How to value Ethereum and other layer 1s

Transcript

GM good morning welcome to the milk Road show The Daily crypto show where we keep the summer Vibes alive in our crypto insights even as the days get shorter I'm your host Jay Hamilton and we are joined today by Kyle reidhead co-owner and head of research at milk Road in today's episode we're going to talk about how do you value L1 blockchains and there's a key a few key things here that people are missing there's a lot of conversation going on right now on crypto Twitter around are L1 fee revenues the most important thing in order to Value an L1 blockchain when you're talking about ethereum we talk about salana if you're investing in these you want to know how do you value

these blockchains now and long term and you're going to understand throughout this episode that there's a little bit of a mistake that everybody's making that we're going to set the record straight on and we're also going to talk about when you value these things what is the most important thing in the long term in order for these Investments to be strong in your portfolio now before we jump into today's episode we just need to take a moment to hear from our fantastic sponsors over at Gemini and kelp Dow discover Gemini The us-based Exchange built for new and advanced Traders as a special welcome gift they are offering new customers $15 in Bitcoin just for trading a Gemini security is a top priority as a licensed

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back Jay welcome back how was the uh how was the honeymoon it feels weird for me to be on this side I'm I'm used to be interviewing and all of a sudden now being interviewed again this is exciting well thank thanks for holding down the fort for me while I was off the the wedding and the honeymoon were amazing no time like having time to relax when you have a one-year-old I didn't have my one-year-old for a full week and I got to sleep and hang out with my favorite human my wife so couldn't have been better not look at markets I kind of wish that I was you during that time but uh hey we're back we're here we're ready to go okay let's get into the topic of today's conversation Kai you've been uh really uh active on Twitter these this

past week trying to set the record straight on something that a lot of people seem to be making a mistake on and I don't blame them for making this mistake because when you think about a business obviously you're going to think about revenue and profit and loss like those are the main things and so when you think about a blockchain you think okay well how does a blockchain make money well they make money off fees so fees must be very important why is it that you feel that people are overestimating the importance of fee Revenue when they're valuing L1 blockchains like ethereum and salana yeah so first most tokens in crypto I think the revenue the fees they're

making they really matter profit and loss as you said businesses it matters so for everything that's not an L1 asset I think that that really matters if you're looking at maker you're looking at a you're looking at whatever it is of course they need Revenue needs to be sustainable L1 native tokens for blockchains are a little bit of a different story these are not necessarily businesses yes they sell block space but the assets for the blockchain so eth to ethereum and soul to salana are a little bit different in my opinion ethereum salana these are ecosystems right think of it similar to like a country and in these ecosystems while Revenue matters a little bit and fees matter a little bit I actually think it's the moneyness of these assets that matter much more now everyone hates

that term on crypto Twitter I I feel like if I say the word money you get a million reply guys that are like they so stupid this stuff's not money what are you talking about I'm never going to use eth to buy coffee blah blah blah it's not what I'm talking about so we'll we'll maybe clarify that in a little bit I just think as an L1 the way that it works is we need to cons and they're going to get commoditized they're going to consistently try to be cheaper and cheaper and cheaper for people to want to use these ecosystems for developers to build on there for applications to launch and for users to use It ultimately I think users are never going to think about fees and the applications themselves are going to cover the gas fee costs but they're only going to do

that if things get cheaper and cheaper and cheaper and so I think the fee Revenue we get right now we get so excited about and we're keeping an eye on so much because like ethereum was making I don't know hundreds of millions of dollars a month previously but that was all unsustainable that was all dumb no one was going to pay $60 per transaction for the future of Finance this never going to happen so people got so horned up over these ridiculous fees for absolutely no reason it just made no sense and it never was going to make sense and then all of a sudden salana came along and it was like okay this thing's super cheap and it didn't have a lot of fees and then all of a sudden it started to get more fees as more users started using it now people are like oh

my God it's catching up to ethereum it's getting more revenue and then ethereum launched the eiip 4844 and fees became very cheap on l2s l2s weren't paying much back to ethereum they still aren't and so people are all worried they're like oh my God ethereum doesn't has no more fees anymore but salana does so like ethereum's useless and everyone's going to use salana and souls the best token and blah blah blah blah and I just think guys the whole purpose of these blockchains is to continuously get cheaper and every single year moving forward both Solana and eth will only focus on getting cheaper and cheaper and cheaper for their customers it's the whole point and so every time that fees get up a little bit more the whole all the cord devs are go how can we get this thing cheaper and so like yeah we had

