While smart contract blockchains have proven themselves to be extremely useful and inherently valuable, people have struggled to align on the intrinsic value of smart contract blockchains over the decade since Ethereum’s introduction.
Unlike Bitcoin, which has long been analogized as digital gold and valued on a relative basis to the ancient asset, smart contract blockchains have proven more difficult to value on a fundamental basis.
What market are they pursuing? Why should they be valuable at all? Several different valuation methodologies have been put forth, but there is no consensus on how to think about it and those that have been put forth tend to be self referential (e.g., DCF on fees though the fees are paid in the native asset, currency for its internal economy).
Another theory that’s been long discussed is that Ethereum (and alternative smart contract blockchains) may become a Global Settlement Layer, which is intriguing; but what does this really mean, and how valuable could a global settlement layer be?
Essentially the economy consists of people exchanging goods and services, usually mediated by a medium of exchange, most commonly the United States Dollar today. These exchanges are often underpinned by some sort of contractual agreement. Today, the world’s legal system works as the global settlement layer for these paper-based contractual agreements. Courts (and the global security apparatus that enforces the judgements) ensure that commercial agreements are honored. Those courts are of course part of the government, which guarantees their judgements.
These rails of the global economy are so fundamental to modern society that we don’t often explicitly talk about what they’re worth. There are at least two ways to conceptualize the value: (1) revenue — the tax receipts of governments, and (2) expenses — the security expenditure of governments, both domestic and international, that ensure commercial agreements are honored. This could be recut in various ways, but at a high level, this likely ranges from ~$3.7 trillion to ~$9.3 trillion per year. Annual global security spending is ~$3.7 trillion per year, while global taxes on commerce (i.e., consumption and corporate income) total ~$9.3 trillion per year, providing a range for what the current global settlement layer costs the economy today.,
How can we translate this to blockchains? An analogue to blockchains for taxes could be the amount of transaction fees – a form of usage tax – and for security budget, an analogue could be gross token issuance. The fees are what people pay for the service, and the issuance is what the network pays miners or stakers to secure the chains.
Blockchains, like many governments, are currently running deficits, as shown by the fact that they rely on positive net issuance; although on more mature blockchains like Ethereum, these numbers tend to be closer to equilibrium than they are in earlier stage blockchains like Solana – occasionally even resulting in negative net issuance.
Taking a recent month, October 2023, total run rate fees on public smart contract blockchains were $3.2 billion (~65% of which was on Ethereum) and total run rate gross issuance was ~$3.9 billion (~27% of which was Ethereum). These Information Era governance and security costs are understandably much lower than the Industrial Era economic governance and security costs we’re comparing them to for at least three reasons: (1) the bulk of economic activity today is not currently secured by blockchains; (2) even at maturity, it’s unlikely that blockchains secure 100% of economic activity, as other mechanisms will still be required to secure physical property; and (3) using cryptography to secure economic activity should be more economical than using paper and guns.
How can we reason about what the total addressable market (TAM) for this internet-based, natively digital Global Settlement Layer will eventually become? Building on the above, there are two factors that may be relevant: (1) the share of global economic transactions that take place on the internet and (2) the share of economic activity based on intellectual property. These are two related data points that help us size the share of global economic activity that may be better secured via digitally native, blockchain-based settlement than via Industrial Era legal settlement, especially in an increasingly fragmented global economy.
The global digital economy is rapidly approaching $23 trillion (~24% of global GDP), and arguably, this activity should be secured by natively digital settlement layers. That said, a material portion of this activity also has a physical component, so this is probably best thought of as the outside edge of what this TAM figure could be.
A more realistic aim could be the value of GDP underpinned by intellectual property. Intellectual property is inherently digital, and the world today does a relatively poor job protecting intellectual property rights across borders as seen by the growing scourge of IP theft, something that is only worsening in the era of artificial intelligence. Despite those issues, ~$10 trillion of annual economic activity is currently underpinned by intellectual property (~10% of global GDP). That economic activity would likely be better secured by blockchain technology as it is fully adopted, programmatically ensuring that IP is respected and royalties are paid.
Although it is still very early in the adoption process with an aggregate GDP of ~$3 billion across blockchain application layer economic activity, 10% to 25% of global GDP is likely a reasonable range for the TAM related to economic activity that should be fully secured by blockchains. When overlaid on the $3.7 trillion government security budget and the $9.3 trillion of taxes collected by governments, this produces a total annual fee / gross issuance market of $370 billion to $2.3 trillion per year. Using Ethereum’s fully-staked yield of 1.6% as a proxy for what this implies about asset values, that’s an aggregate market capitalization of $23.1 trillion to $145.5 trillion for smart contract platforms, an increase of 57-361x over the aggregate market cap of smart contract platforms today. While we are not close to using blockchains to secure all IP based commerce today, it does seem like a reasonable stretch goal for where we could be in a decade.
Of course, looking at the market as it is today could be understating the potential. Both the share of global digital economy and the amount of economic activity underpinned by intellectual property are rapidly growing, by 14% and 9% per year, respectively, meaning this TAM should be growing at similar rates. Beyond that, it has been shown that as the security of property rights increases, the level of economic activity increases and blockchain-based digital property rights could be the most secure property rights thus invented by man, so the continued adoption could lead to an explosion of intellectual property that ignites a new wave of global economic prosperity and further grows the TAM of the Global Digital Settlement Layer. If this more secure form of global intellectual property rights unleashes a new renaissance fueled by cross-border, internet-based collaboration, the market for smart contract blockchains could meaningfully exceed $100 trillion.