Original Author: SAM ANDREW

Translation: Deep Tide TechFlow

If we view Ethereum from a corporate perspective, what kind of company is it?

In the second quarter of 2023, there were 340,000 daily active users, equivalent to a gross profit of $700 million (453,000 ETH), with a gross profit margin of 84% and a net income of $420 million (227,000 ETH), representing a 187% increase compared to the previous quarter.

Under strong network effects, the rate of ETH destruction has increased from 0.3% to 0.8%. The successful implementation of Shapella upgrade has not led to a sell-off of ETH, and the metrics of the Ethereum ecosystem (including L2) are growing comprehensively.

This article is an unofficial quarterly report for Ethereum in 2023, mainly analyzing and commenting on the following aspects, providing a comprehensive understanding of Ethereum's operations and financial situation from a data perspective.

• Operational indicators of Ethereum;

• Ethereum ecosystem (integrating L2 metrics);

• Ethereum's income statement;

• Major influences.

Operational Indicators for Q2 2023

Daily Active Users: Q2 had 340,588 daily active users, a decrease of 3% compared to the previous year, but an improvement of around 10% compared to the first quarter of 2023 and the fourth quarter of 2022. In the first few days of July, the average daily active users decreased by 12% compared to Q2 2023. The decrease in daily active users indicates a decline in the number of people using Ethereum daily.

Average Daily Transaction Volume: The average daily transaction volume was 1,046,592, a decrease of 4% compared to the previous year. The rate of decline has slowed down compared to the previous two quarters, stabilizing at around -1%. The decrease in average daily transaction volume is due to the decrease in daily active users. In the first week of July, the average daily transaction volume showed a downward trend.

Staked ETH: Staked ETH accounts for 17% of the total supply. The amount of staked ETH has increased by 58% compared to the previous year, and by 13% compared to the previous quarter.

Shapella successfully executed on April 12, 2023. Contrary to concerns, there was no sell-off of ETH after Shapella.

The amount of staked ETH continued to grow, but at a slower pace. The weekly increment of ETH decreased before and after Shapella (see figure below). Approximately 1.8 million ETH was staked in April, 4 million ETH in May, and 2.2 million ETH in June.

Price: The average price in Q2 was $1861, and ETH has risen by 55% year-to-date, with a 4% increase in the quarter. ETH experienced significant fluctuations within the quarter, dropping 22% from its highest to lowest point before rebounding.

Total Value Locked (TVL): The TVL of ETH decreased by 41% compared to the previous year, and the downward trend is worsening. The TVL decline aligns with the first quarter of 2023, with a 14% decrease.

Ethereum Ecosystem

The health of Ethereum is increasingly assessed through the state of its ecosystem, which includes its layer-two scaling solutions. Arbitrum, Optimism, Polygon zkEVM, StarkNet, and zkSync Era are used to determine the health of Ethereum's second layer. Activities have shifted to the second layer, offering cheaper and faster transaction settlements. Evaluating the Ethereum ecosystem, including activities on the base layer and the second layer, presents a different picture. Daily Active Users (DAU) and average daily transaction counts in the Ethereum ecosystem are growing.

Since 2021, the Daily Active Users (DAU) of Ethereum have been stagnant. In the past year, the number of DAUs in the Ethereum ecosystem has increased from around 400,000 to approximately 800,000 (see figure above). However, the growth in DAUs in the Ethereum ecosystem does not necessarily mean that more people are interacting within the Ethereum ecosystem. A more likely explanation is that some of Ethereum's DAUs have also become DAUs of Ethereum's second layer.

Polygon PoS data is not included in the Ethereum ecosystem. Polygon PoS is a sidechain of Ethereum. Users of Polygon PoS may gradually migrate to the Polygon zkEVM chain. The focus of Polygon is the zkEVM chain. This migration could be beneficial to the Ethereum ecosystem. Polygon PoS has 360,000 DAU, surpassing Ethereum's 300,000 DAU. Ethereum's DAU will not double after the migration. A considerable number of Polygon PoS DAUs are likely also Ethereum's DAUs.

With the emergence of layer 2, there are more and more transactions conducted by DAUs in the Ethereum ecosystem. Since the second half of 2020, Ethereum's daily transaction count has been hovering around 1 million. The daily transaction count of Ethereum is limited to about 1 million. Layer 2 has added a total of 2 million transactions per day. The total transaction count in the Ethereum ecosystem has almost doubled in the past year (see the figure below). For every transaction on Ethereum, there are 2 transactions on layer 2.

