Original title: "Why is ETH Down so bad?"
Original author: Ryan, David, Bankless
Original translation: zhouzhou, BlockBeats

Editor's note:In-depth discussion and summary of Ethereum's performance in recent years and future trends from multiple perspectives. Bitcoin's market value and height have raised questions about Ethereum's relative weakness, but Ethereum's innovation potential cannot be ignored. ETH price performance is affected by multiple factors, especially decentralization and Layer 2 operability issues.

Our discussion will focus on the value of decentralization on the Ethereum route, as well as the competitive advantage analysis of Layer 2 and platforms such as Solana. In addition, the bridge role of stablecoin issuers and centralized exchanges will be analyzed. Driven by these issues, how the future development of Ethereum will evolve still requires our close observation.

TL;DR

Which one is better, Ethereum or Bitcoin? : Ethereum's $300 billion market cap puts its growth at risk of a "gravity effect," and the lack of clarity in its value capture mechanism further weighs down its performance. He advocates dispersing value in productive assets rather than relying on unproductive assets such as Bitcoin or gold. He also emphasizes that the global nature and permissionless consensus of blockchains such as Ethereum enable it to provide a unified API to manage multiple assets.

Layer 2 Adventure: Solving the Interoperability Problem: Interoperability issues and independent standards between Ethereum Layer 2 solutions weaken L1's ability to capture value, and Ethereum's decision to outsource MEV and execution to L2 is a wrong one. KyleKyle is skeptical about the Rollup-centric roadmap, believing that the growing L2 team will compete with L1 and lead to a breakdown in the partnership.

The secret of value capture: Ryan believes that decentralization is crucial in terms of censorship resistance and inflation resistance, so he supports the Rollup-centric route. Kyle believes that Ethereum should focus more on building a permissionless financial system, and over-optimizing node decentralization is not the best strategy, especially at a time when stablecoin issuers and centralized exchanges play a key role in connecting encryption and traditional finance.

Ethereum and Solana, who will win? :Explore the differences in values between Ethereum and Solana. Solana aims to become the world's largest financial exchange, prioritizing user experience and permissionless access, while Ethereum focuses more on decentralization and the distribution of validators. Although Ethereum has advantages in regulatory status and human capital, limitations in system design may hinder the realization of these advantages.

The following is the original conversation:

David:Here, I want to imagine a scenario for Kyle: suppose all your assets magically turned into ETH, and now the only thing you hold is ETH. What will you do next? Welcome to the Bankless program, where we are committed to exploring the forefront of Internet currency and finance. In today's program, we will explore an intriguing question: Why has ETH's price performance been sluggish for at least a year. This is indeed a worrying question. According to the data, the annual growth rate of SOL/ETH in the past year has reached 300%, but the ratio of ETH/BTC has fallen by 50% in the past two years, and the market value has been halved relative to Bitcoin.

Left: The ratio of ETH/BTC has fallen by 50% in the past two years; Right: The annual growth rate of SOL/ETH in the past year has reached 300%

In order to find the answer to this question, Ryan and I asked around, thinking about who is the most suitable guest to answer this question. Suddenly, we thought that Kyle Samani might be the best candidate. When we asked Kyle this question, it showed that ETH holders are indeed in trouble.

This episode of Bankless Nation is more like an opportunity to listen. Ryan and I are going to sit back for a moment and listen to Kyle’s arguments and reasons and see what we can learn from them. Current Solana price performance seems to indicate that Kyle’s investment thesis about Solana is more correct than our predictions in the early years of Bankless. We hope to dig deeper into why this is the case.

Ryan:At the end of the show, I said something that I want to repeat again: This show may bring some frustration to ETH bulls in multiple aspects, but I think it is a healthy reflection. We did this show because we thought it was necessary to hear the opposing side. I don’t think this discussion will be the end of the topic, so there may be more debate in the future, perhaps continued discussions with Kyle, or others recommended by the community to dig deeper into Kyle’s arguments and provide further rebuttal.

Here, I’m excited to introduce you to Kyle Samani, Managing Partner and Co-Founder of Multicoin Capital. Multicoin has been one of the largest investors and supporters of Solana, and they have been pushing the idea of integrated blockchain investing long before Solana completely redefined the crypto space.

