee income. Some platforms increase revenue by setting relatively high transaction fees, while others attract more transactions by reducing transaction fees.

· Grayscale's research shows that fee income can be seen as the main factor driving the growth of token value in this field. Of course, there are other important fundamental factors that deserve our attention as they will have an impact on fee income over time.

· Ethereum, as a leader in the field, has accumulated huge network fee income after years of successful operation and successfully broke through the $2 billion mark in 2023. At the same time, other smart contract platforms such as Solana are also rising rapidly, and their fee income is expected to reach about $200 million in 2024.

Many people mistakenly believe that crypto assets have no substantial value and are difficult to evaluate using traditional investment methods. But Grayscale's view is exactly the opposite. They pointed out that smart contract platforms like Ethereum and Solana can actually generate income through fees collected from economic activities on their networks. Grayscale proposed that if investors want to evaluate the value of smart contract platform cryptocurrencies, one feasible way is to see how much fee income they can generate over time.

Basic Overview of Smart Contract Platforms

Smart contract platforms such as Ethereum and Solana provide developers with a network environment where they can build various decentralized applications. These applications range from gaming to finance to NFTs. The core functionality of these smart contract blockchains is that they can handle transactions for the applications they host in a secure and censorship-resistant manner.

For this reason, the value of a smart contract platform is tied to the activity of its network. Important metrics for measuring network activity include: the volume of transactions the platform can handle, the size of the user base it can support (usually measured in terms of daily active addresses), the value of the assets the platform can carry, the so-called total locked value (TVL), and the platform’s ability to monetize block space, which is reflected in network fee income (more on this later).

Each metric has a specific meaning. For example, Ethereum’s significant advantage in total locked value (TVL) (up to $66 billion, seven times more than its closest competitor) fully demonstrates the platform’s liquidity advantage and unique value proposition in the field of financial applications (as shown in Figure 1). In addition, Ethereum’s leading position in the number of ecosystem applications has further spawned a strong network effect that attracts new developers, new applications, and new users. At the same time, Solana’s key metric of daily transactions not only highlights its advantages of high throughput and low cost, but also shows that its blockchain technology is well suited to cope with large-scale application scenarios, such as DEPIN, as well as retail market-related projects, such as NFTs and meme coins.

In addition to comparing and contrasting these basic indicators across assets, investors can also combine these data with market capitalization or the market’s current valuation of a specific asset for analysis. For example, as shown in Figure 1, while Solana’s total locked value ($4.7 billion) is currently higher than Arbitrum’s ($3.2 billion), Arbitrum’s market cap to TVL ratio (1x) is much lower than Solana’s (16x). These metrics provide investors with insight into the relative strengths and weaknesses of different assets, while also helping them identify potential value investment opportunities.

The Key Role of Fees

While there are numerous theoretical and practical ways to evaluate platform network activity, network fee revenue has undoubtedly become a critical foundational metric when evaluating the value of smart contract platforms (see Figure 2). This metric can be understood as the total fees that users need to pay to enjoy the network services. Smart contract platforms may have a variety of revenue models, but ultimately, they all need to generate fees to create value for token holders.

Similar to how centralized entities compete in traditional industries, decentralized networks are competing for fee income in various ways. For example, some smart contract platforms increase fee income by setting relatively high transaction costs, while others try to attract more transaction volume by reducing transaction costs. Both strategies have the potential to be successful. Take two hypothetical blockchains as examples:

Example Chain 1: Small number of users and transactions, high cost per transaction

5 users, 10 transactions, $10 per transaction: Network fee income = $100

Example Chain 2: Large number of users and transactions, low cost per transaction

100 users, 100 transactions, $1 per transaction: network fee revenue = $100

This case study reveals a phenomenon: even though Chain 2 has far more users and transactions than Chain 1, the two chains generate comparable network fee revenue. Of course, metrics such as users and transaction volume are important, but we also need to consider them in conjunction with transaction costs, as this directly determines the level of fee revenue.

The importance of fee revenue is obvious both empirically and theoretically. For example, Figure 2 shows the relationship between the fee revenue of each component of our smart contract platform in the cryptocurrency industry and its market value (on a logarithmic scale). Although the cryptocurrency market is still in the process of maturing, investors are already able to identify different projects based on fundamental data. Grayscale's analysis shows that the relationship between fee revenue and market value is quite stable, and the correlation between fee revenue and market value is higher than other smart contract platform fundamentals.

