Looking back at 2021: Ethereum expansion and the explosion of new public chains

Author: Wu Zhuocheng

Editor: Colin Wu

As of December 18, the price of Ethereum rose from $736 at the beginning of the year to $3960, an increase of 4.38 times, while BTC only grew by 63% this year. With the approval of three Ethereum ETFs for listing at the end of April this year (namely: Purpose Ether ETF launched by Purpose Investment, CI Galaxy Ethereum ETF launched by CI Global Asset Management, and Evolve Ether ETF launched by Evolve Capital Group), Ethereum has gradually transformed from a "copycat" in the eyes of conservatives to a valuable coin.

Source: https://www.coingecko.com/en/coins/ethereum

With the price surge, miner income also increased rapidly. On May 15, miner income reached a historical high of $130 million in a single day, but then fell to a low of $32 million following a market crash and the issuance of a ban in China. Subsequently, due to Ethereum's implementation of a burning mechanism, miner income has not returned to the levels seen in May (as can be seen from the chart, block rewards are gradually increasing, but fee income has significantly decreased).

Source: https://www.theblockcrypto.com/data/on-chain-metrics/ethereum

Despite the surge, the price of Ethereum at the end of 2021 was still only 2.6 times the highest historical record of 2017 ($1448). However, the ecosystem on Ethereum has developed to a current value of $150 billion, of which $130 billion was accumulated in 2021. Compared to the beginning of the year, the TVL of DeFi has increased sevenfold this year. However, Ethereum's dominance in DeFi has decreased from 97% at the beginning of the year to 63%, and the following sections will explain the competitive advantages of other public chains in detail.

Source: https://defillama.com/chain/Ethereum

Due to high usage, Ethereum experienced peaks in gas prices throughout 2021. Before the market crash in May, the median gas used mostly maintained above 100 gwei, dropping to less than 30 gwei during the downturn, but rising again as the market warmed up. However, the volatility of gas used in the second half of the year was much smaller than in the first half, mainly thanks to the burning mechanism in EIP-1559. Regarding the impact of EIP-1559 on the network, Wu said Real conducted an analysis before its implementation, concluding that it would not reduce gas fees but could reduce their volatility and increase predictability, which has largely matched the actual situation.

Source: https://studio.glassnode.com/metrics?a=ETH\&category=\&ema=0\&m=fees.GasPriceMedian\&mAvg=7\&mMedian=0\&s=1577505170\&u=1639872000\&zoom=

On August 5, Ethereum initiated the London upgrade at a height of 12,965,000, burning nearly 9,000 Ethereum daily on average. By the end of the year, the total number of Ethereum burned exceeded 1.2 million, worth about $4.9 billion (previously, Wu said Real article estimated that the annual burning amount would be nearly 2 million, at that time in a bear market with low trading volume. If calculated in a bull market, the annual burning amount would exceed 3 million, and overall, the actual number may lie between the two).

Source: https://www.theblockcrypto.com/data/on-chain-metrics/ethereum

Currently, Ethereum's daily output is about 13,000, with a total output of 119 million, and an annual inflation rate of about 4.1%. The burning mechanism can reduce it to about 1.4%, lower than the current inflation rate of Bitcoin (1.7%). When Ethereum officially transitions to 2.0, the inflation rate may further drop to negative, achieving deflation. According to Ethereum's economic model, the annual issuance of Ethereum 2.0 will increase with the rise in staking amounts. When the staking amount exceeds 100 million, the annual issuance rate will stabilize at 1.71%, which means a daily output of about 5,600. If Ethereum 2.0 can maintain the current burning amount, it will achieve a 1% deflation annually.

Source: https://docs.ethhub.io/ethereum-basics/monetary-policy/

As of December 19, the Ethereum 2.0 beacon chain address has staked 8.71 million Ethereum, worth about $34.4 billion, accounting for only 7.3% of the total issuance, with actual staking returns of about 5.4%. From the chart, it can be seen that the growth rate of Ethereum 2.0 staking has significantly slowed this year. In 2020, it took only 2 months to accumulate 2.18 million Ethereum, but this year, from the beginning of the year to now, it has only increased by 653. This is closely related to the slow progress of Ethereum's upgrade.

