GM DOers!
Apple sells iPhones. 📱
Starbucks sells coffee. ☕️
Blockchains sell blockspace.
For all the complexities that come with blockchain technology, it’s really as simple as that.
Blockchains produce a product called blockspace and they sell it via a term called gas.
I’d love to take credit for the saying above, but I have to give that to our friends over at Bankless, Ryan and David.
They’ve ingrained this into my head over the years and it makes understanding the sustainability of this space so much easier.
If you want to understand which web3 real estate to build on, store your assets on or to invest in, understanding this concept is critical.
Blockchains are a business that sells a product.
Like any business, if they are not profitable, then over time the business will fail.
Luckily for us, a blockchain’s revenues and expenses are all on-chain. So we can take a look at how business is doing anytime we want 👀🔛⛓️
Today, we will do just that.
I’m going to show you how to understand the profitability of any blockchain in the space, from Layer 1s to Layer 2s.
Blockspace has found product-market fit in recent years.
On Ethereum alone, we’ve spent over $15,000,000,000 to use its blockspace.
But why has it reached product-market fit?
The ability to move a digital good in a permissionless and peer-to-peer manner seems to be a valuable thing to many people around the world.
Whether that means moving US Dollars via a stablecoin, trading a currency, buying or selling access to a community or some digital art, whatever it is, people are willing to pay for it.
We value freedom of speech. Well, we also value freedom to transact. That’s what blockspace offers to the world.
Of course, like most products, not all blockspace is made the same. Some is more valuable than others.
Bitcoin blockspace, for example, only facilitates simple transactions, or static NFTs with no utility.
Ethereum and most other L1s, on the other hand, offer an insane level of value for its blockspace price by enabling smart contract features.
Programmability of transactions is an enormous plus when you try to do more than just a basic coin transaction.
Furthermore, some blockspace occurs on more secure real estate than others. Some blockspace is faster than others. And of course, some blockspace costs more than others.
Regardless of the product's features and costs, which is often what the crypto world fights about on Twitter, it’s the bottom line that matters.
Many good products have come and gone because, while they may have found product-market fit, they couldn’t find profit.
Myspace, WeWork, and AOL are all companies that were in solid industries, which had product market fit, however were unable to become profitable, and thus are no longer with us or went bankrupt.
This is no different when it comes to blockchains. If they don’t sell their blockspace at a profit, eventually they will have to close down shop.
You might be wondering, aren’t all blockchains profitable since they don’t have any expenses, like employees or offices? Aren’t these simply public goods that run on their own?
While you are correct that blockchains don’t have employees or offices and ultimately can become public goods that are self-sustaining, they do, however, have both revenues and expenses.
And long-term this needs to be net positive (profitable) if the blockchain is going to remain self-sustaining (more on what that means below).
Layer 1 (L1) blockchains have both revenues and expenses. Layer 2 (L2) blockchains do too, however they are a bit different.
Let’s start with understanding the L1 model first and then we will move into L2s.
Blockchains charge a fee to use their blockspace, which is called gas. In order to transact on any blockchain, gas is typically paid in the native token of the blockchain.
This can be considered the earnings or revenue of the blockchain.
Below are the 1 day revenues of various L1 Blockchains as well as their 7 day averages in $USD.
Blockchains have expenses too. In order for the chain to function, remain secure and execute transactions, blockchains must pay the miners or validators who make that possible.
Blockchains do this in 2 ways, meaning, they have 2 forms of expenses:
Expense #1: Gas Fees
The fee that is collected via gas as revenue is then paid to the miners or validators who are securing the blockchain and enabling the transactions to occur.
For most blockchains, all fee revenue is paid out directly to its miners and validators. So the same chart above will show you the gas fee expenses for each blockchain.
This form of expense is sustainable, since it comes directly from revenues.
Additionally, in blockchains like Ethereum and Polygon, they use a feature called “burn”, which can be compared to the traditional finance world as a “share buy back”.
The idea here is that rather than pay out $ETH or $MATIC to validators, the blockchain burns a % of the fees to lower the supply and thus ideally increase the value of the non-burned tokens.
