Ethereum 2023 Q2 Data Research: Gross Profit of $700 million, ETH Burn Rate Accelerates from 0.3% to 0.8%

Ethereum Q2 2023: Gross Profit of $700M, ETH Burn Rate Increases to 0.8%.

Despite the successful implementation of Shapella, there has been no sell-off of ETH, and metrics for the Ethereum ecosystem (including L2) are growing overall.

By looking at Ethereum from a corporate perspective, what kind of company is it?

In the second quarter of 2023, there were 340,000 daily active users, gross profit equivalent to $700 million (453,000 ETH), gross profit margin of 84%, net income equivalent to $420 million (227,000 ETH), and a quarter-on-quarter growth of 187%.

Under strong network effects, the rate of ETH burnt has increased from 0.3% to 0.8%. Despite the successful implementation of Shapella, which has not led to an ETH sell-off, metrics for the Ethereum ecosystem (including L2) are growing overall.

This article is an unofficial data report for Ethereum in the second quarter of 2023, analyzing and commenting on the following:

  1. Ethereum’s operational metrics;

  2. Ethereum’s ecosystem (integrating L2 metrics);

  3. Ethereum’s profit and loss statement;

  4. Major influences.

Operational Metrics for Q2 2023

Daily active users: Q2 daily active users were 340,588, a 3% year-on-year decrease, which improved compared to the first quarter of 2023 and the fourth quarter of 2022, which were about 10%. In the first few days of July, the average daily active users decreased by 12% compared to the second quarter of 2023. The decrease in daily active users means that the number of people using Ethereum every day has decreased.

Average daily transaction count: The average daily transaction count is 1,046,592, a 4% year-on-year decrease. The rate of decline has slowed compared to the previous two quarters. The average daily transaction count was almost stable at -1%. The decrease in the average daily transaction count is due to the decrease in daily active users. The average daily transaction count is trending downwards in the first week of July.

ETH staked: ETH staked accounts for 17% of the total supply. The number of ETH staked has increased by 58% year-on-year and 13% quarter-on-quarter.

Shapella upgrade was successfully executed on April 12, 2023. Contrary to some people’s concerns, there was no sell-off of ETH after Shapella.

The amount of ETH staked continues to grow, but the growth rate has slowed down. The amount of ETH added per week has decreased before and after Shapella (see chart below). Approximately 1.8 million ETH was staked in April, 4 million ETH in May, and 2.2 million ETH in June.

Price: The average price in Q2 was $1,861. ETH has risen 55% year-to-date and 4% for the quarter. ETH had significant fluctuations during the quarter. It fell 22% from its high point to its low point during the quarter and then rebounded.

Total value locked (TVL): ETH’s TVL decreased by 41% YoY, and the downward trend is still worsening. TVL is down 14% from Q1 2023.

Ethereum Ecosystem

Ethereum’s health is increasingly being evaluated through the health of the Ethereum ecosystem, which includes its layer-two scaling solutions. Arbitrum, Optimism, Polygon zkEVM, StarkNet, and zkSync Era are being used to determine the health of Ethereum’s layer two. Activity has migrated to the second layer, which provides cheaper and faster transaction settlements. Evaluating Ethereum’s ecosystem, including the activity on Ethereum’s base layer and second layer, presents a different picture. Daily active users (DAUs) and average daily transaction counts in Ethereum’s ecosystem are growing.

Since 2021, Ethereum’s daily active users (DAUs) have remained stagnant. Over the past year, the number of DAUs in the Ethereum ecosystem has grown from 400,000 to around 800,000 (see chart above). However, the growth of DAUs in the Ethereum ecosystem does not necessarily mean that more people are interacting with the Ethereum ecosystem. A more likely explanation is that some of Ethereum’s DAUs have also become DAUs on Ethereum’s layer two.

