Why is Ethereum performing poorly? Analyzing supply and demand through the Three Plate Theory

Recently, the performance of Ethereum seems to have puzzled many. Although the technology and developer base are solid, it is normal to have new challengers in every round, but why does Ethereum seem so weak this time? Let's delve into an analysis from the perspectives of supply and demand.

Demand Side of Ethereum

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

The internal demand mainly stems from the new applications brought about by the development of Ethereum technology, which are usually priced in ETH, thus driving the demand for ETH. For example, the ICO boom in 2017 and the DeFi explosion in 2020/2021. Logically, the main driving force behind this market cycle should be L2 and Restaking. However, the L2 ecological projects overlap significantly with the main chain, making it difficult to trigger explosive growth in trading. PointFi and Restaking essentially lock up ETH to reduce liquidity, rather than allowing more assets to be priced in ETH. In fact, the pricing power of some large restaking projects has shifted to exchanges (USDT-based), rather than being on-chain (ETH-based) like in the previous cycle with YFI, CRV, and COMP. Without a large amount of new assets priced in ETH, users lack the incentive to hold ETH.

Another internal factor is the burning mechanism brought by EIP1559. The main function of ETH is as a settlement layer, where large DeFi settlements occur on the main chain. However, now that L2 and the main chain have highly overlapping functions, a large amount of demand has been diverted to L2, and the burning amount caused by these transactions is only a fraction of what it used to be, weakening the demand for ETH.

External demand mainly includes 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 be bought but not sold, while ETF allows both entry and exit. Since the ETF was opened a month ago, the total net outflow has reached -140.83K, mainly through Grayscale. This stands in stark contrast to the continuous net inflow since the launch of the Bitcoin ETF, equivalent to both new and old large holders of ETH cashing out through the ETF.

Understanding the Supply Side of Ethereum

Ethereum is essentially a dividend-type project. Whether in the POW or POS era, the main selling pressure comes from new output. But why has there been a problem this time? The key lies in the change in its production cost structure.

ETH POW Era (before September 15, 2022)

In the POW era, the output logic of ETH is similar to that of Bitcoin, produced by miners through mining. The costs for miners to obtain ETH include fixed costs (such as the investment in mining machines) and incremental costs (such as electricity fees, hosting fees, etc.). These costs are all denominated in fiat currency, and most of them are non-recoverable sunk costs.

When the market price of ETH is lower than the acquisition cost, miners tend to hold onto their assets to avoid losses. Over time, the new generation of mining machines becomes more expensive, mining competition intensifies, electricity and hosting costs rise, and government regulatory pressure increases. These factors collectively raise the actual cost of Ether, forming a price floor.

ETH POS era (after September 15, 2022)

After switching to POS, the role of miners is replaced by validators. To obtain ETH output, it is only necessary to stake ETH to the validation node. Although the cost for validators is still based on fiat currency, theoretically, it can accommodate an unlimited amount of ETH staking, and there is no issue of equipment depreciation, so the cost of acquiring ETH per unit is almost negligible. Besides opportunity cost, stakers have basically no fiat currency cost to obtain ETH output, and the transaction fees are also in crypto.

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

The Dilemma of ETH: Hidden Risks Buried in 2018

This is a regrettable story:

At the end of the ICO era in 2018, a large number of ICO projects priced in ETH indiscriminately sold off their ETH, causing the price to drop below $100. From the perspective of splits, the split rate during the ICO era was extremely high, but there was a lack of DEX for trading based on usable ETH. Project teams could only sell ICO tokens and ETH in exchange for USDT, which ultimately led to a sharp decline in ICO returns, with the opportunity cost exceeding the returns from holding coins, resulting in a double blow.

Perhaps learning from the painful experience of 2018, we see that both Vitalik and the foundation have been emphasizing the roadmap, main narratives, and orthodoxy, forming a group of "core circle" developers and venture capitalists. The success of DeFi Summer further reinforced this system, concentrating the chips in the hands of core participants in the Ethereum ecosystem, rather than dispersing them to everyone, to prevent chaotic fragmentation and sell-off.

However, this ultimately evolved into the phenomenon of "Entrepreneurship towards V", where "compliance with ecological concepts = high valuation", leading to:

• The rate of split is too low: Developers and projects that can achieve considerable liquidity and assets have sharply decreased.
• Overall market returns lag behind competitors: "alignment with ecological concepts" and "circle effect" lead to overvaluation, resulting in overall returns weaker than other public chains.

The addition of L2 weakened the burning effect, and the low-cost selling pressure brought by POS 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 experience of Ether?

1. For dividend-type projects to develop steadily and sustainably in the long term, they should not blindly innovate, but rather establish fixed costs and incremental costs priced in fiat currency. With the improvement of asset liquidity, the cost line should be continuously raised to elevate the lower limit of asset prices. If uncertain about how to proceed, one can refer to Bitcoin's cost model.

2. Reducing selling pressure through splitting is just a temporary measure; the real goal should be to make your underlying token a pricing asset, allowing holdings to not only rely on the appreciation of the token itself, thereby expanding the demand base and liquidity.