Kyle: Hey, everyone. It’s great to be on the show.

What’s happening with Ethereum?

Ethereum’s “Mid-Life Crisis”

David: Just to give you a quick background, SOL/ETH is up 300% year-over-year, while ETH/BTC is down 50% in the last two years, and the Bitcoin to Ethereum ratio appears to have been falling for over 700 consecutive days. While there have been some days of bounces, the overall trend is still clearly downward. Let's talk about Ethereum first, and then we'll talk about how Solana affects Ethereum's valuation.

I want to start with Ethereum itself, assuming it's in a vacuum. What's the first thing that comes to mind when you see Ethereum's price performance is weaker than its competitors to explain this trend that has been going on for over a year?

Kyle: I think the most important variable is probably what I call "gravity." It's hard to get a large asset to go up. Ethereum is now worth about $300 billion. There are not many assets in the world with a market cap of $300 billion, maybe only 20 to 40. If you don't count commodities and just look at stocks, there are even fewer.

The law of large numbers is a phenomenon that exists, like most companies or things, when they reach this size, it becomes more difficult to maintain large-scale revenue growth and profits.

Ryan:I'll give you a statistic, Ethereum is actually the 34th largest asset in the world, and Bitcoin is the 10th largest. There are only 33 assets in the world with a market cap larger than Ethereum's current $320 billion. Just like Visa's market cap is about $400 billion to $500 billion, so they're roughly in the same range.

Kyle:I think what ETH holders may not realize is that it's very difficult to grow at this scale. But there are exceptions, like NVIDIA, which recently grew rapidly from $200 billion to $2 trillion, and you're fighting against "gravity" at this scale.

And then there's another part, which I tweeted a few weeks ago, which is: The larger the market cap, the higher the market's expectations of you for incremental performance in the future. Or to put it simply, someone making $200,000 or $500,000 a year, you expect them to be more economically productive than someone making $50,000 a year, which is obvious.

The same thing applies to the market cap of a company, or a stock, or a token. You should hold them to a higher standard. So I think it's very unusual for Ethereum to be at a market cap of $300 billion, and it's now the 34th largest asset in the world, as Ryan just said. If you're at this scale, you need to have a very clear understanding of the risks that support an asset of this size. The lack of clarity on the fundamental value capture mechanism for Ethereum, in my opinion, is a very vulnerable point to me. I think that's also a big part of what has been dragging down ETH's performance over the past year or two.

David: Yeah, any asset that reaches $300 billion or $500 billion, no matter what it is, will have some degree of difficulty growing, and this is not just an Ethereum problem. It just happens that Ethereum is at this "trough", and all assets will eventually go through this test of trying to break through the first trillion market value.

Kyle: Yeah, but I don't want to think of it as a "trough", but it's harder to grow from a base of 300 billion than from a base of 5 billion. This is mathematically obvious. The only real special case is Bitcoin, because the whole feature of Bitcoin is "value storage". If you buy into the value proposition of Bitcoin, then it is indeed partially exempt from the impact of "gravity theory", not completely exempt, but at least partially exempt.

Ryan: Okay, so I want to dig into this question. While it is an exception to the rule, I would say that this is also the expectation of many ETH holders, including ETH bulls like David and me. Bitcoin is now the 10th largest asset in the world and Ethereum is the 34th largest asset. Its current market capitalization is $1.2 trillion. Bitcoin reverses external forces such as gravity or entropy that affect large-cap assets to reach trillions of dollars.

Global ranking of the top 15 assets by market capitalization, data source: Global ranking

Bitcoin bulls believe that it is actually on its way to surpassing the world's largest asset, gold, which has a market capitalization of $16.7 trillion. I think many ETH bulls will think that if Bitcoin can reach these heights, why can't Ethereum? Because Ethereum is like Bitcoin, but better and more programmable. I guess this may involve your opinion on whether Bitcoin is really worth $1.2 trillion. But I still throw this question out and ask you to respond. Why is this possible for Bitcoin but not for Ethereum?

