The Value of Ethereum and L2: An Analysis from the Perspective of Crypto Business Models

Written by: IOSG Ventures

1. Business Models of Crypto

Recently, there have been many criticisms regarding the value accumulation of Ethereum and L2. The rapid exploratory development of Ethereum and L2 has brought challenges to their value assessment. This article attempts to provide some directions for thought. Before discussing how to specifically view the business models of Ethereum and L2, let's first look at the overall business models present in the Crypto space.

1.1 "Enterprise" Type

Core: Control + Monopoly (Permissioned), Price Discrimination Leads to Profit

The focus of this model is on achieving revenue growth through a high level of control over services and protocols, which is no different from traditional business practices. Decentralization here is highly dispensable; it only needs to be at a level acceptable to users. Essentially, as a profit-oriented company, it must ensure efficient operation, and there should be no transfer of control.

For such projects, competition lies in the business model, specifically the ability for price discrimination, the speed of response to user needs, and the ability to drive user growth. Tokens primarily serve as a means for customer acquisition and assetization.

Taking the Solana Foundation as an example, its high level of control over the ecosystem can be said to even approach the level of monopoly. Solana claims to be the Global Onchain Nasdaq and has consistently emphasized fundamentals, especially business models and profits, which constitute the core value of this narrative. Solana's revenue largely comes from MEV income, which is the price discrimination generated after monopolizing block space, while the SOL asset itself serves as a concentrated assetization tool.

1.2 "Protocol" Type

Core: Permissionless Participation (Asset Issuance, Business), Open and Relatively Fixed Fee Structure

The focus here is on creating open, almost unchangeable protocol standards, governed by DAOs or foundations with minimal intervention, allowing the protocol to operate autonomously. The use of the protocol is permissionless, and the profit model is open and difficult to change, allowing anyone to use the protocol to create markets and assets for their own business or profit. "Protocols" often have an assessment of their degree of autonomy, meaning there is a range of decentralization, with the minimum being that the team retains the right to update the protocol and is subject to market oversight; at the extreme, they may relinquish their update rights and leave the product to the market, with varying degrees of hard or soft decentralization governance differences. Tokens here play more of a role in dividends and governance.

For such projects, the test is the sustainability of product operation, the sustainability of demand, and the network effects brought by the timing of entry. Often, early adopters who find PMF (Product-Market Fit) have a significant competitive advantage.

1.3 "Asset" Type

Core: Focus on the Value of the Asset Itself

This includes BTC, Memecoins, decentralized algorithmic stablecoins, etc. The asset itself gains consensus based on its characteristics, and the empowerment of the asset continues based on this. The attributes of the asset include three aspects: first, the consensus and network effects brought by "early adoption" in specific scenarios, such as BTC as a store of value, USDT as a payment medium, and ETH for asset issuance; second, the mechanism attributes of the asset, including rarity, deflation mechanisms, price anchoring, etc.; third, the widespread acceptance and dissemination brought by its symbolic significance, such as the widely understood BTC as "digital gold," ETH as "programmable credit currency," and the cultural effects of Memecoins.

For such projects, the test is the strength of consensus and the adoption and continuity of the asset.

In the Crypto world, different projects and assets correspond to the above business models or combinations of models. We can also attempt to evaluate the current state of Ethereum and L2 from this perspective.

2. What Business Model Does L2 Represent?

2.1 Current Positioning of L2

The initial positioning of L2 was to scale Ethereum, to accommodate Ethereum's transactions on a larger scale. This goal has been achieved to a certain extent. From the perspective of offloading Ethereum transactions and bringing in incremental growth, it has been relatively successful. Currently, L2 has become an important part of the Ethereum ecosystem, accounting for 85% of transaction counts and 31% of transaction volume, making it a significant component of Ethereum's fundamentals.

The number of active addresses is 3-4 times that of Ethereum.

Due to the low transaction costs on L2, the actual increase in Ethereum's overall transaction data may be somewhat inflated, but the impact of L2 adoption can still be observed.

However, L2 has not brought a proportional increase in revenue for Ethereum under such transaction volumes. The revenue brought by L2 mainly falls into two categories: the first is DA fees, which were transaction data fees before EIP4844 and are Blob fees after EIP4844. The second is MEV; apart from the current Based Rollup, L2 has completely absorbed this income into its own pockets, and in the short term, the expectation of returning revenue to Ethereum is low. This has effectively led Ethereum into inflation, and the concept of "ultrasound money" is gradually fading.

Here, let's explain why DA fees cannot contribute to L2's revenue to L1.

