From Digital Oil to a Digital Nation — Narratives for Ethereum in 2021
Summary
There are five compelling Ethereum narratives in market today:
- ETH is a Digital Commodity
- ETH is a Non-Sovereign, Digital Store of Value
- Ethereum is a Payment Network
- ETH is a Productive Financial Asset
- Ethereum is a Digital Country and ETH is a Reserve Currency
There are four levers in how one might assess the value of ETH:
- Rate of adoption
- Network fees
- Price-to-earnings (or similar metrics) multiples the market will bear
- Market share of the overall crypto market
The “Ethereum is a payment network” narrative suggests the lowest network value, with a market capitalization below $1T if there is fee compression over time.
The “ETH is a commodity similar to oil” and “Ethereum is a digital country” narratives suggest the highest market capitalizations, both showing paths to over $20T.
If you believe in a power-law distribution in the crypto networks market, you likely also believe that one network will reach a market capitalization of $10T-$20T in the next 10–20 years.
Where is Ethereum’s investor narrative?
A unified narrative is important to create a unified valuation framework that serves as a Schelling Point for market price. The market has accepted Bitcoin as digital gold since roughly the block wars of late-2017. Investors have not yet converged on a primary narrative on how to value ETH. There are five broad narratives for ETH being discussed in the community:
- Commodity
- Store of value
- Payment network
- Productive financial asset
- Digital Country
Below we offer quantitative frameworks for each narrative to structure the conversation around valuation. Our goal is not to suggest a price target for ETH. Rather we aim to understand what these narratives mean for Ethereum and what market participants’ expectations must be to support various return profiles.
Key Assumptions
Planned Ethereum updates will be successful
- We anticipate a successful transition to PoS and EIP 1559 implementation.
- We assume a fixed ETH supply of 115,000,000 in our calculations, due to upcoming monetary policy changes.
- We assume a decrease of 80% to 95% average transaction revenue compared to Q1 2021 levels due to network upgrades and layer 2 solutions.
Internet-level growth rate
- Technologies invented after the Internet, such smartphones and social media, tend to grow even faster than the Internet. We generally assume a growth similar to that of the Internet, not faster.
- From January 2016 to January 2021, Ethereum transaction volume grew at a 161% CAGR and. Our models use a 44% and 63% CAGR from 2020 to 2030.
Lower average transaction fee
- The average cost of a transaction in Q1 2021 was ~$31 (and median transaction fee was ~$17)¹
- Significant effort is being put into decreasing transaction fees. Layer 2 scaling solutions, the release of ETH 2.0 and transition to proof of stake, and future network upgrades all aim to improve user experience by increasing throughput and decreasing fees.
- Our assumption in the models presented below is that the average transaction fee will decrease by 80% to 95%, leading to an estimated average fee between $2 and $7 (while also assuming significant growth in network value, thus implying a significant increase in the settlement volume driven by these transaction fees).
Narrative 1: In a Digital World, ETH is a Commodity
One common narrative is that ETH is similar to oil. Oil powered us through the industrial age, but we are now in the software age, and ETH could be the fuel for a digital economy. With the upcoming network changes and the progress of DeFi in the past year, the comparison sounds increasingly relevant:
1. Similar to oil, ETH is “burned” as it is used.
2. Similar to oil, demand for ETH comes from different, diverse use cases:
- Participate in DeFi.
- Secure the ETH 2.0 network.
- Issue, buy, sell, or transfer digital assets such as ERC20 tokens including stablecoins and NFTs.
- Use the EVM for computation.
- Store value in an alternative asset class.
- Create cross-chain bridges, where ETH would be held in reserve.
3. Similar to oil, supply of ETH is limited and supply growth should slow down meaningfully in the near future.
- EIP 1559 will burn ETH that was previously sent to miners.
- The switch to PoS will require locking a significant amount of ETH, creating a one-time supply shock and a lasting change on circulating supply.
- The upcoming network upgrades may burn more ETH than the network issues, further decreasing supply.
4. Similar to oil, geopolitics influences demand and sentiment creates volatility.
As a commodity, ETH has a lot of room to grow
The above statements also apply to many other commodities, so we consider the total value of global oil reserves, as well as the proven reserves of other limited-supply commodities to create rough estimates for the possible value of the Ethereum network.
The table below shows the price of ETH if the market capitalization of Ethereum was to reach the market value of a natural resource (assuming today’s known reserve units of these commodities and a fixed supply of ETH).
For example, if ETH were to become as valuable to the global economy as Copper, it would be worth $63,913 per ETH.
