A new development in the world of cryptocurrency could bring more people into the fold. The Securities and Exchange Commission (SEC) recently approved a new type of investment vehicle for Ethereum, the second-largest digital currency.

These spot Ethereum ETFs are similar to stock ETFs, which allow investors to buy a basket of assets without having to buy them individually. In the case of Ethereum ETFs, the underlying assets would be Ethereum coins.
This is seen as a positive step for Ethereum because it could introduce more investors to the concept of smart contracts and decentralized applications (dApps).
Smart contracts are self-executing agreements written in code that can be used to automate transactions on a blockchain. DApps are applications that are built on top of a blockchain, such as Ethereum.
The potential benefits of spot Ethereum ETFs are twofold. First, they could help to increase the adoption of Ethereum by making it more accessible to a wider range of investors. Second, they could help to raise awareness of smart contracts and dApps, which have the potential to revolutionize the way we conduct business online.
It is important to note that Ethereum is a different type of asset than Bitcoin, the leading cryptocurrency. Bitcoin is primarily seen as a store of value, similar to gold. Ethereum, on the other hand, is a decentralized computing platform that can be used to build a wide variety of applications. As such, investors interested in Ethereum should consider its unique characteristics before making an investment.
Smart Contracts: The Engine of Decentralized Applications
Building on the foundation of Bitcoin, Ethereum introduced a revolutionary concept: smart contracts. Imagine self-executing agreements written in code. These contracts automatically perform specific actions when pre-defined conditions are met, eliminating the need for intermediaries.
Think of a vending machine. You insert money, select your item, and the machine dispenses it without human intervention. Smart contracts function similarly in the digital world. Users interact with them using digital tokens, triggering programmed actions. These actions can encompass anything from exchanging currencies to issuing loans or verifying identities.
The magic lies in the power of blockchains, like Ethereum’s. Beyond tracking ownership, they can record changes in data state, essentially acting as a giant public computer. This, combined with smart contracts, allows blockchains to host a vast array of applications, forming the backbone of a potential future digital economy.
Ethereum’s Performance: A Look Beyond the Price Tag
Ethereum’s native token, Ether (ETH), reigns supreme within the Smart Contract Platforms Crypto Sector, boasting the largest market capitalization. While its performance in early 2023 mirrored its sector (see Exhibit 2), it lagged behind Bitcoin, the overall crypto kingpin, and even Solana, the runner-up in smart contract platforms.
However, there’s more to the story than just price. Compared to traditional investments, Ether, along with Bitcoin, has delivered competitive returns when adjusted for risk since the beginning of 2023. This trend holds true over longer timeframes as well, though with a significant caveat: cryptocurrencies are inherently more volatile.
Ethereum’s Modular Magic that is Powering the Future
Ethereum’s design breaks the mold. Unlike monolithic blockchains where everything happens in one place, Ethereum embraces a modular approach. Different types of blockchain infrastructure work together seamlessly to deliver a smooth user experience.
The key players here are layers
Layer 1 (L1): The Ethereum mainnet, the secure and decentralized foundation.
Layer 2 (L2) networks: These are additional software “layers” built on top of L1, handling transactions and scaling the ecosystem. They periodically communicate with L1 for final settlement and security benefits.
This approach stands in contrast to blockchains like Solana, where everything occurs on a single layer. Ethereum’s modularity allows L2 networks to specialize and optimize for specific functions.
The recent “Dencun” upgrade in March 2024 marked a significant step towards this modular future (see our report “Ethereum’s Coming of Age” for details). The results are impressive: L2 network activity has skyrocketed, now accounting for roughly two-thirds of all Ethereum ecosystem activity!
The Double-Edged Sword of Scaling: Ethereum’s Tokenomics in Flux
Ethereum’s innovative modular design brings both benefits and challenges. While Layer 2 networks have successfully scaled activity, they’ve also impacted Ethereum’s tokenomics, at least in the short term.
Understanding Tokenomics
Smart Contract Platform blockchains, like Ethereum, rely on transaction fees to accrue value. These fees typically incentivize validators (who secure the network) and can even reduce the total supply of tokens.
In Ethereum’s case
Base fees are burned: Destroyed permanently, reducing overall token supply.
Priority fees (tips) go to validators: Rewarding them for securing the network.
When Ethereum’s mainnet bustled with activity, transaction fees were high, often leading to more ETH being burned than issued, causing a decline in total supply.
The Layer 2 Impact
The shift to Layer 2 networks has resulted in:
Lower fees on the mainnet: Less activity translates to lower fees collected.
Increased ETH supply: Burning has slowed down, and new issuance may even be outpacing it.
It’s important to note that Layer 2 networks do pay fees (blob fees and others) to interact with the mainnet, but these fees are generally lower.
The Future of Ethereum’s Value: A Balancing Act
For the Ether token (ETH) to appreciate over time, Ethereum’s mainnet needs a boost in transaction fees. This can happen in two ways:
1. Increased Layer 1 Activity: More users conducting transactions on the mainnet, even if they pay slightly higher fees.
2. Significant Layer 2 Growth: A surge in activity on Layer 2 networks, even with their lower fees.
Our Research predicts a combination of both approaches will fuel growth.
Where will the growth come from?
We believe Layer 1 is likely to see an uptick in
High-value, infrequent transactions: Activities that involve significant sums and happen less often, justifying the higher fees.
Transactions requiring strong decentralization: Especially true until Layer 2 networks become more decentralized themselves. This could include various tokenization projects, where the transaction cost is negligible compared to the overall value being transferred. For instance, around 70% of tokenized U.S. Treasuries already reside on Ethereum’s blockchain!
The High-Value Collectibles Stay Put
We also expect high-value NFTs (non-fungible tokens) to stick to the Ethereum mainnet. Their value hinges on the network’s robust security and decentralization, and they typically trade infrequently. This aligns with our prediction for continued growth in Bitcoin NFTs for similar reasons.
Layer 1 vs. Layer 2: Where the Transactions Happen
Ethereum’s modular design presents a choice for developers: Layer 1 or Layer 2? Each layer caters to different transaction types.
Layer 1: Ideal for:
High-value, infrequent transactions: Think large financial deals or tokenized assets (like those 70% of tokenized U.S. Treasuries!). The slightly higher fees are a small price to pay for the security and decentralization of the mainnet.
Transactions requiring strong decentralization: Especially relevant until Layer 2 networks mature. This could include various tokenization projects.
Layer 2: A better fit for
High-frequency, low-value transactions: Perfect for applications like social media (friend.tech, Farcaster), gaming, and retail payments. These transactions can leverage the lower fees of Layer 2 networks.
The Fee Factor
While Layer 2 offers lower fees, it’s important to remember that significant user growth is needed on these networks to generate meaningful fee revenue for the entire Ethereum ecosystem.
The Takeaway
The future of Ethereum’s value hinges on a healthy balance between Layer 1 and Layer 2 activity. Both layers play a crucial role in attracting users and driving transaction fees.