• DA only generates priority fees when it reaches saturation, i.e., monopolistic pricing power.
• DA is a commodity in an unsaturated state, and over the long term, users can hedge and seek alternatives.
• The growth rate of DA demand is disproportionate to the growth rate of supply. L2 has a large proportion of bot transactions, which do not have the same necessity as real user transactions. If the C-end costs brought by DA fees are too high, this portion of transactions will naturally slow down. Therefore, the assertion that transaction numbers can increase several times until Blob saturates is not a reasonable conclusion.

Essentially, expansion itself contradicts DA charging; in the pursuit of continuous expansion, profitability should not be designed around transaction congestion. The architecture of Ethereum L2 inherently reflects this. Previously regarded as ETH's Beta asset, it still narratively identifies itself as "Ethereum L2." In terms of fundamentals, it has drifted further away. In the future, L2's revenue will no longer imply Ethereum's revenue. The two should have their own valuation systems.

2.2 What Are the Business Models of Different L2s?

2.2.1 Universal L2

Universal L2 refers to general-purpose L2s that seek to become an application ecosystem in their own right. Many early Universal Rollups have moved towards a consortium model, and the currently well-performing Universal Rollups have mostly innovated in their profit distribution mechanisms to better incentivize developer innovation and retention, as well as active user participation. The trend for L2 is gradually to rely less on Ethereum, maximizing their customizability through modular solutions.

The management approach of Universal L2 is team-centric, expanding outward. The competition faced by Universal L2 comes directly from external L1s, and the revenue acquisition of Universal L2 is almost 100% retained under its profit distribution mechanism.

This positioning aligns more with the "enterprise" model we described, suitable for valuation through a model similar to Alt L1, meaning its value is assessed based on its ecosystem, especially its fundamentals and revenue. Compared to Alt L1, its advantage lies in fully utilizing Ethereum's community and ecosystem, as well as the liquidity of ETH. Its disadvantage is that its token assetization capability is relatively lacking, and its customer acquisition ability is slightly inferior compared to Alt L1.

2.2.2 Consortium L2

Consortium L2, like Ethereum, has its own layer and second layer (L2/L3). The difference between a consortium and Ethereum is that issuing L2/L3 within the consortium requires permission, which ensures the business model of consortium L2.

Early Universal L2s have all moved towards consortium L2, which means that after gaining a certain level of market attention, consortium L2s are often better businesses. The pre-transformation Arbitrum and Optimism, as well as the recent zkSync and Initia, are all working in this direction. For consortium-type L2s, they are essentially developing their own L1 ecosystem while still relying on Ethereum's security and using ETH as the settlement currency. The characteristic of consortium L2s is that through their management capabilities, they change the business models and participants within the ecosystem. Therefore, viewing consortium L2s as a "protocol" with a higher degree of centralization is more fitting.

Consortium L2s are more often seen as a controlled version of Ethereum, similar to Optimism, which still delegates the task of application development. The difference from Ethereum is that this delegation is more strategically significant. Through permissioned models and centralized management, they can concentrate resources, expand synergies, and allow excellent resources to come in to share liquidity and ecosystem. After the new ecosystem is launched, they can feed back into the original ecosystem through revenue channels. This is also why Coinbase and Sony choose Optimism. Leveraging the "enterprise" capabilities of L2, they hope to see more breakthrough applications emerge.

Previously, we mentioned that the "protocol" type has different degrees of decentralization. In the exploration of protocol decentralization, there are often cases of chains or applications escaping, such as the early DyDx in the Arbitrum ecosystem and the later TreasureDAO. Balancing the degree of decentralization of the protocol while developing and consolidating its ecosystem is the core measure of the value of consortium L2.

2.2.3 Appchain L2

Appchain L2 is more of an application with a new business model and value capture. Its valuation should return to the application itself plus the new value brought by the L2 business model, regardless of whether its application aligns more with the "enterprise" or "protocol" model. Most App Rollups will choose to attach themselves to consortium L2s, benefiting from lower startup costs while relying on stronger ecosystem radiation effects.

Currently, Appchains are mostly dependent on consortium L2 and RaaS, with very low costs for building a chain. However, the design of chain compatibility and supporting infrastructure (such as data browsers, etc.) still requires investment. For Appchains, the visible benefits include more effective use of tokens and capturing MEV, while the trade-off is the loss of the Lego effect on a single chain and stronger liquidity. Not all applications are suitable to become Appchains based solely on input-output considerations; suitable applications have strong endogenous cycles, such as Perp DEX, Gamefi, etc. In the long run, losing the narrative heat of transforming into L2, how to reasonably assess ROI becomes more important.