EIP 4844 that happened eventually you're going to get a bunch more traction on l2s I mean every month it's already going through all-time highs more and more people are going to go on there it's going to start to get more fees and ethereum is going to go okay what can I do now make it even cheaper and then even cheaper and salana is going to do the same freaking thing and so I think fees are going to basically Trend to zero and so is me this is the other type of Revenue that that blockchains can can create and I think both of those are going to Trend to zero because it's better for the end user for it to Trend to zero and so I don't think we should ever be valuing any of these blockchains by fees now I think that's the way we do

it now and the price action sort of reflects that as eth has gotten worse in fees it's gone down salana kind of the opposite and so I think that's the way we're currently valuing these assets and I think we we really need to stop and we need to look at these assets for what they are which is money within an ecosystem so I'll leave it there and there's probably a ton of questions because I know a lot of this is confusing we'll talk more about all that but I'll let you take the floor for a second yeah it's it's never confusing when you explain it Kai so we're we're all gravy as long as the words are coming into your mouth okay I want to touch on me and I want to explain what that is but before we get there and I also want to touch on Mone and this term

because I think that is a key concept to understand is in order to understand the value of L1 blockchains you need to understand the importance of their assets as money within their ecosystem so you brought up two things we're going to get to but before we get to those I just want to bring up a couple of charts to look at the fees on ethereum and salana you mentioned this briefly but if I pull up here's the chart of ethereum fees over the last since uh 2018 uh so over the last six years since it's its Inception what do you see when you see this does this say the the story that you're trying to tell us yeah I mean so first of all I mean you have these crazy fees back last cycle when it cost so much use ethereum which never made any

sense people were so bullish on that that was the best thing ever and then obviously it goes down in bare markets which happened in 2022 and then it started to climb back up over the last you know year and a half or so as we started to get more bullish prices start to go up again more activity by the way the fees that we're looking at here are gas fees so basically when people transact on top of ethereum there are or not just people when other chains transact in use ethereum like layer 2's there's a a fee that you have to pay and that goes to to validators so that's the fees that we're looking at here now it's gone really really low over the last little bit part because price has been down for the last six months so there's not a lot of activity both on the layer

one and on l2s or l2s are not paying too much and then also we had the EIP 4844 which brought down the costs for l2s to settle transactions or to put data on ethereum and so that became very very very cheap and uh and so now it's basically you can think of it the Broadband moment for ethereum it's got a bunch of Supply now for Block space and it's not being used enough yet there's not enough demand and so its fees are are and revenues are are very cheap as a result right A lot of people post this chart as a bearish chart fees are going down therefore ethereum won't have enough revenue and won't be value but that's not how you feel you're not I think it's super bullish chart because the thing is if you look at ethereum and its entire ecosystem its usage in terms

of users and in terms of transactions and in terms of apps deployed it's is at alltime highs and yet it's the cheapest it's ever been for all these apps and all of these users what more could you ask for that's perfect right the whole point here is to expand the ecosystem of crypto get more and more developers more and more users to use this that's not going to happen if they have to pay $100 per trans transaction no user is going to do that and no app is going to launch on that that's obvious right the only reason they did it five years ago is because there was nothing else but ethereum but now that there are cheaper blockchains and cheaper you know l2s of course they're going to go and use the cheaper stuff because that's how you can scale and get social media on chain and

get payments etc etc dpin all that stuff doesn't exist when it's really expensive and so the fact that we are now getting super super cheap for people to use ethereum the number one blockchain in the world currently where all the liquidity is all the developers are that is extremely bullish especially as we reach all-time highs on all the different metrics for users that's exactly bullish I don't know how you can take it any other way right so the natural follow-up question which I don't necessarily want want you to answer right now but I know this is on the mind of all of our listeners is okay great that this is bullish but if a business is not making revenue and their number one Revenue source is fees then can that business be successful long term and

