The Triple Halving: Where We Stand
The Triple Halving: Where We Stand
TLDR: I'm very bullish on Ethereum over the next 18 months
The Triple Halving: An Update
ETHUSD since initial Triple Halving Report published
This post is far, far too long to be contained in an email. Please click into the article itself as it most likely is cut-off in your email app.
First, let’s set the stage: Since I published my report we’ve had a run +60% in early May 2021, a -60% drawdown from May to July 2021, a +180% run from July 2021 to Nov 2021, and recently a -65% drawdown from Nov 2021 peak to now….and with all of that excitement, total performance is -3% since this writing - AKA sideways.
So we’re about 8 months into my initial 19 month time horizon and on the surface, we’re exactly where we started. If you look beyond price, however, a lot has changed. I think it’s important to note these changes and incorporate them into the framework to inform my decision-making as we move forward. The world is changing and no thesis can stay static. Where does the triple halving stand today?
Original Thesis in Brief
“PT $30-50k base case, $150k by Jan2023 in illiquid & speculative peak”
Illiquidity Drivers: Fee burn to remove the most liquid supply, then Defi & Staking lock away further supply.
Demand Drivers: Much higher degree of retail & institutional access, ETF timing is a wildcard, ESG thesis
Catalyst: EIP1559 expected (at the time) in July 2021, Merge expected (at the time) in Nov 2021. Together, act as a triple halving event.
Narrative Adoption: ETH price increase + ETH/BTC ratio increase will bring attention to Ultrasound Money, Low Fees, Attractive Yields. ETH Google search will be higher than BTC google search and ETH will have its moment.
Before I start, credit to so many others!
This post is FULL of tweets from other amazing people from whom my ideas develop. If I add any value at all, it’s in the synthesis of others’ ideas. I intentionally put the tweets in directly, instead of just linking to them, so that you can click into them and follow these folks. This work is built from their writing, so I’m thankful for all of them!
Illiquidity Drivers
ETH in DeFi
When I first wrote my report, 10.8M ETH were locked in DeFi. Today that has declined to 8.8M (-19%). As you can see in the chart, ETH locked in DeFi has hit a plateau.
Why has DeFi on Ethereum slowed? Impossible to prove, but it’s likely a mixture of ETH Layer 1 gas fees being too high and the emergence of alternative layer 1 solutions such as Solana and Avalanche in the past few months to funnel away excess capital that balked at those fees.
So what’s next? The rise of Ethereum’s Layer 2. As Layer 2 rises, the cost of participating in DeFi will fall by orders of magnitude. This will increase the potential user base for DeFi on Ethereum and allow it to challenge alt-L1’s for their users. Up until this point, Ethereum hasn’t been competing for those users at all. That’s about to change. I’ll go into further detail on L2s later, but suffice to say I see no reason that ETH locked in DeFi has a hard ceiling here. If anything, the value proposition of Decentralized Finance on Ethereum will only get stronger as the rollup solutions mature, and we should see the uptrend renew in the near future as fees approach 0 and focus shifts to improving UX and onboarding new users.
Staked ETH
When I first wrote my report, 3.94M ETH had been staked. Today that has increased to 9.1M (+130%) ETH staked in the Beacon Chain. I expect this trend to continue for the next few months, and it will likely accelerate into the merge as reduced uncertainty around the merge date reduces the cost of locking up capital.
Another big change since my initial report is the maturation of multiple major staking derivative protocols. I wrote about Lido Finance fairly extensively in my report addendum, where I discussed the likelihood that I had dramatically underestimated the amount of Ether that would be staked. Now, however, we’ve also seen the rise of decentralized solution RocketPool to go along with centralized exchange staking solutions in Kraken and Coinbase.
The current model is that ETH supply will cap out at around ~120M after the merge, meaning that 7.5% of all future ETH supply is currently staked. Expect that to quintuple over the next year (accelerating after the merge).
EIP1559
When I initially wrote my report, I was expecting EIP1559 to occur in July 2021 and burn ~30% of issuance. Today we know that EIP1559 was enacted in August 2021 and is burning 70% of issuance.
Well…did it work?
Absolutely. The intention of EIP1559 was to fix a wonky gas fee market by introducing predictable fees and reducing average transaction wait times. In doing so, we also got ultrasound money. Below we can see empirical research showing that EIP1559 has accomplished its goals in the gas fee markets.
How about the burn itself? The burn has been far, far more intense than we expected. In my report I initially estimated a 30% fee burn, but as you can see below we’re at something more like a 70% fee burn right now.
