Ethereum’s Downturn: A Symptom of Broader Web3 Issues

Ethereum’s downturn isn’t just a reflection of its own challenges but also of the broader Web3 ecosystem. Vitalik Buterin, the founder of Ethereum, was motivated to create a decentralized world after becoming disillusioned by the imbalance introduced to the game World of Warcraft. Similarly, many of today’s Web3 pioneers were disillusioned by the monopolistic tendencies of tech giants in the Web2 era. In China, the internet landscape has been dominated by Alibaba and Tencent for the past 15 years. These giants, often ignoring regulation and user interests, drew emerging internet unicorns into their competitive trenches, stifling innovation and creating significant societal friction. Although the Chinese government has since reined in these practices, the market structure has remained largely unchanged, with the exception of ByteDance, which continues to disrupt the status quo.

As we transition into Web3, the industry faces a different set of challenges. The once-idealistic vision of decentralization has been overshadowed by a flood of VC-backed tokens, which have turned the space into a battleground for short-term profit rather than long-term innovation. Unlike in Web2, where investment management regulations and IPO procedures helped maintain some order, Web3’s financial libertarianism has unleashed powerful entities like Bitcoin and Ethereum without the necessary governance structures to self-regulate. The result is a market plagued by short-lived Ponzi schemes and unproven projects churned out by VC pipelines, leaving retail investors as the ultimate bag holders.

The Ethereum Conundrum

Ethereum’s current struggles represent a dim moment before the widespread adoption of Web3. Although Ethereum has underperformed compared to Bitcoin recently, this is partly due to the broader global financial cycle. Bitcoin and Ethereum serve different asset classes: in periods of macroeconomic instability, Bitcoin, with its hedge against inflation, performs better. Bitcoin’s position has been further solidified by the introduction of ETFs and greater acceptance by U.S. mining companies and Wall Street. On the other hand, Ethereum is more closely tied to the performance of U.S. tech stocks, which tend to rebound in the later stages of interest rate cuts. Despite underwhelming performance during the peak of U.S. tech stocks, Ethereum remains the foundational infrastructure for Web3, representing the next evolution of the internet.

Over the past few years, Ethereum’s narrative has focused heavily on infrastructure, often at the expense of application-layer development. Builders, along with VCs and foundations, have concentrated on creating modular components for enterprise clients, developing concepts to attract VC funding. However, Web3 is supposed to represent an evolution in production relations. Yet, many research-driven VCs have become fixated on the ZK (Zero-Knowledge) technology track, pushing the boundaries into hardware development, such as ZK computing miners, which bear a striking resemblance to Bitcoin mining. This seems to circle back to the same old problems.

The Changing Economic Role of Web3 Users

As Web3 applications scale, the economic role of users is shifting. Initially, strategies to attract Web2 users to Web3 focused on lowering the time cost for users. Today, Web3 is saturated with investors and builders, but users are conspicuously absent. Many users who entered the space in 2021 have become inactive, particularly on platforms like Twitter. As users’ time costs decrease, so does their sensitivity to the ideals of decentralization. The question arises: who will bear the costs of decentralized infrastructure built on Ethereum or Web3, which are often funded by multi-billion-dollar VC-backed projects?

Overemphasizing decentralization and designing projects without a solid commercial logic can become a burden for Web3 as a whole. These VC-backed tokens often pass the cost onto users, significantly raising the entry barrier for Web2 users transitioning to Web3.

A more relatable analogy might be this: imagine Web3 users ranging from Wall Street investors to rural market shoppers. These shoppers don’t care if their currency is decentralized; they care about its stability and convenience. If you build a bank and plan to profit from them through inflation, they will simply switch to a different currency.

Reevaluating the Development of the PoS Mechanism

Whether we look at Layer 2, the Liquid Staking Derivatives (LSD) sector, or Data Availability (DA) modularity, they all operate under the banner of shared security. While the shared security model itself is sound, the fair pricing of the opportunity cost of staked assets presents a significant challenge, especially for projects growing on Ethereum, an L1 chain that is inevitably affected. Venture capitalists (VCs) favor Layer 2 and LSD sectors, but these have also become hotbeds for speculative “VC coins.”

By using the Restake method to allocate tokens to large Total Value Locked (TVL) holders, projects, the Ethereum ecosystem, and large stakeholders can all benefit. However, the losers in this scenario are the broader market and ordinary users. The notion that staking alone can grant a share in a project’s tokens, essentially its ownership, is difficult to justify. The ownership structure or credentials of a project should ideally reward individuals or organizations that contribute to the project’s operation and growth. Yet, staking, with its straightforward but blunt approach, caters to the project team’s need to rapidly increase TVL and satisfies the wallets of large holders who want quick profits from staking and selling. This has led to a distorted business model where staking not only earns tokens but sometimes even direct payouts from the project team.

