Ethereum's Slump Reflects the Web3 Development Dilemma

The Sluggish Ethereum

The crypto world was once hailed as the new frontier for internet outsiders. Young people disillusioned with Web2, driven by the ideals of decentralization, entered Web3, with Ethereum being their first stop. As the largest smart contract platform with EVM programmability, Ethereum serves as the most advanced Web3 financial infrastructure, spawning tracks like SocialFi, DeFi, GameFi, and CreatFi — decentralized versions of leading Web2 products. Decentralized platforms like Farcaster (Twitter), DeTiktok (TikTok), and DeBox (WeChat) are emerging continuously.

Ethereum's position as the leading public chain is acknowledged not just for its market cap or technology, but because of the charismatic, young decentralization advocate, Vitalik Buterin (V神), who has been building the Ethereum ecosystem on the purest decentralization principles for nearly a decade. In contrast, some other chains have mechanisms and token distributions overly favoring VCs.

Vitalik's disillusionment with the unbalanced changes in World of Warcraft inspired his vision for a decentralized world. Similarly, many "disillusioned Web2" individuals were swept out by the monopolistic internet market dominated by large corporations and capital. China's internet landscape has remained unchanged for nearly 15 years, with the Alibaba and Tencent factions drawing nascent internet unicorns into their trenches, vying for half of the internet. This led to significant social friction costs, stifling innovation until government intervention brought the industry back on track. However, the basic landscape was firmly established, except for the boundary-pushing disruption by ByteDance, the world's most valuable unicorn.

As we transition to Web3, the industry is burdened and troubled by VC-driven "VC coins," losing its idealistic shine of decentralization. In the traditional Web2 world, investment management regulations constrain corporate strategic investment departments (e.g., a central economic work conference in December 2020 highlighted "strengthening anti-monopoly and preventing disorderly capital expansion" as a key economic task, resulting in strategic investment adjustments at major companies like ByteDance and BiliBili). Yet, the Web3 world, with its blockchain financial libertarianism, unleashed crypto giants like BTC and ETH but also struggles with a lack of self-purification, oversight, and governance, leading to a prevalence of Ponzi schemes with short lifespans and unchecked VC-driven project concepts. In reality, we are all just secondary market bag holders.

Returning to Ethereum, its current downturn represents a gloomy moment on the eve of large-scale Web3 application. Ethereum underperforming Bitcoin partly stems from the unique global financial cycle. Bitcoin and Ethereum embody different asset attributes. During macroeconomic instability, high inflation, and pre-interest rate cuts, Bitcoin's inflation absorption or hedging attributes make it perform better, bolstered by its status through ETFs, and greater recognition as an asset by US mining companies and Wall Street.

Ethereum is more aligned with the US tech stock cycle, expected to perform better in the late stages of interest rate cuts. Although it underperformed when US tech stocks hit new highs, Ethereum remains the representative infrastructure of Web3, an upgrade of Web2. For years, Ethereum's narrative has been infrastructure-centric, neglecting the application layer. Builders, catering to VCs and foundations, focus on B2B Lego-like modular expansions, creating concepts to persuade VC-style entrepreneurship. Web3 inherently signifies an evolution in production relations, yet many self-proclaimed research-driven VCs are fixated on the ZK track, delving into unmastered productivity directions, culminating in ZK mining hardware—resembling Bitcoin mining, seemingly back to square one.

Let's analyze how user economic attributes shift with the large-scale Web3 application development. Initially, Web3's expansion strategy to attract Web2 users led to a steep decline in users' time costs. Now, Web3 is flooded with investors and builders, but lacks users. Those who entered the space in 2021 now appear silent on Twitter. As users' time costs drop, sensitivity to decentralization ideals wanes. Who bears the cost of decentralized infrastructure spun from Ethereum or Web3? Who shoulders the burden of multi-billion-dollar VC coin projects? Overemphasizing decentralization and designing projects devoid of commercial logic impose costs on Web3, forcing users to absorb VC coin costs, drastically elevating Web2 users' entry barriers to Web3.

A vivid analogy is Web3 users transitioning from Wall Street investors to countryside market shoppers. They don't mind whether their currency is decentralized; they care about its stability and commercial convenience. If you intend to build a bank and fleece them through inflation, they'll simply switch currencies.

