Analyzing On-chain Financial Statements part 1: Layer 1 blockchains
By Daniel Gardeñes, marketing responsible at Vottun.
The crypto revolution has brought us a new type of assets that in most cases the market values for speculative reasons, trends, or other elements such as monetary premium and network effects.
While it is true that most crypto investors do not use traditional business valuation techniques, we are at a point where we can analyze many of these assets as if they were traditional companies.
This can give us an alternative perspective on how to value these assets, although it is important to bear in mind that for the time being most retail investors invest for other reasons. For example, a DEFI protocol with a good P/E does not imply that its token will appreciate accordingly, and conversely, assets with zero fundamental value such as a memecoin can have astronomical returns.
This is the first in a series of articles where we will analyze various types of Web 3 projects (ranging from layer 1 blockchains to lending & borrowing protocols) using traditional business valuation techniques. I have extracted most of the data you will see in this article from https://tokenterminal.com/.
Important: both in these financial statements and in all those we see throughout this series of articles, the values of crypto assets expressed in dollars are based on the average dollar value of the respective crypto asset throughout the selected period.
In this first part, we will analyze the major layer 1 blockchains: Bitcoin, Ethereum, and Solana. In the images that we will see throughout this analysis, you will find the simplified income statement for each of these protocols.
Bitcoin
Let’s start with Bitcoin, the king of crypto assets. Here is the simplified income statement of Bitcoin for the last 3 years (including the current period, 2024).
Fees: Total transaction fees paid by users.
Supply side fees: Share of transaction fees that goes to the miners.
Revenue: Share of transaction fees that goes to the protocol (BTC holders).
Expenses (Token incentives): Total onchain expenses for the protocol, in this case, BTC emission.
Earnings: Revenue minus token incentives.
As we can see, analyzed as a company, Bitcoin’s business model is not particularly attractive. On one hand, users pay fees to use the Bitcoin network, which amounted to $796 million in 2023. The issue is that these revenues are not income for the protocol, for example through a burning mechanism, but rather go to miners, who are an external actor (we can define them as “security providers”). Therefore, from an accounting standpoint, we have an income “Fees”, and an expense of the same amount “Supply-side fees,” leaving us with a revenue of 0 for the network and its tokenholders.
On the other hand, the Bitcoin blockchain issues BTC with each block (which halves with each halving), which we measure as expenses from an accounting standpoint because the value of BTC gets diluted with new emission, and miners tend to sell some of the BTC they earn to cover their infrastructure costs. The dollar value of BTC issued during the year 2023 is $9.71 billion.
Therefore, if we analyze Bitcoin using traditional business valuation techniques, we find that the protocol incurred annual losses of $9.71 billion in 2023.
However, let’s remember that Bitcoin is a blockchain, and therefore this type of analysis is not the only one we should consider. Despite Bitcoin not generating revenue for its tokenholders, its value lies in being a store of value. Therefore, as the issuance decreases through subsequent halvings, as long as the fees collected by the protocol are sufficient to pay the miners, we will have a real and interesting store of value.
Ethereum
Once again, we will start by breaking down the income statement of Ethereum, the leading layer 1 smart contract platform.
Fees: Total transaction fees paid by users.
Supply-side fees: Share of transaction fees that goes to validators (thus an expense for the protocol, as it is a portion of the income paid to an external agent).
Revenue: Share of transaction fees that are burned (accrue to ETH holders).
Expenses (token incentives): Total on-chain expenses for the protocol, in this case, the issuance of Ether distributed among validators.
Earnings: The difference between the Ether burned and issued.
Since the transition from proof of work to proof of stake, Ethereum is one of the few layer 1 blockchains that are economically profitable or sustainable today. As we can see in 2022 (a year that passed with 9 months of proof of work until it was changed to proof of stake on September 6), the blockchain incurred losses of over $5 billion annually due to the expensive proof of work consensus mechanism.
In contrast, if we look at the data for 2023 (now with proof of stake), since the issuance of Ether by the protocol is drastically lower, the difference between the Ether burned through transaction costs paid by users (which is the revenue) and the Ether issued (which are the expenses) is $623 million.
Therefore, during the year 2023, Ethereum not only was economically sustainable as a blockchain but also indirectly reported profits to its holders through the reduction of the total Ether supply, something very similar to a stock buyback in traditional companies.
