The Battle for Value in Smart Contract Platforms
Will Ogden Moore
Last Updated: 6/7/2024 | 20 min. read
In the Smart Contract Platforms Crypto Sector, value accrual is a flywheel that connects fees and network usage with token valuation and the security and decentralization of a network.
Networks within the Smart Contract Platforms Crypto Sector take different approaches to compete for fee revenue: some pursue it with relatively high transaction costs, while others seek to capture more volume with relatively low transaction costs.
Grayscale Research believes that fee revenue can be considered the primary driver of value accrual for tokens in this market segment, although other fundamentals are important to monitor as well, as they can influence fee revenue over time.
Smart contract platforms like Ethereum and Solana are networks where developers can build decentralized applications ranging in nature from gaming to finance to NFTs. The role of a smart contract blockchain is to process the transactions of the applications it serves in a manner that is secure and resistant to censorship.
As a result, the value of a smart contract platform is intrinsically related to the activity on its network. Key indicators of a network’s activity include the amount of transactions it can process, the number of users it can support (typically measured by daily active addresses); the value of assets it supports, known as total value locked (TVL); and the network’s ability to monetize its blockspace, or network fee revenue—more on this later.
In addition to comparing and contrasting these fundamental metrics across assets, investors can put these numbers in the context of market capitalization, or where the market currently values a particular asset. For example, as seen in Exhibit 1, while Solana’s TVL ($4.7bn) is currently greater than Arbitrum’s ($3.2bn), Arbitrum’s Market Cap-TVL ratio (1x) is substantially less than that of Solana (16x). These metrics allow investors to not only gain a view of the relative strengths and weaknesses of different assets but also help them uncover value as well.
The Central Role of Fees
Still, while there are many different ways to measure network activity, theoretically and empirically, the most important single fundamental variable for a smart contract platform valuation is network fee revenue (Exhibit 2). This metric can be thought of as the aggregate amount of fees paid by users to use the network. Smart contract platforms have many different revenue models, but ultimately need to generate fees in order to deliver value to token holders.
Similar to centralized entities in traditional industries, there are different ways for decentralized networks to compete for fee revenue. For example, some smart contract platforms pursue fee revenue with relatively high transaction costs, while others attempt to capture more volume with relatively low transaction costs. Both approaches can be effective. Consider two hypothetical blockchains:
Example Chain 1: Small amount of users and transactions, high cost per transaction
5 users, 10 total transactions, $10 per transaction
Example Chain 2: Large amount of users and transactions, low cost per transaction
100 users, 100 total transactions, $1 per transaction
This illustrative example shows that, despite the fact that Chain 2 has substantially more users and total transactions, both chains generate the same amount of network fee revenue. While measures like users and transactions are also important, they need to be considered alongside transaction costs, because this will determine fee revenue.
Exhibit 2: Network fee revenue is most closely correlated with market cap
Grayscale Research believes that one reason there is a close relationship between fees and market cap partly is because of how critical network fee revenue is for token value accrual. Value accrual means that protocols structure their tokens in a manner that links network activity with the long-term sustainable value of that token. Different stages of value accrual can be found through the following three examples: Ethereum, Solana, and Near.[6]
Ethereum: The “Premium Chain” with Proven Value Accrual
Exhibit 3: Increase in network usage (reflected in periods of greater supply burn) tend to correspond with higher valuation
Solana: The “High-Performance Chain” That Is Figuring Out Value Accrual
In the past, this lack of value accrual has reflected a relative disadvantage for Solana; however, in 2024, this has been changing. Year to date, Solana has already generated six times the fees it had from all of 2023, closing the fee gap between Ethereum and Solana from 154x in 2023 to 16x (Exhibit 4). This indicates that the Solana model—low transaction costs and high throughput—can also help generate economic value.
Exhibit 4: Solana has started to figure out value accrual with its fees
Exhibit 5: ETH’s Dencun upgrade led to cheaper Layer 2s; increase in fees has helped Solana figure out value accrual
Because Solana has become more expensive on a per transaction basis to its users than Ethereum Layer 2 Arbitrum, it potentially risks some of its positioning as the go-to cheap, high throughput chain. Despite this, Grayscale Research believes that overall this increase in fees is a net positive development because 1) it reflects high levels of user activity, and 2) it indicates value accrual to stakers and token holders.
Near: Proven Adoption in Onboarding to Crypto but Early in Network Monetization
These two prior examples are contrasted by Near, a smart contract platform that has recently gained significant adoption from non-speculative use cases but has yet to demonstrate value accrual. Near is the underlying platform for KaiKai and Hot Protocol, the two largest decentralized applications (dApps) by users in all of crypto. Near leads all smart contract platforms with 1.4mm daily active users and is competitive in throughput with the fastest chains in the sector such as Solana (Exhibit 6).