your answer is yes they can be successful even with low fees don't go ahead don't answer it now well I just want say yeah don't think of this as a business right I I think you need to think of it as an ecosystem like a country yes countries need Revenue but like they mainly just don't want to be in a ton of debt they want to make sure there's a lot of growth happening and then their asset gets used across the ecosystem their their currency right and it becomes the currency for their own company or their own country and then maybe for other countries as well right like gold has no revenues but it's used as money as a store of value and so it works Bitcoin is not in terms of like a business is not a sound business at all it's bleeding every single month and it

has been since it first started and yet it's still money and it's worth one point whatever trillion it's because it's used as money within not its ecosystem because there's not much in its ecosystem but like it's just used as money store of value a different means of money but I don't think we need to think of these things as businesses as much as most people are okay and then just to quickly look at the salana chart because the salana chart tells the story of no fees no fees no fees no fees and then starting at the basically the start of this bull run Q4 last year all of a sudden fees started to Skyrocket and and this is still bullish like Lana is very cheap to transact and its fee revenue is coming up is increasing right now it's still not near ethereum but it's getting

there and so I still think this is bullish and the reason I say this is the key here is that the average transaction fee or just the median whatever you want to call it like the transaction fee for users needs to be extremely cheap but if you get enough volume then you'll get enough revenue from that while keeping the transactions really really cheap that's kind of the goal here but the goal is not to just like print money and make as much revenue as possible it's just get enough Revenue that validators are happy and that you're burning enough so that your inflation isn't too high right it's like in the US inflation at 2% is fine that's what everyone wants there's still inflation but you but 2% is still okay you can have a little bit right as long as there's still new demand and more people com to the

country and more things happening in the country it's all good to inflate just a little bit and so even in bitcoin's case everyone's like yeah it's inflating at I don't know I think it's 0 eight% or something right now like it's fine because there's enough demand that the price is still going up and so I think revenues matter what we want is for these assets to become deflationary which you need revenues for that because we burn half the revenues essentially that's how more than half for eth and Sal is something similar so like we definitely need to control inflation the problem right now salana has like six s% inflation right ethereum has like point I don't know five or6 and so a little bit boost in Revenue which we'll get as activity comes up will make eth deflationary right or close to it or neutral that is fine that's all you need

it doesn't need to be any more than that right now it's a bonus if it gets more and I think in 10 years now when volumes and transactions and users 10x 100x THX 10,000x you got to understand like what's happening right now does not really matter in crypto we're GNA have so many more transactions as everything moves on chain that as long as we can continue to make things cheaper and cheaper and cheaper so that we can have a 10,000x increase in volumes and in transactions then you're going to have enough Revenue to keep these assets deflationary right and so I think people are kind of missing that aspect is like the revenues don't really matter right now it's so small who gives a let's just keep trying to get cheaper so we can get more apps more in Innovative apps that can't exist on blockchains

today okay so fee revenue does not matter to the success of a blockchain of an L1 blockchain long term right now fee revenues are very high so it's very easy to look at that and say hey that's that's amazing great business let's invest let's talk about me for a second what is me and how does me impact L1 blockchains yeah so me this this is the sort of second way that blockchains can ACR revenue and when I mean say blockchains I mean validators can actually acre the revenue and Kyle Sani from multichain capital is the one that comes out saying look fee Revenue doesn't really matter that's probably going to zero me is actually all that matters and if you don't know what m is all of you have had the negative impact

of me which is basically this when I try to initiate a transaction on a blockchain it's public so when I say hey I want to swap you know my $100 of usdc for $100 of eth that's public and so there's about 15 seconds or whatever between blocks on ethereum for example and however long it is on other chains doesn't really matter but what that means is there's a little bit of time for validators or for Bots or whoever to Arbitrage that and to actually put in a transaction before me that undercuts that and makes the price go a little bit lower so that they can actually get the better price on that trade and they can skim the top off me and so I'm actually never getting the best price this happens everywhere in blockchains it happens even in traditional world every time you go to buy an asset in

traditional World there is me type that is sort of taking a cut from you it's like a hidden tax basically now the good thing about blockchains is we can actually prevent this now we don't know exactly how to do it yet but we've got apps and we're kind of working on ways to start preventing this and so Kyle Sani anyway thinks that m is going to be the biggest thing and that that's really what matters and salana is doing a really good job at basically getting meev which means stealing money from users right which is bit ridiculous but that's what he thinks ethereum had that as well but then layer twos kind of take away from that because ethereum doesn't get any me anymore l2s take all that me so the ethereum validators don't so people think that's a big problem again I don't think this an issue I think me