Bitcoin ≠ Public Chain

Kyle: The whole value proposition of Bitcoin is that it is special. It is "sound money", it is the first to appear, it is simple, does nothing extra, and has a low risk of error. Proof of work is objective, while proof of stake is subjective in nature. You can analyze this issue from many angles, but in summary, Bitcoin is special.

But I don't think Bitcoin is special. I am in the minority on this point. Everyone else in the world thinks Bitcoin is special. So far, I am not going to convince the world that Bitcoin is not special. I will challenge this view at some point, but now is not the time. But what I understand at the moment is that everyone thinks Bitcoin is special, and this is the reality. Don't hate the gamers, hate the game itself.

Ethereum and Solana are obviously not Bitcoin. They are not as special as Bitcoin. This is very clear. Ethereum and Solana are often described as functional things, and we talk about finance, or we're reinventing global finance and democratizing access, and other interesting things like asset issuance and tokens and so on. So fundamentally, the lens through which Ethereum and Solana are discussed is that they are changing finance, changing the rails of payments. So if you look at companies like BlackRock, Visa, Stripe, they're obviously relevant to the discussion of these two major economic sectors. So it's reasonable to think of Ethereum and Solana as tech stocks or growth assets that compete to some degree with these companies that I mentioned and others.

So I think it's fundamentally correct to think of Ethereum and Solana as stock-like assets, not in the true sense of the company, CEO, compensation structure, etc., but they are like stocks in the sense of functionality, products, and meeting user needs, and therefore generating cash flow.

Ryan: The same framework that David and I used in the past is that you have capital assets that generate cash flow, like stocks, or real estate that has rental income, and these assets are productive assets, they are capital assets. Then you have other types of assets like commodities, which are consumer goods that are typically used in the process of producing other products. And finally, you have store-of-value assets, which are special things in the world.

So you could say that gold is special because it doesn't generate cash flows, it's not a capital asset, it's not a particularly important raw material in the production of other goods. Its main value comes from people believing it has value. I want to quickly dig into this.

It sounds like you are bearish on Bitcoin at $1.2 trillion, and I assume you would be even more bearish if Bitcoin reached $10 trillion. So my question is: Kyle, for an asset like Bitcoin, if enough people believe it is special, is that narrative and story enough?

If the crypto world believes it is special, if Larry Fink starts to believe it is special, if the new president of the United States starts to believe it is special and puts it permanently on the balance sheet of the U.S. Treasury and starts buying it, if enough people believe an asset is special, then it actually becomes special. It's a reflexive cycle that seems hard to deny, right? Does that explain the current $1.2 trillion market cap for Bitcoin? Do you question the pattern that we see in asset markets? Do you think there is something wrong with it?

On Bitcoin’s Value Investment

Kyle: I need to counter part of what you said, which is the discussion about commodities, capital assets, and stores of value. Commodities are different, like oil, wheat, etc., which are obvious inputs to the basic economy. We have capital assets, things that can produce income, right? Then you mentioned that stores of value are independent. I don’t agree that there should be a third type of asset, because I don’t think we need non-productive assets. The only exception is cash, because you need a unit of account to measure the price of things. People need to know that coffee is $2 instead of 4 bushels of wheat. It is useful to have an abstract, universal unit of account, and this is usually dictated by the government. I am not trying to fight the government, but I don’t agree with the premise that stores of value should exist independently.

The basic argument that gold or Bitcoin has value is that the government can’t print more of them. I understand the point, but I think this way of looking at a store of value is ridiculous because there are a lot of assets that are naturally inflation-resistant and produce yield. The most obvious examples are Walmart and Amazon. If the price of goods goes up, they raise the price of their goods. I'm referring to the retail business here, not the AWS business. It's not a perfect hedge because they may become more or less competitive with other retailers. But if you believe in it, you can buy a basket of retail stocks that are inherently inflation-resistant within the scope of their operations.

