The market capital of Bitcoin at the time of writing this article is around USD 400 Bn with a “B”. It’s down from its peak market capitalization of USD 1.27 Tn. While market capital of Ethereum is approximately USD 150 Bn down from USD 500 Bn. To put things in perspective, Google has a market capitalization of USD 1.4 Tn and the entire GDP of India is around USD 2.6 Tn the 5th largest GDP in the world.
In short, Bitcoin and Ethereum market caps are HUGE! Google, Amazon, Facebook everyone sells amazing products have earned billions in revenue to attain such valuation and, in turn, market capitalization. But what does Blockchain sell? What is their business model? Are these profitable? Let’s explore the answer to these questions in today’s post.
Blockchains are in the business of selling block space.
Blockchains generally have a limited about of block space. The higher the demand for blockspace, the higher the charges (fees) to use the blockspace. Simple, supply-demand dynamics at play. Now, why do people want to use this block space? What’s so special about them? How is it different than a single computer? This block space can be used to record information, run code, and transfer things (currency, digital objects). It’s a trustless, immutable, decentralized, and permissionless blockspace. It means, ideally, no one can alter or censor anything. This is often expressed via a single term “security”. Needless to say, security is the most important component. If it is compromised, the block space is not worth much. Therefore, the higher the security, the more valuable the blockspace. Security is essentially derived from independent miners/validators. High decentralization and high miners/validators mean higher security. Miners/validators are similar to employees of the blockchain enabling the ecosystem and ensuring security.
So, let’s see the business model of Ethereum!
Profit = Revenue - Cost
Revenue → Simply the transaction fees earned by the system. The fees users are willing to pay to use the blockspace. This revenue varies and is dependent on the demand. Over the last year, daily revenue ranged from $4 Mn - $80 Mn! On average around $10-$15 Mn per day!
With EIP-1559, a significant chunk of the fees is burned. When it’s burned, it is kind of equivalent to stock buybacks which adds values to the stocks or in this case coins.
Burn → Approximately 0.17x of ETH issued currently is burned. This is not a fixed amount and depends on a number of factors. This reduces the supply of ETH in the system. It is interesting to note that this is the primary mechanism of transferring value directly to ETH holders aside from an indirect mechanism of an increase in token value.
Therefore actual revenue of the system is transaction fees - eth burned
Cost → Fees paid to miners/validators
Currently in a Proof of Work mechanism, Ethereum issues ~4% to miners/validators as a block incentive reward. This incentive is necessary to attract a large number of miners/validators and therefore higher security. This amounts to a total of ~ $32Mn worth of Eth issuance every day.
Clearly, the Ethereum business model is not profitable currently. It’s similar to a new startup or company which runs promotional campaigns in order to attract network participants. However, the good thing is it soon will be profitable!
With Ethereum migrating to Proof of Stake, the issuance will reduce by 90%! Therefore, its issuance cost post-merge is around $3 Mn. This is less than Ethereum's current average revenue! Therefore, Ethereum will become a profitable business model with a profit margin of ~75%! Of course, with continuous innovations, the use cases Ethereum can support will increase. This will further increase the demand and therefore the revenue of the chain.
However, what about security, you may ask? Since the entire purpose of the issuance was to provide high incentive and therefore high security. Now here is the catch, the security is not compromised in any way. It’s like Proof of Stake is a highly efficient way of providing security. We will cover Proof of stake in another article in detail. However a quick brief, in the proof of stake consensus mechanism, miners do not need to run expensive hardware and incur high electricity costs for mining ETH. Instead, they can just stake their ETH and become a validator. It essentially significantly reduces the cost to mine ETH and therefore the entire cost of security to ETH reduces.
The Positive Flywheel!
As discussed before, with more and more dapps deployed on Ethereum, the demand for Ethereum block space increases. This implies high gas fees which in turn implies high gas burn. Reduction in supply means increasing ETH prices. Higher ETH prices draw even higher interest and demand. At the same time, increased incentive increases security as well which increases its utility again! This positive flywheel further improves the profitability of the blockchain in the long run. I am really excited to witness the post-merge era! Are you?