If we calculate the P/E ratio for Ethereum during the year 2023, it gives us a multiple of 139.1x. Does this mean that Ethereum is overvalued with such a high P/E? I don’t think so.
As mentioned in the introduction, in this article, we are analyzing crypto protocols as if they were traditional companies, but they are not. It is likely that this very high P/E is justified because what really gives value to Ether is the network effect (it is used not only on the Ethereum blockchain but also on all layer 2 blockchains and even as collateral in DeFi on other layer 1 blockchains) and the monetary premium, which is the extra added value to an asset for being a reliable store of value or medium of exchange.
While the monetary premium is difficult to measure and highly subjective, it is a fact that assets like Bitcoin, Ethereum, and Gold have it.
The example of gold is very clear; without the monetary premium, the $15 trillion market cap it has today would hardly be justified solely by its industrial use.
Another factor to consider is that if you own Ether, you can be a staker, either through having your own validator or through third-party services like Lido Finance, and therefore access a large portion of the Ether issuances and the supply-side fees that we can see in the income statement.
Solana
Finally, we have Solana, the trending layer 1 blockchain at present. Let’s analyze its income statement.
Fees: Total transaction fees paid by users.
Supply-side fees: Share of transaction fees that goes to the validators.
Revenue: Share of transaction fees that are burned (accrue to SOL holders).
Expenses (Token incentives): Total onchain expenses for the protocol. In this case, block rewards.
Earnings: The difference between the SOL burned and issued.
The case of Solana is very interesting. We will focus again on the numbers from 2023 as they encompass the entire year, but as you can see in the income statement, Solana has experienced a boom in this year 2024, something reflected in the fees obtained from users.
On one hand, users have paid a total of $24 million in fees during the year 2023. From this amount, we deduct $12 million as an expense, as it is the portion of fees that goes to validators, which we can classify as “the network’s security providers.” The other half, another $12 million, is destroyed through Solana’s burning mechanism, making it revenue for the protocol and SOL holders.
On the other hand, we have expenses. The Solana blockchain issues $769 million in SOL to pay its validators, representing an expense for the protocol.
Therefore, we have revenue of $12 million and expenses of $769 million, leaving us with negative earnings of $756 million.
Thus, we have a blockchain that is far from being economically sustainable and profitable if analyzed as a traditional business today. However, it has the mechanisms to become a sustainable business model if the number of transactions on the network increases exponentially, something that could happen in the coming years.
Another way to increase the long-term economic sustainability of the Solana network is to reduce expenses, in this case, the issuance of SOL. This decision should only be made if the new amount of SOL issued to validators is sufficient to maintain the security of the network.
Conclusions
As we can see, when analyzing the main layer 1 blockchains using basic traditional business valuation techniques, the results we encounter are quite inconsistent.
- If Bitcoin were a business, it would be extremely unsustainable.
- If Ethereum were a business, it would have an extremely high P/E ratio that in no way would justify its current price.
- Lastly, if Solana were a traditional business, it would have huge losses in proportion to its revenue.
However, as I have reiterated throughout the article, fortunately, a blockchain is not a traditional business. Therefore, while it is interesting to conduct this type of analysis, we should not use it as the primary method to measure the value of these networks.
In the next articles of this series, we will analyze other types of web3 protocols such as layer 2 blockchains and DeFi protocols, such as decentralized exchanges, lending & borrowing and Liquid staking derivatives. As we will see, under my perspective, this analysis will become much more important on these occasions.
Having said that, if we are not aiming for a good P/E ratio in a blockchain, as other elements like the monetary premium are at stake, it is important in the long term for the net income to be positive for it to be economically sustainable.
Thus, I believe that blockchains should seek a security model with minimal viable issuance; issuing the minimum amount of native tokens to pay their miners/validators while achieving a high level of security. To achieve this goal, the most viable consensus mechanism is likely proof of stake, as proof of work requires a lot of resources from miners, and properly rewarding them is extremely costly for the network.
Disclaimer
This article is for informational and educational purposes only. None of the opinions expressed in this article should be construed as investment advice. Neither Vottun nor Daniel Gardeñes offer investment advice, and any investment decision made based on the information provided in this article is the sole responsibility of the reader.