Expense #2: Issuance:
Blockchains also create new tokens and give those as rewards to the miners or validators. You can think of this type of expense like a government subsidy.
The blockchain is inflating its asset in order to incentivize participants to run a validator or miner.
If we think about supply and demand dynamics, always increasing supply means we always need increased demand to make up for it.
Unless the blockchain has a burn mechanism, which is higher than the supply increase, it is an unsustainable expense as it leaks value from the token.
Below is a list of yearly issuance and the dollar value from some of the L1 Blockchains that are listed on Cryptofees.info
Let’s take a second and compare the profitability of a few L1s.
Below are the revenues (gas fees), expenses (issuance) and the resulting “profit” of 4 L1 Blockchains. Profit is in quotations as it's not technically profit, I will explain below.
Bitcoin:
Revenue = $563,748/day
Expenses = $21,996,207/day
Profit = - $20,988,086/day
Avalanche:
Revenue = $15,231/day
Expenses = $757,324/day
Profit = -$1,022,682/day
Solana:
Revenue = $47,257/day
Expenses = $1,744,088/day
Profit = - $1,696,832/day
Ethereum:
Revenue = $6,151,473/day
Expenses = $3,918,375/day
Profit = $2,233,098/day
So what are we looking at here?
Let’s remember that the goal of a blockchain is to become self-sustaining. In order to do this, it must find a way to generate enough revenue to pay for its security (the miners or validators).
It must do this without overinflating its currency, while also ensuring the miners or validators are incentivized enough to continue to secure their network.
Like anything, if they are not profitable or are not making enough, they will move their resources elsewhere.
In terms of just simple revenue - expenses metrics, we can see above that Ethereum is the only truly profitable blockchain of the 4. This is true of every blockchain in existence at the time of this writing.
However, let’s look into things a bit more granular.
Proof-of-work blockchains must pay those who secure their network (miners) much more than those who secure a proof-of-stake blockchain (validators).
Why?
Because miners are required to have much larger and more robust equipment versus validators, which also must be replaced every few years.
In addition, depending on where they source their energy from, miners have costs for electricity to run the miners (which is why many miners are looking for renewable energy sources).
Regardless, miners must make enough to pay for their expenses.
Currently, 97.4% of Bitcoin’s security costs are subsidised by inflation. That inflation rate is cut in half every four years until all 21 Million Bitcoins are mined around year 2140.
This means that unless the price of Bitcoin goes up or Bitcoin finds a way to generate more fees, Bitcoin miners will make 50% less every 4 years (yikes).
In terms of fees, the Bitcoin network is earning only $563,748/day and is showing no signs of trending upwards.
Thankfully, Bitcoin has managed to continue to grow and drive demand for BTC, driving its price upwards over time. As it continues to half its inflation, the price increase has made up for its lack in revenues.
What this means is that Bitcoin's current path towards sustainability is nothing more than hoping that more people join the network and buy more Bitcoin to drive up the price.
If demand and price stagnate over the next 120 years, then Bitcoin won’t be able to afford its security costs and could end up going bankrupt (aka miners will no longer secure the network because they are not profitable).
The other hope for Bitcoin is that expenses for miners (mining equipment and electricity costs) are reduced significantly.
To secure a proof-of-stake blockchain, all that is required in terms of expenses of the validator is a typical laptop or computer and the electricity to run it (essentially nothing).
This means that validators can be profitable with much less, lowering the required security expenses of proof-of-stake blockchains.
In Solana’s case for example, 98% of its security budget is paid for by inflation, which is currently sitting at 6.29%/year.
If Solana were to remove its inflation subsidies, it would only have a budget of $35,012/day to pay validators.
As we can see below, Solana currently has 1,891 validators, which equals about $19/day per validator if subsidies did not exist (yikes).
Currently, Solana has no choice but to subsidize its security with inflation and as a blockchain which promises to always remain low fees, it's tough to understand how it becomes a self-sustaining network in the future.
Ethereuem, on the other hand, does things a little differently. If Ethereum had the same set up as the other blockchains, 71% of its security budget would be paid by its revenues and only 29% from inflation.
As a business, this seems much more manageable.
