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Source: Grayscale Research; Compilation: AIMan@Golden Finance
Key points:The smart contract platform is the core infrastructure of decentralized applications and blockchain finance. Therefore, they are at the heart of the vision of public chains providing new architectures for financial markets and digital commerce.
Grayscale Research believes that adoption of smart contract-based applications will accelerate in the next 1-2 years, partly due to changes in the U.S. regulatory and upcoming legislation. Ethereum is the largest smart contract platform based on (i) market capitalization, (ii) the size of its application ecosystem and developer community, and (iii) the value of its on-chain assets. However, it has recently lagged behind certain competitor activities including Solana in terms of expenses and other on-chain asset metrics.
We believe that Ethereum’s differentiated characteristics, including a culture that emphasizes decentralization, security and neutrality, will help it continue to occupy a considerable share in the user, developer and transaction fees. Even some newer blockchains are adopted and take market share. Therefore, ETH should be regarded as an important part of diversified cryptocurrencies’ portfolio.
The prospects for smart contract platform fees are very uncertain, partly because we don't know how much pricing power a platform like Ethereum can maintain in the long run. However, Grayscale Research shows in this report how Ethereum has increased its total expense revenue to over $20 billion (annualized expense revenue for the past six months by executing its scaling strategy and maintaining pricing).
Ethereum, like Linux, Python and some other examples, can be regarded as one of the most important open source software projects of all time. Despite being less than 10 years old, the Ethereum network today consists of more than 11,000 nodes, process 35-40 million transactions per month, ensuring approximately $46 billion in value and benefiting from the support of more than 2,100 full-time developers. The broader Ethereum ecosystem consists of interconnected blockchains that currently process about 400 million transactions per month.
Although Ethereum network’s token ETH has a place in the crypto industry and launched its spot exchange-traded product (ETP) last year, its market value is far behind Bitcoin (BTC). In fact, the ETH/BTC price ratio has fallen back to its mid-2020 level (Figure 1). By market capitalization, Ethereum’s market capitalization has increased by about $90 billion since the end of 2022, while Bitcoin’s market capitalization has increased by about $1.35 trillion (i.e. about 15 times more). Ethereum has also lagged behind tokens from some other smart contract platforms, including Solana and Sui.
Figure 1: Ethereum has lagged behind Bitcoin for more than two years
The ongoing downturn has led some observers to question the prospects of Ethereum network activity and the value of ETH. Despite uncertainty about the prospects of each crypto asset, we still believe that ETH should be seen as an essential component in a diversified cryptocurrency portfolio.
Ethereum and Bitcoin cannot be compared directly. The Bitcoin network is a monetary system, and Bitcoin assets are mainly used as media of exchange and store of value. For these reasons, it is part of the Grayscale Currencies Crypto Sector . Bitcoin’s relatively strong price returns reflect investors’ demand for its scarcity and censorship-resistant digital currency attributes.
Ethereum, by contrast, is an application platform, and ETH provides practicality for users of these applications. Ethereum and Solana, Stacks, Sui and many other networks are part of the Grayscale Currencies Crypto Sector. Despite the bright prospects of smart contract technology, we have not seen large-scale adoption of smart contract-based decentralized applications. There are many early success stories—including the growth of stablecoin transactions—but the current adoption rate is very low compared to the vision of smart contract platforms, which aim to bring most of the traditional financial chains.
Grayscale Research believes that the adoption of smart contract-based applications will accelerate in the next 1-2 years. Partly due to changes in the U.S. regulatory and upcoming legislation. Trump has made changes to federal crypto, which should allow the industry to invest and thrive in the U.S. states. In addition, senators from both parties proposed the "Guiding and Building the U.S. Stablecoin Innovation Act" (GENIUS). The bill is based on relevant efforts by the previous Congress to provide a comprehensive regulatory framework for issuing payment stablecoins. Increased regulatory transparency should help increase investment and adoption of blockchain-based applications, thereby increasing on-chain activity (such as transactions and fees) and ultimately bringing value-accumulative tokens to smart contract platforms.
After the initial lead, Ethereum now faces fierce competition from other smart contract platforms, which requires execution of its ambitious development plans to succeed. But Ethereum also has differentiated features, which we expect to be particularly valuable for financial use cases—including a large number of on-chain capital pools and design choices that emphasize decentralization and neutrality. Therefore, we expect Ethereum to occupy a large share of future on-chain activity, which in turn pushes value to ETH.
