Build a Quantitative Model to Explore Ethereum: From Digital Petroleum to Digital Nation
The 5 most popular opinions in the Ethereum community today:
ETH is a digital commodity
ETH is a non-sovereign digital store of value
Ethereum is a payment network
ETH is a productive financial asset
Ethereum is the digital nation, ETH is the reserve currency
4 ways to value Ethereum:
adoption rate
network fee
The P/E (or similar metric) multiple the market will bear
Market Share of the Entire Crypto Market
Below we provide a quantitative framework for each viewpoint. Our goal is not to come up with a price target for ETH, rather, we aim to understand what these narratives mean for Ethereum, and market participants' expectations, various return scenarios.
Key premise: Assuming the Ethereum London upgrade will succeed
We expect a successful transition to PoS and EIP 1559 implementation.
Due to upcoming monetary policy changes, we assume a fixed ETH supply of 115,000,000 in our calculations.
We assume an 80% to 95% decline in average transaction revenue compared to Q1 2021 levels due to network upgrades and layer 2 solutions.
Technologies invented after the Internet, such as smartphones and social media, tend to develop faster than the Internet. We usually assume that growth is similar to the Internet, not faster.
From January 2016 to January 2021, Ethereum transaction volume grew at a compound annual growth rate of 161%. From 2020 to 2030, our model uses compound annual growth rates of 44% and 63%.
Average transaction cost in Q1 2021 ~$31 (median transaction fee ~$17)¹
Efforts are underway to reduce transaction fees. Layer 2 scaling solutions, the release of ETH 2.0 and the transition to proof-of-stake, and future network upgrades are all aimed at improving the user experience by increasing throughput and reducing fees.
Our assumption in the model below is that the average transaction fee will drop by 80% to 95%, resulting in an estimated average fee of between $2 and $7 (while also assuming a significant increase in network value, thus implying a significant increase in the settlement of these transactions fee-driven transaction volume).
Participate in DeFi.
Secure the ETH 2.0 network.
Issue, buy, sell or transfer digital assets such as ERC20 tokens, including stablecoins and NFTs.
Calculated using EVM.
Store value in alternative asset classes.
Create a cross-chain bridge where ETH will be kept.
EIP 1559 will destroy ETH previously sent to miners.
Moving to PoS will require locking up large amounts of ETH, creating a one-time supply shock and a lasting change in circulating supply.
Upcoming network upgrades may consume more ETH than network issues, further reducing supply.
There are a limited number of alternatives to oil (coal, solar, hydro, nuclear, etc.), but cryptocurrencies can fork and new cryptocurrencies can be created. For this narrative to hold true, one has to believe that Ethereum's network effects will make it the preferred, dominant solution, and that the crypto network will eventually have power l$aw or a winner-takes-all market distribution.
Digital goods are generally cheaper to produce than physical goods, so when we compare ETH to oil, even if ETH becomes as important to the global economy as oil, it may be worth less than oil.
Ethereum's supply and monetary policy are modifiable, meaning that while the supply will be limited in the near future, it is technically possible for it to grow (or shrink) someday.
Annual Supply Growth:
Gold: 2.5%
BTC：1.75%
ETH: Probably less than 2% per year after EIP 1559, possibly lower or negative.
BTC already dominates the market, and network effects may prevent other cryptocurrencies from gaining market share.
ESG concerns about energy-intensive mining operations could favor chains with proof-of-work alternatives.
It’s unclear whether there might be two “golden” or if digital stores of value are a winner-takes-all market. The precious metals market shows that a leading store of value can capture as much as 70% of the market.
In the 12 months ending December 2020, Visa⁶ and Mastercard⁷ processed $17.7T at an average transaction cost of 2.5% to 3%
As of October 2020, Ethereum transaction volume (including ERC20 tokens) was $989B and transaction spend was $1.64B (0.17% of transaction volume).
In May 2021, Ethereum is processing $20B to $30B in stablecoin transactions per day ($7.3T to $11T annual run rate) and ~$10B in ETH per day ($3.7T annual run rate), with an average miner revenue of ~$60M days ($21.9B per year). Fees only account for about 0.16% of transaction volume in stablecoins and ETH.
As of the fourth quarter of 2019, the PE multiples of Visa and Mastercard were 38 and 37, respectively. We use pre-pandemic multiples as more "typical" multiples.