Source: https://dune.xyz/hagaetc/eth2-0-deposits

ETH 2.0 Roadmap

At the World Blockchain Conference held in Hangzhou in July, Ethereum co-founder Vitalik Buterin delivered a speech titled "What Will Happen After Ethereum 2.0?" Vitalik stated that the merger of Ethereum 1.0 and Ethereum 2.0 would occur in six months or longer. In the early stages of the merger (Phase 1), Ethereum will implement some smaller upgrades, introducing sharding in conjunction with Rollup, ideally achieving 100,000 transactions per second. In the later stages (Phase 2), Ethereum will focus on making improvements at the consensus algorithm level to simplify the protocol while deploying cryptographic technologies such as zero-knowledge proofs and quantum resistance. The future Ethereum will focus on decentralization through Layer 1, while Layer 2 will drive significant innovation.

The Phase 1 plan for Ethereum 2.0 is set to begin in the second half of 2022, and the merger must be completed before sharding, so it will not be later than the third quarter of 2022. According to past analysis, the merger should not occur before the difficulty bomb is activated, and with the launch of the Arrow Glacier upgrade, the difficulty bomb has been clearly postponed to June next year, so we can basically confirm that the merger is likely to occur in the third quarter of next year.

Currently, Ethereum's progress is generally following the established route. In early December, Vitalik published an article on his personal webpage stating that the future production of Ethereum blocks should be centralized, while block validation should be trustless and highly decentralized. This has always been the case; Layer 2 does not have the concept of blocks. We can see that a batch on Layer 2 corresponds to a transaction rather than a block through Arbitrum or Optimism browsers. Vitalik's reiteration of this point seems to emphasize the previously designed roadmap centered around Ethereum, which inevitably raises speculation about whether it is related to recent rumors about conflicts of interest between the Ethereum team and Layer 2 teams.

Layer 2

Given the current slow progress of Ethereum 2.0, some believe that Ethereum will find it difficult to start sharding next year, but this does not mean that Ethereum cannot achieve scalability next year. On the contrary, with the gradual maturity of Rollup technology, the hope for Ethereum to achieve scalability in the short term relies on Layer 2 adopting OP-rollup or ZK-rollup.

For technical progress and classification of Layer 2, it is recommended to read Vitalik's long analysis published on his personal homepage or similar supplementary explanations (the article was published nearly a year ago, and some data may be outdated, but the understanding of the pros and cons of various technologies is very accurate, and reading it now is still beneficial).

In summary, the following table distinguishes several major Layer 2 technologies.

Source: https://twitter.com/VitalikButerin

Plasma was proposed the earliest and has the simplest logic, but it has gradually been abandoned due to various drawbacks. Matic initially adopted this technology and thus struggled for a long time until it rebranded as Polygon and shifted its focus to being a Layer 2 aggregator.

Rollup moves computation off-chain while keeping data on the main chain. Compared to other Layer 2 scaling solutions, Rollup is versatile; for example, EVM can run in Rollup, allowing existing Ethereum applications to migrate to Rollup without writing new code. The main difference between ZK-rollup and OP-rollup lies in their data validation methods. OP-rollup uses fraud proofs in the verification phase, similar to Plasma: the main chain records the Merkle root of each step of off-chain computation, and if a node finds that the new Merkle root corresponding to a batch of computation results is incorrect, they can publish a proof of error on the main chain. If the verification passes, all transactions in that batch will be rolled back. Therefore, withdrawals on OP-rollup require a week of waiting time, although actual rapid withdrawals can be achieved through some third-party cross-chain bridges. ZK-rollup uses validity proofs to solve the above problems: each state return requires providing a zero-knowledge proof (ZK-SNARK), which will be verified by the Rollup contract on the main chain, proving that these transactions exist and are signed by the initiator, thus eliminating the possibility of operators submitting invalid states or tampering with states.