Limitations of comparing ETH to commodities
- There are a finite number of alternatives to oil (coal, solar, hydro, nuclear, etc), but cryptocurrencies can be forked, and new cryptocurrencies can be created. For this narrative to hold, one would have to believe that the network effects of Ethereum will keep it as a preferred, dominant solution, and that crypto networks will end up having a power l $aw or winner-takes-most market distribution.
- Digital goods are generally cheaper to produce than physical goods, and so while we compare ETH to oil, ETH could be worth less than oil even if it became as important as oil to the global economy.
- The supply and monetary policy of Ethereum can be changed, which means that while supply is limited in the near future, it technically could one day grow (or shrink).
Narrative 2: ETH is a Non-Sovereign, Digital Store of Value
The “digital gold” narrative has already been accepted by many BTC investors. With the upcoming Ethereum upgrades, there are four reasons to believe that this narrative is relevant to Ethereum:
1. Like BTC, ETH has properties that make it preferable to gold. Cryptocurrencies are easier to acquire, transport, and transfer, and are easier to use to buy and sell goods and services.
2. BTC and ETH have lower supply growth than gold:
Yearly supply growth:
Gold: 2.5%
BTC: 1.75%
ETH: likely below 2% yearly after EIP 1559, possibly lower or negative.3. ETH is easier to build on than BTC, which creates strong network effects.
Due to ease of programmability, ETH became the reserve currency for DeFi, and processes more transactions today than any other network. There is already demand for more programmability from BTC: as of May 2021, over 1% of BTC supply has been “wrapped” into Ethereum² so that it can be programmed and transacted on the Ethereum network. An increasing amount of BTC is being used on Ethereum:
4. The market for a global digital store of value could be bigger than that of gold.
a) More utility and accessibility could increase the market size — The world’s total gold total above-ground supply is worth ~$11T today³. Digital stores of value lower friction, provide better access and offer programmability, which could increase the total market size compared to gold.
Take the US Taxi and Limousine Services and Uber as an imperfect but relevant comparison. In 2009 (the year Uber was founded), the US Taxi and Limousine Services market was $9.4B and growing at a 3.2% CAGR⁴. By 2021, after companies like Uber improved the user experience, the US Ride Hailing and Taxi market grew to an estimated $47B, and growing at an estimated CAGR of 11.7%⁵.
b) Investors fear inflation, increasing demand for good stores of value — With the record-level money printing that happened in 2020, many believe that inflation and/or fear of inflation may drive higher the price of fixed supply assets.
c) Younger generations want to hold crypto more than gold — While an estimated 12% of Americans hold gold, 25% of millennials with more than $50,000 in savings already own some form of crypto and another 42% are interested in purchasing crypto.
If ETH becomes a leading digital store of value, it may capture significant value (even as a runner-up to BTC).
Our method for this framework is to 1) offer the range of total market size of a digital store of value compared to gold, and 2) the proportion of that market that ETH could capture.
General Observations on ETH vs BTC
- BTC already dominates the market, and network effects might prevent other cryptocurrencies from gaining market share.
- ESG concerns over energy-intensive mining operations could favor chains that have alternatives to proof-of-work.
- It is unclear if there could be two “golds”, or if a digital store of value is a winner-takes-most market. The precious metals market suggests that the leading store of value can capture as much as 70% of the market.
Narrative 3: Ethereum is a Payment Network
Like a payment network, Ethereum has millions of users who pay fees to have their transactions processed. If Ethereum became solely a global payment network, we could value it by estimating its transaction volume and transaction fee (validator revenue), and comparing it to existing payment networks such as Visa and Mastercard.
In estimating the range of possible transaction volume and fees, we considered the following:
- For the 12 months ending in December 2020, Visa⁶ and Mastercard⁷ processed $17.7T, with an average transactions cost of 2.5% to 3%
- Ethereum transaction volume (including ERC20 token) LTM as of October 2020 was $989B, with $1.64B spent on transactions (0.17% of volume).
- In May 2021, Ethereum processed between $20B and $30B of stablecoin transactions daily ($7.3T to $11T annual run rate) and about $10B of ETH daily ($3.7T annual run rate), with average miner revenue at about $60M per day ($21.9B per year). Accounting only for stablecoins and ETH, fees are ~0.16% of transaction volume.
- As of Q4 2019, Visa and Mastercard had respective PE multiples of 38 and 37. We use multiples prior to COVID as a more “typical” multiples.
We can estimate the range of possible Ethereum Network Value by assuming a 37x price to earnings ratio and inferring fees from a transaction fee rate and transaction volume.
