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State of Ethereum Q1 2023

Apr 21, 2023 ⋅  9 min read

Key Insights

  • Q1 2023 marked a period of recovery for the crypto market. Turbulence in traditional finance highlighted the need for neutral stateless money and decentralized financial infrastructure.
  • With a buoyed sentiment, activity across the Ethereum ecosystem improved across the board. DEX volumes, NFT volumes, and total value locked saw material growth.
  • Stablecoin supply fell by $13 billion. USDC briefly depegged, and Paxos announced it would discontinue BUSD under regulatory pressure.
  • Layer-2 solutions continued to boom. Arbitrum and Optimism contributed 45% of the transactions across Layer-1 and Layer-2.
  • A smooth Shapella upgrade completed Ethereum’s transition to Proof-of-Stake. The next upgrade is Cancun/Denneb, which will likely make transactions on rollups 10-100 times cheaper.

Primer on Ethereum

The Ethereum blockchain network is a decentralized computation and transaction validation platform. The breakthrough introduction of smart contracts and a virtual machine on the network creates a decentralized Turing-complete software solution. There are thousands of applications built on top of the Ethereum blockchain. The protocol gained broad recognition after developing a deep decentralized finance ecosystem and, more recently, interesting Web3 use cases. The protocol made the transition to Proof-of-Stake from Proof-of-Work on September 15, 2022. The next step for Ethereum is to meet the growing demand for blockspace by creating a network of Layer-2 solutions that enable it to scale throughput while maintaining decentralization. Today, Ethereum is the world’s second-largest cryptocurrency by market capitalization.

Key Metrics

Quarter’s Highlights

Financial Overview

The last year for crypto was marred by controversies, crashes, bankruptcies, and fraud. But, the first quarter of 2023 saw early signs of recovery in sentiment and price. A key accelerant to the narrative was failure of Silicon Valley Bank and Credit Suisse. Believers and non-believers of crypto were reminded of the need for hard stateless money and decentralized banking infrastructure run by code, not imperfect humans.

Bitcoin emerged as the primary beneficiary as macroeconomic concerns snowballed around the stability of the U.S. dollar and the fiat system at large. Ethereum benefitted as well with its sustainable monetary policy and a large ecosystem of decentralized applications offering a differentiated proposition.

Q1 2023 was Ethereum’s second quarter of negative net issuance. As market sentiment improved, there was an uptick in on-chain activity, which led to higher fees and greater burn. Cumulative base fees for the quarter rose by 50%, and cumulative priority fees increased by 5%. Over the quarter, the supply of ETH shrunk by ~79,000 ETH, 19 times higher than the burn last quarter.

Validators’ annualized real yield for the quarter was 5.9%, marginally lower than the 6% they earned in the previous quarter. Nominal yield was 5.6% lower by 0.4% for the quarter, but its impact was partially offset by higher net deflation of 0.3% compared to 0% in the previous quarter.

With lucrative real yields, there were strong flows into the staking contract for the quarter. Over 2.2 million new ETH was staked over the quarter, increasing staked supply to 18 million. At the end of the quarter, Ethereum’s staking ratio was 15%, up from 13% at the beginning of the quarter. Staking ETH was recently derisked thanks to the Shanghai/Capella upgrade that enabled withdrawals from the staking contract. With lower risk of staking, the amount of ETH staked should grow materially over the coming quarters.

Network Overview

In Q4 2022, when fears of censorship were at their all-time high, we wrote that Ethereum’s censorship concerns were overstated. Time has proven this to be true. The percentage of validators using censoring relays was just 29% at the end of the quarter, down from 61% at the beginning of the quarter. Any address sanctioned by the United States Office of Foreign Assets Control (OFAC) can have transactions included in 2 out of 3 blocks. Ethereum remains a neutral base layer.

Onchain activity was flat for the quarter, with average daily transactions at 1.1 million. There was a huge fall in DeFi activity as DeFi transaction count fell by 40% to 60,000. This was offset by growth in NFT and other transactions that grew by 10% and 22% to 171,000 and 241,000, respectively. Bridge activity increased by 18% to 14,000.

DeFi activity may have fallen due to the growing role of Ethereum’s Layer-2s (L2). L2 share of transactions has grown consistently every quarter since their launch. In Q1 2023, L2 share of transactions increased to 45% in Q1 2023 from 38% in Q4 2022. L2 share fell as Optimism’s incentive program ended in January, but it recovered later in the quarter from growth in Arbitrum transactions. L2 share hit its all-time high of 73% on the day of the ARB token launch.