Interestingly, this 70% is a new high (initially the total net burn was closer to 60%) and reflects that the burn rate has been increasing over time.
I think it’s likely that even without the merge to PoS, ETH would eventually become deflationary as demand for ETH block-space increases more and more. Will L2 adoption be a headwind to this? L2s have only onboarded something like 2% of ETH. If L2’s reduce fees by 100x or more, wouldn’t the fire essentially stop?
Yes, but no. This could absolutely be a temporary hiccup in fees, but I don’t expect L2’s to cause ETH L1 gas fees to drop long term. L2’s will drive higher demand, eventually leading to higher long-term gas fees for a few reasons.
Low gas fees will drive more total demand for ETH blockspace: As fees drop, ETH becomes more competitive with alt-L1 solutions. Remember that L2 fees are a function of L1 fees. If L2 adoption is high enough that it causes L1 fees to drop, L2 fees will drop even more, causing more L2 adoption. While initially this increased L2 adoption would be spurred by a drop in L1 fees, over time it would make L2’s more competitive on an absolute level as L2s (unlike alt-L1’s) get cheaper with more activity. Over time, we’d likely see L2 fees plummet to near 0 with further increased activity raising L1 fees back up again.
Many Alt-L1s brag about having a higher transaction throughput than Ethereum. Recently, SBF noted that Solana had more transaction throughput than all other blockchains combined (a response to Solana network congestion issues). Of course…this is highly misleading. Solana collects 300x less fees than the Ethereum network every day. So yes, Solana might have more transaction throughput, but that is because it attracts a specific kind of user - a user who wants to transact far, far more often at much, much lower cost. This market (at least so far) is 300x smaller than the value of Ethereum’s blockspace to its users. However, there’s no reason to think that when Ethereum L2 fees become competitive we won’t see this kind of increase in transaction frequency from Ethereum’s users. If you were willing to spend $100 on a transaction on Ethereum because you valued the security, decentralization, and network effects of the ecosystem, then when gas fees go down to $1, you should be willing to transact 100x more often (if you have that need). I don’t expect all users to need that, so activity might not jump 100x immediately, but I definitely expect Ethereum user activity to explode and compensate quite a bit for the fee drop.
L2s being cheap creates an incentive to use blockchains differently. Complex apps that require higher throughput will absolutely soak up the blockspace in ways that just weren’t possible before. To repeat the last point, if users were willing to pay $30-40M in fees before, there’s no reason to think they won’t be willing to pay the same for 100x more value in the future - the product suite just needs to expand to give customers reason to spend that money, and it will.
L2s are more price insensitive than individual agents. As long as gas prices are determined by individuals, there’s an upper limit to how high the burn can get. When individuals are paying cents on the dollar to transact and L2s are the big fish paying huge gas fees to settle on L1, gas fees (and the associated burn) will rocket as L2s won’t pause to think before spending $10k on gas for a single transaction. The implication here is that while there may be a temporary drawdown in fees from L2 adoption, we have a long term set up in L2s that allows fees to go much higher than would have ever been possible before.
One other thing: EIP1559 burns fees that are being used in transactions - the most liquid, fast moving, unstaked Ether. At a 70% burn, we’re seeing this Ether gradually drained from the market….but as long as issuance is higher than the burn it doesn’t need to directly affect price.
After the merge, when there is net deflation, the burn will actually drain liquidity from ETH markets. If $40M in transaction fees are spent in Ether everyday, users have to buy that unstaked Ether from somewhere. If unstaked Ether is getting staked more and more, and the remainder is increasingly being burned without adequate replacement from new issuance, liquidity will drain fast from the unstaked Ether market (at least until Ethereum is no longer deflationary).
EIP1559 is the catalyst that works underneath the surface. For now it reduces volatility, makes things less bad than they could be (can you imagine what this selloff would look like if $4B of extra ETH were sitting on miner balance sheets being dumped?). In the future, it will make upside volatility far, far higher than it would have been.
Demand Drivers
Access
In my original report, I pointed out the access retail investors had to Ethereum and compared it to earlier crypto cycles. That continues to expand into institutions
UX First Experience
These days though, access isn’t the primary demand driver - it’s beliefs. The more relevant question is why would investors use the access they have to make the decision to buy ETH - what is driving the next marginal buyers?