Polygon's PoS chain has an average of 2.4 million transactions per day. If these transactions are migrated to the Polygon zkEVM chain or other Ethereum layer 2 solutions, the daily transaction count of the Ethereum ecosystem will almost double.

The average daily transaction volume of the entire Ethereum ecosystem reached 3 million transactions in the second quarter of 2023, higher than the 2 million transactions in the first quarter of 2023. The quarter-on-quarter growth rate of the average daily transaction volume in the Ethereum ecosystem has accelerated from 17% in the first quarter of 2023 to 50%. In the second quarter of 2023, the average daily transaction volume of the Ethereum ecosystem increased by 139% year-on-year (see the figure below).

The average daily transaction volume on the Ethereum ecosystem is 3 million transactions, accounting for 16% of the total daily transaction volume of programmable blockchains excluding Solana (see the figure below). Solana's transaction data cannot be directly compared with other chains. Solana executes 20 million transactions every day. It can be said to be one of the highest-performing blockchains. However, due to its high transaction throughput and low fees, a significant portion of these transactions are spam transactions.

If we include the Polygon PoS, the share of the Ethereum ecosystem in total transaction volume will double to around 30%. Without considering BNB and Tron, the Ethereum ecosystem currently holds a 60% market share in daily transaction volume. BNB and Tron are significantly different from the other blockchains in this group as they are more centralized.

Ethereum Profit and Loss Statement

Total Expenses: Q2 total expenses amounted to 453,235 ETH (equivalent to $843,470,335), a 17% decrease compared to the previous period. Transaction fees decreased by 13%, while transaction volume dropped by 4%. Total expenses increased by 56% compared to the previous period. The increase was driven by a 57% rise in fees per transaction, while transaction volume decreased by 1%. Total expenses represent the total cost paid by users for processing all transactions posted to the Ethereum network. In traditional financial terms, this would be considered the "revenue" generated by the "company".

Gross Profit: The gross profit is 381,565 ETH (equivalent to $710,092,465), with a gross profit margin of 84% for the quarter, meaning 84% of total expenses were destroyed. Gross profit is often referred to as "network revenue". It captures a portion of the total fees accrued by token holders. Gross profit has increased compared to total expenses.

The daily expenses and gross profit (i.e., revenue) doubled in May (see the chart below). This growth was driven by the Pepe-induced Meme coin frenzy. Subsequently, expenses and gross profit (i.e., revenue) returned to normal levels. Unless there is another one-time expense driver, expenses should decrease sequentially in the third quarter of 2022. Compared to the average daily expenses in the second quarter of 2023, the average daily expenses in the first week of July decreased by 27%.

Net Income: Q3 net income was 227,147 ETH ($422,720,567), nearly triple the previous quarter. The growth in net income is due to a 56% increase in total expenses. The increase in net income demonstrates the operating leverage of Ethereum. The cost of Ethereum does not increase with the growth in total expenses. The cost of Ethereum does not increase with the growth in total expenses. Total expenses grew by 56%, but Ethereum's fixed costs (the cost of issuing tokens to validators) decreased by 5%. As a result, net income increased by 187% compared to the previous quarter.

Since the introduction of PoS, Ethereum has been profitable every quarter. The significant improvement in profitability is due to a 90% decrease in the cost of token issuance.

Outstanding Tokens: The number of tokens burned by Ethereum in Q2 2023 exceeded the number of tokens issued. The outstanding tokens decreased from 120.45 million to 120.22 million. Net issued tokens (calculated as annualized net issued tokens divided by the initial balance) decreased to -0.8%. Ethereum increased the number of outstanding tokens by approximately 3% in 2022. Now, it has reduced the number of circulating tokens by approximately 1%.

How to interpret Ethereum's income statement?

Total expenses represent the fees paid by users to have their transactions published on the Ethereum blockchain. Total expenses include base fees and tips. Tips are transferred fees that are paid to validators. Note that the tip item is the same number as the fee item paid to validators. It is a variable cost. It grows proportionally with usage. Users pay tips to prioritize their transactions.

Base fee is the fee paid by users to process transactions. Note that the base fee figure is the same as the gross profit figure. Gross profit represents how much funds (in ETH) the Ethereum blockchain earns from processing its transactions. It is sometimes referred to as "network revenue." The gross profit margin represents how much is burned out of the total Ethereum fees. Burned tokens will be removed from circulation. This is similar to share buybacks.

The cost of token issuance is the cost paid to validators to maintain network security. This is a fixed cost. It does not grow proportionally with usage.

Net income is the difference between the base fee (i.e., gross profit) and newly issued tokens. Ethereum's net income in Q2 2023 was 227,147 ETH, which means it collected 227,147 more tokens in base fees than the newly issued tokens. Therefore, Ethereum's outstanding tokens decreased by 227,147.