3. How Does L2 Affect Ethereum's Business Model?

After the Merge, especially after EIP1559, Ethereum continued to capture high priority fees and MEV from the limited block space transaction volume. After L2 expansion, it effectively relinquished the MEV from these expanded transactions and reduced the priority fees brought by L1 native transactions. After EIP4844, it also gave up this portion of income as DA. This active relinquishment of such profits is not typical behavior for a company. In fact, Ethereum has never developed towards the "enterprise" model as we defined it. By ceding this portion of profit, Ethereum is allowing the DA and settlement layers to maintain a high degree of decentralization and autonomy, maximizing the space for L2 to develop a large ecosystem and as many applications as possible under minimal economic burden, even at the cost of some decentralization.

3.1 Ethereum as an L2 Issuance Protocol

Since establishing the Rollup Centric path, Ethereum has moved towards a direction that is more "protocol" than "enterprise." Although it has proposed some requirements for Rollups, such as L2beat Rollup stages, there has been no actual interference. Currently, Vitalik has proposed some Ethereum Alignment requirements, which will steer Ethereum's "protocol" governance model towards a more cohesive direction. However, overall, it remains a highly autonomous "protocol," with the long-term effect of issuing Ethereum L2.

Currently, Ethereum L1 still carries over half of the entire ecosystem's transaction volume. In the long run, Ethereum is more like a platform providing highly decentralized autonomy, censorship resistance, and the highest security for permissionless L2 issuance (settlement layer).

Generally speaking, the model of a permissionless issuance platform involves extracting a certain percentage from new asset issuance and trading, such as Uniswap extracting user fees, Pumpdotfun charging users for token issuance in its early days, and prediction markets extracting user trading fees, etc.

Therefore, although Ethereum is an L2 issuance protocol, it did not set up profit channels through L2 in the early stages. This has led to the emergence of many L2 ecosystems that depend on Ethereum's liquidity and community but do not contribute revenue back to Ethereum, meaning Ethereum is the "protocol" model that pursues decentralization and autonomy the most. Looking at successful non-permissioned protocols like Uniswap, they have opened fee switches on pools with absolute monopolistic positions and network effects, attempting to extract fees after achieving network effects, within a range acceptable to users. This is an advantage brought by centralized management. Currently, Ethereum is making some attempts at fee channels through Based Rollup, but it does not strongly pursue profit, allowing the previously unprofitable L2 ecosystem to continue to grow rapidly.

3.2 Ethereum as a Store of Value Asset & Programmable Trust Currency

ETH is difficult to value through "enterprise" or "protocol" models in the long term because the early L1 business model no longer holds after expansion. After all, a company willing to relinquish its profits and a protocol willing to permanently shut off its fee switch should not be valued from the perspective of traditional enterprise & protocol fundamentals.

The intention behind Ethereum's relinquishment of fundamentals is to provide more space for the overall ecosystem's development. As the ecosystem flourishes, the value of Ethereum will ultimately rest on the monetary value of ETH. So, what potential value can a prosperous Ethereum ecosystem bring to ETH?

Some believe it is the security attributes brought by ETH. However, some technical factions that are anti-crypto believe that P2P networks should not be tied to specific and speculative currencies to provide incentives for nodes. Some argue that incentives should be provided in a less speculative manner, such as stablecoins or early PoW mining forms. The decentralization pursued by distributed networks and the capital-intensive PoS mining do not naturally align and require many governance improvements. At the same time, the security value of ETH is affected by its price, exhibiting considerable reflexivity. We have mentioned these two points in our previous discussions on economic security. Currently, whether in terms of incentives or security models, ETH is performing well, but in the long run, it may not be its strongest suit.

So, what is the most important value of ETH in relation to the Ethereum network, which will be recognized by the market?

We may find some clues from Ethereum's development history, which has five highlights so far:

• Direct Token Issuance
• DeFi Summer Liquidity Mining
• Liquid Staking
• L2 Mining
• Re-staking AVS Mining

The earliest direct issuance of token assets through Ethereum opened up a new world of asset issuance and allowed Ethereum to find its initial PMF. Since then, the major development milestones of ETH have been closely related to asset issuance.

During the DeFi Summer era, the asset issuance model evolved into liquidity mining, which not only made ETH a supporting asset for asset issuance but also turned it into a liquidity benchmark with pricing capability. Thus, ETH found its second PMF—liquidity pricing asset. From then on, asset issuance in the Ethereum ecosystem would gradually incorporate considerations for liquidity improvement.