Everything is computerEthereum is the first major smart contract platform blockchain. Just like Bitcoin, the Ethereum blockchain can be used to send and receive transactions. However, with the addition of smart contracts, Ethereum can also run decentralized applications. These applications can beAnything, from decentralized lending platforms to identity solutions to video games. Because Ethereum acts as an infrastructure for applications, it can be regarded as a software-based computer, sometimes referred to as a "world computer." Ethereum has more on-chain assets (such as stablecoins and tokenized assets) than other leading smart contract blockchains, but has recently lagged behind some other blockchains in on-chain activity (Figure 2). By market cap, Solana is the second largest network with more activity in its active addresses, transactions and fees over the past 30 days, but its market cap is only 30% of Ethereum.
Figure 2: Ethereum is the smart contract platform with the largest market value
The investment theme of the smart contract platform is that new applications will bring more users, more transactions, and ultimately more fees to the underlying agreement. We estimate that the transaction volume of smart contract platforms has risen from about 20 transactions per second (TPS) five years ago to about 1,200 transactions today, meaning an annualized growth rate of about 130% (Figure 3). By comparison, Visa network processed approximately 7,400 TPS in the 12 months ended September 30, 2024. If the share of smart contract blockchain in the digital payments field can continue to grow and can establish competitive barriers and maintain pricing power, this will lead to increased expense revenue and may lead to an increase in token prices.
Figure 3: Smart contract blockchain processes approximately 1,200 transactions per second
According to the FTSE/Grayscale smart contract platform cryptocurrency industry index (Figure 4), ETH's performance is basically consistent with similar products. The market segment currently includes 70 tokens with a total market capitalization of US$428 billion. Since the beginning of 2024, the smart contract platform index has fallen by 22%, while the price of ETH has fallen by 18%. By comparison, Solana's price rose 18% and Bitcoin's price rose 90%.
Figure 4: Ethereum's performance is roughly consistent with its tokens on the same track
How Ethereum makes moneyEthereum monetizes network activities through transaction fees, which is the so-called "Gas fees", which are the fees required to execute transactions or interact with smart contracts. With Solana Unlike many other blockchains, activity in the Ethereum ecosystem takes place both on the L1 Ethereum main network and on the L2 network. This is how Ethereum intends to scale to millions of users, because L1 itself cannot fully scale without sacrificing decentralization. If coordinated, this hierarchy should provide users with options for high throughput and low-cost L2 transactions, while preserving L1's security and decentralization. However, the migration of activity to L2 affects the level of cost allocation across the network, which we explain below.
The Gas fees for Ethereum's L1 and L2 networks differ in structure, reflecting their different roles in protocol scaling strategies. The fee model adopted by Ethereum's L1 has three different components:
1. Gas unit: The fixed computational cost of certain operations (for example, ETH transfer requires 21,000 gas).
2. Basic Fee: The payment amount of all transactions is denominated in gwei per unit of gas (1 gwei equals one billionth of ETH). The basic expenses are adjusted through algorithms according to the requirements per unit of gas.
3. Priority Fee ("Tip"): �
For example, a transfer of 1 ETH (requires 21,000 gas), with a base fee of 10 gwei and a tip of 2 gwei, is:
=21,000*(10+2)=252,000 gwei or 0.000252 ETH � Priority fees are paid to the validator as part of the pledge reward, similar to dividends. The underlying fee is destroyed to reduce the supply of ETH and reward all token holders, similar to a buyback. (Chart 5)
Chart 5: Fees are allocated to token holders through pledge rewards and destruction
L2 networks such as Arbitrum One and Base also charge transaction fees. Because they rely on the Ethereum L1 network for final settlement and security, L2 is able to charge much lower transaction fees and process more transactions per second. However, L2 will remit some of the fees to L1 as payment for settlement and security services. Last year, Ethereum underwent a hard fork (network upgrade) called Dencun, designed to help expand the L2 ecosystem. Dencun Upgrade introduces blob transactions, a low-cost way for L2 to publish data to L1. Success in upgrades significantly increased the number of users and transactions on L2 (Figure 6)
Figure 6: Significant growth in activity on Ethereum L2
However, the introduction of blob transactions also affected the fee level and allocation of the entire network. Most importantly, blob transactions reduce the fees paid by L2 to L1 (Figure 7). This leads some observers to believe that L2 is an "parasite" of Ethereum, because in the short term, the success of L2 comes at the expense of L1. But if L2 benefits from staying in the Ethereum ecosystem (such as security and other network effects), then in the long run, the huge L2 ecosystem will ultimately bring more value to the Ethereum network and ETH.
Figure 7: Ethereum L2 now pays less to L1
Future upgrades will continue to expand L1 and L2. The Pectra upgrade, scheduled for April 2025, combines enhanced capabilities of Prague (execution layer) and Electra (consensus layer). Specifically in terms of expansion, Ethereum improvement proposal-7691 optimizes blob storage, with the goal of 6 blobs/blocks, doubles the blob capacity of Dencun. Looking ahead, Ethereum's expansion potential may increase significantly with the implementation of the full Danksharding concept (Figure 8). This upgrade involves expanding the number of blobs per block and the size of each blob, thereby significantly increasing the upper limit of TPS. Figure 8 shows that Pectra and Full Danksharding may affect Ethereum’s transaction capacity L2s.
