Unveiling the Deep Advantages that Solidify Ethereum's Position

ETH Narrative

ETH plays a diverse role, being referred to as Ultrasound money that controls supply through reduction, as well as an internet bond that provides non-inflationary staking yields. With the rise of Layer 2 scaling and re-staking technologies, new concepts such as "settlement layer assets" and "general labor proof assets" have emerged.

Translator's Note: Under the PoS mechanism, users can participate in network maintenance by staking ETH and earn rewards, similar to earning interest from purchasing bonds, but with more decentralized characteristics. Since staking rewards come from network transaction fees and newly issued ETH, and the total supply control strategy limits excessive issuance, this staking reward model is seen as more anti-inflationary compared to traditional inflation.

Ultimately, we believe that these individual narratives do not fully capture the vitality of ETH. In fact, the increasing use cases of ETH complicate the ways to assess its value, making it difficult to define a single measurement standard. Moreover, the interweaving of these multiple concepts can sometimes create confusion, and their contradictions may distract market participants from the true drivers of ETH's value increase.

Spot ETF

The spot ETF is crucial for Bitcoin, as it not only clarifies the regulatory framework but also attracts new capital inflows. Such ETFs fundamentally reshape the industry landscape, and we believe they disrupt the previous cyclical pattern where funds first flowed from Bitcoin to Ethereum and then to higher-risk alternative assets.

There is a barrier between the funds invested in ETFs and those on centralized exchanges, which can access a broader range of crypto assets. Once the spot Ethereum ETF is approved, this barrier will be removed, allowing Ethereum to access capital sources currently only available to Bitcoin.

In fact, the logic behind the approval of the Bitcoin spot ETF applies equally to the Ethereum spot ETF, as the futures prices on the Chicago Mercantile Exchange (CME) are closely related to spot prices, effectively monitoring and preventing market misconduct.

The relevant research period for the correlation study referenced in the approval of the Bitcoin spot ETF began exactly one month after the launch of Ethereum futures on the CME in March 2021, which we speculate was intentional to apply the same logic to the Ethereum market in the future. Previous data analyses from Coinbase and Grayscale also show that the correlation between Ethereum's spot and futures prices is similar to that of BTC.

Challenges from Other Layer 1s

Some high-performance integrated chains, especially Solana, are gradually encroaching on Ethereum's market share. These chains offer high-speed and low-cost transactions, leading to an increasing amount of trading activity moving away from the Ethereum mainnet. For example, in just the past year, the DEX trading volume in the Solana ecosystem surged from 2% to 21%.

We observe that compared to the previous bull market cycle, the differences between these L1s and Ethereum are now more pronounced. They no longer rely on the Ethereum Virtual Machine, and DApps are being designed anew from scratch, creating their unique user experiences. Additionally, the integrated/holistic strategies adopted by these chains enhance the synergy between different applications, addressing issues such as poor user experience and fragmented liquidity during bridging processes.

While these unique value propositions are crucial, we believe it is still premature to judge success solely based on incentive-driven activity metrics. For instance, the user trading volume on some Ethereum Layer 2s decreased by over 80% after the peak of airdrops. Meanwhile, Solana's share of total DEX trading volume grew from 6% at the time of the Jupiter airdrop announcement on November 16, 2023, to 17% on the first claim date of January 31, 2024 (Jupiter is a major DEX aggregator on Solana).

As there are still three airdrops pending for Jupiter, Solana's DEX activity is expected to remain high. However, during this period, assumptions about the long-term retention of active users remain speculative.

On the other hand, leading Ethereum Layer 2s (Arbitrum, Optimism, and Base) currently account for 17% of total DEX trading volume, along with Ethereum itself at 33%. This is particularly important when comparing the demand growth for ETH against other Layer 1 solutions, as ETH serves as the foundational fuel asset in all three Layer 2s. Furthermore, the additional demand drivers for ETH within these networks, such as MEV, have yet to be fully developed, leaving room for future demand growth. Therefore, from the perspective of DEX activity, this provides a more suitable comparison between integrated and modular scaling approaches.

Additionally, another more enduring metric for measuring user adoption of the network is the supply of stablecoins. The circulation and issuance/redemption of stablecoins are restricted by bridging, resulting in slower velocity.

When measured by stablecoin issuance, activity remains concentrated on Ethereum. We believe that many emerging chains still lack the trust and reliability to support large-scale capital, especially capital locked in smart contracts. Large capital holders tend to be less sensitive to Ethereum's higher transaction fees (relative to transaction size) and prefer to minimize risk by reducing liquidity interruption time and minimizing bridging trust.

In fact, the growth rate of stablecoin supply on Ethereum Layer 2 has outpaced that of Solana. Since the beginning of 2024, Arbitrum has surpassed Solana in stablecoin supply (currently $3.6 billion vs. $3.2 billion), while Base has increased its stablecoin supply from $160 million to $2.4 billion this year.