is going to zero and the reason I say this I think we already have innovative ways to get rid of it if you think of the incentives of where are things going to go if an app can launch and not have me so that their users don't get scammed what do you think is going to happen of course they're going to go the route of not getting scammed if users can choose to use an app that doesn't scam them and they can get a better rate what do you think they are going to do they're going to go the route of not getting scammed okay now in traditional world we don't have that choice I have to get scammed every single time because it's not an open public Ledger I can't just go and do something else my money's in Robin Hood I'm getting scammed by Robin Hood

there's nothing I can do about that right but in crypto on blockchain it's very different and so I think that me will go the way of nothing down the road and so I think meev doesn't matter fees matter a little bit but just enough to make it you know deflationary is but I don't think again it's the way that we need to Value an asset okay so the obvious follow-up question is if everybody in the world thinks that fee Revenue matters and that matters and you're saying it doesn't what does matter when we're valuing these blockchains so I think it's money and when I say money I don't mean using these assets to pay for coffee we'll probably never use ether Soul or Bitcoin to pay for coffee like that's just a people are delusional we'll probably

just continue to use USD or usdc usdt blah blah blah whatever where I think we use these assets as money is multiple different ways one in defi as collateral if I want to get die right or I want to get SSD which is from Athena if I want to get out of stable coin I use my eth to as collateral to get stable coins right if I want to take out a loan if I want to lend I'm usually going to do that on eth and even better eth that's staked because it gets a bit of yield same with soul soul that Stak that gets yielded these are the best assets I could possibly use for money for collateral trading pairs on dexes every time you put an asset on a DEX when I use Unis swap if you want to get usdc there has to be a trading pair on there

usually it's done with the native asset of the of the blockchain sometimes it's also done with stable coins but the native asset is also often there gas fees every app every user whatever that wants to use Salon or wants to use eth or anything in the ethereum ecosystem they have to use that native token as a gasby and so there is a money there for the digital ecosystem and I think that the more that these ecosystems or these blockchains kind of proliferate they get more users they get more applications they get more use cases they get more developers it just means that these assets are more or proliferated as money throughout their ecosystems now why why use eth on ethereum or ethereum l2s instead of maker token or a token or whatever the key answer here and the one

thing that we know will always be true is that eth will always be the most trustless asset on ethereum sole the same for salana why because I don't need a team to launch the token of eth it just exists natively on the blockchain every other asset I don't care what it is a stable coin a token for a company uh real world asset of a stock I have to have a team that launches that and controls that and then I also have a smart contract that has to initiate that and so there's risk of the team and there's risk of the smart contract always but there is not that for eth and there's not that for soul and so for the native tokens of l1s they are money they are collateral because they are the most trustless asset they are already a form of money on the ecosystem by default and

there's nothing anyone can do about that because you cannot transact on salana without paying in Soul and same with ethereum without paying with eth even all the l2s everyone says l2s are parasitic because optimism can use op as its gas token don't care I can still pay o op to transact an OP but it still has to pay eth to settle those transactions up on ethereum and so it's always going to be gas money on these ecosystems it's always going to be the most trustless and so it would make sense that it becomes the collateral it's also the most decentralized token meaning it has the the most holders of any other assets on there it's hard for anyone to compete with that because you need to hold it to pay for gas so there's so many reasons that make these assets money on their ecosystem now all that matters of course

money on ecosystem doesn't matter if there's nothing on that ecosystem right so like it needs to be a vibrant ecosystem and so as long as there are things being built on it that need to use that asset then it becomes more and more money and that is the demand for these tokens right if you look at eth right now something like 40 or 50 or whatever it is percent is in smart contracts 30% of that or 30 something per of that is in in staking and another 10 15% is in defi that is money that is collateral that is so much demand and that just continues to happen right and so the more l2s that do well in ethereum it's not parasitic to ethereum not at all because all it does is proliferate eth as money right doesn't matter if that L2 is ethylin or not ethylin I

