Thread by @TaschaLabs

I’m bearish on Ethereum.

But it may not be for the reason you think.

Transition from single chain to layer 1-layer 2 structure has large implications for ETH token valuation. And most people aren’t yet thinking this through 👇

First off I wrote abt how to value blockchain platform tokens like nation state currencies a while ago. I recommend a read cuz it’ll help you understand what I’m gonna say next, as it’s an application of same framework.

https://twitter.com/TaschaLabs/status/1457060324939423745?s=20

In short, think of L1 platforms like nation state economies. You need native token to pay fees in every transaction on platform just like you need USD in every economic transaction in US. The on-chain economic activities thus form fundamental demand for native token.

That means given any starting equilibrium of economy size & ETH price, if ethereum economic activities grow 10%, ETH token demand’ll grow proportionally (assuming stable token velocity). Since supply is relatively constant, that translates to proportional increase in ETH price.

This dynamic btw growth of economy & increase of token price is mechanical & doesn’t require belief in any revenue-based valuation assumptions, which are mostly memes.

Indeed data shows activity growth is single most important driver in ETH price over long run. Using # of txns as rough proxy for size of eth economy, you can see correlation btw txn growth & price growth is overwhelmingly significant— 10% txn growth implies ~13% price growth.

Note this is fundamental-driven long term relationship. Short-term price volatility is obv much bigger b/c of speculative cycles.

W/ this relationship in mind, is there any wonder why ETH price growth has stalled in last 6 mos? Tnxs have declined since May as high gas costs discourage activities & other alt L1s take off. Activity is now even lower than previous cycle peak.

Active wallets, another way to measure activity level, have also declined since May.

If it weren’t for EIP-1559 introducing token fee burns in August & putting downward pressure on supply, we’d have seen bigger ETH price drop given demand dynamics.

To solve scaling/congestion, ethereum is adding layer 2 rollups— to have eth L1 as security/settlement layer w/ contract & tnx executions done on L2s. It could boost speed & lower cost for end users, by a lot.

But as investor, all you need to care abt is this— is this structural change going to increase or decrease activities on eth L1? (Cuz activities—> demand for eth —> price growth, remember?)

By all considerations the answer is negative, at least in short-to-medium term.

Eth L1 does 1.3 million daily tnxs right now. ZK rollups can have 60k-80k tnxs in a batch before submitting to L1.

If we move all end-user tnxs from eth L1 to rollups today & all L2 batches are full, that means # of tnxs on eth L1 could drop to 1/20 of current level.

https://twitter.com/TaschaLabs/status/1475691062559707143?s=20

You say, 1) proof verification is high value-add, complex tnx, which costs way more gas than most other tnxs.

2) there’ll be explosion of activities on L2s given lower cost. That’s the point of scaling. If L2 activities grow exponentially, it’ll boost verification needs, i.e. more activity on eth L1.

For 1), L1 verification cost per batch for zkSync rollup is 600k gas. Simple wallet tnx cost on current eth L1 is 21k gas. If a rollup batch has more than 28 simple wallet tnxs, gas cost on L1 is already lower than current. Batch has capacity for 80k tnxs. Do the math.

For 2), activity levels on popular alt L1s give useful benchmark for how much activity you can realistically expect on a new eth L2. Solana, the alt L1 w/ highest activity level rn, has a realized TPS (tnxs per second) of abt 1000 (not counting consensus voting tnxs).

Other chains have much lower realized TPS. E.g. Polygon, the success example all new eth L2s aspire to, has TPS of abt 85. Mind you, low realized TPS on these chains are not b/c of tech constraints. They can do much higher but there’s simply no higher demand from activities rn.

If one day web3 economy grows so big that numerous eth L2s operate at high capacity & continue growing at warp speed, yes that’d indeed increase activity on eth L1. But that day is not today & no eth maxi can tell you definitively when that day will be.

Btw today & promised L2 land, ethereum has to cross the no man’s land, where L2 growth is taking existing tnxs away from eth L1, while L2s don’t have enough business yet for their proof verification txns to more than compensate for activities they take away from eth L1.

While eth is crossing this no man’s land, activity growth on eth L1 would likely be stagnant or negative. That means to the left & down on our chart of activity vs price. Rational choice for eth ecosystem investor would be to sell eth & long high growth L2 tokens.

You say, what abt institutional investors? They prefer large caps w/ lower risk. So large waves of institutions coming to crypto in near future would shore up demand for BTC & ETH.

It may. But I wouldn’t keep hope too high for dumping bags on institutions, unless you truly have an abysmal opinion on their IQ.

B/c truth is people--whether institutions or individuals-- are in crypto for returns, not safety, & large caps are not “safer”.

Here’s Sortino ratio for major L1s, which measures how much you’ve gained for each unit of downside risk you took. LUNA had the highest score in 2021. ETH & BTC both rank low.

There’s another concern abt ETH valuation that’s less obvious but no less important.

(BTW, like this so far? I write about ideas on investment, macro and human potential. Subscribe to my newsletter for updates 👉 taschalabs.com/newsletter .)

The network effect of L1 tokens comes from wide ownership participation of those tokens. BTC & ETH become most popular collaterals in deFi b/c almost everyone in crypto owns them. Exchange volumes are high & liquidities ample.

But 180 mn eth wallet addresses are the result of the fact that for the longest time, to use smart contract you have to own some eth.

W/ alt L1s rising that’s already less true. W/ eth L2s coming you won’t need to own eth even in ethereum’s own ecosystem. You can buy, say, ZK tokens on centralized exchange, transfer to your ZK Metamask wallet & spend ZK in ZK L2 chain, all w/o touching eth token.

In other words, as ethereum transitions from B2C to B2B model, direct interaction w/ end users may drop, which would imply lower ownership coverage, liquidity & volume for eth token. All of those are important parameters supporting token valuation.

You say, as security layer of ethereum eco, importance of eth token is paramount & surely users would value that.

Yes you’re right. But if “importance” is the decisive factor for token value, ChainLink & Graph would have higher mkt caps than Doge & Shib.

Truth is “face time” w/ as many end users as possible is a precious advantage for a token. (And you should consider this when thinking of investing in any crypto project that only serves “enterprise use cases”.)

This is not just a phenomenon in crypto. In tech stocks, for example, software companies w/ mass-mkt apps have higher P/E ratio than other IT sub sectors like system software or semiconductor.

B/c the former get more eyeballs even w/o necessarily having higher growth prospect.

As average investor, it’s much easier to buy stocks of Zoom or Slack—cuz you know & use them often— than investing in something like, idk..."Paragon Database Solutions".

For a L2 to compete w/ alt L1s they need native tokens for users to rally behind & share the gains of values created on L2 platform. That means they take eyeballs away from eth just like alt L1 competitors.

https://twitter.com/TaschaLabs/status/1465036440413380614?s=20

You say, but other modular L1 chains have same problem. E.g. an Avalanche subnet token would dilute value accrual on AVAX too.

Yes, but AVAX, ATOM or ALGO is not valued at $400 bn mkt cap.

They’re much smaller & still on high growth path of their L1 eco, any L2 add-on is not a drastic structural change of status quo like ethereum situation. The starting equilibrium matters.

Crypto is a fast changing industry & my thinking abt ethereum case will surely continue to evolve. But hope this gives you something to ponder on.

TLDR:

• Activity growth determines price growth for L1 tokens

• Shifting to L1-L2 structure may mean stagnant or negative activity growth of Eth L1 in ST/MT

• Transition from B2C to B2B model reduces exposure of Eth token to end users, negative for liquidity, volume, price

Read article in full at taschalabs.com/why-im-bearish…

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