In short, ZK-rollup has better scaling effects but is technically more challenging; OP-rollup is the opposite. This is why OP-rollup currently has over $3.2 billion in TVL, while ZK-rollup has less than $800 million (although dYdX has nearly $1 billion in TVL, it is not compatible and cannot interoperate with other protocols, so it is not counted). However, in the long run, ZK-rollup has greater potential. According to Messari's 2021 annual summary report, by 2023, OP-rollup's share of total Layer 2 usage will be less than 50% (Layer 1's share will be less than 20%).

Source: https://l2beat.com/

Regarding the internal competition between ZK-rollup and OP-rollup, two insightful articles are recommended: Layer 2 Notes and "The Best Comparison on zkRollups Today."

When discussing Layer 2, one cannot overlook Polygon, which was the first to rebound after the market crash in May. The daily active addresses surged and surpassed Ethereum, peaking in September.

Source: https://pro.nansen.ai/multichain/polygon

Polygon claims to be a scalability solution aggregator, but StarkWare co-founder Uri Kolodny emphasizes that Polygon is a sidechain rather than Layer 2, implying that Polygon's security does not rely on Ethereum. In practice, Polygon has not helped Ethereum achieve scalability (it is evident that Polygon is expanding itself); it is similar to BSC, a completely independent Ethereum clone based on PoS mechanism, simply using the existing Geth, removing the consensus code, increasing the gas limit, and using multisig to bridge back to Ethereum.

However, does this security risk matter to users? Haseeb Qureshi eloquently articulated this phenomenon in his article "I'm Worried Nobody Will Care About Rollups": "The narrative of Rollup scalability makes sense to everyone; decentralization maximalists tell a grand story about scaling Ethereum without trade-offs. Traders draw lines on price charts about how Rollups will drive ETH to $10,000. Meanwhile, ordinary users, while crazily farming AAVE-MATIC yields and participating in digital horse racing on Polygon, nod curiously at the Rollups narrative." Looking at the current explosive growth in the public chain sector, with BSC leading, Polygon in the middle, and Avalanche following, it seems they only need to achieve EVM compatibility, fork projects on Ethereum, and then spend money to pump the market to become faster and cheaper than Rollups. In comparison, Rollups have not even completed EVM compatibility.

In the article, the author mentioned two ways to make users abandon sidechains for Rollups. One is that these non-Rollup sidechains catastrophically fail, not just the "nodes cannot sync" issues commonly seen with BSC, but rather significant security incidents like "funds are gone." This would make people deeply realize the importance of decentralization, but this possibility is low. The second way is that Rollups accomplish things that other sidechains cannot, not only the advantage of decentralization that users cannot deeply experience but also require cryptographic technologies like ZK-SNARKs to achieve large-scale computation compression, protect privacy in smart contracts, and provide provable MEV resistance.

Coincidentally, a month after Haseeb Qureshi published this article, Polygon announced a $1 billion investment in ZK-rollup-related work. It subsequently announced two acquisitions worth $650 million: Hermez and Mir. Recently, it also announced Polygon Miden, a STARK-based aggregator compatible with Ethereum, and Polygon Nightfall, a privacy-focused aggregator established in collaboration with Ernst & Young. Unlike BSC or Avalanche, which merely replicate the ecosystem on Ethereum, Polygon's imitation of Ethereum is both form and spirit.

Currently, Polygon's gas fees are less than 0.01% of Ethereum's (even if Ethereum completes sharding and Rollup, it cannot reduce gas fees to such an extent), and its speed is comparable to BSC. If it can achieve ZK-SNARKs, it will be the most competitive candidate for the second position among EVM-compatible public chains (this is just my personal opinion).

Solana

Solana had the largest increase among all public chains in 2021, with its TVL jumping into the top five, briefly ranking third after Ethereum and BSC. Moreover, Solana's level of decentralization is considered second only to Ethereum (in the public chain sector). As of December 19, Solana had 1,327 staking nodes, with validators relatively dispersed, mainly concentrated in Europe and the United States.