Again, the goal is not to assert a potential value for ETH. The idea is to build an intuition for what one must believe to justify ETH at some potential value in the future. Is it more plausible that Ethereum might transaction $5T or $30T in transaction volume? Is it more likely that fees drop to 0.5% or all the way to 0.01% in time?
Where Ethereum differs from payment networks
- Ethereum has a native currency, which makes it different from today’s payment networks. If users need to hold ETH to use the network, the valuation of Ethereum may differ from that of payment networks.
- Ethereum can process more than simple payments: It is a platform that can compute very complex financial contracts.
- Ethereum is non-jurisdictional and cross-jurisdictional, thus users may be willing to pay a premium for a non-sovereign solution.
Narrative 4: ETH is a Productive Financial Asset
The transition to PoS will allow validators to generate cash flow with their capital, which means ETH would have value as a productive financial asset. In order to create a cash flow model, we considered the following:
- Transaction fees and block rewards could represent meaningful revenue — fees paid to miners grew from $46M in 2019 to $630M in 2020, and over $2.4B Q1 2021⁸.
- Average transaction fees are likely to decrease in the future vs Q1 2021 — Reduced fees mean less revenue for validators and likely faster adoption, as high fees are a deterrent for users.
- Profit margin in proof-of-stake will be higher than in proof-of-work — the upcoming switch to proof-of-stake, if successful, will remove the need for highly specialized, expensive machines to mine transactions, along with energy-intensive PoW machines. For simplicity, we assume 100% profit margins.
Below are two frameworks to estimate a price of ETH based on future cash flows:
- Discounted cash flow of all validator revenue generated from 2021 to 2050 to estimate the net present value of ETH today.
- Price-to-earnings multiples for the revenue generated by Ethereum in 2030.
Method 1: DCF on validator revenue, and net present value of the Ethereum network.
Method 2: PE multiple of revenue from tx fees, and value of the Ethereum network in 2030.
Challenges in estimating future cash flows
- The impact of layer 2 changes on the average transaction fee and the volume of transactions is unclear.
- The market may ask for a higher discount rate given the volatile nature of cryptocurrencies.
- Cryptocurrencies today are highly speculative, and the price-to-earnings ratio may be significantly different than that of traditional financial assets.
- There are significant regulatory uncertainties that could create dramatic changes in the adoption rate.
Narrative 5a: Ethereum is a Digital Country
In many ways, Ethereum is similar to a country. It has citizens (wallets and users), a government (Ethereum Foundation), a currency (ETH), corporations (DAOs and Dapps), a financial market (DeFi), and relationships with other digital countries (bridges between different chains).
In this comparison between Ethereum and a country, one would be able to compare Ethereum’s money velocity with that of other countries, where money velocity consists of the ratio of nominal GDP to a measure of money supply (M1, M2)⁹ ¹⁰ ¹¹. To do so, we need to:
- Define the GDP of Ethereum.
- Define the money supply of Ethereum.
- Measure different countries’ money supply-to-GDP ratio.
- Estimate what the GDP of Ethereum could be in 2030 to calculate the potential value of the network.
Defining Ethereum’s GDP
Three examples of goods and services produced and sold on Ethereum today are mining revenue, DeFi revenue, and NFT sales¹². A simple annualization of the YTD GDP of those three categories, respectively $3.7B, $2.7B, and $8B, suggests a 2021 GDP of $14.4B. There are reasons to believe that these numbers will keep growing:
- Miner revenue is growing
- DeFi volume is growing
- NFT sales volume is growing
- There are likely additional products and services produced and sold through Ethereum in the future. For example, it was technically possible to create and sell NFTs a few years ago, but they only recently really took off. Similarly, in the 1990’s, a minority of people could imagine that the Internet would one day facilitate billions of video calls, video streaming, and other broadband-intensive applications.
Defining Ethereum’s money supply
If Ethereum is a country, then ETH is its money supply. The ETH supply is most similar to a country’s M1 supply (coins and notes in circulation and other assets that are easily convertible into cash). However, unlike in the traditional banking system, ETH has a finite supply and cannot be created by the crypto equivalent of commercial banks leveraging their reserves to create loans. Therefore, while ETH is most similar to M1 in definition, we use M2 in relation to GDP in our frameworks.
In a country, M2 consists of¹³
- all currency held by the public
- transaction deposits
- savings deposits
- small-denomination time deposits (less than $100,000)
- and retail money market securities.
Ethereum already has look-alikes for the components of M2:
- ETH and DAI in user wallets is currency held by the public.
- ETH and tokens in exchange wallets are similar to transaction deposits.
- DeFi products like Yearn and Curve are savings deposits.