I think that things like gold or Bitcoin are inflation-resistant mainly based on meme. It's true that there is usually a certain positive correlation between the price of gold and inflation, while Bitcoin has almost no such long-term correlation. While gold may have this correlation, I can't explain why this correlation must hold unless we want to repeat the same trades in the market to the trillions, which I think will eventually break down. Therefore, I reject the premise of a store of value as a separate asset class

Left: Gold's correlation with long-term inflation, source: GoldPriceForcast; Right: Bitcoin's correlation with 10-year Treasury bond rates, source: CoinDesk

I understand that others believe in the value of Bitcoin, but I personally don't think it has such a high value when managing my balance sheet. Having said that, I do hold some Bitcoin, and the Multicoin fund also holds some Bitcoin. But intellectually, my view on Bitcoin is bearish. I am not shorting it in actual operations, but intellectually, I am bearish on Bitcoin at $1.2 trillion, and I will remain intellectually bearish even if it reaches $10 trillion.

David:This investment strategy is a bit like Buffett, very value-oriented. I think you are more inclined to the type of productive assets, you understand value, and invest with this reference frame. You think the productive asset framework can swallow the store of value framework, right?

Kyle: Yes. By the way, I wrote a blog post in 2018 that was probably titled "The Path to 100 Trillion" or "The Path to Tens of Trillions," and that post discussed the store of value theory, the utility theory, or the stablecoin theory, about the path to get crypto assets to that scale. It's interesting to reflect on this question from the perspective of six years ago.

David:Another way to understand what you're saying is that you still believe that humans will want to store their value, it's just that they will spread that value across two other asset classes, such as capital assets, and this will also be reflected in the prices of capital assets and commodity assets. We don't need a separate class specifically for storing value. I understand that this is your and Kyle's view on this issue, and this is also Warren Buffett's view.

But it's a bit like an atheist going to tell all religious believers that there is no God, you have to convince them. I think because store of value is such a memetic, human consensus game, there will probably always be a need for it. It's probably human hardware set up. Even if you don't like it personally, I guess what that shows up in your fund is that you're not looking to short Bitcoin as a store of value, right? You can understand why it's going up.

Kyle: I think at some point we do get to short Bitcoin in a big way. Not in the foreseeable future, but long enough that I expect we'll have a big short Bitcoin play. But that's a long way off. I just sent you a link to the blog post "The Utility Hypothesis" that you can include in the podcast when it's released. It's six years old, so I'm sure a lot of the terminology might read a little weird because it's older, but I think it really captures the core belief that what's interesting about crypto is that we have a weird path dependency.

Bitcoin came along, but it was functionally incomplete, had low transaction throughput, didn’t have features like DeFi, and proof of work couldn’t complete transactions quickly, which made it very difficult to build a functional financial system on top of Bitcoin. So the story of Bitcoin became “digital money”, “hard gold”, “something that doesn’t change, that’s stable”, and people thought Bitcoin was special, and Ethereum came along a few years later.

The idea of Ethereum is: we can make finance better, because it turns out that there are benefits to having heterogeneous financial rails for payments of different sizes, whether it’s ACH, credit cards, or wire transfers, and different foreign exchange effects between countries. And then you have all the asset markets, bonds, stocks, commodities, all the things I just mentioned, and they’re all managed on different rails. Each has independent database servers and APIs, very heterogeneous and very complex, and none of them operate 24/7.

Obviously, time zones are an issue. So when you need to transfer assets across time zones, the process becomes very slow, painful, and terrible. And cryptocurrencies are global by nature, and the APIs are permissionless, and you implement the core concept of ownership through cryptography. It turns out that when you have this permissionless consensus cryptography, you can use any API to represent assets, whether they are commodities, bonds, stocks, equity, fake tokens, or meme coins, it doesn't matter. It turns out that it is much simpler to have a unified API to manage all assets, which is the definition of truth.

So I think when we look back at the history of cryptocurrencies 20 years from now, we will find that when Bitcoin first came out, we thought it was "digital gold", which was cool. But the real story is that we built better financial rails. It may take 10 to 20 years for the rest of the world to recognize that we do have better financial rails and start moving assets over. We are starting to see some clues now, such as BlackRock's BUIDL fund, Hamilton Lane and PayPal's actions. You will find that these signs are gradually increasing.

