Challenges and Opportunities Facing Ethereum: Long-term Value Accumulation Outlook

The upcoming Ethereum Cancun/Deneb upgrade is expected to reduce the fees that Rollup operators pay for block space, which may negatively impact Ethereum's fee revenue in the short term. ETH may perform poorly as a result, especially when Rollup projects built on Ethereum increasingly interoperate with other higher-performing and relatively lower-cost settlement and data availability chains. In the long run, if the theory of blockchain modularity proves to be correct, the main network fee drivers for layer-1 public chains like Ethereum and Celestia will be the layer-2 Rollup service providers, rather than the end users. Additionally, as layer-2 public chains increasingly adopt account abstraction, the main individuals holding Ether to pay for block space are expected to be Rollup operators, rather than end users.

The cryptocurrency industry has long faced the challenge of maximizing network decentralization and security while scaling public chains. The recently launched Celestia represents a new solution to the impossible triangle problem of public chain scalability. Celestia is the first highly optimized public chain that can provide data availability for Rollups (DA). As a data availability layer, Celestia does not execute transaction native functions but instead provides block space for Rollups to temporarily publish batches of user transaction data.

Ethereum is also working hard to reduce the cost of block space used for DA purposes, but at the cost of higher node requirements. Proto-Danksharding is the main code change in Ethereum's next network upgrade Cancun/Deneb, which is expected to increase the temporary data storage space of Ethereum nodes by 768kB. It is estimated that the additional block space for Rollup transactions will reduce Ethereum's DA cost by at least 10 times.

As Ethereum implements network upgrades to better support Layer 2 Rollups, the share of protocol revenue from Rollup Sequencers may be larger than that of direct L1 end users. Currently, Rollups account for 12% of all Gas paid on Ethereum, up from 3% at the beginning of the year.

Since January, the trading activity of Ethereum L2 has more than doubled. In 2023, both the nominal growth and percentage growth of daily transaction totals on L2 are at their highest. Among L2s, Optimism and Arbitrum have experienced the largest decline in total value locked in Ethereum L2 in 2023, decreasing by 11% and 7% respectively. Base and zkSyncEra have seen the most value growth, with total value locked in L2 increasing by 9% and 4% respectively.

It is worth noting that Coinbase's Rollup named Base, launched this year, has seen a rapid increase in adoption and popularity among L2 users. As of December 12, Base's total locked value ( TVL ) ranks third among L2s. Among the top three L2s by Ethereum TVL, Base Sequencer generates income by ordering user transactions and batching them into blocks, accounting for approximately 20% of total revenue. So far, the Optimism, Base, and Arbitrum sequencers have generated $140 million in revenue from user fees.

Looking ahead to 2024, with the activation of the Cancun/Deneb upgrade, the cost of batch user transactions completed on Ethereum will be significantly reduced, thereby increasing the profit margins of Rollup sequencers while decreasing Ethereum's fee revenue. The main code change in the Cancun/Deneb upgrade is Ethereum Improvement Proposal (EIP)4844, also known as Proto-danksharding. By activating EIP 4844, each block will increase by 768 KB of data space for Rollup transactions.

In the short term, Ethereum's revenue will still mainly come from transactions initiated directly by end users on L1. As the cost savings from trading on L2 increase due to scalability upgrades of L2, and as the decentralization and interoperability of Rollups improve, user adoption of L2 will increase. Additionally, cryptocurrency companies that choose to use alternative decentralized layers like Celestia to enhance cost-effectiveness can achieve higher profits simply by passing on part of the saved costs to cryptocurrency users.

In the long term, over five years or even longer, with the widespread adoption of blockchain-based applications and services, Ethereum's revenue may increase, and the usage rate of Rollup for transaction execution could be ten times or even higher than that of Ethereum. Lower L2 fees can bring new use cases for blockchain applications across various industries such as gaming, social media, entertainment, and sports. The new use cases that drive broader adoption of blockchain-based applications are expected to increase the overall demand for Ethereum's block space, thereby increasing Ethereum's total revenue. In this scenario, Ethereum's main source of revenue comes from Rollup services acting as the settlement and DA layer.

Despite Ethereum's dominant position in the 2023 market as the settlement and DA public chain with the highest security, value, decentralization, and network effects, competition from Celestia and other public chains that have been designed specifically to support Rollup activities from the outset will become increasingly fierce. Although Celestia is fewer in number compared to Ethereum and its development has just begun, over time, Ethereum's dominance as the DA public chain supporting Rollup transactions may be weakened, although this possibility remains quite small.

Regarding the long-term value accumulation from L2 to L1, there are two factors worth discussing: the trend of activating native account abstraction on L2, and the re-staking solutions on Ethereum. If L2 Rollup sequencers ultimately become intermediaries relied upon by end users for interacting with blockchain-based applications, then in the future, users are also likely to no longer hold Ethereum directly, but instead be able to pay transaction fees in stablecoins or even fiat currencies, depending on the design of the sequencers and Rollups, with the Rollup sequencers converting these payments into Ethereum on behalf of users to pay Ethereum transaction fees.

Re-staking protocols like EigenLayer may take years to mature and gain widespread adoption on Ethereum. The first active validation services (AVS) on EigenLayer will be offered to node operators through re-staking support, and these services will initially be carefully orchestrated and practically tested. To some extent, re-staking has become a reliable and scalable activity on Ethereum, similar to the liquid staking activities that have become very common through the Lido protocol. Therefore, re-utilizing staked Ether to provide additional security for operations like ( such as sorting ) is expected to benefit Rollups.

Overall, Ethereum's revenue will benefit from the ability to maintain larger-scale trading activities through L2, although in the short term, the network may face revenue reduction issues due to a lack of Rollup adoption and the implementation of upgrade subsidies for Rollup costs. In the long run, technologies such as native account abstraction on L2s will further reduce the demand for end users to hold ETH directly. More likely, with the existence of liquidity solutions and the maturation of restaking solutions like EigenLayer, end users and DeFi protocols will hold token representatives of ETH and their cumulative earnings. The primary holders of native ETH may be Rollup operators, who use token representatives to purchase block space on Ethereum on behalf of end users.