Grayscale emphasizes that there is a close connection between fees and market capitalization, in part because network fee revenue plays a key role in the value accumulation of tokens. Value accumulation means that the way the protocol builds tokens can link network activity to the long-term sustainable value of the token. We can observe the different stages of value accumulation through the following three examples: Ethereum, Solana, and Near.

Ethereum: A proven value accumulation "high-quality chain"

Ethereum is not only the first smart contract blockchain, but also the one with the highest market capitalization. However, since 2022, it has begun to face severe expansion challenges. As the frequency of use increases, network congestion has become increasingly prominent, causing users' transaction fees to rise sharply: on May 1, 2022, the average network fee per transaction was as high as $200.

Despite this, the surge in usage and high average transaction fees have also brought huge value accumulation to Ethereum. In 2023 alone, Ethereum's total network fee revenue exceeded $2 billion. Every time a user makes a transaction, the base fee is "burned", which means that this part of the coin will disappear from the network permanently, reducing the total supply. At the same time, the tips paid by users will be used to prioritize transactions, and these fees will be rewarded to validators and network security maintainers who participate in staking.

Thus, in 2023, the Ethereum network achieved the "burning" of 2 million Ethereum tokens (1.7% of the supply) through huge revenue, which not only created value for Ethereum holders, but also brought up to $390 million in rewards to validators and staking participants, thereby incentivizing them to work harder to improve the security of the network.

Ethereum has entered a mature stage and has fully demonstrated its ability to generate value accumulation. On the Ethereum mainnet, users are willing to pay a high price for high-quality products - the "product" here is the block space supported by a smart contract platform with top network security. This is especially important for applications that involve large transactions and attach great importance to network security, such as stablecoins or tokenized financial assets. As of June 6, 2024, the platform's valuation has reached a staggering $458 billion, almost six times that of any other smart contract platform. This significant advantage undoubtedly highlights its superior ability and market maturity in user monetization.

Solana: Exploring the value accumulation "high-performance chain"

Different from Ethereum's fee income model, Solana has chosen a unique path and has gradually narrowed the gap with the market leader in the near future. As the second-largest smart contract platform by market cap, Solana has long been seen as a faster, more affordable alternative to Ethereum, with its 335 transactions per second and low average transaction cost of just $0.04. Despite processing far more transactions than Ethereum in 2023, Solana only earned $13 million in network fees, compared to Ethereum’s $2 billion (a 154x difference).

In the past, this lack of value accumulation reflected Solana’s relative inadequacy; however, in 2024, this is changing. So far, Solana has generated six times as many fees as it did in all of 2023, reducing the fee gap between Ethereum and Solana from 154x in 2023 to 16x (see Figure 4). This shift suggests that Solana’s model—low transaction costs combined with high throughput—can also create significant economic value.

The significant growth in network fee revenue is mainly due to the significant increase in average transaction fees (up 37 times compared to last year), rather than relying solely on the overall increase in transaction volume (up only 33% compared to last year). Interestingly, while Ethereum's L2 transaction fees have decreased due to the Ethereum Cancun upgrade, SOL, traditionally known as the "cheap choice", has seen an increase in average fees. Since April 1, although the average transaction fee for Solana users ($0.04) is still lower than Ethereum ($4.80), it is higher than L2's Arbitrum ($0.01).

Compared to Ethereum’s L2 solution Arbitrum, Solana’s transaction fees have increased for users, which may have some impact on its brand image as a low-cost, high-efficiency chain. However, Grayscale pointed out that from an overall perspective, the increase in fees is still a positive sign. It not only reflects the high activity of users, but also reflects the continued growth of value for staking participants and token holders.

Near: Leading the Entry of Crypto, Network Monetization Emerges

In sharp contrast to the two cases mentioned above, Near, a smart contract platform that has recently been widely used in non-speculative application scenarios, but has not yet shown significant performance in value accumulation. Near is the underlying platform for KaiKai and Hot Protocol, the two decentralized applications (dApps) with the largest user base in the cryptocurrency field. Among all smart contract platforms, Near has performed particularly well, with 1.4 million daily active users and a throughput that rivals that of the fastest chains in the industry, such as Solana (see Figure 6).

Despite its significant lead in user numbers, Near has lagged far behind its competitors in terms of monetizing its user base, generating only $4.1 million in fees over the past year. This reflects its relatively immature stage of development, which can also be seen in its market capitalization relative to its competitors ($7.9 billion, compared to Ethereum’s $458 billion and Solana’s $78 billion). While the Near network has demonstrated the ability to process transactions at high speeds, it has not yet created enough value accumulation for token holders or depositors to justify its market capitalization to the level of its larger competitors.

