The Disrupt Weekend

Blockchains sell blocks! That’s the revenue. And what are a blockchain’s expenses? Security! Both issuance and transaction fees. Simply put: Net Profit = Transaction fees (in $) – Issuance (in $).

But here’s the dirty little secret: blockchains are hemorrhaging money. None are profitable. None are sustainable at current security levels. But for the first time in crypto history, one chain is about to become profitable. Not profitable by a little. Profitable by a lot.

As a crypto investor, one thing you can do is find the most profitable blockchain business and invest in that. The best blockchain sells its blocks for the most value as people are willing to pay for it, meaning it has product-market-fit as a settlement layer.

We can analyze “successful blockchain businesses” by looking at the amount they spend to secure the blockchain versus the amount of revenue they bring in via transaction fees. If a blockchain is paying more for security than the revenue they bring in, they’re running a deficit.

Ethereum is bringing in nearly $13M in transaction fees every day, making it the most valuable blockchain by this measure. However, the flip side of that is that in order to produce those blocks, the network is distributing $36M in ETH per day in issuance to miners. As such, Ethereum is currently operating at a -64% loss.

Virtually all [other] major Layer 1s are operating at a loss of around 90% or worse. Despite a decade of issuance reductions—three Bitcoin halvings—the Bitcoin network is still operating at a -98% loss.

So what’s the path for blockchains to become profitable? There are two main levers:

  1. Increase transaction revenue – The primary way for a blockchain to increase its transaction revenue is to increase its block utility; to increase the value of what can be done within each block. This can be done by building valuable applications on top of the network, increasing the surface area for what’s possible on the network and the utility that users can derive. Blockspace revenue is almost directly correlated to the number of valuable applications on the network and the opportunity they hold. And all of this is contingent on the network being decentralized and secure. As mentioned, blockspace isn’t that valuable if transactions can be reversed or censored and fewer applications will set up a long-term home in such a network.
  2. Reduce the security expense – Increasing blockspace utility largely has to happen organically. As such, the main pathway to sustainability for blockchains will be to reduce the issuance over time, lowering the network’s expenses. The big tradeoff when you reduce issuance is that you’re spending less on security. Unless the price goes up, every time a network reduces its issuance, there’s less of an incentive for validators/miners to keep operating. Blockchains must balance the supply of blockspace they produce with the issuance that this brings along with it. If you want more scale, you must pay for more security.

Ethereum is the first blockchain on a clear path to economic sustainability with The Merge. Sometime later this year, likely in June/July, the network will shift to Proof of Stake and reduce its issuance by 90%.

Later this year, the network will be distributing $4M per day in issuance while generating $13M in revenue, generating a net profit of $9M and a profit margin of +72%.

The interesting part of The Merge and Ethereum’s shift is that it’s not just a pure issuance reduction. There’s a fundamental change in how that “security budget” is spent while tapping into higher security efficiency. Given the shift in the consensus algorithm and the improvements it holds, Proof of Stake makes Ethereum more secure while simultaneously allowing the network to reduce issuance.

It’s worth highlighting that ETH also completes the triple point asset thesis with the Merge and its full transition to become an interest-bearing asset. All of the transaction fees generated from the network will go to ETH holders via EIP 1559 (buybacks) and staking (dividends). As a result, ETH staking yields will shoot up to a double digit APY, driving more demand for the asset as investors race to soak up those yields, all while the network becomes more secure from the increased stake.

Ethereum is on course to become the first profitable blockchain. And it will happen in months, not years. Will other chains follow Ethereum? That depends very much on the quality of the product they sell. How much will the market pay for their blocks? Will they still buy them when token incentives dry up? How will Layer 1s compete for profitability against Layer 2’s that don’t have to pay billions per year on security through token issuance? We’ll find out in the months and years to come.

In the long run, only the profitable survive.”

See Also: The Empire Model for Blockchains

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