Ethereum's Flippening Narrative - By the Numbers

Aug 19, 2022 - 6 min read

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As the Merge inches closer with less than a month to go, Ethereum has captured a lot of attention from the crypto-wide ecosystem. In this week’s Decrypt, we therefore take the opportunity and highlight a multitude of metrics to get an idea about the so-called flippening, a term that is running hot as we count down towards the Merge. We dive into generic protocol metrics, metrics defined by the protocol’s monetary policy and some proxies describing the current network utilization and activity.

Heading into the Merge

With the last and most important testnet Goerli successfully transitioning to PoS, all eyes are now on the upcoming mainnet Merge scheduled for September 15, 2022. The transition to PoS brings massive implications to Ethereum’s monetary policy, its energy consumption, and its security. While Ethereum’s miners aim to fork Ethereum in order protect their mining hardware, the US Treasury’s sanctions towards the crypto mixer Tornado Cash sparked discussions about Ethereum’s censorship resistance and the centralization risk that might be linked to the PoS transition.

In order to enhance our knowledge about Ethereum’s current, past and possible future network condition, we put its network in the context of the ever dominating and impressively robust Bitcoin network. As we aim to compare a broad spectrum of metrics, this week’s Decrypt is poised to be chart-heavy. As such, expect less text but more data.

Since the emergence of cryptocurrencies, blockchain enthusiasts have been compiling rankings based on numerous factors. Market capitalization typically serves as the benchmark for "The Flippening." This term refers to the hypothetical moment of ETH unseating BTC as the largest cryptocurrency by market capitalization. It is rightfully debated whether that should continue to be the only metric used to analyze the dominance of a network. As such, there are various other metrics that are subject to flippenings and are therefore worth analyzing in order to derive insights. For instance, Ethereum flipped Bitcoin very recently in the options market for the first time on record in August. Diving in medias res, Table 1 provides some important metrics to get a brief overview of the two most important cryptocurrencies.

Table 1: Snapshot of some important metrics for Bitcoin and Ethereum
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SOURCE: CRYPTOCOMPARE, ULTRA SOUND MONEY, ETHERSCAN BITCOIN SUISSE RESEARCH

*TVS includes all assets running on the underlying chain (for Ethereum $23.7b in NFTs and $208.7b in ERC20s)

**Note that Ethash is Ethereum's PoW mining algorithm. PoW mining will be switched off post-Merge and Ethereum will be secured using a PoS mechanism.

As seen above, Bitcoin clearly dominates in hashrate and market cap. As the Merge comes closer, recent ETH strength has caused ETH/BTC to soar and it is approaching the highs of 2021, see Illustration 1. The ETH/BTC pair, a helpful metric observing the strength of ETH regarding BTC, has currently hit its “flippening ratio” at 0.159 (as of August 16 2022). The equation below serves to calculate the ratio at which Ethereum’s market cap overtakes Bitcoin’s.

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Illustration 1: ETH/BTC YTD
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SOURCE: (DATA AS OF AUGUST 12, 2022) TRADINGVIEW, (CHART) BITCOIN SUISSE RESEARCH
Network issuance and revenue

As current macro conditions and central bank monetary policy shows, inflation rates and economic strength are of systemic importance, and so are they for any present blockchain or DLT. When it comes to network issuance, a process of creating new tokens by means of mining or staking rewards that are added to the total supply of the underlying cryptocurrency, Bitcoin’s is currently significantly lower at 1.77% than Ethereum’s at 4.09%. The annual issuance, the percentage of new native units issued over a certain interval, extrapolated to one year and divided by the current supply at the end of that interval, of both networks over a five year period is shown in Illustration 2.

Illustration 2: Annual network issuance over 5 years
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SOURCE: (DATA AS OF AUGUST 17, 2022) MESSARI, (CHART) BITCOIN SUISSE RESEARCH

Both networks reduce their emissions continuously over time. Bitcoin’s mechanism for that reduction is the well known halving, reducing the block rewards for miners every four years by 50%. The next halving taking place in 2024 will lead to yet another reduction of Bitcoin’s issuance (3.125 BTC block reward down from 6.25 BTC) and will therefore drop the annual issuance below 1%. As there is no burning or other mechanisms altering the supply, the annual issuance is equal to the protocol’s inflation rate given no Bitcoins are lost.