At the same time, I think this will be a story for the next 20 years, because the cryptocurrency track is objectively much better than the traditional track. As more and more activities move to the crypto track, there may be emerging areas like crypto games, or perhaps things like DePIN, which I think will definitely continue to exist, and most of these things will happen on Ethereum and Solana, or on some DeFi smart contract platforms such as Aptos and Sui.

At some point, maybe 5 or 10 years from now, most people in the world will look at Ethereum, Solana, Sui, Aptos, etc. and say, "Wow, these platforms are clearly running the entire world in a very real sense. The world's assets and finance will be represented on these systems." And when they look at Bitcoin, they will see that it is still the same as it is today, just a digital rock under your bed that does nothing. They will start to question why these systems have something in common, like their assets are no longer dependent on the DTCC (Depository Trust and Clearing Corporation) or the traditional financial world. They use the same terminology, such as cryptography, permissionless consensus, etc. So people may ask, why is Bitcoin special, it does nothing, but is worth 2 trillion, 5 trillion, or 10 trillion dollars, while Solana or Ethereum is only about 300 billion or 50 billion? I think eventually people will realize that one of the systems is a superset of the other, one system is stupid and the other is useful. Eventually, this view will become a consensus. I don't think we are far from that moment.

Ryan: You would have chosen to short Bitcoin then, not now, right?

Kyle: Yeah, I'll have to see how the discussion evolves. But I do expect to be shorting Bitcoin a lot at some point.

David: Given this valuation framework and understanding of the future of crypto, why has the price of ETH performed so poorly over the past two years? There are a lot of shortcomings of Ethereum that may be relevant here.

L2 Dilemma: Solving the Interoperability Puzzle

Ethereum Shortcomings

Kyle: I think the most direct impact on price may be the interoperability issue. The ramifications of this are that a lot of people use Ethereum and they hate cross-chain bridges, hate paying high fees, and hate waiting for confirmation times to complete cross-chain transfers. And also, each asset ledger is independent. Your asset ledger on Binance is different from Coinbase, which is different from Ethereum L1, which is different from Arbitrum, Base, Solana. These are independent asset ledgers, and each system records what you own. On Solana, everything is convenient, and on Ethereum, that's not the case. Of course, we have systems like Li-Fi that try to solve these problems, but for people who understand how Li-Fi or other bridge aggregators work, they have to pay slippage fees for it, which feels bad. So I think the experience of most crypto users today is that interoperability is poor and they don't like it, and on Solana, they don't have to deal with these problems. I think this may be the root cause of a lot of people moving their ETH positions to SOL, their actual experience when using these two systems.

Ethereum mainnet funds frequently migrate to various L2s every week, data source: Dune

Ryan: ETH supporters might respond, "Yes, Kyle, Ethereum will solve this problem. There is actually a roadmap to solve this problem." They might list some different ideas on the roadmap, such as different Layer 2s creating their own "superchains", integration between Layer 2s, shared sequencers, and Rollup-based solutions. Vitalik once tweeted that we are actually very close to solving this problem, we just need to adopt some EIP-type standards to make the wallet experience smooth and make it feel like the same Ethereum chain. What is your response to this? Do you think Ethereum will solve this problem? Most ETH supporters will probably admit that this is a current problem, but it will not be a problem in the future.

The L2 Interoperability Conundrum

Kyle: First of all, I don’t think there is a solution to this problem, because it’s obviously true that teams like Polygon, Optimism, Starkware, Arbitrum are all building their own interoperability standards within their respective ecosystems. I don’t see any standard that is universal across all of these ecosystems. I’m also not sure if it would actually be possible to implement a standard even if Vitalik proposed one, given the way assets are stored in underlying cross-chain contracts in systems like ZK-Sync, Starkware, Optimism, Arbitrum, etc., I’m not sure if it would be possible to make all of these systems interoperable as smoothly as Solana. I could be wrong here, but it’s really difficult.

Even if such a proposal existed, there’s no guarantee that it would be implemented, because you need all teams to agree to implement it, and there’s no guarantee that they will agree. So it’s essentially a standards problem.

The problem with standards is that you have to get everyone to agree to the standard. However, there are clearly some obvious incentives for people not to reach consensus. So I don't take it for granted that even if it's theoretically possible, it's very difficult in practice because there are very clear economic interests that hinder the implementation of standards.