Reconsidering the Current Status of PoS Mechanism Development

Whether it's Layer2, the LSD track, or DA modularization, all wave the flag of shared security. The shared security model is inherently sound, but fairly pricing the opportunity cost of staked assets is a significant issue, especially as many projects grow on Ethereum's L1. Inevitably, Ethereum is affected, and VCs favor L2 and LSD tracks—the epicenter of VC coin issues.

Restaking distributes tokens to large TVL holders, allowing projects, the Ethereum ecosystem, and whales to benefit, while the market and users lose. Understanding how staking can yield project tokens akin to shares is perplexing. Shouldn't a project's ownership structure or credentials align with contributors to its operations and development? Yet, the blunt staking approach caters to rapid TVL growth demands of project teams and the wallet expansion needs of whales, evolving into a distorted business model—staking yields not just tokens, but project teams offer direct cash incentives.

Currently, the PoS model also curtails competition efficiency in blockchain consensus maintenance. In PoS, whales not only earn rewards but significantly increase their and VC institutions' influence over ecosystem development, leading to the emergence of VC coins, exemplified by certain parallel chain designs. Conversely, PoW's network maintenance threshold is lower. Despite major mining companies gaining temporary advantages through iterations, small miners face lower barriers to joining Bitcoin network maintenance, with higher fairness than PoS.

Poor PoS Mechanism Management May Lead to Governance Token Asset Bubbles

Most public chains' PoS designs, especially in staking reward rate designs, easily deviate from market norms, mismatching rates with ecological development levels relative to the open market. Hence, inflationary rates raise asset and user entry barriers to public chain ecosystems, while deflation stifles ecological development. Staking primarily secures blockchain network safety, with dynamic and elusive security costs rendering it challenging to align reward models with this design. If the staking market is small and lacks marketization, such inequitable distribution is more pronounced. Mainstream PoS chain staking inflation channels into foundation reserves, yet foundations may not consistently operate efficiently, diminishing development efficiency, centralizing benefits, causing uncontrolled ecosystem inflation, and ultimately, governance token asset bubbles. Currently, Ethereum's PoS mechanism is industry-leading.

Data Observation

On-chain

1. Ethereum's current network base fees hover between 1 to 2 gwei, marking a multi-year low. Concurrently, low gas fees have driven ETH daily burns to new lows.

   

2. As of August 6, Ethereum network transaction numbers fell to a five-month low, with a seven-day moving average of 1.12 million daily transactions. Increasing activity has shifted to Layer 2 networks, with Coinbase's Layer 2 network Base leading in transaction volume, reaching a seven-day moving average of 3.83 million transactions.

   

3. The SOL/ETH exchange rate surpassed 0.064, hitting a historic high.

These data reflect several trends: Ethereum has fulfilled its current mission by lowering network transaction costs through technological upgrades, paving the way for decentralized infrastructure to support a broader L2, laying the foundation for overall Web3 development. Solana's challenges lie in its rapid application-layer development and efficiency gained by sacrificing decentralization. Solana's application-layer advancements cater more to new Web3 users, with products like MEME coin launch platforms and Web2 bridging tools like Blink, Solana Phone, and Depin. While Solana's innovation is aggressive, it aligns more closely with the market than Ethereum, as Web3 remains Web, with new users prioritizing UI, interaction experience, efficiency, and wealth creation over decentralization. Decentralization is a narrative for VCs, not users, who reject the decentralization costs elevated by VCs.

Major Institutional Moves

Jump Trading recently transferred about $315 million worth of staked Ethereum to cryptocurrency exchanges, sparking market debates and speculation. This move preceded a historic crash in the Japanese stock market when the Nikkei 225 index plummeted 12.4%. Some analysts suggest Jump Trading anticipated a market downturn, converting risk assets to stablecoins. The chart below shows the change in Jump Trading's ETH holdings.

Around August 3's crash, five major market makers collectively transferred over 130,000 ETH directly or indirectly to CEX within that week. The chart below shows Binance's ETH holdings at a high level.

Recent Whale Activity

Recently, a whale liquidated 14,387 ETH, incurring a $12.55 million loss. Moreover, a whale dormant for seven years transferred over 92,000 ETH, causing ETH prices to dip below $3,100. Another Ethereum ICO participant address moved 48,500 ETH to OKX in the past month, valued at approximately $154 million.

