ParaFi Capital Insights on Ethereum Economics

The ParaFi team has been digging into Ethereum’s activity post EIP-4844. We focused on 3 critical questions:?

1) What is the latest with Ethereum’s burn?

2) How is L2 traction faring??

3) What is the economic relationship between L2s and Ethereum??

After EIP-1559 and The Merge, there was excitement around the economics of ETH as a cash-flow generating asset. Initially after the two upgrades, the supply of ETH did drop, falling ~0.38% from September 2022 to April 2024, but since then the supply has been climbing as the burn rate has slowed.

The ETH staking rewards rate has been on a downwards trend over the past 12 months, as the number of Ethereum validators has grown 79% over the past year, and L1 transaction fees have declined.

While the burn has decelerated, smart contracts tied to Uniswap, Tether, 1inch, and MetaMask continue to drive a majority of gas consumption on Ethereum.?

Arbitrum and ZKsync were major gas users in 2023, but have lost some prominence this year, partly because EIP-4844 has helped L2s post data with more cost efficiency due to lower data storage requirements.?

The number of transactions on Ethereum has stayed relatively stagnant over the past two and a half years, while L2s saw their total transaction count exceed their L1 counterpart by 10x in August 2024.?

Growth in layer 2 activity can be attributed to both new L2s launching and some existing L2s seeing breakout success. Both Base and Arbitrum have individually processed more daily transactions than Ethereum since March. This is by design, as rollups are an essential part of the Ethereum roadmap and are meant to aid in Ethereum’s scalability, offering a cheaper alternative for execution to the mainnet while tapping into its security.

While this chart aggregates transactions over several L2s, each one of them is offering alternative block space to Ethereum, highlighting L1 activity migrating towards L2s.?

The growing prominence of Ethereum L2s is also showcased by how much DEX market share they are attracting away from Ethereum. After the EIP-4844 upgrade, Ethereum L2s have managed to push Ethereum’s DEX market share to below 60%.?

This also emphasizes the fragmented liquidity environment that is emerging as a result of the vast network of rollups that are available.?

Despite the rampant success of these L2s, they are spending a relatively small amount to publish their data on Ethereum due to the EIP-4844 upgrade. Implemented in March 2024, EIP-4844 introduced a new data storage mechanism called “blobs” to Ethereum, a much cheaper alternative to the previous calldata structure.

In March 2024, L2s paid over 10,000 ETH in fees on Ethereum, but in July they paid less than 400 ETH, falling by ~96%. With this decline in costs, L2s are now contributing much less to the ETH burn and also helping drive gas prices lower on the mainnet.?

L2s have to post large amounts of transaction summary data on-chain, so they quickly adopted blobs. At least 16,000 blobs have been posted per day on Ethereum since the beginning of June. This has led to a decrease in the share of total fees spent by major L2s, which has dropped from 12% to 1% in 2024.?

L2 operating profit margins have increased substantially since the implementation of EIP-4844. While total sequencer revenues (the sum of fees paid on L2 networks) for scaling solutions declined ~48% on average year-to-date, operating costs declined ~87% respectively, meaning rollups are now keeping a majority of the fees they bring in.

Many major L2s are now boasting a 90%+ operating profit margin, even after passing significant cost on savings to users. Users are benefiting from a ~90% drop in fees in the past year on networks utilizing blobs, with median transaction costs often below $0.01.

EIP-4844 has had a clear impact on the Ethereum L1.?

While L2 usage has soared, the direct benefit to ETH as an asset has been less clear.

The ETH burn rate has fallen over the past few months, leading to less value flowing to ETH, despite the L2s seeing a sizable rise in profits.?

It leaves the Ethereum ecosystem with a lot to think about:?

• As L2 usage continues to grow, what role will L2 tokens serve? And how much value will be captured by L2 tokens versus ETH?
• Are rollups benefiting disproportionately relative to Ethereum? Or is this structure ideal to attract more users and developers into the broader Ethereum space??

• As more L2s launch, how will users and liquidity interoperate across these various networks??

• With fees now historically low on Ethereum mainnet, will we see developers reconsider deployment directly on the L1, or are L2 environments still more attractive??

Disclaimers:?

The above thread is provided for informational purposes only. It should not be construed as investment advice. Please see https://parafi.com/disclosure for more information