Valuation Framework for Public Blockchains

This report compares blockchains to the likeness of traditional companies and uses a profit & loss framework to encapsulate this idea. Figures are annualised and do not represent forecasts.

Blockchains quite simply, sell blockspace. Each blockchain has a methodology for pricing transactions that are included in blocks that range from auctions to a target number of transactions per block. However, not all blockspace is valued equally as different chains offer different security guarantees, transaction throughput, dApp ecosystems, and other capabilities as trade-offs.

The amount that a network sells its blockspace for can be seen as supply-side revenue, that is the total fees paid by users who want to have their transactions included in the network. Below we show the estimated annualised network fees for the leading smart contract platforms. Ethereum has by far the most demand for its blockspace as evidenced by the approximately $4.8 billion in network fees followed by Binance Smart Chain and Avalanche with $449m and $128m respectively. Despite having more daily transactions, Solana and Polygon don’t generate as much in fees due to the low cost per transaction.

However, the production and protection of the blockspace do not come for free, the network must pay out rewards to key participants of the network to maintain liveness, order, and security. These participants (validators) incur costs such as capital requirements for the machinery and the stake as well as ongoing energy costs. Validators also take on technical and crypto-economic risks and need to be compensated for this as well. The network typically pays for these costs from block subsidies which are predetermined rewards for producing a block.

Below we show the estimated annualised issuance rates (predetermined rewards) of the leading smart contract platforms. Ethereum once again tops the charts although this is not necessarily a good thing. While it is important to reward validators, it’s also important for the health and long-term sustainability of the network not to overpay for these services. We differentiate between the estimated issuance rates of Ethereum under Proof of Work and Proof of Stake to highlight the change when the merge takes place.

The blockchains highlighted all operate at varying scales (different hardware requirements, number of users, transaction speeds, number of validators, etc.) meaning that the issuance rewards for each network will differ based on specific needs. Therefore, we calculate below a ratio of network fees to issuance to more appropriately examine the sustainability of the tokenomics (token-economics). We see that under Proof of Stake, Ethereum could generate over 4x more in fees than the total issuance of ETH.

Having high supply-side revenue (total fees paid by users) is important, it implies valuable blockspace and product-market fit within the network. However, a network with high blockspace revenue isn’t by itself an implicit value driver for coin holders. Fees are paid out to validators who may then choose to sell their coins to cover the cost of running their operations or take profits. This can actually be counterproductive as this sell pressure lowers the value of the coins and hence also makes rewards less valuable. Under Proof of Stake, energy and maintenance costs aren’t as expensive as under Proof of Work, which does help to alleviate the sell pressure as less funds are needed to sustain the validator operations.

Importantly, a network secured by Proof of Stake requires that the stake have significant value to ensure the right crypto-economic incentives are in play. Due to this need for value accrual, some blockchains have started to “burn” a portion of the fees paid to validators. Burned coins are sent to an address from which they are irrecoverable hence the terminology “burned”. The burning of these coins reward coin holders as the reduction in the supply creates more scarcity. This has a similar effect to what share buybacks do for shareholders - less supply with the same demand results in a higher price per share/coin.

We show below the annualised value burned for select blockchains. As burned coins are proportional to supply-side revenue, it is no surprise to see Ethereum once again at the top of the leader board followed by Avalanche in a distant second.

There are a variety of burning mechanisms among different chains. Ethereum’s transaction fees have two components, 1) the base fee, which is the cost of the transaction and 2) the tip, which is the optional fee to increase the likelihood of a transaction being placed in the next block. Ethereum’s burn mechanism burns the entire base fee but leaves the tip untouched. Polygon has a similar mechanism while Avalanche also burns the tips. Solana and Fantom each burn a fixed percentage of the transaction fee while Binance Smart Chain’s burn mechanism is based on the price of the BNB coin. It’s still too early to tell which mechanism is most effective for value accrual but these mechanisms likely won’t accrue value if there isn’t any demand in the first place.

The net issuance of a blockchain is the number of coins issued less the number of coins burned. Chains with a negative net issuance (greater burn than issuance) are in an ideal state for value accrual. We highlight below a snapshot of the current net issuance levels (and for Ethereum under Proof of Stake when the issuance costs will be materially reduced).

From the network point of view:

• Supply-side revenue (total network fees) is akin to the GMV (gross merchandise volume), usually referring to the total value of merchandise sold over a given period of time on a platform. This is the value of transaction fees on the blockchain (value of the blockspace sold) over a fixed period of time.

• Burned coins are akin to revenue. For most layer-1s, the value of burned tokens is proportional to the value of transaction fees hence this can be seen as a take-rate (the fee charged by a marketplace on a transaction).

• Issuance rewards are a cost on the network required to pay for the liveness, order, and security of blocks on the blockchain.

• Burned coins less issued coins can be seen as a form of profit for the chain. If burned coins are greater than issued coins, then value is accrued to the remaining coins (and benefits coin holders). But if issued coins are greater than burned coins, then this dilutes existing coin holders.

Within this framework, we have a form of revenue, cost, and profit. We can now calculate and compare a form of pseudo-profit margins among the chains.

It should be noted that Ethereum is at a later stage in the cycle. Thanks to its first-mover advantage, higher incentives early on, and network effects, Ethereum is a much more mature platform than its competitors and is likely to have a negative net issuance post-merge. This is because Proof of Stake is cheaper than Proof of Work to run, so the issuance rewards (costs) can be significantly decreased without impacting total network fees (hence the amount burned). Similar to Ethereum, most chains have planned for a decrease in their block subsidies over time and hope to increase fee revenues and hence value accrual through burning. The stage has been set for a sustainable and valuable blockchain ecosystem.