Text: Grayscale Research, Translated by: Golden Finance xiaozou
Summary
In the crypto space of smart contract platforms, value accumulation is a flywheel that ties fees and network usage to token valuation and the security and decentralization of the network.
Smart Contract Platforms Networks within the crypto space take a variety of approaches to competing for fee revenue: some platforms seek fee revenue at the expense of relatively high transaction costs, while others attempt to capture more transaction volume at relatively low transaction costs.
Grayscale Research believes that fee yields can be viewed as the primary driver of token value accumulation in this segment, but other fundamental factors are also important as they impact fee yields over time.
While industry leader Ethereum has accumulated network fee revenue for several years (over $2 billion in 2023), other smart contract platforms such as Solana have also shown maturity (~$200 million in fee revenue so far in 2024).
There is a common misconception that crypto assets have no fundamental value and cannot be analyzed like traditional investments. Grayscale Research believes this is not the case. For example, smart contract platforms like Ethereum and Solana generate fee income from economic activity on their networks. Grayscale Research believes that one way investors can value assets in the smart contract platform crypto space is by analyzing their ability to generate fee income over time.
1. Smart contract platform fundamentals
Smart contract platforms like Ethereum and Solana are networks that support developers building decentralized applications, ranging from gaming to finance to NFTs. The role of the smart contract chain is to process transactions for the applications it serves in a secure and censorship-resistant manner.
Therefore, the value of a smart contract platform is inherently tied to the activity on its network. Key metrics of network activity include the number of transactions the network can process, the number of users it can support (usually measured by daily active addresses), the value of assets it can support — known as Total Value Locked (TVL), and the network’s ability to monetize its block space, or network fee revenue — more on this later.
Each metric tells a story. For example, Ethereum’s leading position in the TVL metric ($66 billion, more than 7 times larger than the next largest competitor in TVL) reflects its liquidity advantage and value proposition for financial applications. In addition, its advantage in the total number of ecosystem applications creates a network effect that continuously attracts new developers, applications, and users. Meanwhile, Solana’s daily transaction number—reflecting its throughput advantage and low cost—makes the chain more suitable for high-volume use cases like DEPIN, as well as retail-friendly use cases like NFTs and meme coins.
In addition to comparing these basic metrics between assets, investors can also think about this data in the context of market capitalization, or the market's current valuation of a particular asset. For example, as shown in the figure below, while Solana's TVL ($4.7 billion) is currently higher than Arbitrum's ($3.2 billion), Arbitrum's market cap to TVL ratio (1x) is much lower than Solana's (16x). These metrics can not only help investors understand the relative strengths and weaknesses of different assets, but also help them discover value.
Figure 1: Smart Contract Platform Fundamentals
(Bold indicates the largest fundamental indicator of its kind)
2. The core role of fees
While there are many different ways to measure network activity, the single most important fundamental variable for smart contract platform valuation, both theoretically and empirically, is network fee revenue (see figure below). This metric can be thought of as the total fees paid by users to use the network. Smart contract platforms have many different revenue models, but all ultimately generate fees in order to provide value to token holders.
Similar to centralized entities in traditional industries, decentralized networks also use different ways to compete for fee income. For example, some smart contract platforms seek fee income at relatively high transaction costs, while others try to obtain more transaction volume at relatively low transaction costs. Both methods are valid. Let's assume there are two blockchains as follows:
Chain 1: Fewer users and transactions, higher cost per transaction
5 users, 10 transactions, $10 per transaction fee
Network Fee Earnings = $100
Chain 2: Larger number of users and transactions, lower cost per transaction
100 users, 100 transactions, $1 per transaction
Network Fee Earnings = $100
The example above shows that both chains generate the same network fee revenue, despite Chain 2 having more users and total transactions. While metrics such as users and transaction volume are also important, they need to be considered in conjunction with transaction costs as these will determine fee revenue.
The importance of fee yields holds true both empirically and theoretically. For example, the chart below shows the relationship between fee yields and market capitalization for each component of our smart contract platform crypto space. Although the crypto market is still maturing, investors already differentiate between different projects based on fundamentals. Grayscale Research's analysis shows that the relationship between fee yields and market capitalization is relatively stable over time, and fee yields are more correlated with market capitalization than other indicators of smart contract platform fundamentals.