Source: https://solanabeach.io/

Solana's explosive growth reflects the underlying logic of the new public chain sector's explosion this year. First, the congestion of Ethereum provided an opportunity for competitors to catch up, with BSC being the first to seize this opportunity, simply replicating Ethereum as previously described. The subsequent EVM-compatible public chains followed this pattern. However, Solana took a different path by choosing not to be EVM-compatible. Its scalability strategy differs from Ethereum's, adopting a Proof of History (PoH) consensus mechanism; specific technical features can be referenced in "Solana Summer."

The second logic is that public chain competition can start from the ecosystem rather than technology. This does not mean that technology is unimportant, but it is indeed worth considering for some old-fashioned public chains that are overly focused on technology but have seen little price movement. To foster a thriving ecosystem, the Solana team and its investors have implemented a series of incentives to encourage users to experience their platform, such as introducing liquidity mining, providing subsidies for developers, hosting hackathons, and offering funding for donations, etc. In all these examples, public chains do not need particularly advanced technology; they only need money, and Solana has plenty of it. This does not mean Solana's technology is low-quality; rather, compared to other public chains, when we mention them, we first think of the founders, while Solana primarily evokes thoughts of its investors.

Polkadot

On December 17, the first batch of 5 auctioned parachains on Polkadot successfully joined the network, namely Acala, Moonbeam, Astar, Parallel Finance, and Clover. The next batch of Polkadot auctions will begin at height 8263710 (around December 23, 2021), with a total of 6 auctions, and the 6 winning parachains will go live at height 9388800 (around March 11, 2022).

The major events for Polkadot in 2021 can perhaps only be summarized in these two sentences. It does not have a glamorous story, and progress remains slow, but we can never overlook it when discussing which public chain can challenge Ethereum. Especially with the rise of new public chains, the "multi-chain coexistence" picture painted by Gavin Wood is becoming increasingly clear. There is no need to elaborate on its technology here, as it has not yet produced a plethora of modification protocols like Ethereum. For more information, you can read the Blue Fox Notes' Polkadot series.

Terra

Terra is, in my opinion, the most interesting public chain. First, it is the first public chain built around a stablecoin protocol. Second, it is the public chain most closely linked to traditional finance. Finally, it is the public chain that has the best relationship with government regulatory agencies. Mint Venture provided a detailed explanation of its stablecoin business in a research report.

As of December 19, Terra's locked value has risen to $15.2 billion, ranking third after Ethereum and BSC. Among the top 10 public chains, it is the only one whose TVL has not experienced explosive growth, sharp declines, or stagnation.

Source: https://defillama.com/chain/Terra

Terra underwent multiple rounds of financing this year. In January, Terra raised $25 million, mainly for the synthetic asset protocol Mirror and the savings protocol Anchor. In March, Anchor completed a $20 million financing and launched version V1. In July, Terra launched a $150 million ecosystem fund to support ecological applications. The team is currently focused on developing the latest version of the mainnet, Columbus-5, which is a very important mainnet upgrade that includes significant updates to treasury fund allocation and burning mechanisms.

Terra currently faces three main issues. First, Terra's stablecoin UST is an uncollateralized stablecoin, and its price is pegged to the market value of Luna. If Luna crashes, UST may experience price decoupling. From May 19 to May 25, UST experienced a negative premium of about 10% for the second time, lasting for 2-3 days.

The second issue is how to respond to regulatory scrutiny from other countries. Terra's second-largest protocol, Mirror, synthesizes some U.S. stock assets, allowing users to freely long or short and farm, which clearly cannot pass U.S. SEC regulations. In March of this year, the Bank of Thailand announced that any activities involving digital stablecoins (THT) related to the Thai baht would be considered illegal.

The third major issue is the serious lack of decentralization, with most nodes concentrated in South Korea and controlled by conglomerates, resulting in low information transparency.

