Why Is Ethereum Layer-1 Network Revenue Plummeting?

Ethereum’s L1 network revenue is haemorrhaging pretty badly. It crashed by a whopping 99% from a peak of $35.5 million on March 5, 2024, to a mere $578,000 as of September 2, 2024, raising valid concerns about the future of one of crypto’s most dominant ecosystems.

The Dencun upgrade, launched on March 13, 2024, has been fingered as a major reason for this decline, which is indeed ironic as the upgrade was deemed a game-changer due to its design objectives—it was to improve scalability and reduce transaction costs. So, what went wrong, and how did these well-intentioned improvements end up with on-chain revenue at the bottom of the Grand Canyon?

What Led to the Revenue Drop?

The Dencun upgrade introduced EIP-4844, or proto-danksharding, which made L2 solutions on Ethereum more efficient by reducing their transaction costs through off-chain data storage.

Due to this, millions of users shifted from Ethereum’s L1 network to the currently more cost-effective L2 solutions. This transition caused a notable decrease in Layer 1 transactions and a corresponding drop in revenue.

Meanwhile, the downturn in the DeFi sector, which relies heavily on Ethereum, exacerbated this revenue decline. In August 2024, DeFi protocols experienced a substantial drop in fee revenue, with total fees decreasing by 24.4% to $288.38 million. This reduction in DeFi transactions and active users further eroded Ethereum’s L1 fee income, compounding the overall financial impact.

The broader cryptocurrency market was also on red alert , with bearish sentiment leading to decreased trading volumes and heightened investor caution. The market capitalization of the entire crypto industry fell sharply from $2.51 trillion in May 2024 to $1.95 trillion by August. This downturn significantly impacted Ethereum, with its seven-day moving average for daily trading volume dropping by 55% during August. Consequently, reduced on-chain activity further strained Ethereum’s revenue streams.

Ethereum is facing increased competition from alternative chains like Solana, Binance Smart Chain, and Avalanche, which offer lower fees and faster transaction speeds. These competing networks have attracted developers and users, posing a significant challenge to Ethereum’s dominance and forcing it to focus on scalability and cost reduction to stay competitive.

What are the Economic Impacts of this Revenue Drop?

The Dencun upgrade has had some unintended economic consequences. One of the most significant impacts has been the inflationary pressure on the supply of Ether (ETH). Before Dencun, EIP-1559 played a crucial role in managing ETH’s supply by burning a portion of the transaction fees, which helped create deflationary pressure and reduce the overall supply of ETH.

However, the lower transaction costs brought about by the Dencun upgrade have weakened this deflationary mechanism. As a result, the supply of ETH has steadily increased, countering the intended effects of EIP-1559.

This combination of increased supply and reduced demand has put downward pressure on the price of ETH. As a result, ETH has struggled to maintain its value, dropping below the $3,000 level, which has further shaken market confidence and impacted Ethereum’s overall market capitalization.

So, is this the End of the Ethereum L1 Network?

The Ethereum L1 network was once the cornerstone of the blockchain world. However, the success of L2 solutions has not only fragmented the market but also diverted attention and resources, leaving the L1 struggling to stay relevant.

The Ethereum ecosystem is now crowded with L2 and even Layer 3 (L3) players, each competing for dominance. This intense competition has made investors increasingly skeptical, as many of these developments haven’t led to meaningful user adoption or price growth for Ethereum’s L1.

According to Adrian Brink, CEO of Anoma, there are roughly ten times more L2 scaling solutions than the market actually needs, indicating an oversaturation in the space. This oversupply only adds to the challenges facing Ethereum’s L1 network.

Despite these challenges, not everyone sees the decline in L1 revenue as a negative.

Ryan Berckmans, an Ethereum validator, argued that the success of L2 solutions has actually made Ethereum’s base layer more accessible for larger entities. He emphasized that fees are not the primary goal of Ethereum; instead, they are a byproduct of the network’s utility. In this view, the drop in L1 fees is a sign that Ethereum is achieving its broader mission by becoming more scalable and accessible.

Future Outlook for Ethereum’s Layer-1 Network

Looking ahead, Ethereum’s Layer 1 network’s success will depend on how well it adapts to the rapidly changing blockchain environment.

Layer 2 solutions have already made a significant impact by speeding up transactions and reducing costs, but Ethereum’s Layer 1 must continue to evolve through upgrades like sharding and the full rollout of Ethereum 2.0 to enhance its performance. It needs to capitalize on its strengths, such as its robust developer community and strong security, while addressing its weaknesses. Forming strategic partnerships and continuing network improvements will help Ethereum stay ahead of rivals like Solana, Binance Smart Chain, and Avalanche.

Rather than seeing L2 solutions as mere competitors, Ethereum might benefit from integrating them more closely. By ensuring a seamless interaction between L1 and L2, the network could balance the transaction load and stabilize its revenue stream.

Disclaimer: This article is intended solely for informational purposes and should not be considered trading or investment advice. Nothing herein should be construed as financial, legal, or tax advice. Trading or investing in cryptocurrencies carries a considerable risk of financial loss. Always conduct due diligence.

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