Ethereum has a native currency, which makes it different from today's payment networks. If users need to hold ETH to use the network, the valuation of Ethereum may be different from the valuation of the payment network.
Ethereum can handle more than simple payments: it is a platform that can compute very complex financial contracts.
Ethereum is non-jurisdictional and cross-jurisdictional, so users may be willing to pay a premium for non-sovereign solutions.
Internet-level growth rate
lower average transaction fees
Viewpoint 1: In a digital world, ETH is a commodity
A common claim is that ETH is similar to oil. Oil got us through the industrial age, but we are now in the software age, and ETH could be the fuel for the digital economy. With upcoming network changes and the progress of DeFi over the past year, this comparison sounds increasingly important:
1. Similar to oil, ETH "burns" when used.
2. Similar to oil, demand for ETH comes from different and diverse use cases:
3. Similar to oil, ETH has a limited supply and supply growth should slow down significantly in the near future.
4. Similar to oil, geopolitics affects demand and sentiment creates volatility.
The above statement applies to many other commodities as well, so we considered the total value of global oil reserves, as well as proven reserves of other commodities in limited supply, to get a rough estimate of the likely value of the Ethereum network.
The table below shows the price of ETH if the market value of Ethereum reached the market value of natural resources (assuming a known reserve unit of these commodities and a fixed supply of ETH).
image description
The picture shows: comparing various assets, the corresponding price of Ethereum
Limitations of comparing ETH to commodities:
Viewpoint 2: ETH is a non-sovereign digital store of value
The term "digital gold" has been accepted by many BTC investors. With the upcoming Ethereum upgrade, there are four reasons to believe this narrative is relevant for Ethereum:
1. Like BTC, ETH has properties that make it superior to gold. Cryptocurrencies are easier to acquire, transport, and transfer, and are easier to use to buy and sell goods and services.
2. The supply growth of BTC and ETH is lower than that of gold:
3. ETH is easier to build than BTC, which creates a strong network effect.
image description
Pictured: The number of BTCs on the Ethereum network
4. The global digital store of value market may be larger than the gold market.
a) More utility and accessibility could expand the market size - the total global above ground supply of gold today is worth about 11 tonnes³. Digital stores of value reduce friction, provide better access and programmability, which may increase the total market size compared to gold.
Take American taxi and limousine services and Uber, an imperfect but relevant comparison. In 2009 (the year Uber was founded), the US taxi and limousine service market was $9.4B and growing at a CAGR⁴ of 3.2%. The US ride-hailing and taxi market grows to an estimated $47B by 2021 and grows at an estimated 11.7% CAGR⁵ after companies like Uber improve the user experience.
b) Investors worry about inflation, increasing demand for quality stores of value - With record levels of money printing in 2020, many believe that inflation and/or the fear of inflation could drive up the prices of fixed-supply assets .
c) Younger generations want to hold cryptocurrencies more than gold – while an estimated 12% of Americans hold gold, 25% of millennials with savings over $50,000 already own some form of cryptocurrency, and 42% are interested in buying cryptocurrencies.
If ETH becomes the leading digital store of value, it could gain enormous value (even as a runner-up to BTC).
Our approach for this framework is:
1) Provide a range of total market size for digital stores of value compared to gold
2) The percentage of this market that ETH can capture.
A Comparative Look at ETH vs. BTC
Point 3: Ethereum is a payment network
Like the payment network, Ethereum has millions of users paying fees to process their transactions. We can assess the value of Ethereum if it becomes a separate global payment network by estimating its transaction volume and transaction fees (validator revenue) and comparing it to existing payment networks such as Visa and Mastercard.
When estimating likely transaction volumes and fee ranges, we considered the following factors:
We can estimate the range of possible Ethereum network values by assuming a 37x P/E ratio and extrapolating fees from transaction fee rates and transaction volume.
Again, our goal is not to assert the potential value of ETH. The idea is to build an intuition of what one has to believe in order for ETH to have some potential value in the future. Is it more plausible that Ethereum transaction volume might reach $5T or $30T? Is it more likely that the fee will drop to 0.5% in time or all the way down to 0.01%?
How Ethereum differs from payment networks:
Viewpoint 4: ETH is a productive financial asset
Transaction fees and block rewards can represent significant revenue — fees paid to miners grew from $46 million in 2019 to $630 million in 2020, and more than $2.4 in Q1 2021.
