The Dilemma of Ethereum: An Analysis from the Perspective of the Three-Game Theory

Recently, there has been a lot of negative commentary surrounding Ethereum (ETH), but it seems that none of it has touched the core of the issue. Although the technology and developer base remain strong, it is normal to see new challengers emerging each round. But why has Ethereum performed so weakly this time? Let's delve into this issue from the perspectives of supply and demand.

Demand Side Analysis

The demand for Ethereum can be divided into two factors: endogenous and external.

Endogenous factors mainly refer to new applications priced in ETH that arise from the development of Ethereum technology, thereby driving the demand for ETH. For example, the ICO boom in 2017 and the DeFi wave from 2020 to 2021. In this round of market, L2 and Restaking, which should have been the main narratives, failed to generate the expected trading boom. The L2 ecological projects highly overlap with the main chain, making it difficult to stimulate explosive growth; while PointFi and Restaking essentially lock up ETH to reduce liquidity rather than create more assets priced in ETH. Large restaking projects like Eigen, Rez, and Ethfi have their pricing power in centralized exchanges (USDT-based), rather than on-chain like in the last round with YFI, CRV, and COMP (ETH-based). This leads to a lack of incentive for users to hold ETH.

Another endogenous factor worth noting is the burning mechanism brought by EIP1559. The main function of ETH is as a settlement layer, and the liquidations of large DeFi projects occur on the main chain. However, the high overlap of L2 and main chain functions has led to a significant diversion of demand, reducing the transaction burn on the main chain and further weakening the demand for ETH.

External factors mainly include external ecological demand and the macro environment. The previous cycle was an easing cycle, while this cycle is a tightening cycle. In terms of external ecological demand, the last round was Grayscale Trust, and this round is ETF. Grayscale Trust can only be bought and not sold, while ETF can be both entered and exited. Since the ETF was launched a month ago, the total net outflow has reached 140.83K, mainly through outflows from Grayscale. This sharply contrasts with the continuous net inflow since the launch of the Bitcoin ETF, indicating that both new and old large holders of ETH are cashing out through ETF.

Supply Side Analysis

Ethereum is essentially a classic dividend model, where the main selling pressure comes from new output, regardless of the POW or POS era. However, the reason for the issues in this round lies in the change of its output cost structure.

POW era (before September 15, 2022)

The output logic of ETH is similar to that of BTC, produced by miners mining. The costs for miners to obtain ETH include:

1. Fixed costs: One-time non-refundable investments, such as the cost of ETH mining machines.
2. Incremental cost: The costs that increase with mining time, including electricity fees, custody fees, accidental costs, etc.

These costs are denominated in fiat currency and are non-recoverable sunk costs. When the market price of ETH falls below the acquisition cost, miners choose not to sell to avoid losses, which creates a lower price support for ETH.

POS era (after September 15, 2022)

In the era of POS, the role of miners has been replaced by validators. To obtain ETH output, it is only necessary to stake ETH to a validator node. The cost structure has changed to:

1. Validator: Costs of infrastructure provided (such as personnel, servers)
2. Staker: The opportunity cost of staking ETH and the fees paid to validators.

This change has led to a significant reduction in the fiat cost of ETH output, to the point where it can even be negligible. Stakers no longer maintain a price floor for ETH like miners do, but can infinitely mine and sell. Even if we assume that the average entry price for stakers is the average price of the previous round, this mechanism cannot continuously raise the floor price of ETH. As long as the new ETH supply is positive, the price will continue to be under pressure.

Conclusion and Insights

The dilemma of Ethereum stems from the hidden dangers planted at the end of the 2018 ICO era. At that time, a large number of ICO projects priced in ETH indiscriminately sold off their ETH, leading to a price crash. To prevent similar situations from happening again, the Ethereum ecosystem began to emphasize roadmaps, main narratives, and orthodoxy, forming a group of "core circle" developers and investors.

However, this practice has led to two problems:

1. The split rate is too low: Projects that can obtain considerable liquidity and assets have sharply decreased.
2. Market Beta returns are weaker than competitors: The high valuations caused by "Halal" and "Zanjv" result in Beta returns being weaker than other public chains.

Additionally, L2 has weakened the burning mechanism, and POS brings cost-free selling pressure, which offsets the efforts made by Ethereum's core to prevent disorderly selling pressure, ultimately leading to today's predicament.

From the experience of Ethereum, we can obtain two important insights:

1. To ensure long-term stability of the dividend model, it is necessary to establish fixed costs and incremental costs denominated in fiat currency, and continuously raise the cost line as asset liquidity improves, thereby increasing the lower limit of asset prices.
2. Reducing selling pressure is only a temporary measure; the real goal should be to turn the native currency into a priced asset, making holdings not reliant on the appreciation of the native currency itself, thereby expanding demand and liquidity.