Author: Donovan Choy, Thor, Hyphin Source: onchaintimes Translation: Shan Ouba, Golden Finance
introduction
How profitable are PoW (Proof of Work) and PoS (Proof of Stake) blockchains? How does Ethereum compare to Solana? Is blockchain profitability important for investors? How does Vitalik handle Ethereum gas fees?
There has been a lot of heated discussion on Crypto Twitter recently around these issues. This post attempts to parse the big picture issues surrounding the thorny topic of L1 valuations in Web3.
Profitability of PoW Ethereum
Let’s say we want to determine which L1 token has the highest upside potential. The first step in this research is to understand the underlying profitability of the blockchain. So, if you ask a Wall Street analyst about the profitability of a blockchain, they might calculate it like this:
Revenue (Total Transaction Fees) - Fees (Total Tokens Issued) = Profit
When applied to PoW Ethereum:
The conclusion is simple: Ethereum PoW is unprofitable and its business model is fundamentally broken. 100% of transaction fees are paid to miners, so Ethereum has no income. Worse, the ETH issued to incentivize blockchain validation is very high, making the chain deeply loss-making. Of course, we know in hindsight that the price of ETH has increased, but the price increase in those years was purely driven by speculative enthusiasm, not intrinsic factors.
EIP-1559 and merged updates
Today in 2024, there are two major criticisms of the above simple analysis. The first criticism points out that a lot has changed since PoW, while the second makes a more subjective structural argument (discussed in detail in the next section).
What has changed?
1. Since EIP-1559 in August 2021, Ethereum Gas fees are divided into base fees and priority fees. The base fee is destroyed, which makes ETH more scarce, thereby increasing the value of ETH, so the "real" value is underestimated. The priority fee is paid to the validator as a tip.
2. Since the merger in September 2022, the transition to PoS has significantly reduced token issuance.
3. Since the release of Flashbot’s MEV-Boost software, validators on PoS Ethereum are paid additional fees through users’ block inclusion, so their income has been underestimated.
In summary, there are four variables that influence the profitability of the Ethereum network:
Base Fee (destroyed)
Priority Fee (paid to validators)
MEV (paid to validators)
ETH issuance/inflation (paid to validators)
When we update the above table:
Ethereum financial metrics by year
Since EIP-1559, part of the network transaction fees are destroyed, as shown by the fees paid by users minus the portion paid to validators.
2023 marks the first full year that the network is “profitable,” largely due to the shift to PoS.
MEV payments are paid in full to validators, so ETH holders do not see this portion of revenue.
Conclusion: Ethereum PoW used to be deeply loss-making and its business model was fundamentally broken. But thanks to EIP-1559’s more efficient gas pricing and drastically reduced token issuance since the merger, Ethereum is running a profitable business today.
Note that PoW miners/PoS validators also spend money on electricity and hardware, but these external costs are ignored here because they are costs borne by the validator, not the "network". Blob fees are also an income item paid to Ethereum by L2 rollups since March 2024, but this is relatively small and so is also ignored.
Is token issuance a cost?
The second criticism is that viewing token issuance as a cost is simply wrong. This argument has been made by prominent figures such as Jon Charbonneau, Kyle Samani, and especially Anatoly, most recently in his debate with Justin Drake at Bankless.
Treating token issuance as a cost implies that token holders are diluted — just like the Federal Reserve dilutes your USD savings through its printing press. But this is not the case, as users are entitled to the network’s inflationary token issuance by staking on liquid staking platforms such as Lido. In addition, ETH stakers also earn priority fees and MEV payments.
If you agree with this line of thinking, then you will ask yourself this question: By staking on a liquidity staking platform, the actual return on ETH is net positive. As an ETH holder, why should I care whether Ethereum is "profitable" when I can easily get this cash flow?
Consider a thought experiment, if all the money printed by the central bank was distributed equally to every citizen at the same time, no one would be worse off or better off. The Gini coefficient does not change, everyone's fiat holdings are nominally higher, but the same amount of real value is chasing the same amount of goods and services. Of course, this is impossible in the real world. When the printing presses are printing money like crazy, the new money supply reaches different players in the economy at different times, thereby benefiting those who receive the new money supply first (called the Cantron effect). But this is exactly what happens in a PoS blockchain economy.