Figure 2: Network fee revenue is most closely correlated with market capitalization
Grayscale Research believes that part of the reason for the close relationship between fees and market capitalization is that network fee income is critical to token value accumulation. Value accumulation means that the protocol structures its token in a way that ties network activity to the long-term sustainable value of the token. The following three examples show different stages of value accumulation: Ethereum, Solana, and Near.
(1) Ethereum: a “premium chain” of value accumulation
Ethereum, the first and largest smart contract blockchain by market capitalization, has been facing serious scaling issues since 2022. Increased usage has led to network congestion, which has made transactions expensive for users: its average daily network fees reached a high of $200 per transaction on May 1, 2022.
However, increased usage and high average transaction fees have also translated into significant value accumulation, with Ethereum generating over $2 billion in total network fee revenue in 2023. The network fee revenue of the Ethereum network consists of two parts: base fee and tip. Whenever a user pays a transaction fee, the base fee is burned, removing the ETH supply from the network. At the same time, tips paid for prioritizing transactions will be distributed as rewards to validators and stakers who help secure the network.
As a result, the massive Ethereum network revenue in 2023 resulted in approximately 2 million ETH being burned (1.7% of supply), accruing value for ETH holders and providing $390 million in rewards to validators and stakers, incentivizing the promotion of higher levels of network security.
Ethereum has reached a stage of maturity where it has demonstrated its ability to create value accumulation. On the Ethereum mainnet, users pay a premium for quality products - in this case, block space backed by the smart contract platform with the greatest network security. This is particularly important for applications that involve large amounts of transaction value and prioritize network security, such as stablecoins or tokenized financial assets. Its ability to monetize users is quite mature, which is reflected in its $458 billion valuation (as of June 6, 2024), nearly six times that of other smart contract platforms.
Figure 3: Increased network usage (reflected in periods of greater supply depletion) tends to correspond with higher valuations
(2) Solana: A “high-performance chain” for value accumulation
While Ethereum has a fee revenue capture model, Solana has taken a different approach and it has recently been closing the gap with the market leaders and making significant progress. Solana, the second-largest smart contract platform by market capitalization, has long been considered a faster and cheaper alternative to Ethereum, with impressive transaction processing speeds (335 transactions per second) and low costs (average $0.04 per transaction fee). However, in previous years, Solana was unable to convert these into fee income. In 2023, despite processing significantly more transactions, Solana generated only $13 million in network fee revenue, compared to Ethereum’s $2 billion (154x less).
In the past, the lack of a value accumulation mechanism was a relative disadvantage for Solana, however, this has changed in 2024. So far this year, Solana has generated 6 times the fees it did in all of 2023, narrowing the fee gap between Ethereum and Solana from 154 times in 2023 to 16 times (as shown in the figure below). This shows that the Solana model - low transaction costs and high throughput - also helps create economic value.
Figure 4: Solana has begun calculating value accumulation through its fees
It is worth noting that this large increase in fee revenue coincides with a large increase in market capitalization. The large increase in network fee revenue is mainly due to the large increase in average transaction fees (up 37 times compared to last year) rather than the overall increase in transactions (up only 33% compared to last year). Ironically, the increase in average fees for a blockchain traditionally known as the "cheap option" coincides with the decline in Ethereum L2 transaction fees due to the Dencun upgrade (see figure below). Since April 1, the average transaction fee for Solana users ($0.04) is still lower than Ethereum ($4.80), but higher than Arbitrum ($0.01).
Figure 5: ETH’s Dencun upgrade makes Layer 2 cheaper; increased fees help Solana accrue value
Since Solana’s per-transaction fees are more expensive for its users than Ethereum L2 Arbitrum, it could jeopardize its position as a cheap, high-throughput chain. Nevertheless, Grayscale Research believes that overall, this fee growth is beneficial because it reflects both high levels of user activity and value accumulation for stakers and token holders.
(3) Near: has achieved solid adoption in terms of entry-level crypto, but is still in the early stages of network monetization
The above two examples stand in stark contrast to the smart contract platform Near, which has recently gained a lot of adoption through non-speculative use cases but has yet to demonstrate its value accumulation capabilities. Near is the underlying platform for KaiKai and Hot Protocol, two of the largest decentralized applications (dApps) for all crypto users. Near leads all smart contract platforms with 1.4 million daily active users and competes with the fastest chains in the industry such as Solana in terms of throughput (see figure below).