The third point, and probably the most important point, is that Ethereum is nine years old. It just turned nine a few weeks ago. In terms of time, that's a long time. For example, SpaceX launched its first successful rocket in six years. I remember the first three failed, but the fourth was successful, and it took about six years or six and a half years, and the total investment was about $100 million or $80 million. Musk only had $180 million at the time, and he was the only investor in SpaceX. Ethereum is nine years old, and it's estimated that billions of dollars have been invested in the development of cryptocurrencies. So I think there is a basic anxiety among people: guys, why is this taking so long? We've been waiting here for so long.

Secondly, there are features on Ethereum that are not in production yet. I think if you are a $300 billion asset, don’t just tell me, show me. Why should I trust you? When you have a $300 billion market cap behind you, this is the standard you have to meet. This is no longer a “Devcon Zero” thing where five researchers are running around in London.

David: You mentioned the actual user experience. This broken layer 2 interoperability issue is the first thing that users encounter when they touch the chain. It’s in front of them, it’s the choice they have to face. So it’s as obvious as the part of the iceberg that’s above the water. How much of a role do you think this user experience plays in the actual pricing, like the ETH/BTC ratio, the ETH/SOL ratio, the USD price of ETH? How much of an impact do users actually experience slippage on Ethereum and the friction of cross-chain bridging have on price?

Kyle: I think that's the biggest factor. The money in crypto, or the wealth in crypto, is using Ethereum and Solana. Obviously, in a sense, 100% of the capital was originally in Ethereum, not Solana. If you go back to before the Solana chain was launched, the ratio has basically been adjusting in one direction since the Solana chain was launched. I think the reason why capital moved from the initial 100% Ethereum to the current relative wealth distribution of about 80% Ethereum and 20% Solana is obvious is because of the actual user experience.

I think it took a long time for people to come to two conclusions. One, to use Solana, there were enough NFTs, enough assets, enough things to play with, that it felt worth getting up, setting up a wallet and starting to use it. Everyone has different thresholds for experimentation and different motivations to do these things. Second, it was finally clear that the experience of one platform was clearly superior to the other.

Then looking at the Ethereum roadmap, while you can see that Ethereum has a lot of advantages, you can't understand how it competes with Solana in the actual user experience. I think more and more people have realized this at different points in time over the past four years.

Ryan:As for Bitcoin, obviously different rules apply. I'm not sure how many users are actually using the Bitcoin chain or Bitcoin wallets, but the experience is obviously not very good. But people buy Bitcoin for other reasons.

Kyle: Yes, Bitcoin is special. While I don’t agree with it intellectually, I understand why it is special socially.

We can go into the Layer 2 issues for Bitcoin, and I think they are interesting and will have some impact. But I don’t understand how any Layer 2 solution for Bitcoin can compete with Solana or Ethereum in the long term.

David: So that’s the discussion about Layer 2 interoperability issues. Do you know which of these is probably the second issue that has the biggest impact on the whole price lag?

Kyle: I think the second issue is the issue of data availability (DA) as a value capture mechanism, or what you might say is L2 is capturing value rather than L1, or even “parasitic”. I have publicly stated many times that I think L2 is harmful to L1, and I still stand by that view. We use software every day. If you’re listening to this podcast, you’re obviously using an iPhone or a computer or something. The actual experience that every one of us has with software every day is that the marginal cost of software is almost zero, that software is free and wonderful and accessible, and that’s the economic revolution of software — the marginal cost of software is zero — and we all understand that instinctively.

Then blockchains came along and we figured out that you can’t have marginally free software because of the scarcity of throughput, you have to have a fee market. This was obviously an economic imperative in the earliest days, especially when scaling was absolutely terrible. Bitcoin can only do about 4 transactions per second, L1 is probably 7 or so. So given that the V1 versions of these systems were technically extremely inefficient, this was a necessity at the time.