- Locked DeFi deposits are time deposits.
- DeFi products like Aave and Compound are money markets.
Measure different countries’ money supply-to-GDP ratio.
Countries have different money supply-to-GDP dynamics. We looked at the M2-to-GDP ratio of several countries to create a range for our assumptions.
Estimating Ethereum’s addressable GDP
We looked at a wide range of potential GDP captured, with the following comparables:
A) $2T
- Amazon facilitated $490B of sales in 2020
- 2020 GDP of California is $3.1T
- 2030 GDP estimate for Canada is $2T
- The digital economy contributed $1.85T to the US GDP in 2020¹⁴
- $2T is 1.46% of global 2030 GDP estimate ($137T)
B) $5T
- 2030 GDP estimate for Japan is $5.5T
- The finance, insurance, real estate, rental, and leasing industry contributed $4.7T to the US GDP in 2020¹⁵.
- $5T is 3.65% of global 2030 GDP estimate ($137T)
C) $10T
- 2030 GDP estimate for Eurozone is $15.6T
- $10T is 7.3% of global 2030 GDP estimate ($137T)
D) $20T
- Global financial services market: $25T-$30T by 2030
- 2030 GDP estimate for the US is $22T
- $20T is 14.6% of global 2030 GDP estimate ($137T)
Valuing Ethereum as a digital country
We can calculate different scenarios for Ethereum and its programmable currency using the M2 money supply comparables and a range of GDP assumptions:
The difficulty of this approach is that no one knows how much GDP Ethereum will create. There are a number of competing chains which could each capture a large portion of their target sector. For example, take NFTs as one sector where Ethereum is facing competition. NBA Top Shot, one of the largest NFT marketplaces, was built using the Flow blockchain, not Ethereum.
In order to reach the GDP levels used in our assumptions, Ethereum doesn’t have to win everywhere. In fact, a meaningful GDP could be reached with financial services and DeFi alone.
Narrative 5b: ETH will be a Global Digital Reserve Currency
There are two notable, recent catalysts that could trigger a change in reserve currencies and favor a cryptocurrency with limited supply:
A) The creation of new fiat money increases inflationary pressure on fiat currencies.
B) There is a growing global distrust of institutions.
The following data from Pew, Gallup, and Edleman shows that many around the world have lost faith in the institutions that formed the foundation of modern society — the press, public schools, banks, etc. This is not a side effect of the Internet in the 90s or social media in the 2000s. Trust has been eroding since the 1960s in all of these institutions.
On average, reserve currencies have retained their status for 100 years
Historically, reserve currency transitions can happen in just 20 years. Gold, for example, went from being the preferred foreign exchange reserve currency, accounting for 60% of central banks foreign exchange reserves in 1980, to about 15% in 2000, with the US dollar growing from about 28% to 60% in the same period¹⁶ (including gold). A similar transition happened to the British pound after World War I when it lost its status as a reserve currency, and the French livre and the Dutch guilder before that. All three currencies held their status as reserve currency for approximately 100 years.
Why cryptocurrencies, and why ETH?
Cryptocurrencies are relevant here because they have the intrinsic properties of good currencies: they are durable, portable, divisible, uniform, and in many cases, have limited supply. When looking at reserve currencies, we also need to consider three emergent properties: global demand, acceptability, and status as reserve currency compared to others.
ETH today is still far from achieving success in these three dimensions: global demand is very small compared to other currencies, even compared to BTC; ETH is accepted as a payment method virtually nowhere outside of crypto; prices are highly volatile; other cryptocurrencies are competing with ETH; and central banks around the world are working on their own competing digital currencies.
However, ETH differentiates itself as a ready contender to become a currency that many businesses and countries may choose to hold in their reserves in time.
1. There is a growing, diverse demand for ETH:
- Investors want ETH to store value, earn passive income in DeFi, and invest in other crypto opportunities.
- Consumers want ETH to access the different Dapps on the Ethereum network, buy and sell digital assets such as art, gaming assets, insurance, and so on, and transact with better privacy and anonymity
- DeFi protocols want ETH to use as collateral to create other assets such as DAI and synthetic assets, to use as reserve currency to allow users to trade, and to raise capital.
- Builders and creators want ETH to accept payment from crypto users, build businesses that can only exist with programmable money, monetize creative content without relying on platforms that could censor them.
- Other blockchains want ETH reserves to bridge their chains to the largest ecosystem, Ethereum.
2. ETH has already established itself as the reserve currency of DeFi.
- On Uniswap, the largest DEX today, there is more than 3.5x ETH than the three most popular USD stablecoins combined (as of May 2021). On Sushiswap, the multiple is over 4x.