Exhibit 6: Near leads all smart contract platforms in daily active users
Despite its relative inability thus far to monetize, Near’s substantial adoption serves as an important starting point. If the network is able to either continue to scale network adoption or increase average transaction fees without reducing network activity (similar to Solana’s recent progression), it could realize meaningful value accrual.
Each of these three smart contract platforms—Ethereum, Solana, and Near—represent different stages of maturity in network fee revenue generation of a decentralized network. Ethereum has multiple years of revenue and growth. Solana has a history of a strong user base but has only just started to generate substantial revenue. Finally, Near has shown traction with its product, in part due to low costs, but has not yet shown meaningful revenue.
Caveats and Nuances on Fees and Valuation
Similar to how a valuation of traditional assets might involve future cash flows discounted back to the present, the valuation of a crypto asset also could involve future expected network fees generation discounted back to the present. This variable accounts for future potential growth in adoption, usage, or monetization of a particular network in a manner that is distinct from current overall fees generated today. For example, one could rationalize that Ethereum’s valuation of $458bn is pricing in not only its current amount of fee generation but also its potential to take advantage of its network effects and grow Layer 2 adoption, usage, and fee revenue generation in the future.
Lastly, the valuation of certain crypto assets may include a “money premium.” In other words, users may be willing to hold the asset for its functions as a money medium—as a medium of exchange and/or store of value—above and beyond the network’s ability to generate fee revenue. For Ethereum in particular, the concept of a money premium may be important for considering its valuation (especially if the token becomes widely used as a collateral asset across the industry).
If value accrual is properly implemented into a protocol, an increase in network usage incentivizes users to not only hold a token, taking it out of circulation and potentially boosting its value, but also to be a validator or stake tokens, helping improve network security. In addition to network security, fees incentivize more validators to come online, resulting in greater levels of decentralization and censorship resistance.As a result, value accrual is a flywheel that connects fees and network usage with token valuation and the security and decentralization of a network.
While it is important to acknowledge that fees can serve as an indicator of the level of maturity of a network, there are many other elements of this flywheel that can influence the growth of a network and its valuation. For example, if a particular application takes off in adoption, that could lead to more users, attracting more developers to build within the same ecosystem. As a result, network fees should be viewed within both the context of the other fundamental metrics and the context of the relative valuation of a particular ecosystem (market cap).
Going forward, it will be important to monitor some of these growth stories. Can Ethereum continue to grow its fees on the mainnet despite relatively high average transaction costs for users ($4.80) through use cases with high-value transactions like tokenized financial assets? Can Ethereum grow its fees with increased Layer 2 activity? How will Solana straddle the line between monetization and keeping its chain low-cost enough so it doesn’t lose users to other cheap, high throughput chains? Will Near attempt to monetize or will it continue to forgo meaningful levels of fee revenue generation while prioritizing the growth of its user base?
These dynamics underscore the importance of monitoring fundamental metrics including fees, transactions, active users, and TVL. Grayscale Research believes that as the crypto asset class continues to mature with increased adoption, the importance of these fundamental metrics will continue to grow as well. These metrics will provide deeper insights into the relative strengths and opportunities within the Smart Contract Platforms Crypto Sector—ultimately helping to guide informed investment decisions by fostering a more nuanced understanding of network value.
[2] Artemis, data as of 6/6/2024
[3] Decentralized Physical Infrastructure Networks like Helium or Render, both on the Solana network.
[4] Ordered by top 20 by market capitalization as of 6/6/2024
[5] We ran an analysis of the correlation between the annual average of daily fundamental metrics and the annual average of daily market caps for each asset in the Grayscale Smart Contract Platforms Crypto Sector. Fundamental metrics we tested against market cap included transactions, daily active users, TVL, and fees. We performed this analysis from 2022 through 2024 year to date and found, in each case, that fees correlates most closely with market cap.
[6] Assets chosen as illustrative examples of different stages of value accrual maturation.
[11] Artemis, monthly averages as of May 26, 2024.
[13] Artemis, as of May 26, 2024
[14] Artemis, as of May 26, 2024
[15] Artemis, as of June 6, 2024
[16] Artemis, as of May 26, 2024
[17] Artemis, as of May 26, 2024
[19] Maximum Extractable Value (MEV) is the highest profit a blockchain miner or validator can make by reordering, including, or excluding transactions within a block.
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