Q1: What are the main differences between Bitcoin and Ethereum? How does Ethereum differ from other assets in the Smart Contract Platforms Crypto Sector?
A: Bitcoin’s primary use case today is as a store of value, while Ethereum’s primary use case is as a platform for decentralized applications.
In 2009, Bitcoin became the first public blockchain and the first investible blockchain token. Today, Bitcoin can be considered a asset and digital alternative to gold.
In 2015, Ethereum applied the concept of a public blockchain to smart contracts — self-executing computer code — creating a whole new category within the crypto asset class with entirely different use cases from Bitcoin.
Ethereum can be likened to a decentralized version of Apple’s App Store, as it provides the foundational platform for applications to be built upon. These decentralized applications (dApps) can range from financial applications to gaming to identity tools.
In comparison to Bitcoin, Ethereum currently allows for greater transaction throughput, lower average block times, and around the same level of transaction fees for users.
Q2: How much does the supply of Ether (ETH) increase and what determines the issuance rate?
A: Since the transition to Proof of Stake (PoS) in 2022, the supply of ETH has been approximately unchanged. The issuance rate is determined by block rewards and transaction fees.
In 2022, Ethereum underwent a major upgrade dubbed “The Merge,” which included a shift from a Proof of Work (PoW) to a Proof of Stake (PoS) consensus mechanism. Before the Merge, Ethereum had an average annual inflation rate of about 3%.
Since the Merge and shift to PoS, Ethereum supply has been about unchanged. Like Bitcoin, limited ETH supply growth underpins its value as a scarce digital asset.
ETH issuance is influenced by block rewards and transaction fees. Block rewards are newly minted ETH distributed to validators, contributing to inflation. Transaction fees, or gas fees, include a base fee that is burned (deflationary) and a priority fee that is given as a reward to validators (neutral impact on inflation).
Q3: What is “gas” on the Ethereum network? What is Ethereum network fee revenue and how does it accrue value to token holders?
A: Transaction fees on Ethereum are referred to as “gas,” which can be considered the network’s revenue. Revenue accrues to token holders through mechanisms that resemble equity dividends and buybacks.
Ethereum network fee revenue is generated by gas, or fees paid in ETH to perform transactions and use applications on the Ethereum network. Gas is necessary to help regulate network usage: without some type of transaction cost, the network could be overwhelmed by spam transactions.
Gas fees consist of two parts: base fees and tips. Similar to a stock buyback, base fees are "burned," removing ETH supply from circulation. In this way, rising transaction volumes can help benefit all token holders.
Similar to an equity dividend, tips are distributed as rewards to validators. However, the difference in this case is that validators help secure the network by processing transactions and maintaining the blockchain
Gas fees are crucial for the functioning of the Ethereum network as they provide an economic incentive for validators to participate in the network's security. By tying the network's usage directly to the value of ETH, network fee revenue plays a critical role in Ethereum's value accrual mechanism, benefiting token holders, validators, and the overall network ecosystem.
Q4: What makes Ethereum attractive to developers building on the network? What are the largest applications on Ethereum?
A: Ethereum is attractive to developers because of network effects and network security. Most of the largest decentralized applications (dApps) today have financial use cases.
Ethereum is attractive to developers building on the network for many reasons. Ethereum is a category leader in terms of number of applications (~4,700 decentralized applications in total) and has the largest developer community (~580 weekly developers), showcasing a robust environment for application interoperability and innovation.
Ethereum also dominates its competitors with $54 billion in TVL, a key indicator of ecosystem liquidity. These advantages position Ethereum particularly well towards retaining and attracting new developers.
Ethereum is also a sector leader in terms of network security, which we believe helps garner confidence with users and developers alike. The theoretical cost of attacking the Ethereum network is prohibitively high.
For instance, gaining control of 51% of the network to execute a majority attack would require an enormous amount of computational power and financial resources, making such an attack economically unfeasible. The extensive network of decentralized nodes further helps enhance network security by ensuring redundancy and eliminating single points of failure.
Decentralized applications on Ethereum range in use cases from financial/tokenization to gaming and NFTs. Two of the largest applications built on Ethereum based on metrics like users, fees, and TVL include Lido and Uniswap.
Lido, a liquid staking solution, enables users to stake their ETH while retaining liquidity through the issuance of derivative tokens (stETH). Uniswap is a decentralized exchange, which enables peer-to-peer trading of various crypto assets without an intermediary. Both use Ethereum as a settlement layer, designed to execute secure and decentralized transactions.
Q5: What does it mean that Ethereum is a modular blockchain design?
A: Ethereum’s modular design means that different types of blockchain infrastructure (multiple software “layers”) work together to deliver the end user experience.
Blockchains can be considered a type of digital infrastructure. And just like infrastructure in the physical world, they can experience congestion. In May 2022, for example, increased congestion on the Ethereum network led to average daily gas fees reaching $196 for a single transaction.