Although the final conclusions in the scaling debate are far from clear, early signs of stablecoin growth may actually be more favorable for Ethereum Layer 2 than for other Layer 1 chains.

The rapid development of Layer 2 technology has sparked discussions: Layer 2 reduces the demand for Layer 1 block space (thus reducing the amount of ETH burned as transaction fees) and may also support non-ETH gas fees within its ecosystem (further reducing ETH burn).

However, in-depth analysis shows that this situation does not negatively impact ETH.

Since Ethereum transitioned to PoS in 2022, the annualized inflation rate of ETH reached its highest level. While inflation is generally considered a structurally important component of BTC supply, we believe this does not apply to ETH. In fact, all newly issued ETH is directly allocated to stakers, and the growth rate of these stakers' ETH holdings is astonishing, far exceeding the issuance rate. Unlike the Bitcoin mining economy, where miners frequently sell BTC to maintain operations, the low staking costs of ETH allow stakers to accumulate ETH over the long term without the need to sell.

At the same time, staking has become a magnet for ETH liquidity, with the growth rate of staked ETH being over 20 times that of ETH issuance.

The rise of Layer 2 has further exacerbated the liquidity tightening of ETH, with over 3.5 million ETH migrating to Layer 2, not only directly transferring ETH but also prompting users to prepare ETH as reserves for Layer 2 transactions, effectively locking up ETH.

Despite the growing Layer 2 ecosystem, core financial services and governance activities such as EigenLayer's re-staking, Aave, Maker, and Uniswap still rely on Layer 1, ensuring fundamental demand for ETH. Particularly for large capital holders who prioritize security, they tend to stay on Layer 1 until Layer 2 fully achieves decentralization and permissionless fraud proof, which also supports market demand for ETH.

In summary, the development of Layer 2 has not weakened ETH; rather, it has promoted ETH's appreciation in a complex manner. It serves as a driver for ETH demand growth while reinforcing ETH's core value through increased use cases and its role as the fee unit for Layer 1 and pricing basis for Layer 2.

Advantages of Ethereum

In addition to the common data-driven narratives, we believe Ethereum possesses other difficult-to-quantify but still very important advantages. These may not be short-term tradable narratives but represent a set of core advantages that can sustain its dominance over the long term.

High-Quality Collateral Asset and Pricing Benchmark

ETH plays a central role in DeFi, being widely used in both L1 and L2, serving as low-risk collateral on lending platforms like Maker and Aave, and as a base trading pair in many DEXs. As DeFi applications expand on L1 and L2, the demand and liquidity for ETH also increase.

While BTC is recognized as the primary store of value asset, the wrapped BTC (WBTC) used on Ethereum involves additional trust bridging issues. Currently, it seems unlikely that WBTC will replace ETH's position in Ethereum DeFi—WBTC's supply has remained stable for a long time, over 40% lower than its previous peak. In contrast, ETH's value and role are continuously highlighted due to its widespread applicability in a diverse secondary ecosystem.

Continuous Innovation and Decentralization in the Ethereum Community

What sets Ethereum apart is its ability to maintain strong innovation while continuously advancing decentralization. The outside world sometimes criticizes Ethereum's upgrade plans for delays, without fully recognizing the difficulty of coordinating developers from diverse backgrounds to achieve technical progress.

To ensure uninterrupted network operation, teams involving more than five execution clients and four consensus clients must work closely together to push updates.

For example, since the significant upgrade (Taproot) in Bitcoin in November 2021, Ethereum has implemented a series of transformations: including the introduction of dynamic transaction fee burns (August 2021), successful transition to PoS (September 2022), opening of staking withdrawal functions (March 2023), and the addition of Blob storage for L2 (March 2024), along with numerous other technical improvement proposals (EIPs). In contrast, some rapidly developing blockchain platforms, while iterating quickly, appear more centralized and fragile due to reliance on a single client.

While decentralization may lead to a more cumbersome decision-making process, even to some extent rigidity, it is also a necessary cost to ensure security and fairness. For other ecosystems that may embark on a similar path of decentralization in the future, establishing a development model that is both efficient and inclusive of diverse opinions remains a challenge to be solved.

Rapid Advancement of L2 Innovations

This is not to say that innovation on Ethereum is slower than in other ecosystems. On the contrary, we believe that innovations surrounding execution environments and developer tools actually exceed those of competitors. Ethereum benefits from the rapid centralized development of L2s, all of which must pay settlement fees to L1 in the form of ETH. The ability to create diverse platforms with different execution environments (such as WebAssembly, Move, or Solana Virtual Machine) or other features, such as privacy protection or enhanced staking rewards, means that L1's slower development timeline does not hinder ETH's adoption in more comprehensive technical use cases.