What’s incredibly salient now, compared to previous cycles, is how much better the experience will be for newly onboarded retail investors this time around. The user experience of first time users has always been a MetaMask wallet they didn’t know how to use and gas fees they weren’t willing to pay. Now, however, the first user experience of a newly onboarded retail investor is going to be this (see the video in the tweet below).
Argent on ZKsync
is setting the industry standard for what user experience must be. That may seem mildly interesting to you today. Gradual, incremental steps forward from a clunky expensive past. However, in a future adoption cycle where Ethereum becomes more well known to households than Bitcoin, this “crypto user’s first experience” is incredibly important. When the triple halving arrives, and newspapers write about Ethereum, curious new investors will experience DeFi this way - and when they show their friends it will be intuitive, easy, obviously useful, usable immediately. That’s how adoption happens.What about the ETF? Just waiting…
There’s been just about 0 action on the Ethereum ETF front, and honestly that’s how I’d prefer it at this point. The Bitcoin market is leading the way and so far has shown no ability to get a spot ETF to market. The futures ETF doesn’t have the same impact on liquidity and is ultimately a bad deal for investors due to high fees. I believe that if crypto establishes itself further and further as a necessary asset class, investors will apply more and more pressure on the SEC to allow fair and low cost exposure to these assets via spot ETF’s.
Until then, I’m not particularly excited by the idea of an Ethereum Futures ETF, and if an Ethereum spot ETF were approved after the merge it would have a more profound impact on price anyways (I’d prefer that demand to come after liquidity has been drained - to have maximum price impact), so I’m happy to wait.
Institutional Private Investments
One major difference in this cycle is how much venture and private investment funneled into the crypto space. This is not captured well at all by the random motions of crypto asset prices, but is crucial to understanding how entrenched this space is today. Crypto is HUGE. It is a behemoth with an army of fully funded developers working on a legion of products that are coming to market in the next 1-3 years. As these institutional investments come to fruition, we should see the results affect flows into the platform layer as well as many of these investments will have been made on Ethereum blockspace. I’ll discuss the Electric capital developer report further a bit later, but check it out for another vantage point on the sheer raw number of developers building in crypto.
Proof of Work still has Climate FUD
Not much to say here. Nothing’s really changed? If you talk to anyone bullish Bitcoin, Bitcoin is dramatically improving the economics of renewable energy. If you talk to anyone bearish Bitcoin, Bitcoin is wasting electricity and destroying the climate. I don’t see a lot of successful persuasion going on for either side, but Ethereum manages to sidestep the entire argument with Proof of Stake. That’ll be an advantage in the future, but as long as the merge is delayed it isn’t a real advantage in the present. Climate is a long-term recurring narrative though, so expect this to narrative cycle to come back in force in the future.
Staking Yield is in high demand
Honestly, this shouldn’t even need mentioning, but high staking yields are incredibly lucrative in a yield starved global marketplace like today. The Arrington Anchor Yield fund is a perfect example of this. It is a $100M fund launched to take advantage of crypto staking yield products. Expect more of this kind of institutional investment in the future, especially as Ethereum staking yields give investors access to a far more liquid and sizeable instrument with much higher yields than have been available before.
Institutions will view Staked Ether as an Equity
After a conversation with Hal Press (check out his ETH report here), I think I’m finally coming around to seeing staked ETH as an equity. At the merge, staked ETH will have a P/E multiple <10. If you believe fees are even a bit stable, or even more so, that fees will grow over time as L2 adoption expands demand to completely fill blockspace with more price insensitive buyers (L2s are more price insensitive than whales), then this yield is insanely attractive. As I detailed in my report, it’s a yield that isn’t really ETHUSD price sensitive. Moreover, if you’re an institution afraid of ETHUSD risk, you can always just buy the yield and hedge out your ETH price exposure (like buying a gold miner’s earning stream and hedging out gold price risk).
Moreover, this yield doesn’t even account for buybacks (the deflationary burn from EIP1559 can be modeled as a share buyback, reducing the overall share count and increasing % ownership of every investor). If Ether supply actually has net 3% deflation, this should get tacked on top of the already existing staking yield.
I think the merge will force staked Ether to be revalued much, much higher. Moreover, demand for staked Ether will lead to more and more Ether getting staked and locked out of the fee markets, leading to an unstaked Ether supply squeeze. This is the same thesis I had before, and it’s absolutely still intact.
More detail on Staking Yields
Above is a screenshot from Justin Drake’s most recent estimates (January 8th 2022) on Ether Staking Yields. Interestingly he even added longer term calculations.