So just like it’s pointless to obsess over the “profitability of the U.S. economy,” it’s also pointless to focus on the “profitability” of the Ethereum blockchain when everyone is equally receiving the same cash flow from the central bank’s printing presses.
This is not the end. If the logic of this analysis is correct, and token issuance is not a cost, then this means that non-stakers are actually being diluted because they are not receiving token issuance.
The key analytical question is: What is the difference in value flows between ETH holders and ETH stakers?
There are a few things to note here:
Priority fees, MEV payments, and ETH issuance are now all “revenue” items instead of “costs”.
ETH holders are still net positive due to EIP-1559 burns and the shift to PoS, but ETH stakers receive a larger share of the value through their contribution to network validation.
A negligible cost item for stakers here is Lido’s commission rate of about 10%.
In summary, a "non-profitable" blockchain looks bad, but stakers are still net positive from value flows. The simple revenue-cost=profit framework in traditional finance makes sense because shareholders have a legal claim on dividend payments or assets. But stocks are different than L1 tokens, so the macroeconomic view of "blockchain profitability" is less relevant.
Solana Network Profitability and Value Flow
Now let’s take a look at Solana.
Solana’s transaction fee model divides fees into voting transactions and non-voting transactions. Voting transactions are submitted by validators to sign votes for network consensus, while non-voting transactions are the main metric for tracking network activity as it involves the transfer of SOL between different Solana accounts/smart contracts. Both are calculated as revenue items here.
From a network perspective, Solana is deeply loss-making.
However, Solana supporters often argue that the above valuation model is irrelevant because SOL holders can obtain network issuance through staking. Therefore, let’s look at the value flow of SOL holders and stakers:
As expected, the value flow to holders is deeply negative, as SOL holders are heavily diluted by network issuance. But SOL stakers are net positive, as they receive network issuance.
Due to Solana’s ultra-low gas fees, the network faces a perverse incentive problem with spamming transactions on a first-come, first-served basis. To mitigate this, Solana developers have given users the option to pay a priority fee, 50% of which goes to block builders (called “leaders”) and the other 50% is burned. Both are revenue items, as SOL stakers benefit from it. Notably, as of a week ago, governance has allocated 100% of priority fees to validators.
A brief explanation of PoW consensus
Going back to the original point, value accumulation only applies to L1 tokens of PoS chains.
In the case of PoW chains (like Bitcoin or pre-merger Ethereum), since there is no platform like Lido that can opt-in to receive a portion of BTC issuance, there is no such value accumulation. BTC issuance is a direct cost to the network, just like the Fed printing dollars and diluting the actual value of any holdings.
To make matters worse, 100% of BTC issuance is paid to miners who consume huge amounts of electricity to provide services in exchange for rewards. Miners will sell BTC to cover their operating costs, thus creating selling pressure on the market. In summary, if you hold BTC, not only will you be diluted due to token issuance rewards, your holdings will also be subject to significant selling pressure from miners.
All this makes Bitcoin look like a poor digital asset built on broken token economics. However, this conclusion is an attempt to apply the same valuation model used for ETH to BTC. Bitcoin maximalists may consider this a serious analytical error, treating BTC and ETH as the same type of asset, while BTC is more like a commodity-like monetary asset.
If so, then valuing BTC requires a different model that rationally accounts for its monetary premium, rather than a simple revenue-cost=profit framework.
in conclusion
Regardless of which side you fall on, there is no denying that in an ideal world, token issuance should be zero or at least close to zero. Even if token holders have easy ways to escape dilution, non-stakers still lose value, as Polynya points out. All non-stakers are subject to the inflationary pressure of token issuance — including anyone who keeps their tokens in a cold wallet for safety, off-chain crypto investors, anyone using their L1 tokens for high-risk yield DeFi activities, etc.
Key thought leaders in the Ethereum community typically take one side of the “token issuance is a cost” debate, while other L1s take the other side. Considering the massive effort Ethereum developers have put into making ETH a deflationary currency, and the ongoing discussions around further reducing ETH issuance, it’s not hard to understand why Ethereum leaders place so much emphasis on viewing issuance as a cost.
On the other hand, other L1s tend to have higher token inflation and staking ratios tend to be much higher than Ethereum, which may explain their motivation to try to explain token issuance as a cost.