Public Chain Valuation Considerations

Valuing public chains has always been a challenge, unlike DeFi protocols that can calculate value through metrics like PE or PS. The biggest problem is that it is difficult to calculate how much network value a public chain's token captures. TaschaLabs has provided a reference thought: comparing a public chain to a country, then the token is the currency of that country. According to the currency equation: M × V = P × Y (representing money supply, velocity of circulation, price, and real GDP), it can be deduced that the token price is proportional to the public chain's GDP and inversely proportional to the token's issuance and circulation speed. Of course, how to measure a public chain's GDP and the circulation speed of its token still requires further analysis of on-chain data, but through simple chart observations, we can roughly verify the formula: the price of public chains shows a positive correlation trend with the number of active addresses or new addresses.

However, the currently popular valuation method in the blockchain field is still simple analogy. For example, people like to compare Bitcoin to digital gold or the dollar's M0. Under this assumption, one can predict a target price by dividing the market value of gold or M0 by the number of Bitcoins. But this is just a target price; when it will reach this target remains unknown. Similarly, people have begun to compare public chains to internet companies, with the top few public chains naturally likened to FAMGA. The total market value of these five companies is about $10 trillion, averaging $2 trillion each. Ethereum's current market value is about $450 billion, which is still 3-4 times lower than the average market value of FAMGA. Considering the changes that Ethereum 2.0 will bring to the network, this estimated increase is not exaggerated.

As for which other public chains could become the FAMGA of the blockchain field, that question can only be answered by time.

Supplement

The previous sections have mentioned the on-chain ecosystem in bits and pieces, so here is a summary. In the DeFi sector this year, in addition to a significant increase in locked value, the three biggest changes are: the launch of V3 AMM, the emergence of perpetual options, and the advent of DeFi 2.0, while other DeFi rules basically continue from last year. As of December 19, the total locked value in DeFi is $236.6 billion, with the top ten public chains ranked as follows: Ethereum (63%), BSC (7%), Terra (6%), Avalanche (5%), Solana (5%), Tron (2%), Polygon (2%), Fantom (2%), Arbitrum (1%), and Cronos (1%).

In the spot DEX sector, Uniswap's dominance has been increasing, rising from 48% at the beginning of the year to 78%, with the turning point being the launch of V3. For an introduction to V3, it is recommended to read the official explanation directly; if interested in mathematical models, you can also study this long article.

Source: https://www.theblockcrypto.com/data/decentralized-finance/dex-non-custodial

In the derivatives DEX sector, perpetual futures are completely dominated by dYdX, while the options market currently has negligible trading volume. However, the perpetual options model designed by SBF in May may have a revolutionary impact on the options market. dYdX saw a surge in trading volume after launching trading mining, with a peak daily trading volume of $9.1 billion, but since epoch 3, the trading volume has stopped increasing. Currently, there is only 1 day left until the end of epoch 4, but the total trading volume is only $51.5 billion, significantly lower than epoch 2's $92 billion and epoch 3's $85.5 billion. In terms of coin price, DYDX has been declining since reaching $26.8 on September 30, and as of December 19, it is only $7.8.

Source: https://www.theblockcrypto.com/data/decentralized-finance/dex-non-custodial

Some DeFi projects have gradually realized that the "mine, withdraw, sell" model of 1.0 is unsustainable, so they have begun to create "liquidity as a service" plans, renting liquidity from other protocols. OlympusDAO has become a new exploration. For more information on OlympusDAO, you can refer to Wu said Real's previous analysis.

It can be said that the market has had almost no participation from the DeFi sector in the warming trend since August. With the market crashing again on December 4, the token prices of DeFi 1.0 protocols even fell below the lowest prices during the 519 period. However, this is not surprising; the emergence of hotspots will inevitably lead to the expansion of bubbles, followed by the panic of bursting. Only those who survive the crisis will have longer-term development, and the current GameFi is no exception. But regardless of how the hotspots in the sector shift, public chains will always be the foundational infrastructure.