If 50M ETH were staked and fees were on the low end (5k), we would still expect yields of 3.3%. I downloaded the spreadsheet and tinkered a bit to find that if 50M ETH were staked and fees were on the high end (15k), yields would be 4.6%.
I’ll just pause and repeat that. 50M ETH would be staked - that’s more than 40% of today’s supply. That supply would be decreasing actively via EIP1559 induced deflation…and the yield would still be 4.6%.
Look around the market for assets yielding anywhere near that and you’ll essentially be looking exclusively at value traps and junk bonds. With Ethereum, institutional investors will get the opportunity to invest in a large, liquid asset with a 4+% yield even once scaled which represents a bet on the future of the entire crypto market.
Talk about institutional demand flows. One thing worth noting is that as fees rise and gain stability, this yield will go higher and higher
. We can speculate what that would mean long term, but it’s absolutely bullish.
Organic Growth in Demand for High Quality Blockspace
One thing that has changed since I first wrote my report is the level of activity under the surface. There is so much building happening in crypto right now, it’s unbelievable. More importantly, the entire space is at a tipping point. Crypto isn’t being invented, it’s here - the technology is ready and being packaged into improved UX’s for shipment. As Kyle Samani points out, crypto has the advantage of past technology for distribution too - once it’s ready, it can spread much, much faster than previous technologies could. If crypto can prove its use case to users, there’s good reason to think it will be adopted much faster than the internet was…because the internet would help it distribute!
With adoption of L2’s, we’re going to see the first major pushes to onboard “non-crypto retail.” We’ve never really seen this before. So far it’s been “intra-crypto” products and the size/scope of “intra-crypto” has been expanded…but if you really think in terms of TAM, crypto hasn’t done much to break into normal spheres of life. As L2s mature and we move out of the infrastructure build phase of crypto development and into the product phase, we’ll start to see the amount of activity Ethereum can truly support
.Catalyst
EIP1559 is working better than expected
EIP 1559 is burning 70% of fees - that is wild. When you go to the market to buy unstaked ETH, the pool of liquid ETH is $4B smaller because of the burned ETH that isn’t being recirculated from miners back into the market. Now obviously things have been rough in the entire crypto market, but recognize that for an asset with a market cap of $300B, removing $4B from circulating supply has implicitly reduced the damage. In other words….things could be worse.
We can see with ultrasound.money that
Current issuance rate is 5.4M ETH per year
Current burn rate is 3.5M ETH per year
After the merge, issuance will drop to 0.5M ETH per year
Have patience. The merge will come.
The triple halving IS the merge to proof of stake. So as you can imagine, the delays in the merge are… mildly frustrating. However, I’m just an investor - the real work is done by the builders, and I can respect how hard & high stakes their job is. Ultimately the merge is the crux of the entire thesis - it fundamentally changes the supply/demand structure of the ETH market, moves ETH into a deflationary regime, creates incentive for staking demand, and cements ETH’s geopolitical grade security status. When I first released my paper, I was expecting a Nov 2021 merge. My timeline of Jan2023 was based on 1 year runway post-merge to build up demand for staking and allow for narrative development. If the merge happens in June 2022, I’ll be targeting a similar timeline. It wouldn’t be surprising, as a result, if my thesis doesn’t fully play out until July 2023, or even early 2024 depending on how late the merge actually happens.
The obvious con of having the merge delayed is macro risk. If we enter into a heavily inflationary environment with the duration trade completely zonked, the potential for ETH mania reduces substantially.
On the other hand, there actually are real silver linings to delaying the merge. When the merge happens, per my thesis, I expect price to rise - and with price narrative will follow. However, at the center of any narrative is a core of fundamentals, and crypto fundamentals are changing constantly. If the merge happened in Nov 2021, it would’ve been before L2 development got off the ground. If the merge happens in June 2022 it will happen as L2’s fully onboard the full suite of DeFi primitives and finish the build out of CEX bridges and direct fiat onramps. A narrative built on stronger fundamentals can run farther, and I think I’ll show you below that the narrative in January 2023 could be one where Ethereum begins to be synonymous with the security layer of crypto. Full stop.
What if the merge just never happens?
The merge is in the Ethereum end game. Like EIP1559, which was years later than anticipated, the merge too will happen - it’s just a matter of time. With the merge delayed, Ethereum traders become Ethereum investors - and that scares people. Don’t let it. Things are getting built here, and my view is that the more the ecosystem is built out, the higher the upside when Ether does eventually breakout. Would I love the merge to happen sooner? Of course. But if it gets pushed back a few more months, I will entirely predictably just expand my time horizon so long as I believe the merge will actually happen and the rest of the L2 ecosystem is continuing to be built.