When network congestion increases, gas fees rise, which can crowd out many types of network activity. As a result, Ethereum has pursued a modular (or layered) design philosophy, in which different types of blockchain infrastructure work together to deliver the end user experience.
Ethereum's modular design divides the network into specialized parts, such as execution (processing transactions), data availability (storing transaction data), and consensus (ensuring all transactions are valid).
This approach allows for targeted innovations and updates without disrupting the entire network, enabling Ethereum to address its scalability challenges while still maintaining its network security.
This design contrasts with Solana’s monolithic approach, where each of these functions — execution, data availability, and consensus — are handled within a single layer, optimizing for speed, efficiency, and consistency.
Q6: What are Ethereum Layer 2s, and how do they connect to the Ethereum mainnet?
A: Ethereum Layer 2s are scaling solutions built on top of Ethereum that execute transactions at lower cost.
Because Ethereum operates a modular design, it can separate transaction execution from transaction settlement. As a result, Ethereum Layer 2s process transactions, batch them together, and then send a compressed version back to the main network — the Ethereum mainnet or Layer 1— for settlement.
Through this batching process, Layer 2s can offer users significantly greater throughput and lower costs in comparison to transactions executed on the main chain, while still relying on Ethereum’s network security.
Today, there are a wide variety of Layer 2 scaling solutions including Optimistic Rollups, such as Optimism and Arbitrum, and ZK Rollups, such as Starknet and ZkSync.
From the standpoint of blockchain activity, Layer 2 networks have allowed the Ethereum ecosystem to expand significantly; Layer 2s now account for about two-thirds of total activity in the Ethereum ecosystem.
Layer 2 adoption can, in part, be attributed to Ethereum’s recent Dencun upgrade. With this upgrade in March 2024, Ethereum significantly reduced data costs for Layer 2s by providing a designated storage space for them on the mainnet. This allowed Layer 2s to lower their transaction fees, making Ethereum Layer 2s, in some cases, as affordable and accessible as Solana.
Q7: How does Ethereum achieve consensus, and how do you measure network security?
A: Ethereum achieves consensus through a Proof of Stake algorithm. Network security can be measured in different ways, including the value of ETH staked and number of validators.
Originally, Ethereum achieved consensus through Proof of Work, similar to Bitcoin. However, in 2022, Ethereum transitioned to a PoS network with “The Merge” upgrade. This upgrade was designed to increase the efficiency and scalability of the network while reducing energy consumption by 99%.
The PoS consensus used by Ethereum differs from PoW by selecting who has the right to confirm the next block based on the value of their staked tokens, rather than through competition among miners. In the PoS consensus mechanism, validators must stake in increments of 32 ETH to become eligible to confirm blocks for rewards.
Ethereum network security can be measured by the total amount of ETH staked on the network, currently valued at around $112bn. This represents the overall ecosystem’s economic commitment to network security (also referred to as Ethereum’s security budget). Another measure is the number of validators, currently standing at ~1 million, which reflects the decentralization of the Ethereum network.
Q8: What are the opportunities and challenges for the Ethereum network going forward?
A: Ethereum benefits from strong network effects and liquidity advantage. At the same time, it faces certain challenges, including Layer 2 centralization and increasing competition from other smart contract platforms.
Ethereum benefits from several fundamental positives. Most importantly, Ethereum’s network effects and liquidity advantage position it favorably towards retaining and attracting new developers, applications, and users.
Ethereum also generates the most network fee revenue (over $2 billion in 2023) of its peer set, indicating its maturity, ability to monetize its user base, and its advantage towards attracting validators and stakers for network security.
In total, Ethereum has the largest network security budget at 33mm ETH (currently worth around $112 billion).This is particularly important for use cases that require high levels of security such as stablecoins and tokenized financial assets.
Ethereum ETPs could increase the willingness of institutions to hold ETH as an asset and to adopt technology on the Ethereum blockchain. We have already seen strides in this direction, as the list of Wall Street firms building tokenized funds now includes Goldman Sachs and Blackrock, with Blackrock developing its BUIDL fund on Ethereum.
Beyond traditional finance, a spot Ethereum ETP approval could have implications on broader retail awareness of Ethereum, flows into ETH the asset, and adoption of the Ethereum network.
At the same time, Ethereum faces several challenges. For example, most Layer 2s are centralized today. To fully achieve its potential as a truly permissionless, decentralized ecosystem, Ethereum Layer 2s will need to progressively decentralize over time.
Additionally, as network activity has transitioned to Layer 2s, network fee revenue on the Ethereum mainnet has recently declined. This underscores the importance that Ethereum continues to grow its fee revenue. This could occur either through i) modest growth in Layer 1 activity, paying higher transaction costs, or ii) significant growth in Layer 2 activity, paying lower transaction costs.
Ethereum faces increasing competition in the Smart Contract Platforms Crypto Sector. To maintain its dominance in a competitive market segment, Ethereum will need to leverage its strengths and bring in additional users as well as grow fee revenue.
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