Today, obviously we haven’t reached some theoretical state of perfection, and transaction costs still exist, but transaction costs are clearly approaching zero. And the whole point of L2 is “it’s cheaper than L1,” and that’s obviously approaching zero. I think from a valuation perspective, I would model transaction costs at zero. Obviously today on Solana, Sui, Aptos, ETH or other L2s, transaction costs are not zero. But from a valuation perspective, the intellectually conservative approach is to model it as zero, because that is the history of the software, and the experience of using the software every day is that the marginal cost of the software is zero.

Ethereum Call Data Cost and Blob Cost Comparison after EIP-4844, Data Source: Dune

So I don't think execution or data availability (DA) is valuable under this premise. Maybe I'm exaggerating a little bit, the costs are not necessarily completely reduced to zero, but they are asymptotically approaching zero. Whatever the cost is, close to zero means it is financially negligible. If you are a market maker, you need to know how much gas fees you pay on your balance sheet, and that's okay. But for Solana and ETH holders, and for valuation models of these assets, it is conservative to model transaction costs as zero.

The only input that has a fundamental impact on valuation is MEV (Maximum Extractable Value). MEV is nothing more than a function of entropy in financial markets, which is always present in financial markets. The more assets you own, the more assets you trade, the more entropy and MEV there is, and this will always be true. Obviously, there are ways to mitigate the effects of MEV, and depending on the system design, you can direct the value capture of MEV to different places. There are a lot of people working on these issues today in the Ethereum and Solana space.

But MEV will always be there, and I think MEV is the only value driver for L1 or L2 assets. And Ethereum's L2 centralized roadmap very clearly abandons MEV.

You might say that a Rollup-based solution would solve the problem. I don't fully understand how Rollup-based solutions work, but from a path dependency perspective, it seems unlikely to me. Because now we have these huge Layer 2 teams that have raised a lot of money, have resources, brands, and assets, and they are attracting customers, whether it's Base, Arbitrum, or other teams. They are unlikely to give MEV (maximum extractable value) back to Ethereum L1. So even if the Ethereum Foundation launches a Rollup-based solution and provides some excellent libraries and calls for people to use these Rollups, the leading teams currently building L2 will not choose to join this scheme because it will destroy their own revenue. So to answer your valuation question, this is the core.

David: Yeah, I don't think anyone can deny the cash flow coming in from places like Arbitrum's Treasury or Optimism Collective. We discuss the revenue Coinbase earns from Base at least once a month in our weekly report. As to whether this revenue is "stolen" from Ethereum L1, it may be a question worth discussing. ETH bulls might explain it this way: we are creating induced demand, this is newly created economic activity for these Layer 2s, and Ethereum would not have been able to capture this value otherwise. But there is undoubtedly a one-way flow.

ETH bulls might argue that we have Base, Arbitrum, Optimism, and soon we will have all the ZK EVMs, such as Polygon and ZK Sync, and eventually Ethereum will become a "blockchain of blockchains" and generate a lot of entropy. You look at Optimism and Arbitrum, they may be fragmented, but they are still growing revenue and have positive cash flow. ETH has value simply by generating this network. This may be a simplified argument for Ethereum, although it is not expressed perfectly, but how would you refute it? Or do you oppose this point of view?

How does L2 suck ETH?

Kyle: Yeah, first of all, you don't capture MEV. MEV goes to all L2s, and that's my fundamental question. I think transaction costs will eventually go to zero. What is an Ethereum transaction? About 50 bytes of data? 100 bytes of data? Based on the price of a 1TB hard drive you can buy, that's almost a rounding error, close to zero. Yes, you have a 1,000x or even 10,000x replication factor on the network, but it doesn't matter because it still costs close to zero. So I don't understand how transaction fees support $300 billion worth of assets.

The generic answer is "ETH is money", and I want to say, okay, but you didn't tell me it's special, like Bitcoin is. While this argument is not entirely self-consistent, the problem is that Bitcoin has enough social consensus that it is a special entity, while Ethereum faces competition. Solana, Aptos, Sui, etc. are all saying, "Look, my system is better." You may disagree whether they are better, but the problem is that there are enough other systems that explicitly reject the "ETH is a special entity" framework because these systems are functionally equivalent. This proves that ETH is not a special entity. I don't think anyone thinks ETH is a special entity like Bitcoin.