From structural supply to structural demand
I had an influential conversation the other day with Hal Press of Northrock Digital. When I framed the triple halving, I had framed it as a supply demand dislocation and used the Bitcoin halving to frame the effects. Hal made it simpler: issuance is structural supply, fees are structural demand. Pre-merge, Ethereum (and all crypto assets) are structural supply assets - their price is fundamentally held back by the headwind of their issuance-based supply. Yes, this even applied to Bitcoin, but it’s even more severe for chains like Solana. Post-merge, Ethereum is a structural demand asset - existing use cases demand more unstaked Ether to be bought for use as fees than there is issuance, so price must go up.
“Remember — with PoW there is a chip shortage. With PoS there is a capital shortage.” - Me paraphrasing Hal Press from that one zoom convo that one time. Insightful guy.
The Post-Merge Pre-Withdrawal period is max structural demand
Hal had another, potentially more crucial point. For about 6 months after the merge, staked Ether and yield cannot be withdrawn. That means total fees (including issuance and fees) will all go into lockup each and every day. Well, for the last 7 days Ethereum fees have been around $35M. This increases when price volatility rises either to the upside or downside. So for the 6 months after the merge, Ethereum will have structural demand of $40M in buy pressure every day soaking up excess supply. As we breakout, this demand would exacerbate upside moves and in ordinary trend consolidations, this will soak up excess supply faster than any usual move.
As I’ve been saying, this breakout will feel different than ETH price action has in the past because ETH will be a fundamentally different asset post-merge. This will go along nicely with high ETH staking yields and newly proved scalability, a narrative that can support a much higher price.
I felt like Hal’s way of looking at it was really constructive and meshed well with how I thought about it before, so I hope you do take a look at his thesis!
Post-Withdrawal Headwinds and Tailwinds
Will there initially be a lot of sell pressure? Yes. It’s literally the IPO lockup effect working against us. There will be investors with staked ETH and yield that are ready to take some profits, and the more I’m right and the post-merge pre-withdrawal period is a powerful tailwind, the higher prices will be and the more incentive there will be to take profits heavily in this period.
However….after this point is where the door gets fully opened for liquid staking derivatives to hit their maximum potential. When there’s free staking-unstaking liquidity is when the staking arbitrage trade really opens up, and if it can be done on L2s it will cost nearly nothing put this trade on. High yields, whether directly or via the staking arbitrage trade, will bring in new marginal buyers of ETH to buy the new supply of ETH, and after price settles, I believe we will see further upside from here.
Remember, the biggest tailwind post-withdrawal period is the unstaked ETH squeeze. As L2 adoption increases and the burn increases + more and more unstaked ETH is staked, there will be a structural shortage of unstaked ETH for use on the ever more valuable ETH L1 blockspace. In such an environment, we will see unstaked ETH squeeze to new all time highs. What does this depend on? It depends on the ability to transact on Ethereum being valuable. So, if you do choose to hold ETH through the withdrawal period, you’re making a bet on developers making something people want to use. Honestly, it always boils down to ETH fundamentals, but in the post-withdrawal period this will be more salient as the primary demand squeeze will come from use of the network itself.
Narrative Adoption
User Experience Narrative
As I’ve said before, price leads narrative. In past crypto euphorias, the first user experience was often expensive, slow, confusing. In the next euphoric peak, the gold standard user experience will be the Argent Wallet + Zksync experience.
I don’t expect Argent to stand alone for long. We should see a phase shift in product quality as the location of major crypto competition moves from scaling to UX.
Scaling Narrative (AKA the L2 Army)
ZK-Tech.
At its core, scaling is a technology narrative. It’s the story of a new technology (rollups) and a newer technology (ZeroKnowledge Proofs).
This innovation is moving FAST.
From this point on, I’m going to make my argument regarding L2s with a horde of tweets and links to just demonstrate - in one place - how fast things are moving and how much progress is being made.
Transition from Multi-Chain L1 to Multi-Chain L2 Narratives
Led by epolynya, the modular>monolithic blockchain narrative has arrived.
I’ll let you click through to the links to see what the narratives and arguments actually consist of (epolynya and Bankless have done a much better job than I could in synthesizing it).