Between late July and August 8, Ethereum on-chain ETH transfer activity spiked. Coupled with major institutional moves, high-risk whales were more sensitive to market changes during the transition phase, resulting in significant on-chain liquidations. High leverage is another reason for Ethereum's recent underperformance.

Furthermore, James Fickel, a long-term holder of ETH/BTC long positions, began reducing his holdings. He sold 10,000 ETH to exchange for 425.75 WBTC to repay loans, thus reducing his ETH/BTC long position. From January to July this year, he continuously borrowed WBTC from Aave and converted it to ETH to bet on the ETH/BTC exchange rate, costing about 0.054. Despite partial reductions, his ETH/BTC long position remains substantial, with 2,438.5 WBTC loans valued at approximately $148 million.

ETF Data

Since the launch of the Ethereum ETF, there has been a net outflow of funds over multiple days, primarily due to Grayscale's sales.

A Decade of Crypto Reflection

Over the past decade, cryptocurrencies have evolved from an emerging technological concept to a significant force impacting global financial markets. Initially led by Bitcoin's decentralization revolution, they challenged the authority of traditional financial systems while fostering Ethereum and other blockchain platforms. These platforms serve as more than digital currencies; they provide a vast stage for smart contracts and decentralized applications. However, accompanying this wave of innovation are intense market volatility, changing regulatory policies, and challenges in security and sustainability. Reflecting on these ten years, cryptocurrencies have shown immense potential in driving financial innovation and promoting industry transparency and inclusivity, yet the risk of bubbles persists.

Venture capital (VC) has played a crucial role in the development of the crypto industry. Through injecting capital and providing strategic guidance, VC has driven the growth of countless blockchain projects and startups, enabling innovative technologies to transition swiftly from concept to market application. VC not only offers necessary funding but also brings invaluable industry experience, networks, and business acumen, helping young crypto enterprises avoid common entrepreneurial pitfalls. Furthermore, VC involvement has added credibility to the crypto industry, facilitating the growth and maturity of the blockchain ecosystem, fostering continuous technological innovation and business model evolution, ultimately steering the entire industry towards a more sustainable future.

Currently, the industry's theoretical foundation and governance mechanisms are still underdeveloped. Here are some reflections on the industry:

1. How can the crypto industry resist and mitigate the negative impacts of VC? Driven by the instinct to seize market share, centralized crypto exchange investment institutions freely cultivate projects (project incubation), build platforms (exchange wallet platforms), host events (listing), and play the role of a judge (delisting tokens) in the Web3 field. Has this led to an arms race in the crypto VC industry, increasing friction costs in the Web3 innovation field and leading to uneven project quality in the secondary market, potentially even hijacking public chain development?

   
   

2. Is there market manipulation by market makers leading to token price deviations from fair value, causing investor losses?

   
   

3. How can decentralized and community-prioritized projects gain more resources instead of only favoring VC and foundation-backed entrepreneurs?

   
   

4. Most application layer products and services remain at the P2P stage. Does the Web3 industry's talent system have issues, and how can it attract Web2 operational talent and spread the decentralization ideology?

   
   

5. Does VC have the qualification to decide which projects should thrive in which tracks? Can the visions and values of VC accurately judge which projects represent progress in productivity and production relations?

   
   

6. Without depending on financing and other funding methods, can the cash flow generated by business models drive project development and operations?

   
   

Conclusion

I remain optimistic about Ethereum's long-term development. Ethereum is the purest decentralized smart contract platform, with strong community consensus and solid foundation governance mechanisms, largely unencumbered by excessive VC and large project party influence. However, it's important to note that L2 development overly relies on VC.

In Ethereum's development, technological advancement, network design, and governance prioritize decentralization over efficiency and commercial viability. This prioritization has led to Solana's network data surpassing Ethereum in certain aspects, due to Ethereum's insufficient focus on the application layer, particularly in fostering a commercial dApp developer environment targeting end-users. Nonetheless, Ethereum is expected to maintain its core position in the Web3 field because the intrinsic driving force of Web3's industry development fundamentally stems from decentralization.

In the short term, the ETH/BTC exchange rate is declining rapidly. Meanwhile, Ethereum developers are actively advancing expansion solutions and introducing account abstraction to enhance user experience and reduce transaction costs. However, ETH's price is currently mainly influenced by macroeconomic factors.