Figure 8: Ethereum upgrade will significantly increase L2 capacity in the future
Outlook on Ethereum revenueThe outlook for smart contract platform fees is highly uncertain, partly because the technology is in its early stages and we don't know how much pricing power a platform like Ethereum can maintain over time. Smart contract platforms compete with each other and also compete with centralized systems. To maintain pricing power over the long term, they need to provide differentiated capabilities to prevent users from moving to cheaper (centralized or decentralized) alternatives. Although the Ethereum blockchain is slower and more expensive than many competitors, Grayscale Research believes that its unique advantages, including high-value on-chain assets and emphasis on decentralization and security, will contribute to adoption and network effects and ultimately provide Ethereum with a level of pricing power time.
Figure 9 shows an example of how Ethereum can increase fees by increasing capacity and maintaining pricing power. We assumeThe average transaction fee on L1 is $5.00, and the average transaction fee in 2019 is $6.30. In the long run, Layer 1 will probably be used mainly for high-value transactions and transactions that require high security assumptions. For L2, we assume that the average transaction fee is $0.05, which is also similar to recent experience. We further assume that Ethereum L1 handles 100 TPS and Ethereum L2 handles a total of 25,000 TPS. These are hypothetical TPS predictions, which can be achieved under Ethereum’s expansion roadmap, over the next 3-5 years, and assume a significant increase in overall demand for smart contract-based applications.
Based on these assumptions, Ethereum Tier 1 revenue will grow to over $20 billion, compared with annualized revenue of about $1.7 billion over the past six months (Figure 9). Despite the high uncertainty of the expense outlook, it should technically be able to significantly increase expense revenue if Ethereum implements its scaling strategy and maintains a certain pricing power. To monitor progress, investors should consider tracking the fundamental variables in this simplified model—i.e., L1 and L2 TPS and L1 and L2 average execution rate charges.
Figure 9: Ethereum fee income can grow with expansion and pricing power
Make a bigger cake � Then in 2021, the price of Ether rose faster, eventually from the market peak in early 2019 to November 2021, with a price return of about twice that of Bitcoin (Figure 10). Some cryptocurrency investors may have been ready for a similar pattern in the current cycle—Ether has significantly outperformed Bitcoin as the cycle matures—but they have been disappointed by the recent weakness of ETH. Figure 10: Ethereum ultimately outperformed Bitcoin in the last cryptocurrency cycle
Grayscale Research believes that poor ETH performance is a healthy signal that the cryptocurrency market is focused on fundamentals. In our analytical framework, the crypto market distinguishes smart contract platforms mainly based on fees. Although fees are not exactly the same way they are converted into token value in individual blockchains, they are usually passed to token holders, and fees are arguably the most direct and comparable measurement activity on blockchains.
In the field of smart contract platform encryption, Ethereum andSolana has relatively high fees and market capitalization (Figure 11). Since the end of 2023, Solana has gained fee revenue and market share in the field of smart contract platform encryption, while Ethereum has lost fee revenue and market capitalization. In other words, the market properly repriced the relative value of Ethereum and Solana due to changes in fundamentals. In the simple framework shown in Figure 11, Solana moves up and right, and now it looks roughly fair (it "grows to its valuation"). By contrast, Ethereum moves down and left, and today's valuation may be higher than its expense income.
Figure 11: Due to weak expense growth, Ethereum is less performing than Solana
These subtle differences in competitive positions are important, but not as important as potential growth across the entire category. Adoption of all smart contract platforms is in an early stage. For example, Ethereum currently has only about 7 million monthly active users, while Facebook parent company Meta Platforms reported that it had 3.35 billion "daily active users" in December 2024. With the increase in adoption rate, smart contract platforms are expected to benefit from network effect compound interest. Increased participation will not only drive the increase in transaction volume and fee income, but also accelerate the activities and flow of developers.Depth of dynamics and interoperability across ecosystems. This cycle of adoption and practicality can expand the acquisition of value across the ecosystem.
Winning networks are likely to be those that receive the most transaction fees over time, and their native tokens have favorable structural supply and demand conditions (e.g., due to limited supply growth and structural demand as collateral assets or payment mediums). Solana, Sui and some other smart contract platforms will distinguish them from their competitors with high throughput, low transaction costs and generally compelling user experience.
Ethereum stands out because it has a large and diverse application and developer ecosystem, a large amount of on-chain capital, and prioritizes decentralization, security and neutrality. We expect these features to continue to attract a large number of users to join the Ethereum ecosystem, and Ethereum will occupy a considerable share of economic activity on the smart contract platform blockchain in the future.