Compared to Q1 2021, average transaction fees are likely to decrease in the future - lower fees mean less revenue for validators and faster adoption, as high fees act as a deterrent for users.
Proof of Stake will be more profitable than Proof of Work - the imminent move to Proof of Stake, if successful, will eliminate the need for highly specialized, expensive machines to mine transactions, and energy - intensive PoW machines. For simplicity, let's assume a profit margin of 100%.
Discounted cash flow of all validator revenue generated from 2021 to 2050 to estimate the net present value of ETH today.
Price-to-earnings multiple of revenue generated by Ethereum in 2030.
The impact of Layer 2 changes on average transaction fees and transaction volume is unclear.
Given the volatility of cryptocurrencies, the market may demand a higher discount rate.
Today's cryptocurrencies are highly speculative and their price-to-earnings ratios can differ significantly from those of traditional financial assets.
There is significant regulatory uncertainty that could cause dramatic changes in adoption rates.
The transition to PoS will allow validators to generate cash flow with their capital, meaning ETH will have value as a productive financial asset. To create the cash flow model, we considered the following points:
Here are two frameworks for estimating the price of ETH based on future cash flows:
Approach 1: DCF of validator revenue, and net present value of the Ethereum network.
(Bai Ze’s note: DCF means discounted cash flow method, which uses the discounted value of the cash flow that the asset can generate in the future to evaluate the value of the asset)
Method 2: PE multiple of transaction fee revenue, and the value of the Ethereum network in 2030.
(Bai Ze’s note: PE multiple means the price-earnings ratio. Generally speaking, the smaller the price-earnings ratio, the better, which means that the time period for investors to recover their investment costs is shorter)
Challenges of Estimating Future Cash Flows
Point 5(a): Ethereum is a digital nation
Define Ethereum's GDP.
Defines the money supply of Ethereum.
Measures the ratio of the money supply to GDP of different countries.
Estimate what Ethereum's GDP might be in 2030 to calculate the potential value of the network.
Miner income growth
DeFi volume is growing
NFT sales are growing
Other products and services may be produced and sold via Ethereum in the future. For example, it was technically possible to create and sell NFTs a few years ago, but they didn't really take off until recently. Likewise, in the 1990s, few could have imagined that the Internet would one day facilitate billions of video calls, video streaming, and other bandwidth-intensive applications.
All currencies held by the public
transaction deposit
savings balance
Small term deposits (less than $100,000)
and retail money market securities.
ETH and DAI in user wallets are publicly held currencies.
ETH and tokens in exchange wallets are similar to exchange deposits.
DeFi products like Yearn and Curve are savings deposits.
Locked DeFi deposits are term deposits.
DeFi products like Aave and Compound are money markets.
Investors want ETH to store value, earn passive income in DeFi, and invest in other crypto opportunities.
Consumers want ETH to access different Dapps on the Ethereum network, buy and sell digital assets such as art, game assets, insurance, etc., and conduct transactions with better privacy and anonymity
DeFi protocols want ETH to be used as collateral to create other assets, such as DAI and synthetic assets, to be used as a reserve currency to allow users to transact and raise funds.
Builders and creators want ETH to accept payments from crypto users, build businesses that can only exist as programmable money, and monetize creative content without relying on platforms that might censor them.
Other blockchains want ETH reserves to connect their chains to the largest ecosystem, Ethereum.
On Uniswap, the largest decentralized exchange today, there is more than 3.5 times as much ETH as the three most popular USD stablecoins combined (as of May 2021). On Sushiswap, the multiple exceeds 4x.
The largest DeFi protocol by total value locked is Maker, which locked over $12B in ETH as collateral for its stablecoin DAI.
ETH is also the reserve currency for projects like Synthetix, where ETH is deposited as collateral to create synthetic assets.
More than 1% ($10B as of May 2021) of Bitcoin's supply has been packaged into Ethereum, indicating the need for more programmability in digital stores of value and reserve cryptocurrencies.
How optimistic is your model for the adoption of blockchain technology
Distribution of outcomes for different chains (winner takes all, power law or fragmentation)
network fee
The cash flow multiple the market is willing to pay
In many ways, Ethereum is similar to a country. It has citizens (wallets and users), governments (Ethereum Foundation), currencies (ETH), companies (DAOs and Dapps), financial markets (DeFi), and relationships with other digital nations (bridges between different chains).