At the same time, the Ethereum community's clear work in defining concepts such as sidechains, Validium, and Rollup enhances industry transparency regarding various trust assumptions and definitions. In contrast, similar efforts within Bitcoin's L2 ecosystem (such as the L2 Beat project) are not yet significant, and the trust models that L2s rely on are diverse and often not clearly understood or adequately communicated by the outside world.

Widespread Adoption of EVM

The innovations surrounding new execution environments do not mean that the Solidity language and EVM will become obsolete in the short term. On the contrary, the EVM has been widely adopted across other blockchains. For instance, the research outcomes of Ethereum L2 are being adopted by many Bitcoin L2s. Some shortcomings of Solidity (such as susceptibility to reentrancy vulnerabilities) are now being addressed by static tool checkers to prevent basic attacks. Additionally, the popularity of the language has spawned a mature auditing industry, a wealth of open-source code examples, and comprehensive best practice guides, all of which are crucial for cultivating a large developer talent pool.

While the direct use of EVM may not necessarily increase the demand for ETH, improvements to EVM stem from Ethereum's development process, and other chains will follow suit to maintain compatibility with EVM. We believe that fundamental innovations in EVM will continue to center around Ethereum or be quickly absorbed by some L2, thereby solidifying Ethereum's position in the minds of developers.

Tokenization Trends and Accumulation Advantages

We believe that the push for tokenization projects and increasingly clear global regulatory policies will primarily benefit Ethereum (among public chains). Financial products typically prioritize technical security over extreme optimization, and Ethereum, as the most mature smart contract platform, has a natural advantage. For many large tokenization projects, relatively high transaction costs (a few dollars instead of a few cents) and longer confirmation times (a few seconds instead of milliseconds) are not major obstacles.

For traditional enterprises looking to enter the blockchain space, having a sufficient number of skilled developers becomes crucial. At this point, Solidity, as the most widely used smart contract language, becomes the first choice, further reinforcing the EVM's widespread advantage. BlackRock's Ethereum BUIDL fund and JPMorgan's proposed ERC-20 compatible ODA-FACT standard are early signals of the importance placed on this developer community.

Dynamics of Ethereum Supply vs. Bitcoin

The changes in ETH's circulating supply are fundamentally different from those of BTC. Even with a significant price increase starting in Q4 2023, ETH's three-month circulating supply did not expand significantly, while the active supply of BTC during the same period increased by about 75%. Unlike the previous Ethereum mining period (2021/2022), where long-term holders increased market supply, now more and more ETH is being used for staking, indicating that staking is an important way to reduce selling pressure on ETH.

Evolution of Trading Patterns

Historical data shows that the relationship between ETH and BTC is closer than with any other crypto asset. However, during bull market peaks or specific events in the Ethereum ecosystem, ETH may briefly decouple from BTC, a pattern also observed in other crypto assets, albeit to a smaller extent. This reflects the market's relative assessment based on ETH's store of value attributes and practical value from technological innovation.

In 2023, a particular phenomenon emerged in the correlation between ETH and BTC: when BTC prices rise, the correlation between ETH and BTC weakens; when BTC prices fall, the correlation strengthens.

This suggests that fluctuations in BTC prices act as a leading signal, indicating subsequent changes in market correlation with ETH. The market's enthusiasm for rising BTC prices seems to drive independent trends for other crypto assets (including ETH), especially during market upswings when various asset types perform differently; conversely, during market downturns, they tend to align with BTC's performance.

However, after the U.S. approved the Bitcoin spot ETF, this pattern has changed. The newly approved ETF attracts different types of investor groups, such as investment advisors and wealth management institutions, whose handling of BTC differs from traditional crypto investors.

In pure crypto asset portfolios, BTC is valued for its lower volatility, but in traditional portfolios, it serves more as a small part of diversification. This shift in capital flow and market structure caused by the changing role of BTC has already affected the trading interactions between BTC and ETH. In the future, if the Ethereum spot ETF is approved for listing, ETH is expected to face similar market structure changes, and its trading patterns may adjust accordingly.

Conclusion

We believe that ETH still has potential upside surprises in the coming months. ETH does not seem to have significant sources of supply-side excess, such as asset unlocks or miner sell-off pressures. On the contrary, the growth of staking and Layer 2 has proven to be a meaningful and sustained absorption point for ETH liquidity. Given the widespread application of EVM and its Layer 2 innovations, ETH's position as the center of DeFi is unlikely to be replaced. At the same time, the importance of the U.S. spot ETH ETF should not be underestimated.

We believe that the structural demand drivers for ETH, along with the technological innovations within its ecosystem, will enable ETH to transcend multiple narratives and continue to maintain its unique position.

ChainCatcher reminds readers to view blockchain rationally, enhance risk awareness, and be cautious of various virtual token issuances and speculations. All content on this site is solely market information or related party opinions, and does not constitute any form of investment advice. If you find sensitive information in the content, please click "Report", and we will handle it promptly.