However, as mentioned above, Ethereum uses a burn mechanism on a % of its fees generated. What this means is that the more fees Ethereum earns, the more ETH is burned.
This mechanism allows Ethereum to continue to issue new currency in the form of inflation to pay validators, while still managing a sustainable token because the resulting burn of ETH from fees ends up in a net negative in supply.
Currently, ETH is reducing its supply by .076% while also paying validators 7% on their investment per year. Now that's a sustainable business model!
Ultimately, for all of these blockchains to remain solvent long-term, the only solution is to generate more revenue in the form of fees.
However, the problem with that is high-fees which means limited scalability and an inferior product to the masses. Most people do not want to use an expensive blockchain.
So what’s the catch? How are any of these blockchains going to become sustainable while also providing a low enough fee for people to use it?
The answer is L2s. L2s are blockchains which generate revenue from fees, the same as L1s do, however, they have no validators or miners.
Instead, they are looking for a secure blockchain to settle their transactions on. The perfect fit for a sustainable and secure blockchain like Ethereum.
If you need a refresher on what L2s are, check out our past PRO report on blockchain scaling.
As mentioned, L2s charge fees in gas the same as L1s do. The 2 most advanced L2s currently are Arbitrum and Optimism, which are L2s on Ethereum. You can see their daily revenues below.
In terms of expenses, L2s simply pay to transact on the L1 blockchain. However, those expenses are paid for by passing down the revenues above. You can see the L2 security expenses below.
Arbitrum:
Revenue = $99,932/day
Expenses = $79,408/day
Profit = $20,524/day
Optimism:
Revenue = $63,495/day
Expenses = $41,271/day
Profit = $22,224/day
L2s have a pretty obvious sustainable business model. They skim off the top of fees and pay the rest to Ethereum to worry about the security and settle the transactions.
L2s can then use that profit to reinvest in their business, their technology or share revenue to their token holders 👀
It’s all about incentives.
For blockchains to function long term, the people that secure the network must be profitable.
This means that blockchains need to think about how they can generate enough revenue, create sustainable tokenomics to retain value in their currency and limit expenses to those securing their blockchain.
And they have to do all of this while maintaining decentralization and producing a competitive product that people want to pay to use.
It’s not as simple as you might think.
Currently, no blockchain is remotely close to having a sustainable business model other than the Ethereum ecosystem.
The combination of the intuitive tokenomics of ETH with L2s makes for a profitable and sustainable model all the way through, from the validators, to the L1 token, to the L2 chains.
Everyone is incentivized to do their job and has the model to scale, while maintaining an extremely low cost for users to transact on.
This isn't to say that other blockchains like Bitcoin or Solana will not find a self-sustaining model long-term, this is just to say that Ethereum is currently there.
Ethereum did not have these self-sustaining numbers just a few years ago, so others can surely find their way to the “promise land” too.
I believe that’s enough on the business model of blockchains. For today anyway.
I sincerely hope this PRO report gives you the tools necessary to evaluate a blockchain’s long-term sustainability, so you can decide where to invest your time and money to build and invest.
If you found this piece valuable or feel like we’ve missed something, please let us know by leaving a comment below.
Your feedback is always appreciated and it helps us at Web3 Academy tailor our content to your needs.
Thanks for reading, and I’ll see you next Thursday. ✌️
Kyle Reidhead
Founder of Web3 Academy and Impact3
Find him: Twitter
Talking about sustainability, did you catch our previous PRO report in which we dissect the war being fought between the new and the incumbent NFT marketplaces? Do any of them have a sustainable long term plan? Read more:
W3A PRO | $LOOKS vs. $BLUR vs. $X2Y2 Tokenomics
If you’re in or around Cleveland, USA at the beginning of May (1st-3rd), we recommend you attend the Creator Economy Expo!
Kyle will speak at the event and we secured a $100 discount for all of our PRO members!
To grab your discount, head here and apply 'W3A100' at checkout.
Want to start your summer right? The Web3 Academy team will be at the Epic Web3 Conference in Lisbon on June 9th&10th! Join us at this web3 industry conference and learn how to build & grow products in the decentralized space. Go PRO to receive 25% off admission.
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