The Alt-L1 Bubble was a perfect storm…which is now ending
In the past year, alt-L1’s have enjoyed a period of near-0 competition. Ethereum L2s weren’t ready yet, and as such any technology that didn’t sacrifice on decentralization could not compete. While competition was still building their first product, alt-L1’s were first to market. By bootstrapping something cheap (but functional!), they soaked up excess demand unwilling to pay Ethereum fees the alt-L1 multi chain hypothesis thrived.
The first step was SOL and AVAX. Cheap. Fast. That’s pretty much the thesis of both chains
. More recently we saw some buzz about NEAR and ATOM. Why has the narrative not come back around to ETH? Well ETH L1 doesn’t scale, and so far L2s haven’t been ready. There haven’t been L2 tokens that could really compete…but that is changing quickly.
Scaling, and any argument of “my blockchain is better because it’s fast and cheap,” is going to become a commodity. And fast. What used to be sold as a premium differentiating feature for alt-L1's like SOL and AVAX will soon be tablestakes as an army of L2 solutions comes online in the next 12-24 months. We’re already seeing adoption beginning now, and take a look below at what the competition coming online looks like.
Going forward, you have the rise of an army of highly talented, well funded, competition in L2s that are, right out of the gate, more secure and decentralized than alt-L1s and are built to use sound money on a credibly neutral platform.
Some of these are popular and mainstream crypto L2s like Arbitrum, Polygon, and Optimism. Others are popular and mainstream tradFi L2’s like Visa and Mastercard’s L2 solutions.
L2 adoption is happening now
Adoption is slow and in bursts - you can see below. Arbitrum opened its doors to ~700K ETH moved, settled at 600k ETH…4 months later it started rising again and is now around 1M ETH. Why? Well Arbitrum is getting better. It is onboarding major apps & functions. It’s improving reliability, decreasing fees, and increasing accessibility.
Note that Arbitrum has 50% market share in the L2 space right now. This, to me, is first mover advantage. Make no mistake, Arbitrum is a fierce competitor in this space, but there’s no reason there should be any single 50% market share leader in the L2 rollup space. We’re going to see a much more even split and this just goes to show how much functionality & onboarding is in front of these L2’s; adoption which the market has NOT seen yet. L2’s are still building, and that’s fantastic.
L2s are still building and improving
L2’s are inherently collaborative - The bridge economy is emerging
A major reason that I believe Ethereum has the upper hand in the L1 competition is because L2s will compete directly with L1's. If you believe Optimism, Arbitrum, ZKsync, Starkware, Polygon, Aztec….. are all competing directly with Solana, Avalanche, then you believe the future is filled with much more competition for those alt-L1 chains than the past. However, it’s more than just increased competition. L2 bridges allow the L2s to be inherently collaborative. Where funds can bridge from L2 to L2 without security sacrifices, funds bridging to alt-L1’s lose significant security.
As the funds involved increase in size, this starts to matter more and more, increasing L2 network effects to the exclusion of alt-L1’s.
The argument that L2 bridges are fundamentally more secure at size than cross-chain L1 bridges adds significant drag to alt-L1 competition. If there are limits to borrowing network effects from other chains unless you’re an ETH L2, then ETH L2s can feed off of each other’s growth while alt-L1’s are limited in their ability to do the same. Each L1 must provide the full suite of products on its own, whereas L2 users can just bridge to wherever they want if products aren’t ready yet on their L2 of choice.
alt-L1s are no finished product either
The narrative so far has been “alt-L1s have a huge lead because of strategic sacrifices in decentralization.” But honestly, alt-L1’s have not solved their scaling issues quite yet. This isn’t to say they can’t be solved - it’s just to point out that in competition with an army of L2s, they aren’t as leaps and bounds ahead as marketing would make it seem.
For instance, the uptime woes.
And the fee spikes?
And…it’s also at least a bit concerning that the CEO of Avalabs doesn’t even understand that L2’s, sidechains, and L1s have substantive differences. This is…very basic rudimentary knowledge of blockchains and I see it as a very significant red flag.
Were alt-L1’s ever even sticky?
Solana costs nearly nothing to use, so it makes nearly 0 in fees. That’s absolutely a great thing for users! But it also means that whether SOL has a value prop to users outside of low fees remains a complete unknown.
On the other hand…when ETH gets scalable, there’s 0 reasons to think ETH folks will be leaving - they were willing to pay 9B in fees last year for the product!