Poor operation of the POS mechanism may lead to bubbles in assets such as governance tokens

The current PoS model also diminishes the competitive efficiency of maintaining blockchain consensus. In a PoS system, large holders not only earn rewards from staking but also significantly increase their influence over the ecosystem’s development, leading to the emergence of “VC coins,” such as in the design of some parallel chains. Conversely, the participation threshold for maintaining a PoW network is lower. While leading mining companies can gain temporary advantages through hardware upgrades, in general, the entry barrier for small miners to join the Bitcoin network is lower than in PoS, making it a fairer system.

If not managed properly, the PoS mechanism can lead to the bubbleization of governance tokens and other assets. The design of staking reward rates in most PoS blockchains, particularly their alignment with market conditions, is prone to divergence. This can result in mismatches between the reward rates and the level of ecosystem development, which, in turn, are measured against the broader public market. Inflationary reward rates may raise the barrier to entry for assets and users into the blockchain ecosystem, while deflationary rates can stifle ecosystem growth. The primary function of staking is to maintain blockchain network security, but the cost of network security is dynamic and difficult to price. It’s challenging to design a staking reward model that aligns with these needs. If the staking market is small and lacks sufficient marketization, these unfair distributions become more pronounced. In mainstream PoS blockchains, staking inflation often flows into foundation reserves, but foundations do not always operate with high efficiency, leading to reduced development efficiency, centralized profit distribution, uncontrolled ecosystem inflation, and eventually, the bubbleization of governance tokens and other assets. Currently, Ethereum’s PoS mechanism is leading in terms of industry standards.

Data observation

on the chain

1.The current basic network fee of Ethereum is hovering between 1 and 2 gwei, a new low in several years. At the same time, due to the low gas fee, the daily destruction volume of ETH has reached a new low.

2.The number of Ethereum network transactions has dropped to a five-month low on August 6, with the seven-day moving average transaction volume being 1.12 million transactions per day. Currently, more and more activities are moving to the Layer 2 network. Among them, Coinbase’s Layer 2 network Base has the highest transaction volume, with a seven-day moving average transaction volume of 3.83 million.

3.The SOL/ETH exchange rate pair exceeded 0.064, reaching a record high.

The above data reflects several trends. Ethereum has completed its mission at the current stage, reducing network transaction costs through technological upgrades, and on this basis, allowing decentralized infrastructure to support a wider range of L2, thus laying the foundation for the entire Web3 development. foundation. Solana’s challenges lie in the rapid development of its application layer and the sacrifice of decentralization for efficiency. Solana is progressing more rapidly in the application layer, and its products are more in line with the needs of new Web3 users, such as the MEME coin launch platform and tools that link to Web2 such as Blink, Solana mobile and Depin. Although Solana’s innovation is more radical, it is closer to the market than Ethereum. Because Web3 is also a Web, new users value UI, interactive experience, efficiency and wealth creation more than decentralization, which is currently the focus of the project. If it is given to VCs, users will not care about it, and users will not accept the decentralization costs raised by VCs.

Head mechanism operation

Jump Trading recently transferred approximately $315 million worth of pledged Ethereum to cryptocurrency exchanges, a move that sparked debate and speculation in the market. The move came ahead of Japan’s historic stock market crash, which saw the Nikkei 225 plunge 12.4%. Some analysts pointed out that Jump Trading may have foreseen the market downturn and converted risky assets into stable coins. The picture below shows the changes in Jump Trading’s ETH holdings.

Before and after the crash on August 3, five leading market makers transferred a total of more than 130,000 ETH directly or indirectly to CEX that week. The chart below shows that Binance’s ETH holdings are also at high levels.

Recent movements of giant whales

Recently, a whale liquidated 14,387 ETH, resulting in a loss of US$12.55 million. In addition, a whale that had been dormant for seven years transferred more than 92,000 ETH, causing the price of ETH to fall below $3,100. Another address participating in the Ethereum ICO transferred 48,500 ETH to OKX in the past month, worth approximately $154 million.

Between late July and August 8, there was a small spike in ETH conversion activity on the Ethereum chain. Judging from the actions of leading institutions, during the market transition stage, whales with high risk appetite are more sensitive to market changes, and their position swap behavior has led to large liquidations on the chain. High leverage is also one of the reasons for Ethereum’s recent sluggish performance.