David: I was going to mention the theory that Polenya developed that all execution will move to Layer 2 and then ETH becomes the unit of account in all of these Layer 2s. Even if Ethereum L1 does not capture much value, the value of the unit of account as a currency still exists. They will say that currency is the greatest value. But we have been talking about this for 20 minutes and you obviously don't accept this valuation. So do you object to the roadmap centered on Rollup as an architecture?

Rollup-Centric False Proposition?

Kyle: People can use Rollup, and Rollup may indeed have its uses, and the most obvious use may be on PerpDex (perpetual contract decentralized exchange). So I am not fundamentally opposed to their existence. There may be some very specific applications that can intelligently utilize them. Whether this is the case remains to be seen. To me, the most obvious category is PerpDex. So they may exist. But betting all on the Ethereum roadmap centered on Rollup, and in particular making a series of design decisions to abandon scaling L1 and push activity to L2, I think this is a catastrophic mistake.

Related reading: "From theory to practice: Can Based Rollup realize the L1 sorting-driven Rollup solution"

We don't know whether the Ethereum Foundation will try to retract this decision or try to reverse this direction slightly, and now this issue is obviously being discussed in the public eye.

But even assuming that they take relatively radical measures and really try to turn the situation around and say "Come back to L1, we're going to solve all these problems", in any case, I think the ship has sailed away from the dock. Now these other teams have clear incentive mechanisms. If the Ethereum Foundation says "Come back to L1, the L2 roadmap is no longer implemented", then all L2 teams will now be in direct confrontation with L1. At present, they may still pretend that everything is fine, such as "ETH is our common goal" or something like that, but I always think this is nonsense, and I don't think it's true. But they are still pretending to be friendly for now. If L1 is to make up lost ground, that superficial harmony will disappear.

Ryan: Kyle, I want to summarize your point, from my perspective, your statement is internally consistent. You are basically saying that Ethereum L1 outsourced all MEV and execution to L2, and that this is a wrong decision.

Kyle: Yeah, sorry, I would like to add an important point, it's not just MEV, it's state. The source of MEV is state, and state is directly tied to fungible assets. This includes stablecoins, Aave, ETH, but also NFTs, liquidity provider positions, lending, etc.

Ryan: Ethereum's state, especially execution state, is clearly moving off L1 and onto L2. This includes smart contracts and assets, all of which are sources of MEV. Ethereum outsourced this to Layer 2, which was a bad decision because if you think of these assets as cash flow assets, all the value comes from block ordering, which is MEV and execution. So the core of the game is which chain can get the most state to extract "rent", which is MEV, and give it back to the asset holder. This is what makes the asset valuable. Ethereum woke up one day and decided to hand this "cash cow" to other chains, which is a bad decision in your opinion.

Kyle: They all look the same to me. I think that’s actually one of their most fatal flaws. They spend a lot of energy trying to be different, but in reality they’re almost 100% the same EVM (Ethereum Virtual Machine) and the same applications. So to me, they’re interchangeable.

Ryan: Kyle, David tried to get you to say something nice about Ethereum at the end. So why don’t we end with this question? Say something nice about Ethereum, okay? At least say something nice about Vitalik.

Kyle: I like the human capital part, that’s pretty good. I think the Ethereum Foundation has been a big part in creating a lot of the right norms and standards for governing a system that claims to be credibly neutral (or at least credibly neutral-ish). I think they’ve gone too far in a lot of ways. But the splits between the original Ethereum founders, like between Charles and Vitalik, were corporate versus non-profit. I think they made the right choice at that critical moment and created a lot of norms and standards that are working and most L1 foundations have adopted and should adopt. I think that's been quite influential.

Ryan: Kyle, thank you so much for joining us today on Bankless. It's been an interesting discussion. Thank you for sharing your perspective. As an Ethereum supporter, I hope this is the bottom of the bear market, but you never know. Of course, these are opposing views, but thank you so much for spending time with us today.

Finally, of course, we have to end with our usual disclaimer. None of the above discussion is financial advice. Cryptocurrency is risky and you may lose the money you invest, but we are heading west. This is the frontier and it's not for everyone, but we are glad you are joining us on the Bankless journey. Thank you, everyone.

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