Summary
Solana is a Layer 1 blockchain and component of the Smart Contract Platforms Crypto Sector (Exhibit 1). Compared to Ethereum—the largest smart contract platform by market capitalization—Solana provides faster and cheaper transactions on a single-layer network, without relying on additional scaling layers. Through its distinctive design choices, Solana achieves a compelling user experience—albeit with higher validator hardware requirements, which could pose greater risk of centralization. Although competition within the Smart Contract Platforms Crypto Sector is likely to remain intense, Grayscale Research believes that Solana is currently best positioned to capture share from market leader Ethereum over time.
Exhibit 1: Solana is the second largest asset of Smart Contract Platforms Crypto Sector
The Token
SOL is the native token of the Solana network, and ownership of the SOL token represents a piece of ownership in the ecosystem (Exhibit 2). The SOL token is used for (i) powering decentralized applications (dApps), (ii) paying transaction fees, (iii) providing network security via staking, and (iv) facilitating network governance. The Solana protocol systematically “burns” (destroys and removes from circulation) 50% of SOL used for transaction fees.
Exhibit 2: SOL token basics
The Network and Technology
The Solana network is designed to provide users and developers with a highly performant smart contract platform that offers scalability at the Layer 1 blockchain level (Exhibit 3). Although Ethereum can also achieve fast transaction speeds and low costs, this requires Layer 2 solutions, which can result in fragmented liquidity and a more cumbersome user experience. To achieve high network performance at the Layer 1 level, Solana developers introduced a novel consensus mechanism known as Proof of History, as well as other innovations. Solana’s scaling strategy also demands comparatively high hardware requirements, which could limit the network’s decentralization over time.
The Solana network also stands out for novel applications of the technology, including a Web 3.0-ready mobile phone (Solana Mobile), a payments application (Solana Pay), and “token extensions” that can bring additional functionality to standard Solana tokens (e.g., related to confidentiality). Overall, the Solana technology stack has delivered a compelling user experience that has attracted a vibrant community of users and developers.
Exhibit 3: Solana stands out for high network performance and low cost
Use Cases
Like most other Layer 1 smart contract blockchains, Solana is a general-purpose platform for dApps. Estimates suggest that the Solana network hosts about 290 dApps[1] with a wide range of functions, including:
Decentralized Finance (DeFi): Automated market makers, lending and borrowing platforms, asset management software, and payments
Web 3.0: Decentralized physical infrastructure applications (e.g., Helium), data privacy web browsers, and open-architecture video games
NFTs: Minting platforms, marketplaces, and community engagement tools
Factors to Consider
The protocols within Grayscale’s Smart Contract Platforms Crypto Sector all offer infrastructure for decentralized applications, but they make different design choices and optimize for other variables. Solana optimizes for performance: fast block times, low latency, and relatively low transaction costs. The network is designed to operate as fast as modern hardware will allow and to scale as hardware improves over time (i.e., with Moore’s Law for processing speed and with Nielsen’s Law for internet bandwidth). Other networks, like Ethereum, trade off performance for potentially greater decentralization and network liveness.
In principle, there is no reason why one design approach is better than the other. The relevant question is which network can draw in developers and users and generate value for token holders over time. In this regard, Ethereum is still the leading smart contract platform, but Solana has gained a lot of ground. For example, Solana has generated fee revenue amounting to 30% of Ethereum’s fee revenue.[2] At the same time, Solana’s market capitalization is only about 20% of Ethereum’s market cap. Because Solana has been able to produce consistently high transaction volumes, which are now translating into meaningful fee revenue, Grayscale Research believes that Solana is currently best positioned to capture share from market leader Ethereum over time.
It is briefly worth noting that the network has also demonstrated a high degree of resilience in the past. The failed crypto exchange FTX had been involved in the project, as a significant token holder and application developer. However, Solana’s community of users, developers, and industry partners remained active after the FTX bankruptcy, helping to set up Solana for its more recent success. If the network’s innovative design and friendly user experience can continue to draw in new users, we believe, the Solana ecosystem should have a bright future.
Investment Risks
Solana faces several possible risks specific to the network, which include, but are not limited to:
Competing Networks: Solana faces competition from other blockchains with smart contract functionality, such as Ethereum and Near.
Economics and Valuation: Despite a high volume of transactions, Solana network fee revenue remains lower than Ethereum’s fee revenue (although it is higher when scaled to market capitalization).
Level of Centralization: Running a Solana validator has relatively high hardware and bandwidth requirements, which may result in network concentration, either in the number of validators and/or their distribution across data centers.
Network Downtime: The Solana network has faced a number of outages in the past, although their frequency appears to be falling. Specifically, the network experienced 14 outages in 2022 and one in 2023. So far in 2024, the network has seen only one (fairly long) outage in February 2024.[3]
[1] Source: DappRadar.
[2] Source: Coin Metrics. 30 days ending June 16, 2024.
[3] Source: status.solana.com/uptime.