don't care doesn't matter if it uses eth as gas or or not again doesn't matter because when they have defi protocols on there people are going to use eth because it's just the most trustless asset that exists and again optimism or whatever L2 that succeeds they still have to use eth as collateral and actually if you want to bring up the um screen share here token terminal just put out a really cool new metric which I thought was quite interesting this came out like the other day and if you look at this metric it's looking at base okay and it's saying of all the protocols that are on base let's look through every single protocol what is the asset that is used the most on every single protocol that exists on base eth wins every single time every single time it's the most used asset so that is a clear

indic Ator that eth is being proliferated as money across l2s and yet this is the thing that Kyle Sani and all these other people hating on eth right now are building this narrative that eth is not money and l2s are parasitic to eth but in fact if you just look at the metrics they are not at all every L2 just pushes eth further along as being money and again when I say money it's not about buying coffee I don't think we will ever use eth to buy coffee it's to use in digital ecosystems so this is a a weird concept for people it's it's hard for people to wrap their heads around it's also one that you can't like measure like I can't just look at a chart of like how money is e you know whereas I can go how much revenue or fees that ethereum generate so it's

easier for people and so I think that's why there's confusion they'll probably continue to be confusion for a while but I think these assets will do well both soul and eth even if the revenues don't matter just for the fact that they become money and there's just demand for that so the utility of these tokens within their ecosystem is the key to their long-term success is what you're saying I think so I I think so I just don't see how it could be any other way one again because it's the most trust if you're going to ever put a loan out on ethereum for and I think institutions here for hundreds of millions of dollars there's no other token that competes with that right now nothing right like you're not going to use any other token except for maybe a stable coin but a lot

of times you want to use collateral of something that could still appreciate no other token's remotely close to being trustless enough and never will be but also no token is remotely close to being as like let's call it decentralized in terms of its holders right not having the risk every other token is so small like the biggest tokens on ethereum that are not stable coins are like I don't know like what's Unis swap like8 billion fdv but it also has unlocks like like no one's using that as in hundreds of millions of dollars as collateral they have to use e now maybe eventually in five years from now maker token becomes so valuable and so good and there's no more token unlocks and whatever that people start to use as collateral but that's 5 years from now maybe right right or maybe it's 10 years from now do

you know how much Network effects eth has over the next five years to build up as collateral like so much and this is even counting like what happens when reaking comes in if eth continues to be the dominant token for that or Soul over on the salon ecosystem again I just don't see how anything can take over its monein now the only one that I've heard that could come true I was talking to actually someone we had in the episode last week and what he was saying is that the only one that could compete with this is Bitcoin Bitcoin is currently the best form of collateral the problem with Bitcoin is it doesn't have a vibrant ecosystem there's nothing to do with your Bitcoin on the Bitcoin blockchain and when ethereum first launched we had wrapped Bitcoin which still exists but to a lesser extent but it was very

popular where you would put your Bitcoin in maker or in a or whatever and so there's still the chance that that happens if Bitcoin continues to proliferate the problem is is that again there is centralization risk because someone needs to custody that Bitcoin right right now like for rat Bitcoin the biggest one we have it's like bitgo or whatever so we have to trust an exchange which is bit odd right especially with the Bitcoin ethos and the ethereum ethos and then there's also just smart contract risk too right like I have to bridge it over there's a bridge risk then I have to have it as this erc20 token that's wrapped like there's a lot more risk there than even just the ERC 20s that exist on on ethereum and so maybe Bitcoin becomes the collateral on salana and on ethereum and on ethereum l2s and then okay that could be an issue

for Ethan soul I just don't see that playing out because there's so much risk there so it doesn't really make sense to me either but but maybe we'll see before we wrap here Kai what would you say are the most common misconceptions that we discussed in this episode that like all of our listeners could take away and be like hey erase these from your mind and try to because these are very difficult things to wrap your head around because blockchains are totally new tech it's like trying to wrap your head around the internet to start of the internet yeah I think the biggest thing is don't look at where we are now and think that this is how it's going to be 5 10 years from now think about okay for this all to work I think everyone here listening to this