Shanghai, Capella, Cancun, and Denneb Upgrades

On April 12, 2023, Ethereum underwent the Shanghai / Capella upgrade, which allows for withdrawals from the staking contract. Rewards accrued by the validators since the launch of the beacon chain are being distributed automatically to them and feature under “Withdrawn Rewards.” “Full Withdrawals” or “Withdrawn Principals” are voluntary exits by validators who wish to unstake. Over 1.1 million ETH has been unstaked, of which 80% were rewards and the rest were full withdrawals. A large part of full withdrawals was done by Kraken, which had to shut down its staking operation for U.S. accounts as part of its settlement with the SEC.

Even then, with 590,000 ETH newly staked since Shapella, deposits outweigh full withdrawals by almost three times. Shapella allowing for staking withdrawals oddly leads to greater inflows to the staking contract as it derisks ETH staking.

With the Shapella upgrade, Ethereum has fully transitioned to Proof-of-Stake. The next key upgrade will make Ethereum scale using a modular architecture. EIP-4844 is a promising upgrade that will likely form part of its next upgrade Cancun / Denneb, later in the year. EIP-4844 or proto-danksharding will introduce ephemeral data storage or storage blobs. These storage blobs will allow rollups to settle transactions and post data on the base layer without competing with other Ethereum transactions, potentially making rollups 10-100x cheaper. As a result, L2 transaction costs will come in line with alt-Layer-1s, reducing the economic pressure on Ethereum’s users and builders to transact and build elsewhere.

Quarterly Chartbook

Network Metrics

In the previous quarter, Binance consolidated its wallets, which led to a spike in the number of active wallets. As a result, the average number of daily active addresses on Ethereum saw a decline of 4% to 425,000. Unique addresses also saw a slowdown in growth, with only 8.2 million new wallets being added compared to 12 million for the previous quarter.

Ethereum had a strong growth of 29% in its total value locked (TVL) to $33 billion. However, its growth pales in comparison to the relative growth in the TVL of L2s. Arbitrum’s TVL grew by 135% to $2.5 billion, and Optimism’s TVL grew by 83% to $1 billion.

Sectoral Metrics

Stablecoins on ETH fell by $13 billion over the quarter to $73 billion. The supply for USDC fell by $10 billion as it depegged briefly after Circle announced that a part of its reserves were in the failed Silicon Valley Bank. BUSD had outflows of $5 billion as Paxos announced that it will be ending its partnership with Binance as per directions from the New York Department of Financial Services (NYDFS). Amidst this chaos, USDT came out as a winner, growing its supply by $4 billion.

Trading volumes on decentralized exchanges increased by 17% for the quarter to $4 billion. March 11, 2023, the day of the USDC depeg, was the day of highest trading for the quarter, with $40 billion in volumes being logged.

Daily NFT volumes saw a huge surge of 146% in Q1 2023 to $45 million. There was a noticeable increase in activity after the Blur airdrop. With $29 million in daily volumes, Blur led NFT volume share with 64%. It was followed by OpenSea with $11 million in daily volumes and a volume share of 25%.

Infrastructure Metrics

TVL on Arbitrum surged to $2.5 billion at the end of the quarter. Native applications GMX and Radiant contributed the highest TVL for Arbitrum, with respective TVLs of $510 million and $330 million.

Optimism’s TVL also increased significantly, growing by 80% for the quarter to $1 billion. Its native applications, Velodrome and Sonne Finance, were the key drivers for TVL growth as they grew by 270% and 190%, respectively.

Annualized validator yield for the quarter was 5.6%, slightly below 6% in the previous quarter. The majority of the yield was on the back of new issuance, which contributed 3.9% of the 6%. Transaction tips and MEV payments contributed 1.1% and 0.6% of the staking yield, respectively.

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Kunal previously worked in equity research and now considers himself a financial analyst in crypto. He specializes in valuation and bottom-up analysis for Layer-1 and DeFi protocols because he has yet to learn of a way to value NFTs.

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About the author

Kunal previously worked in equity research and now considers himself a financial analyst in crypto. He specializes in valuation and bottom-up analysis for Layer-1 and DeFi protocols because he has yet to learn of a way to value NFTs.

Mentioned in this report