- The largest DeFi protocol by total value locked is Maker, which has over $12B of ETH locked as collateral for its stablecoin, DAI.
- ETH is also the reserve currency for projects like Synthetix where ETH is deposited as collateral to create synthetic assets.
- Over 1% ($10B as of May 2021) of Bitcoin supply has already been wrapped to be used on Ethereum, showing that there is demand for more programmability from digital stores of value and reserve cryptocurrencies.
3. Currencies in high demand have natural network effects, and Ethereum has a head start.
4. Supply growth is about to become limited, which means price is likely to increase with demand. Increasing prices contribute to the reserve currency network effects because when prices rise, more people tend to buy and hold the currency.
How much would a global digital reserve currency be worth in 2030 if it was to replace any of today’s reserve currencies? Depending on its comparable reserve currency status, we could add the following amount to the previous scenario of Ethereum as a digital country:
Continuing the Conversation
Our goal with this exercise was not to suggest a price target for ETH. Rather we aim to add some structure around the narratives that are currently being discussed in the community.
Looking at the five narratives, one can see that there are four levers that play a disproportionate role in the future value of the network:
- How optimistic your model is on the adoption of blockchain technologies
- The outcome distribution of the different chains (winner-takes-most, power law, or fragmentation)
- Network fees
- Multiples on cash flow that the market will be willing to pay
We invite you to tweak those assumptions to create your own models on the value of ETH. We also welcome feedback or additional thoughts on what we might have missed.
You can email Gui at gui@electriccapital.com or on Twitter @laliberteg and reach the Electric team on Twitter @ElectricCapital.
Use our models with your own assumptions
Here are our models and assumptions. Feel free to make a copy of these and use your own assumptions.
Narrative 1: In a Digital World, ETH is a Commodity https://docs.google.com/spreadsheets/d/1Nt6FQEmsq3a4iqSZtgigOrt07kUeXam1oyO25lAOM5I/edit?usp=sharing
Narrative 2: ETH is a Non-Sovereign, Digital Store of Value https://docs.google.com/spreadsheets/d/1xFmbCq9y4PyM0q8cfHMchPapBpYJY6F6GTAOUjHY5Fw/edit#gid=1555126314
Narrative 3: Ethereum is a Payment Network https://docs.google.com/spreadsheets/d/1_AnrbsU1Jl0XBbcydi4Rmj65rCn95YBu4v4RQZEP0X0/edit?usp=sharing
Narrative 4: ETH is a Productive Financial Asset
Using DCF to estimate value today: https://docs.google.com/spreadsheets/d/1FwR4BwFqCWhJm9Gr67YdfGZGOBmByiwHHLiMQ5gQ-kY/edit?usp=sharing
Using PE multiples to estimate 2030 value: https://docs.google.com/spreadsheets/d/17rgoCB1TDeUGFqELYJPxmoyNDdzEaXqT-vSYRDQjBIs/edit?usp=sharing
Narrative 5a: Ethereum is a Digital Country https://docs.google.com/spreadsheets/d/1idrwQyDLmxj7muo2dRXvRDbuq9f8L0vDUXc0dNvbwaY/edit?usp=sharing
Articles we read prior to writing this article
[1]: 7 day simple moving average as of 05/11/21
[2]: https://coinmarketcap.com/
[3]: https://www.gold.org/goldhub/data/above-ground-stocks
[4]: https://www.statista.com/statistics/294894/revenue-of-taxi-and-limousine-services-in-the-us/
[5]: https://www.statista.com/outlook/mmo/mobility-services/ride-hailing-taxi/united-states
[8]: https://etherscan.io/charts
[9]: https://tradingeconomics.com/brazil/money-supply-m2
[10]: https://www.ceicdata.com/en/indicator/brazil/money-supply-m2
[11]: https://docs.google.com/spreadsheets/d/1_wkMzTp3mAwDrLaInQ6C8yTzm_di72MSHzYZRlkqOY4
[12]: The value of a transaction on a DEX would not be included, only the fees paid by the user to the liquidity provider would count towards GDP. The same logic would apply for all transactions, where only the value actually produced on Ethereum would count towards GDP.
[13]: https://www.federalreserve.gov/faqs/money_12845.htm
[14]: https://www.statista.com/statistics/961982/digital-economy-gdp-share-usa/
[15]: https://www.statista.com/statistics/248004/percentage-added-to-the-us-gdp-by-industry/
[16]: https://www.principles.com/the-changing-world-order/#chapter5pt2Post1945Charts