Polygon PoS data is not included in the Ethereum ecosystem. Polygon PoS is a sidechain of Ethereum. Polygon PoS users may gradually migrate to the Polygon zkEVM chain. Polygon’s focus is on the zkEVM chain. This migration could be beneficial for the Ethereum ecosystem. Polygon PoS has 360,000 DAUs, exceeding Ethereum’s 300,000 DAUs. Ethereum’s DAUs will not double after the migration. A significant number of Polygon PoS’s DAUs are likely also DAUs of Ethereum.

With the emergence of Layer 2, the number of transactions performed by DAUs in the Ethereum ecosystem has increased. Since the second half of 2020, Ethereum’s daily transaction volume has been hovering around 1 million. The number of Ethereum transactions per day is limited to about 1 million. The second layer adds 2 million transactions per day. The total number of transactions in the Ethereum ecosystem has almost doubled in the past year (see figure below). One transaction on Ethereum results in two transactions on the second layer.

Polygon’s PoS chain averages 2.4 million transactions per day. If these transactions are migrated to Polygon’s zkEVM chain or another Ethereum Layer 2, it will almost double the daily transaction volume of the Ethereum ecosystem.

The average daily transaction volume of the entire Ethereum ecosystem reached 3 million in Q2 2023, up from 2 million in Q1 2023. The quarter-on-quarter growth rate of the average daily transaction volume of the entire Ethereum ecosystem accelerated from 17% in Q1 2023 to 50%. In Q2 2023, the average daily transaction volume of the Ethereum ecosystem increased by 139% year-on-year (see figure below).

The average daily transaction volume on the Ethereum ecosystem is 3 million transactions, which is 16% of the total daily transaction volume of programmable blockchains except Solana (see figure below). Solana’s transaction data cannot be directly compared with other chains. Solana executes 20 million transactions per day. It can be said to be one of the highest performance blockchains. However, due to its very high transaction throughput and low fees, a large part of the transactions are spam transactions.

If Polygon PoS is taken into consideration, the Ethereum ecosystem’s share of the total transaction volume will double to about 30%. Excluding BNB and Tron, the Ethereum ecosystem accounts for 60% of the market share in daily transaction volume. BNB and Tron are very different from the other blockchains in the group, as they are more centralized.

Ethereum P&L

How to read Ethereum’s Income Statement?

Total Fees represent the fees paid by users to have their transactions posted on the Ethereum blockchain. Total Fees consist of a Base Fee and a Tip. The Tip is a transfer of funds and is paid to validators. Note that the Tip item is the same number as the fee item paid to validators. It is a variable cost. It grows in proportion to usage. Users pay tips to have their transactions prioritized for processing.

The Base Fee is the cost of processing transactions that users pay. Note that the Base Fee number is the same as the Gross Profit number. Gross Profit represents how much money (in ETH terms) the Ethereum blockchain has earned from processing transactions. It is sometimes called “network revenue”. The gross margin represents how much of the total Ethereum fee was burned. The burned tokens will be removed from circulation. This is similar to a stock buyback.

The cost of issuing tokens is the cost paid to validators to keep the network secure. This is a fixed cost. It does not grow in proportion to usage.

Net Income is the difference between the Base Fee (i.e. Gross Profit) and newly issued tokens. Ethereum’s net income in Q2 2023 was 227,147 ETH, meaning it charged 227,147 more ETH in Base Fees than it issued in new tokens. As a result, Ethereum’s outstanding tokens decreased by 227,147.

The more net income Ethereum generates, the more ETH is burned, and the fewer outstanding tokens there are. The fewer outstanding tokens there are, all else being equal, the higher the value of each token.

Conclusion

1. The Q2 spike in Total Fees was temporary

The Q2 spike in Total Fees and resulting token burn was temporary. It was driven by a one-time event – the Meme coin craze. This spike lasted for approximately two weeks. QoQ performance is expected to be worse in Q3 2023.