To put this more explicitly, Ethereum users were willing to pay 380x more for ETH blockspace than Solana users for SOL blockspace. If ETH gets cheaper, there’s every reason to think Solana users might want in on ETH blockspace. There is 0 reason to think ETH users will suddenly want Solana blockspace.
The ETH ecosystem being built this way - a value proposition built on decentralization & security - sucked for a long time (damn gas fees). However, the economy we’re left with is also much more comfortably forecastable. Solana and Avalanche users never really were forced to anchor themselves into the blockchain & community in the first place, so the network effect that remains should be much, much more fragile. It is possible there is network effect entrenchment for them, but where for Solana & Avalanche it’s just trust (and hope the users stick around for the long run), for Ethereum it’s verify (with observable fees paid by users for a product they prove they love with their behavior, over and over and over again).
ETH has no competition in security/decentralization
Proof of Stake increases security by orders of magnitude and as the triple halving plays out, Ethereum will emerge as the only blockchain with geopolitical grade security and decentralization. Ethereum is and will be the only credibly neutral blockchain in existence.
Are you ready for the L3, L4 narrative?
In my initial report, I referred to the rise of L2s as an upcoming narrative. I was right, but perhaps I should’ve anticipated the rise of the L3,L4 narratives…
As pointed out by Starkware here, there are tasks that only L2s can perform. The rise of L2-native dapps will again be a competitive advantage of the L2 ecosystem.
So you’re ready for L2 Season? L2 Onramps are Here
As epolynya points out, CEXs won’t just bridge to any random alt-L1. There are real security concerns when it comes to managing money! However, when it comes to L2s with the full security guarantees of Ethereum…all CEXs have an incentive to integrate with the full network of L2s (and even just 1 unlocks the rest via L2 bridges).
L2 Token Airdrops launches L2 Season
As we’ve covered, L2’s are still building product, bridges, onramps…and so they really aren’t interested in token launch just yet…but they will. Many have verified this already…and when they do, they’ll attract major attention. It’s a great decision in my view to not airdrop yet - it’s a huge attention grabbing event, and these projects are NOT lacking in funding. Best to do the airdrop once things are beautiful experiences, so the attention brings people to the ecosystem to stay.
Will L2 Tokens steal ETH flows?
Not really. They’re going to get big flows and big moves because they’re smaller tokens. They’re also riskier by definition because there is much bigger competition. The difference is that the success of L2s built on Ethereum cements Ethereum’s kingship in the background. This is crucial for attracting the kind of marginal buying that makes a difference - institutional level allocations as ETH becomes its own asset class. It fits with a broader narrative that ETH becomes the platform layer of crypto, and everything else succeeds or fails with it.
More funding is coming
There’s the grassroots funding…
And the venture funds (again)
Funds incoming in this space are immense.
A lot of this funding is going to result in product launches in the next 1-3 years. Talk about narrative potential.
Sharding and the Data Availability Buildout
After L2 adoption and the merge, there will be a major narrative shift to sharding and the data-availability layer. This will widely benefit every L2 and provide a scaling advantage relative to alt-L1's. Can’t alt-L1’s just use rollups and shard? Not really… ETH is so decentralized it can support 64 shards today (perhaps more in the future). Alt-L1’s don’t have enough validators to do the same.
Note that Sharding isn’t a prerequisite for increasing data availability on Ethereum. We have celestia till it is here. However, when it gets here, ETH is massively advantaged in how many shards it can have and it will be the only ecosystem capable of this degree of organic scaling.
Execution of the “End Game” Narrative
After EIP1559 happened, people realized the ethereum devs could actually execute. As L2s come online this gets reiterated again…and after the merge it will happen again. As people realize that we are seeing forward motion, I think people will start to take the Ethereum roadmap more seriously…and the truth is, when you do, you realize that there are no other blockchains that have a roadmap like this. Ethereum has a scaling roadmap without tradeoffs on security or decentralization, and in this respect it has no competition.
Ultra-Sound Money
Ethereum is already moving on the path to ultra-sound money, as expected.
It’s worth noting that Bitcoin’s security model relies on fees rising over time to replace issuance in providing network security incentives. This “Bitcoin’s fees will rise” plan doesn’t seem to be going super well.
Hopefully they get the requisite increase in fees on an absolute basis to maintain security, but gosh it helps encourage transactions when your token does stuff.