episode right now believes that we are going to get it to the point where onchain is just like online right it's like everything we do is now onchain think about what that world looks like if that happens it means billions of users right it means quadrillions of transactions in volume like numbers you can't even imagine if the whole financial system comes on chain and social media comes on chain and pay everything we do basically becomes on chain which I think we all think is going to happen think about how much scale we need right everyone thinks right now like salana is the NASDAQ of whatever it's trying to be the fastest blockchain if you don't think that salana is gonna have l2s it already has five by the way if you don't think salana is gonna have l2s it is they already have launched Network extensions

which is an L2 because they are going to have scale issues as well I don't care what anyone says if any chain is going to be successful it has to process billions of people and billions and billions of transactions which is nothing like what we're doing today not even close and so we have to keep getting these blockchains cheaper and cheaper and cheaper and so ethereum and l2s that's all they are going to do over the next 10 years in salana as well and so the fees and the revenues and the users and all this stuff we look at now is all useless it does not matter so think about where will we be in 10 years when all these change just get consistently get cheaper and cheaper and cheaper and cheaper and that's their only goals for the next 10 years because everything is moving on chain in that

world what matters maybe fee Revenue matters probably me doesn't exist I would think it might not I could be wrong there but I I'm pretty sure it's going to go away and fee Revenue actually at that point probably will be pretty large if we have billions and billions and trillions of transactions like at that point maybe it matters a little bit and that keeps these assets deflationary which is great but ultimately I think it's we got to understand where are these assets going to play a role how are they going to make sense in these ecosystems and think of them as ecosystems not necessarily as businesses right ethereum's whole goal is not to get you and I to go and transact and use it absolutely not their whole goal is to get businesses and other blockchains to come and use its Network right Salon same

thing it's whole goal is to get applications and really it's probably to get web two companies like Twitter Etc to come and like Link in and integrate into their chains that's the world we're moving to and so all these chains just need to get cheaper and cheaper and cheaper and we're not going to use blockchains like we do today and so I think it's these underlying assets that are going to matter for collateral and as gas Etc like as money I think that's what's going to matter for these L1 assets specifically this is not true and I I want to make this really clear here this is not true for every other token in all of crypto including L2 tokens these are all businesses and they need revenues they are not money and they probably never will be money right but L1 native tokens are just very different

than anything else out there and I think that's something we all need to wrap our heads around Kyle thank you so much for setting the record straight and helping us understand how to Value L1 blockchains because it's a very difficult thing to do well what's funny is this doesn't even answer the question on how to Value it I don't know how to Value what is money and I don't know that anyone does right so like I just think it's like as long as I keep seeing it being used as money and again by collateral Etc then that's a good thing and that means demand how much demand what does that mean for the price like not a goddamn clue and I don't think anyone will figure that out for I don't know I'm sure someone will figure it out but like I'm not smart enough to figure

that out not right now but basic Supply demand Concepts would tell you so long as demand increases which it is consistently over the past like the since the existence of these smart contract blockchains and adoption continues to increase which it also is increasing and then there is some form of deflationary Supply is decreasing which as you said son hasn't figured it out but I think the key is we're going to keep seeing these moments where all of a sudden the fee Revenue goes down so much cuz we found an unlock in the tech to it f like we just saw with ethereum like everyone's so worried like this was a huge unlock it's so cheap now right now eventually it's going to get more

expensive as more apps come on and we're gonna have to do it again and so we're going to see a big drop in Revenue once again we're going to keep almost like Reinventing the company and like knocking at cutting out at at its knees and getting rid of all its revenue and like okay let's figure it out again now that we're so cheap what else can we build that's new that wasn't possible before and then we'll do it again we'll keep doing that I think salana will do the same but that's a good thing that's a good thing because as it gets cheaper more scale more people can use it more businesses can come on board the movement from the migration to onchain can happen at a faster rate and that's what we want that achieves more adoption and then these assets because they're the most trustless automatically just by

default become the money that all these things use just by default because they're the gas token and they're the trust most trustless so I think don't worry about fees and revenue it's a nice signal but it doesn't actually matter when you see a huge cut this is a bullish signal in my opinion now I could be wrong and maybe people don't care and that's just the way it goes but like I'm pretty sure this is how it's going to play out and we have these debates internally with the milroad pro research team all the time and it always comes back to the same thing so we'll see what happens Kyle thanks so much for joining us today and taking us through this great episode everybody thanks for listening in have a wicked awesome day as always if you liked today's episode please hit subscribe and make make sure

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