Figure 6: Near leads all smart contract platforms in daily active users
Despite leading in terms of user numbers, Near is still far behind its competitors in terms of user monetization, with only $4.1 million in fee income so far this year. This indicates that it is currently in a relatively immature stage of development, which is also reflected in its valuation relative to its competitors (market cap is $7.9 billion, compared to Ethereum's $458 billion and Solana's $78 billion). While the Near network has demonstrated the ability to process transactions at high speeds, it currently does not provide accrued value to token holders or stakers.
Although Near’s profitability has been relatively weak so far, its mass adoption is an important starting point. If the network can continue to expand network adoption or increase average transaction fees without decreasing network activity (similar to Solana’s recent progress), it can achieve meaningful value accumulation.
Each of these three smart contract platforms — Ethereum, Solana, and Near — represents a different stage of maturity in the decentralized network’s ability to generate revenue from network fees. Ethereum has years of revenue and growth. Solana has a strong user base but is just beginning to generate significant revenue. Finally, Near’s product has shown traction, in part because of its lower costs, but has yet to generate significant revenue.
3. Notes and subtle understandings on fees and valuations
To be sure, there are a lot of considerations and nuances when it comes to fees and valuation in the smart contract platform crypto space. First, each protocol involves different forms of value accumulation and different rates of token distribution (inflation) and token burn (deflation). For tokens with higher inflation rates, the impact of fee value accumulation may be greatly diluted by the distribution of tokens. Each protocol has its own fee structure. On Ethereum, transaction fees promote token burns, which benefit all token holders, and priority fees are distributed to validators and stakers. On Solana, the distribution is different: 50% of transaction fees are burned, and the remaining 50% goes to stakers. Recently, a governance vote determined that all of Solana's priority fees will be paid directly to validators. These measures reflect Solana's greater validation hardware requirements. In addition, the high level of MEV activity on Solana provides additional rewards to validators and stakers, but constitutes an "indirect" cost to token holders. So, ordinary token holders will receive more value in Ethereum's fee structure, while Solana's validators and stakers will receive more value through Solana.
Similar to how the valuation of traditional assets may involve discounting future cash flows, the valuation of crypto assets may also involve discounting future expected network fees. This variable captures the potential future growth in adoption, usage, or monetization of a particular network in a different way than the total fees currently generated. For example, one could reasonably argue that Ethereum’s $458 billion valuation reflects not only the fees it currently generates, but also its potential to leverage network effects and the potential for future growth in L2 adoption, usage, and fee revenue.
Finally, the valuation of certain crypto assets may include a “monetary premium.” In other words, users may be willing to hold an asset because its functionality as a monetary medium — as a medium of exchange and/or store of value — outweighs the network’s ability to generate fee revenue. For Ethereum in particular, the idea of a monetary premium may be very important to its valuation considerations (especially if the token is widely used as collateral across the industry).
4 Conclusion
If value accumulation is correctly implemented into the protocol, increased network usage will incentivize users not only to hold tokens, taking them out of circulation and hopefully facilitating their value growth, but also to become validators or token stakers, thereby helping to improve network security. In addition to network security, transaction fees will incentivize more validators to join, thereby promoting greater decentralization and censorship resistance. Value accumulation is thus a flywheel that ties fees and network usage to token valuation and the security and decentralized nature of the network.
But it is important to recognize that while fees can be used as an indicator of network maturity, there are many other factors in this flywheel that can affect the growth of a network and its valuation. For example, if a particular application is widely adopted, it may bring in more users and attract more developers to build in the same ecosystem. Therefore, network fees should be considered in the context of other fundamental metrics and the relative valuation (market cap) of a particular ecosystem.
Looking ahead, it will be important to keep an eye on some of these growth narratives. Despite relatively high average transaction costs for users ($4.80), can Ethereum continue to sustain fee growth on mainnet through high-value transaction use cases like tokenized financial assets? Can Ethereum increase its transaction fees as L2 activity increases? How will Solana balance profitability with maintaining its own transaction costs low enough to avoid losing users to other cheap, high-throughput chains? Will Near attempt to be profitable, or will it give up meaningful fee gains and prioritize user growth as before?
These dynamics highlight the importance of monitoring fundamental metrics, including fees, transactions, active users, and TVL. Grayscale Research believes that as the crypto asset class continues to mature and gain more and more adoption, the importance of these fundamental metrics will continue to grow. These metrics will provide deeper insights into the relative strengths and opportunities in the crypto space of smart contract platforms, ultimately helping guide informed investment decisions by promoting a more nuanced understanding of network value.