Although Near has not yet achieved significant results in terms of monetization, its broad application base is undoubtedly a good start. If the Near network can continue to expand its scope of use or increase average transaction fees without reducing network activity (similar to Solana's recent progress), it has the potential to achieve significant value accumulation.

Ethereum, Solana, and Near are three smart contract platforms that represent different stages of maturity of decentralized networks in terms of network fee revenue. Ethereum has had many years of stable revenue and growth. Solana has a solid user base and is just beginning to generate significant revenue. Near has shown the appeal of its product, in part due to its low cost, but has not yet achieved substantial revenue.

Fees and Valuation: Key Points and Nuances to Watch

The issue of fees and valuation for smart contract platforms in the cryptocurrency space does contain many key points and nuances that need to be carefully considered. The first is that each protocol has its own unique way of accruing value, with different rates of token issuance (inflation) and burn (deflation). For tokens with high inflation rates, the value accumulation effect of fees may be significantly reduced by the large amount of tokens burned.

Furthermore, different protocols set their own fee structures. For example, Ethereum's transaction fees not only contribute to the destruction of tokens, which indirectly benefits all token holders, but also priority fees are distributed to validators and stakers. In contrast, Solana's fee distribution mechanism is different: 50% of transaction fees are burned and the remaining 50% goes to stakers. Recently, a vote determined that Solana's priority fees will be 100% of validators. This strategy reflects Solana’s higher requirements for validator hardware.

It is worth noting that the high level of MEV (Miner Extractable Value) activity on Solana brings additional rewards to validators and market makers, but this reward may constitute an "indirect" cost for token holders. Therefore, from a certain perspective, Ethereum's fee structure seems to provide more value back to ordinary token holders, while in Solana's system, validators and market makers may receive more generous rewards.

Similar to the valuation of traditional assets, which usually discounts future cash flows to the present, the valuation of crypto assets may also involve discounting expected future network fee revenue to the present. This approach considers the potential growth of a particular network in terms of adoption, usage, or monetization, and its evaluation method is different from the current overall fee generation. For example, it is reasonable to assume that Ethereum’s $458 billion valuation is not based solely on the fees it currently generates, but also takes into account its ability to leverage network effects, as well as the potential for future adoption, usage, and fee revenue growth of second-layer technologies.

In addition, the valuation of certain crypto assets may also include a “monetary premium” component. In other words, users may be willing to hold an asset because it functions as a monetary medium - that is, as a medium of exchange or a store of value - and this value often exceeds the network’s ability to generate fee revenue. For Ethereum in particular, the concept of “monetary premium” is particularly important when considering its valuation, especially when the token is widely used as a collateral asset across the industry.

Conclusion

If value accrual is properly implemented in the protocol, then growth in network usage will not only incentivize users to hold tokens, de-circulate them, and potentially increase the value of tokens, but will also further encourage users to become validators or holders, thereby increasing the security of the network. In addition to contributing to network security, the collection of fees can also incentivize more validators to participate in the project, thereby increasing the decentralization and censorship resistance of the network. Therefore, value accrual is like a flywheel that closely links fees, network usage, token valuation, and the security and decentralization of the network.

It is important to recognize that while fees can be used as a measure of network maturity, there are many other factors in this flywheel that can affect the growth of a network and its valuation. For example, when an application has a higher adoption rate, it will attract more users to join, which in turn attracts more developers to develop in the same ecosystem. Therefore, when evaluating network fees, we should consider them in conjunction with other fundamental indicators and the relative valuation (market cap) of a specific ecosystem.

Looking forward, it will be critical to continue to monitor the dynamics of these growth myths. Despite relatively high average transaction costs for users (at $4.8), can Ethereum further increase its fee income on the mainnet through high-value transaction scenarios such as tokenized financial assets? Will Ethereum's fee income grow with the increasing frequency of L2 activity? And how will Solana find a balance between monetization and keeping the cost of on-chain low to prevent users from switching to other low-cost, high-throughput competitors? Will Near attempt to monetize, or will it choose to continue to forgo meaningful revenue opportunities in order to prioritize the expansion of its user base?

These dynamics highlight the importance of continuous monitoring of key metrics such as fees, transaction volume, active users, and total locked value (TVL). Grayscale believes that as the crypto asset class matures and adoption continues to grow, the importance of these core metrics will become more significant. They can provide a deeper understanding of the relative advantages and opportunities of smart contract platforms, helping investors to understand the value of the network more nuanced, and thus provide them with more informed decision support.

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