2. Focus is on L2 solutions

The operational metrics of the Ethereum ecosystem, including second-layer scaling solutions, show a healthy growing network. In contrast, independent operational metrics of Ethereum suggest a stagnant network. Ethereum’s growth is being driven by second-layer scaling solutions. Their success is critical to Ethereum. The upcoming EIP-4844 will have a significant impact on second-layer scaling solutions and Ethereum.

The only way to increase the cost of Ethereum in the short term is by increasing the cost of each transaction by raising the Gas price. Currently, Ethereum has a maximum of about 1 million transactions per day. It is believed that second-layer transactions will increase significantly. Second-layer transactions will be batched and processed as an input to Ethereum’s base layer. The cost of an expensive Ethereum transaction will be shared among many second-layer transaction fee payers.

3. The growth of staked ETH has slowed

There was rapid growth in the amount of staked ETH before and after the launch of Shapella. The trend of slowing growth suggests that the amount of staked ETH may not increase rapidly beyond 50%. To achieve a 50% staking ratio, around 40 million ETH needs to be staked additionally. At the current rate of staking an additional 1 million ETH per month, it will take 40 months or 3 years and 4 months to reach a 50% staking ratio.

This may not necessarily be a bad thing for ETH stakers. The lower the staking ratio, the higher the staking rewards paid to validators, thus the higher the ETH yield. The ETH yield is the sum of staking rewards, revenue from MEV, and inflation or contraction of token supply. The most economically attractive scenario is low staking ratio, high staking reward, high fee, and thus high yield. The least economically attractive scenario is the opposite. The economic perspective is not the only parameter driving ETH value. The higher the staking ratio, the higher the security of the blockchain, theoretically leading to a higher ETH value.

The slower growth of ETH staking has led to poor performance for Lido and Rocket Pool. In this quarter, LDO and RPL fell by 17% and 18%, respectively, while ETH remained flat. The slower growth of ETH staking, coupled with the smaller size of Rocket Pool’s mini pool, means that there are fewer buyers of RPL.

4. Ethereum’s operational leverage leads to massive burning

Ethereum’s profitability and burning mechanism are very important. Ethereum has shifted from $22 million in selling pressure per day (calculated at an ETH price of $1,860) to $5 million in daily buying demand, a difference of $28 million. This $28 million change is equivalent to 4.5% of Ethereum’s market capitalization.

Ethereum’s PoW model has two economic problems. Firstly, Ethereum used to issue 17,000 tokens to miners every day, equivalent to a 5% annual dilution rate. Secondly, it is estimated that 70% of these tokens were immediately sold to reimburse expensive mining. At the current ETH price of $1,860, issuing tokens to miners and subsequently selling them resulted in $22 million in daily selling pressure.

The introduction of PoS and the introduction of a burning mechanism will turn the daily selling pressure of $22 million into a buying pressure of $5 million. Ethereum now burns (i.e., repurchases) tokens worth $5 million per day, instead of selling ETH tokens worth $22 million per day in the past. The following table summarizes the predicted profit and loss statement from PoW to PoS.

Most people misunderstand Ethereum’s operating leverage. Operating leverage is a traditional financial term used to describe assets whose profit growth rate is much higher than their revenue growth rate. The reason for the significant increase in profit is that operating costs do not increase while income does. Technicians usually do not understand operating leverage. Traditional financial investors do not understand cryptocurrencies.

The “Forecast” column in the above chart shows Ethereum’s operating leverage. The Forecast column assumes that total costs will increase by a factor of 5. A five-fold increase in costs leads to a 9.9-fold increase in net income. When total costs increase, Ethereum’s fixed operating costs, i.e., the cost of issuing tokens to validators, do not increase. The net result is that Ethereum’s deflation rate has increased by 9.9 times. Compared to the current deflation rate of 0.4%, when income increases five-fold, Ethereum will reduce the number of tokens to be issued by 4.2% per year. Purchasing demand will increase by 5.2 times, from $5 million per day to $28 million.

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