Think Beyond Bitcoin: Ethereum’s Use Cases and Latest Technology

Michael recently authored The Ethereum Investment Framework, a comprehensive report designed to be the industry standard for evaluating the Ethereum ecosystem. CoinDesk Indices contributed an article in the framework, and sat down with Michael to discover why he believes Ethereum will serve different use cases from Bitcoin, and why it’s important to be educated and informed about it.

The interview was conducted by CoinDesk Indices and is not associated with CoinDesk editorial.

With a lot of focus on Bitcoin, why should the finance and crypto community pay attention to Ethereum?

We believe Ethereum is distinctly different from Bitcoin and serves different use cases. Investors should separate the two based on the following criteria:

Innovation: Ethereum is a Turing-complete computing platform (universally programmable). Therefore, it's endlessly innovative whereas Bitcoin serves one primary use case as "internet money" or "digital gold."
Industries building "on top:" Ethereum introduced a global, shared settlement and economic layer for the Internet. Industries such as finance, digital art and collectibles, music, gaming, e-commerce/brand loyalty, enterprise B2B, digital content, digital identity, etc., are all building and experimenting on Ethereum today.
Number of applications: Today, there are over 7,300 applications building on Ethereum. Bitcoin has very little innovation due to limitations with its Script programming language. For this reason, we believe Ethereum has a much larger addressable market than Bitcoin.
Yield: Ethereum can generate a real yield for holders of ETH, which comes from a combination of user fees and consensus rewards. Bitcoin offers holders no such yield.
Network Effects: Ethereum has larger network effects than bitcoin due to the amount of value locked in its ecosystem ($37b vs $315m for bitcoin). Its number of non-zero wallets (a proxy for users) is more than double that of bitcoin at 111 million.
Utility: ETH has far more utility today than bitcoin. For example, nearly 35% of the circulating supply of ETH is held in smart contracts today, providing services, liquidity, and economic security throughout the ecosystem. This makes ETH a more capital-efficient asset than bitcoin, which often leaves the Bitcoin blockchain to find yield within the Ethereum network.
Financials: Ethereum generated $2.4 billion in user fees last year vs $796 million for bitcoin. On the expense side, the Bitcoin network paid out $9.7 billion in token incentives to its miners. Ethereum paid out only $1.39 billion in token incentives over the same period.

What are the potential portfolio use cases for Ethereum? Does that differ from bitcoin?

Historically speaking, an allocation to ETH can significantly increase risk-adjusted portfolio returns. Backtesting performed by ETC-Group from 2016 reveals a 1% allocation of ETH to a 60/40 portfolio led to a 13.7% increase in returns. A 2.5% allocation to ETH boosted returns by 36.2% and a 5% allocation provided 79.8% more upside. When compared to bitcoin, Ethereum has a 5-year compound annual growth rate of 79% vs 63% for bitcoin. Furthermore, staked ETH can offer investors an additional yield not possible with bitcoin while remaining generally uncorrelated with US equities. Noting past performance is not indicative of future results and this is not meant to be offered as investment advice. Educational information only.

What are the five most interesting Ethereum data points that most people probably aren’t aware of?

The top five most interesting data points from our Fourth Quarter 2023 issue of the Ethereum Investment Framework include:

Onchain P&L. From an onchain perspective, Ethereum was profitable in 2023. This was despite network revenues being down 45% year-over-year. How did it happen? The network cut its operating costs (consensus rewards) by approximately 85% when it moved from proof of work to proof of stake in Q3-22.
Token Economics. Ethereum was deflationary (-.28%) in 2023. This occurred despite onchain activity being down during the year as the crypto winter dragged on.
Non-Zero Wallets. Ethereum now has over 111 million non-zero wallet addresses, up 21% over last year.
Daily Transactions. Volume on the L1 was down 7% in 2023. However, emerging layer 2 solutions such as Optimism, zkSync, Arbitrum, Base, Starknet, and Manta Pacific are now handling more than 3x the number of daily transactions on Ethereum L1. In fact, transactions on L2 are up 5,650% over the last few years — an indication that Moore’s Law is playing out within the Ethereum Network.
ETH Staked. The number of ETH staked in validator contracts is now over 35 million, up 124% during 2023.

How do you help investors apply traditional valuation frameworks and fundamental analysis to crypto networks?

We approach valuation from several angles in The Ethereum Investment Framework:

Addressable Market Analysis. With this approach, we identify the industries already adopting blockchains, while forecasting the percent of each industry that could move onchain by 2030.
Cycle Analysis. With cycle analysis, we analyze past adoption cycles and the growth in key fundamentals to forecast the potential future value of the network.
“GDP” Analysis. One way to compare Ethereum’s valuation relative to other layer 1 networks is with “GDP” analysis. In this case, we quantify and forecast the economic opportunity, or GDP, of the network. The GDP of a blockchain network is the sum of all of the revenues produced by the applications and protocols built “on top” of the L1. Ethereum’s “GDP” was over $2.7 billion in 2023 (covers top 100 applications per Token Terminal).
Total Crypto Market Cap Analysis. The combined market cap reached $3 trillion in 2021. Despite the volatility of the industry, we think crypto is in a long-term secular and exponential adoption cycle. As such, if the industry were to follow past adoption patterns (388% increase last cycle), the combined market cap could reach $10 trillion in the next expansion. Following historical data, we apply a percentage to Ethereum and ultimately get a projected price/token in the next cycle.
Traditional Discount Cash Flow. We apply traditional DCF analysis to Ethereum as one might apply to a stock by forecasting growth rates over a 10-year term using average revenue per day since EIP 1559. While we think this is a useful exercise, we think DCF analysis is flawed when applied to layer 1 blockchains for several reasons which we cover in The Ethereum Investment Framework.

From a more qualitative perspective, what are some important concepts covered in the Ethereum Investment Framework that you think investors should be aware of?

We cover four main themes in detail:

The history of open-source technology and open standards (and why open standards drive innovation). We believe crypto is simply the latest expression of these trends which began decades ago. We have a chapter in the report titled “A Brief History of Open Standards,” which provides context to the permissionless innovation we see within the Ethereum ecosystem today.
Why now? The nature of innovation, and how new technologies are typically deployed and implemented. There are typically 4 distinct phases and we think crypto is nearing the “turning point,” which comes after the “frenzy” period but before the technology is ultimately deployed. “Turning points” are often colored by regulation and policymaking, marking the end of the installation period and the beginning of the deployment period.
The similarities and differences between how the Internet was built and what we see today with public blockchain networks. It’s important to understand where value accrued in web2 and why and how web3 differs. We also cover the business models and margins of each layer of the Ethereum tech stack: L1s, L2s, DeFi Protocols, data oracles, wallets, applications, etc.
Finally, traditional investors may not be as well versed in concepts such as Metcalf’s Law, Lindy Effects, the 10-year window, why network technologies tend toward monopolies, etc. We cover these topics and why they matter in The Ethereum Investment Framework.

Why did you create The Ethereum Investment Framework? What problem does it solve?

Crypto is complicated and it’s difficult to get up to speed fast. One of the main problems we see investors grappling with is there is no single resource in the market to get trusted insights and data in one place.

The Ethereum Investment Framework bundles research, onchain data (over $13k worth of licenses), and industry expertise into one easy-to-read, non-technical document. Our goal is simply to save investors time as they get up to speed. That’s the problem we are solving.

For more, you can download a copy of the latest issue here: The Ethereum Investment Framework.

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