Follow the Developers
This report is absolutely worth digging into yourself. 2 interesting points
Ethereum is an ARMY. Honestly this could be a thesis on its own. When you have an increase of roughly 1,200 developers in the last 12 months and a total of roughly 4,000 developers currently working on making a valuable product, you could just own Ethereum on the bet that in 5-10 years this developer army will make something more valuable than Ethereum is today.
For context on the alt-L1 competition, all of Solana’s developers combined (~900) is less than the number of developers that entered the Ethereum ecosystem in the last year.
2022-2023 is the shift from infrastructure to product
If the L3, L4 discussion earlier felt a bit crazy, like we’re jumping the shark and getting too excited about rollups - don’t worry. It’s more a sign that rollups are hitting their stride and that the conversation can finally move away from scaling than that we’re going to be spending all of our time talking about L6 in 2025…
We had the alt-L1 run, and by EOY 2022 it’s going to become obvious that alt-L1’s will at best be one amongst an army of L2’s. In such an environment, there is still scaling work to do (improving/implementing rollups, expanding the data availability layer with sharding), but largely from a user perspective, scaling will have arrived to Ethereum
.This means where the past of crypto was largely focused on infrastructure, the future of crypto will increasingly focus on product - a welcome and healthy shift as the ecosystem evolved.
NFT’s Experimentation Has Begun
In conclusion
I’m bullish on Ethereum.
Until the merge, happens the time frame is uncertain and could delay past my Jan2023 target.
As we wait, there are many narrative catalysts including the rise of L2s (their adoption, buildout, and eventual token drops), a transition from infrastructure to product, ultra-sound money, and improved user experience.
Once the merge happens, there will be a strong structural demand for Ether and an incredibly enticing staking yield alongside the growth of the staking derivative industry.
Behind all of this is billions in venture investment and organic community funding for products in pipeline that we have yet to see and an army of developers working full time to build build build.
Sorry if my writing is a bit worse than usual. I’m busier than I was when I wrote my initial report, but this update was fun to write and I hope you enjoy it!
EDIT: Interesting post-publication tweets worth checking out
So again, this might seem circular. L2s gain traction dropping L1 fees, dropping L2 fees, causing L2’s to gain more traction, which eventually increases L1 fees…won’t that mean L2s will lose traction? No. L2s, unlike alt-L1s, get cheaper with more activity. The more L2s are adopted, the lower their fees regardless of the ETH L1 gas price. So, while there might be an initial drop in L1 gas prices, if/when L1 gas prices rise back up due to L2 demand, L2s will be cheaper than before, not more expensive. Kinda wild when you think about it.
They’ve stated they’ll be building for Starkware too I believe
Ironically, Bitcoin is the ecosystem that has always been saying “we can transition from an issuance based security model to a purely fee based security model.” Bitcoin, however, has a small fraction of the fees of Ethereum and has failed to grow its fees much at all. If Ethereum can prove long-term sustainable fee growth in an L2 rollup world, there are a few ways things could go. 1) A much higher % of ETH could end up staked (approaching 100% of the ETH over time), 2) Monetary policy could be revised again to cut issuance entirely (with high enough fees we would need less and less issuance to accomplish high levels of security). In any case, when I noticed that most of the yield comes from fees that I expect to grow over time, I thought it was just hilarious that Ethereum is again achieving ultrasound money in a more robust, sustainable way than Bitcoin.
The flip side of this is that true adoption will reveal the scaling challenges of alt-L1 approaches as well. It’s going to be a bumpy ride.
People complain a lot about ETH maximalism, but it’s sort of structural. Ethereum has a fundamentally distinct approach to the scaling problem than other chains. If you’re a SOL advocate, it’s going to be hard for you to take that much issue with AVAX because your thesis is just “fast and cheap is better.”
You’d think in the “Multi-Chain L1 Hypothesis” debate, it would be multichain advocates on one side and maximalists (generally) on the other side. But it isn’t, and not because Avalanche advocates are saints. It’s because being an AVAX maximalist is incoherent. If your thesis is “anything goes if it’s fast and cheap, ” you’re going to end up open to all the fast and cheap options. So, the other side of the multi-chain L1 hypothesis isn’t maximalism…it’s Ethereum maximalism (or decentralization maximalism or security maximalism or whatever you’d like to call it)
Ad-spend for a product launch can actually be worth something if users aren’t confronted with $100’s in gas fees, so expect more traditional approaches to product onboarding to begin in earnest as well
I was actually just checking out your blog yesterday looking if you had made any updates. Cheers man.
Fucking masterpiece. I am in awe. May you live to be a thousand years old.