The more net income Ethereum generates, the more ETH it burns, and the fewer outstanding tokens there are. With fewer outstanding tokens, all else being equal, the value of each token increases.

Conclusion

1. The surge in total expenses in the second quarter is temporary

The surge in total expenses in the second quarter and the resulting token burn is temporary. It was driven by a one-time event - the Meme coin frenzy. This surge lasted for about two weeks. The performance in the third quarter of 2023 is expected to be less favorable.

2. The focus is on L2 solutions

The operational metrics of the Ethereum ecosystem, including second-layer scaling solutions, indicate a network with healthy growth. In contrast, Ethereum's standalone operational metrics suggest a stagnant network. The growth of Ethereum is driven by second-layer scaling solutions. Their success is crucial for Ethereum. The upcoming EIP-4844 will have a significant impact on second-layer scaling solutions and Ethereum.

In the short term, the only way to increase Ethereum's fees is by increasing the cost of each transaction, i.e., higher Gas prices. Currently, Ethereum's daily transaction volume is about 1 million. It is believed that second-layer transactions will see significant growth. Second-layer transactions will be batched and processed as an input to the Ethereum base layer. The expensive cost of an Ethereum transaction will be shared by the fee payers of many second-layer transactions.

3. Slower growth in staked ETH

Before and after the successful implementation of Shapella, the amount of staked ETH grew rapidly. The slowing growth trend suggests that the staked ETH may not grow as rapidly as previously expected, surpassing 50%. To achieve a 50% staking ratio, an additional approximately 40 million ETH needs to be staked. At the current rate of approximately 1 million ETH staked per month, it would take 40 months or 3 years and 4 months to reach a 50% staking ratio.

For ETH stakers, this may not necessarily be a bad thing. The lower the staking ratio, the higher the stake rewards paid to validators, thus resulting in higher ETH yields. ETH yield is the sum of staking rewards, returns, MEV rewards, and inflation or deflation of token supply. The most economically attractive scenario is low staking ratio, high staking rewards, high fees, and thus high yield. The opposite holds for the least economically attractive scenario. The economic perspective is not the sole parameter driving the value of ETH. The higher the staking ratio, the higher the security of the blockchain, theoretically leading to higher ETH value.

The slowdown in the growth of ETH staking quantity has resulted in underperformance of Lido and Rocket Pool. In this quarter, LDO and RPL have declined by 17% and 18% respectively while ETH remained relatively stable. The slowdown in the growth of ETH staking quantity combined with the smaller scale of the Rocket Pool mini-pool means a decrease in the number of RPL buyers.

4. Ethereum's operational leverage leads to significant burning

The profitability and burning mechanism of Ethereum are crucial. Ethereum has transitioned from $22 million in daily selling pressure (calculated at an ETH price of $1860) to $5 million in daily buying demand, resulting in a difference of $28 million. This $28 million change is equivalent to 4.5% of Ethereum's market value.

Ethereum's PoW model has two economic issues. Firstly, Ethereum used to issue 17,000 tokens to miners every day, equivalent to a 5% annual dilution rate. Secondly, it is estimated that 70% of these tokens are immediately sold to offset expensive mining costs. Based on the price of ETH at $1860, issuing tokens to miners and subsequently selling them creates a daily selling pressure of $22 million.

The introduction of PoS and the introduction of a burning mechanism will convert the daily selling pressure of $22 million into a buying pressure of $5 million. Ethereum now burns (i.e., repurchases) tokens worth $5 million every day, compared to selling tokens worth $22 million ETH daily in the past. The table below summarizes the projected profit and loss from PoW to PoS.

Most people misunderstand Ethereum's operating leverage. Operating leverage is a term used in traditional finance to describe assets whose profit growth rate is much higher than their revenue growth rate. Profit growth is significant because operating costs do not increase while revenue does. Technical professionals often do not understand operating leverage, and traditional financial investors do not understand cryptocurrency.

The "Forecast" column in the above figure shows Ethereum's operating leverage. The forecast column assumes a five-fold increase in total expenses. A five-fold increase in expenses results in a 9.9-fold increase in net income. When total expenses increase, Ethereum's fixed operating costs, i.e., the cost of issuing tokens to validators, do not increase. The net result is that Ethereum's deflation rate increases by 9.9 times. Compared to the current deflation rate of 0.4%, when revenue increases five-fold, Ethereum will reduce the number of tokens to be issued annually by 4.2%. The purchasing demand will increase by 5.2 times, from $5 million per day to $28 million.