In addition, James Fickel, who has long held ETH/BTC long positions, began to reduce his positions. He reduced his ETH/BTC long position by selling 10,000 ETH for 425.75 WBTC to repay the loan. From January to July this year, he continuously borrowed WBTC from Aave and converted it into ETH to bet on the ETH/BTC exchange rate, with an exchange rate cost of approximately 0.054. Although he has partially reduced his position, his ETH/BTC long position is still large, with 2438.5 WBTC still borrowed, worth approximately US$148 million.

ETF data

Since its launch, the Ethereum ETF has seen net outflows for many days, most of which came from Grayscale’s sell-off.

Reflections on a Decade of Cryptocurrency

Over the past decade, cryptocurrency has grown from an emerging technological concept to a major force influencing global financial markets. The decentralized revolution initially led by Bitcoin challenged the authority of the traditional financial system and gave rise to Ethereum and other blockchain platforms. These platforms are not only digital currencies, but also provide smart contracts and decentralized applications. a vast stage. However, this wave of innovation has been accompanied by severe market fluctuations, changing regulatory policies, and challenges in safety and sustainability. Looking back on this decade, cryptocurrencies have great potential to drive financial innovation and promote industry transparency and inclusion, but they also need to be wary of bubble risks.

Venture capital (VC) plays a crucial role in the development of the crypto industry. By injecting capital and providing strategic guidance, VCs have promoted the growth of countless blockchain projects and start-ups, enabling innovative technologies to quickly move from the concept stage to market application. VC not only provides necessary financial support, but also brings valuable industry experience, network resources and business wisdom to the project, helping young crypto companies avoid common entrepreneurial traps. In addition, the participation of VCs has also brought credibility to the encryption industry. Through the promotion of venture capital, the blockchain ecosystem has continued to grow and mature, promoting technological innovation and business models to continue to evolve, and ultimately driving the entire industry to become more credible. A sustainable future.

At present, the theoretical foundation and governance mechanism of the entire industry are not yet complete. Here are some industry considerations:

1. How can the encryption industry resist and reduce the negative impact of VC?

Driven by the desire to seize market share, the investment institutions of centralized crypto exchanges are cultivating athletes (project incubation), building tracks (exchange wallet platforms), holding competitions (coin listings), and acting as referees in the Web3 field without restraint ( Has the role of delisting tokens triggered an arms race in the crypto VC industry, increased friction costs in the Web3 innovation field, led to mixed results in secondary market projects, and even hijacked the development of public chains?

1. Is there a market maker manipulating the market, causing the token price to deviate from the fair value, thereby causing losses to investors?

2. How can decentralized and community-first projects receive more resources, not just entrepreneurs from VCs and foundations?

3. Most application layer products and services are still in the P2P stage. Are there any problems with the talent system in the Web3 industry? How to attract Web2 operational talents and spread the concept of decentralization.

4. Whether the VC is qualified to decide which project will run on which track, and whether the VC’s vision and values ​​can correctly judge which projects represent progress in productivity and production relations.

5. Whether the cash flow generated by the business model can drive the development and operation of the project without relying on financing and other means.

summary

The author is optimistic about the long-term development of Ethereum. Ethereum is the purest decentralized smart contract platform. It has a strong community consensus and a good foundation governance mechanism, and is not subject to excessive control by venture capital and large project parties. However, it should be noted that the development of L2 relies too much on VC.

In the development of Ethereum, the primary goal of technological advancement, network design and governance is decentralization, followed by efficiency and commercial viability. This priority setting has led to recent Solana network data surpassing Ethereum in some aspects, because Ethereum has not paid enough attention to the application layer, especially in the commercial dApp developer atmosphere for C-end users. However, Ethereum will still maintain its core position in the Web3 field, because the endogenous development momentum of the Web3 industry essentially stems from decentralization.

In the short term, the ETH/BTC exchange rate has fallen rapidly, while Ethereum developers are actively promoting expansion solutions and introducing account abstraction to improve user experience and reduce transaction costs.However, the price of ETH is currently mainly affected by macroeconomic factors.

Disclaimer：

1. This article is reprinted from [Golden Finance]. All copyrights belong to the original author [Revc]. If there are objections to this reprint, please contact the Gate Learn team, and they will handle it promptly.
2. Liability Disclaimer: The views and opinions expressed in this article are solely those of the author and do not constitute any investment advice.
3. Translations of the article into other languages are done by the Gate Learn team. Unless mentioned, copying, distributing, or plagiarizing the translated articles is prohibited.