The Dilemma of Ethereum: Analyzing the Reasons for Its Decline through the Three-Pan Theory

Recently, there has been a lot of negative commentary about Ethereum, but it seems that the core of the issue has not been addressed. Although Ethereum performs excellently in terms of technology and developer base, it is normal for new challengers to emerge in each round. But why is Ethereum performing so poorly this round? Let's analyze this issue in depth from the perspectives of supply and demand, using the three-tier theory.

Ethereum Demand Side Analysis

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

native factors

Native factors refer to the surge of projects priced in ETH triggered by the development of Ethereum technology, thereby driving the demand for ETH. For example, the ICO boom in 2017 and the DeFi wave in 2020/2021. Theoretically, the main narrative of this market cycle should be L2 and Restaking. However, L2 ecosystem projects overlap significantly with the main chain, making it difficult to trigger explosive trading booms. Moreover, PointFi and Restaking essentially lock up ETH, reducing liquidity rather than increasing assets priced in ETH. Even large restaking projects like Eigen, Rez, and Ethfi have their pricing power on exchanges (USDT-based), rather than on-chain (ETH-based) like the previous cycle's YFI, CRV, and COMP.

Without a substantial amount of new assets priced in ETH, users lack the incentive to hold ETH. Another intrinsic factor is the burning mechanism caused by EIP1559. The primary function of ETH is as a settlement layer, with the clearing and settlement of large DeFi transactions occurring on the main chain. Nowadays, the functions of L2 and the main chain are highly overlapping, leading to a significant portion of such demand being diverted to L2, and the amount of burning caused by these transactions is only a fraction of what it used to be, weakening the demand for ETH.

external factors

External factors mainly include ecological external demand and macro environment. Macro-wise, the last cycle was an easing cycle, while this cycle is a tightening cycle. In terms of ecological external demand, the previous round was Grayscale Trust, and this round is ETF. However, Grayscale Trust can only buy but not sell, while ETF can be both entered and exited. Since the ETF was launched a month ago, the total net outflow has reached -140.83K, with the majority flowing out through Grayscale. This stands in stark contrast to the continuous net inflow since the launch of Bitcoin ETF, equivalent to both new and old large holders of ETH cashing out through ETF.

Understanding the Supply Side of Ethereum

Ethereum is essentially a classic dividend scheme, where the main selling pressure comes from new outputs, whether in the POW or POS era. But why has there been a problem this time? The key lies in the change in its output cost structure.

ETH POW era (before September 15, 2022)

In the POW era, the output logic of ETH is similar to that of BTC, produced by miners mining. The costs for miners to acquire ETH include fixed costs (such as mining equipment investment) and incremental costs (such as electricity fees, hosting fees, 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 will choose not to sell to avoid losses.

As time goes by, mining machines are updated and replaced, mining competition intensifies, leading not only to reduced output and increased difficulty, but also to rising electricity and custody fees. Government regulatory pressure increases as the industry expands. These factors collectively raise the floor price of ETH.

ETH POS Era (after September 15, 2022)

In the era of POS, the role of miners disappears, replaced by validators. To obtain ETH output, you only need to stake ETH to the validation node. The cost of ETH output has become:

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

This change has significantly reduced the cost of acquiring Ether. Although validators have fiat costs, they can theoretically support an unlimited number of Ether staked, and there is no issue of mining equipment becoming obsolete, so the unit cost of acquiring Ether is almost negligible. Besides the opportunity cost, stakers have almost no fiat costs for acquiring Ether output, and the fees are also in cryptocurrency.

This means that there is no longer a "shutdown price"; stakers will not maintain a price floor for Ether like miners do, but can infinitely mine and sell. Even if we assume that the entry average price for staked Ether is the average price of the previous round, this mechanism cannot continuously raise the floor price of Ether. As long as the new Ether supply is positive, the price will continue to be under pressure.

The Predicament of ETH: The Hidden Dangers Sown in 2018

This sad story dates back to the end of the ICO era in 2018. At that time, a large number of ICO projects priced in ETH were indiscriminately dumping ETH, causing the price to drop below $100. From the perspective of split market, the split rate during the ICO era was extremely high, but there was a lack of DEX that could trade and cash out in ETH-based pricing. Project parties could only sell ICO tokens and ETH for USDT, ultimately leading to a sharp decline in ICO Beta earnings, with the opportunity cost being higher than holding the tokens, resulting in a double whammy.

This experience may have influenced the subsequent strategies of the Ethereum community. We see Vitalik and the foundation continuously emphasizing the roadmap, the main narrative, and orthodoxy, forming a group of "core circle" developers and VCs. The success of DeFi Summer further solidified this system, concentrating the chips in the hands of Eth Aligned aligned actors, rather than dispersing them among everyone, to prevent disorderly splits and sell pressure.

However, this eventually evolved into the phenomenon of "to V entrepreneurship" and "Halal = high valuation", leading to:

1. The split rate is too low: The number of developers and projects capable of handling considerable liquidity and assets has sharply decreased.
2. Market Beta performance is weaker than competitors: "Qingzhen" and "Zanjv" led to overvaluation, resulting in Beta returns being weaker than other public chains.

Moreover, the weakening burning effect of L2 and the low-cost selling pressure brought by POS have offset all the efforts made by Ethereum's core to prevent disorderly selling pressure, ultimately leading to today's predicament.

What can we learn from the lessons of Ether?

1. For a dividend platform to maintain long-term stability, it should not blindly innovate, but rather establish fixed costs and incremental costs denominated in fiat currency. As asset liquidity increases, the cost line should be continuously raised to elevate the lower limit of asset prices. If you are unsure how to operate, you can refer to the cost model of Bitcoin.

2. Reducing selling pressure by splitting the disk is only a temporary measure. The real goal should be to transform the parent currency into a priced asset, so that holding does not rely on the appreciation of the parent currency itself, thereby expanding demand and liquidity.