In this comparison between Ethereum and a country, one can compare the velocity of money on Ethereum to that of other countries, where the velocity of money is calculated by the ratio of nominal GDP to the money supply (M1, M2) Ratio composition. For this we need:
Defining Ethereum's GDP
Three examples of goods and services produced and sold on Ethereum today are miner revenue, DeFi revenue, and NFT sales. A simple annualization of the year-to-date GDP for the three categories, at $3.7 billion, $2.7 billion, and $8 billion, respectively, suggests a 2021 GDP of $14 billion. There is reason to believe these numbers will continue to grow:
Defining Ethereum's money supply
If Ethereum were a country, then ETH would be its money supply. ETH supply is most similar to a country's M1 supply (coins and banknotes in circulation and other assets that are easily convertible into cash). However, unlike the traditional banking system, the supply of ETH is limited and cannot be created by commercial banks using their reserves to create the crypto equivalent of loans. Thus, while ETH is by definition most similar to M1, we use GDP-related M2 in our framework.
[Bai Ze’s note: M2 (broad money supply) refers to cash circulating outside the banking system plus corporate deposits, resident savings deposits, and other deposits. It includes all forms of money that may become real purchasing power, and usually reflects Changes in aggregate social demand and pressure on future inflation. 】
In a country, M2 consists of:
Ethereum already has similarities with M2 components:
Measures the ratio of the money supply to GDP of different countries.
image description
Pictured: GDP by country
We can calculate different scenarios for Ethereum and its programmable money using M2 money supply comparability and a range of GDP assumptions:
The difficulty with this approach is that no one knows how much GDP Ethereum will generate. There are many competing chains, each of which can capture a significant portion of its target industry. For example, think of NFTs as an area where Ethereum faces competition. NBA Top Shot, one of the largest NFT marketplaces, was built using the Flow blockchain instead of Ethereum.
In fact, meaningful GDP can be achieved through financial services and DeFi alone.
Point 5(b): ETH will become a global digital reserve currency
There have been two notable recent catalysts that could trigger changes in reserve currencies and support cryptocurrencies with limited supply:
A) The creation of new fiat currencies increases inflationary pressure on fiat currencies.
B) Global distrust of institutions is growing.
The following data from Pew, Gallup, and Edleman show that many people around the world have lost faith in the institutions that form the foundation of modern society—the press, public schools, banks, etc. This isn't a side effect of the internet or social media in the 90s or 2000s. Trust in all these institutions has declined since the 1960s.
On average, reserve currency status is maintained for 100 years
Historically, reserve currency transitions can happen in as little as 20 years. For example, gold went from being the preferred foreign exchange reserve currency of 60% of the central bank's foreign exchange reserves in 1980 to about 15% in 2000, and the US dollar grew from about 28% to 60% in the same period. Period¹⁶ (including gold). Similar shifts took place after the First World War when the pound lost its reserve currency status, and before that with the French livre and Dutch guilder. The status of these three currencies as reserve currencies lasted about 100 years.
Why cryptocurrency, why ETH?
Cryptocurrencies are important here because they have the intrinsic properties of good money: they are durable, portable, divisible, unified, and in many cases have limited supply. When considering a reserve currency, we also need to consider three emerging properties: global demand, acceptability, and status as a reserve currency compared to other currencies.
ETH today is far from successful on these three dimensions: global demand is very small compared to other currencies, even compared to BTC; ETH is hardly accepted as a payment method anywhere other than cryptocurrencies ; prices fluctuate wildly; other cryptocurrencies are competing with ETH; and central banks around the world are developing their own competing digital currencies.
However, ETH stands out as a ready contender for a currency that many businesses and countries may choose to hold in time.
1. Growing and diverse demand for ETH:
2. ETH has become the reserve currency of DeFi.
3. Currencies with high demand have a natural network effect, and Ethereum preemptively strikes.
4. Supply growth is about to become limited, which means prices are likely to rise in line with demand. A rise in price contributes to the reserve currency network effect, as more people tend to buy and hold the currency when the price rises.
What would a global digital reserve currency be worth in 2030 if it were to replace any of today's reserve currencies? Based on its comparable reserve currency status, we can add the following amounts to the previous scenario of Ethereum as a digital nation:
Research needs to pay attention to:
Of the five viewpoints discussed above, four factors can be seen to play a disproportionate role in the future value of the network:
(The original author is Power Capital, and the Chinese version is compiled by Baize Research Institute)