Liquid staking, while addressing the demand for staking, also enhances the value of liquidity pricing. Since then, asset issuance has gradually introduced the property of time opportunity cost mining for ETH, which is staking, marking Ethereum's third PMF.

L2 mining is a manifestation of this asset issuance + liquidity pricing + time cost mining. By bridging ETH to L2, staking and mining native tokens/DeFi protocol tokens while providing liquidity, this liquidity flows to various protocols through the liquidity engine on L2. The three PMFs of ETH converge.

Re-staking and AVS mining represent another realization of the convergence of the three. Liquid re-staking protocols release liquidity, similar to EigenLayer's re-staking protocol providing staking, indefinitely mining AVS native tokens through time cost.

Ethereum continuously repeats and improves such models, creating demand and value for ETH itself in asset issuance and DeFi use cases. It also reinforces ETH as the first choice in both interest-bearing assets and asset issuance, as well as liquidity provision, ensuring that ETH is distributed to protocols and users, becoming the primary focus of infrastructure and the first choice of value currency in users' minds within the Ethereum ecosystem.

Currently, the competition for this value is not intense, with over 80% of currency pairs in mainstream Uniswap pools settled in ETH. However, ETH still faces some potential competition, including competition from L2 native assets and derivative assets in terms of value storage, such as $cbBTC on Base, and competition from off-chain liquidity brought by intention networks.

But in the long run, the network effects brought by building around ETH and the incremental market of economic activities will lead to demand growth, as Myles said, all value will become more valuable.

4. Conclusion

The valuable business models in Crypto include three categories: enterprise, protocol, and the currency itself. The differences between the first two mainly lie in the centralization control, monopoly, adjustment, and price discrimination capabilities of the protocol, which also has varying degrees of autonomy. The currency itself is based on the network effects generated by early use in a specific traction scenario.

Due to the early positioning of Ethereum and its L2 strategy, Ethereum's value is pushed towards the permissionless "protocol" and ETH as "currency." Additionally, due to Ethereum's vision, leadership structure, and early L2 strategy, Ethereum has semi-actively and semi-passively relinquished revenue from L2, reducing the burden on L2 to open up growth space. Although the standards for Ethereum Alignment from the Ethereum Foundation are becoming clearer, the overall open and autonomous positioning also means that Ethereum is no longer positioned as a purely "enterprise."

The evolution of a strong early L2 ecosystem into consortium L2 is essentially a more centralized leadership, permissioned L2 issuance "protocol," which continues Ethereum's mission in a more centralized manner. Universal L2 has returned to the "enterprise" competition at the L1 level, with advantages in startup aspects compared to L1s outside the Ethereum ecosystem but disadvantages in terms of token aspects. The value of Appchain should return to the application itself after improvements in the business model (leaning more towards "enterprise" or a higher degree of centralized "protocol"), requiring more consideration of on-chain ROI. The relatively centralized flourishing of L2 is based on Ethereum's highly decentralized model, sacrificing revenue to provide support and space.

Ethereum, under the premise that DA has been proven not to be a suitable business model, is gradually positioning itself as a permissionless L2 issuance protocol that has relinquished profit channels. It actively gives up monopolistic power in the existing market, hoping to exchange it for the ability to generate revenue in the incremental market. The biggest gamble for Ethereum is how L2 alliances and some enterprise-like L2s can bring new increments without the burden of "taxing" Ethereum.

The value of ETH as a currency comes from the continuous asset issuance and liquidity games on Ethereum. The five PMF Moments continuously bring value and usage inertia to the ETH asset itself. As the overall ecosystem of Ethereum expands, ETH, as the most valuable asset within the ecosystem, plays a crucial role in every aspect from the launch to the operation of the new ecosystem, relying on ETH's strong network effects. While some native assets/wrapped assets may play a supplementary role as the ecosystem stabilizes, they are unlikely to affect ETH's absolute share.

If there comes a day of prosperity for the L2 ecosystem, ETH, with its network effects, will still be able to gain massive returns from adoption brought by increments, even if it does not necessarily have monopolistic effects. At that time, Ethereum will gradually establish a value form dominated by ETH assets.

After understanding the trade-offs of Ethereum as an ecosystem and the value positioning of ETH and L2, we are more confident that L2, as a driving force in the Ethereum ecosystem, will advance lightly with a business interest-driven model, rapidly opening up the ceiling of use cases with rich technical architecture choices and advantages of internal vertical integration. ETH will emerge as the asset with the most network effects, discovering value alongside the flourishing of the entire ecosystem.