However, with the transition from PoW to PoS, Ethereum is expected to flip that metric post-Merge as PoS comes with a reduction of energy consumption of ~99.95%. This cut in energy consumption is accompanied by a significant decrease in issuance, which varies based on the amount staked. At the time of writing, the issuance is expected to drop to 0.6m ETH per year post-merge from 5.5m ETH per year pre-merge and thus by ~89% or an inflation rate of ~0.5%, with no burning considered. Combining the post-Merge issuance with Ethereum’s burning mechanism introduced with EIP-1559 that is linked to its block space demand, Ethereum’s inflation will likely be considerably lower than 0.5% and might even have prolonged deflationary periods. The London hard fork, dubbed EIP-1559, modified the transaction fee structure by introducing the base fee model, which changes the cost dynamically based on network activity and improved the unpredictability of gas prices. Interestingly, the base fee is not delivered to the miners; instead, it is burned, see Table 2.

Table 2: Distribution overview of ETH and supply burnt post EIP1559
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SOURCE: (DATA AS OF AUGUST 17, 2022) ETHERSCAN, BITCOIN SUISSE RESEARCH

Since EIP-1559 went into effect on August 5th, 2021, $8.5b were already burnt overall, massively reducing the supply of ETH.

With the block space demand now altering the supply of ETH, the P/S ratio becomes an even more important metric for Ethereum, that currently resides at 186.7 compared to Bitcoin’s 3’779.7. The P/S ratio is a valuation metric from traditional finance that targets the ratio between a company’s market capitalization divided by the company's sales for the previous 12 months. By stating how much equity is needed to generate $1 in revenue, it assesses the value investors are receiving from a company's stock. For digital assets, the P/S ratio is calculated by dividing the fully diluted market cap with the annualized total revenue and thus shows how the protocol is valued in relation to its revenues based on the transaction fees, see Illustration 3.

However, the metric does not necessarily serve to value digital assets as there is a multitude of purposes a protocol can target. For instance, Bitcoin’s rather high P/S value compared to Ethereum’s should not be of concern since Bitcoin currently aims to be a Store of Value (SoV), a possible reserve asset and a pristine collateral asset. Hence, the revenue generated from transaction fees is no mandatory proxy to value Bitcoin. However, as Bitcoin approaches its maximum supply, this revenue will become a focal point in the years ahead as it likely will be the sole source of income for miners after block rewards fade.

Illustration 3: Daily transaction fees paid to miners over 5 years
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SOURCE: (DATA AS OF AUGUST 17, 2022) MESSARI, (CHART) BITCOIN SUISSE RESEARCH

Going forward, transaction fees for both protocols will be a major metric to follow. Despite Ethereum’s transaction fees cooling down after the DeFi and NFT momentum, it still remains considerable. At the time of writing, $2.79m in daily transaction fees get paid to miners of Ethereum while Bitcoin miners get $0.36m. With Ethereum being the dominant smart contract platform, the protocol will likely continue to generate impressive revenue streams as the majority of NFT projects as well as a number of other web3-focused platforms are currently built on it aside from DeFi applications like Uniswap and Aave that are among the most important technologies.

Network activity and security

When it comes to network activity, Bitcoin is dominating in several areas. Not only in adjusted on-chain volume, but also in trading volume on exchanges and in active addresses, see Illustration 3. Ethereum on the other hand dominates in transaction counts and overall addresses count.

The addresses shown in Illustration 3 are defined as follows:

  • Total addresses: sum of unique addresses holding any amount of native units. Only native units are considered.
  • Active addresses: sum of unique addresses that were active in the network within 24 hours (either as a recipient or originator of a transaction) that interval. Individual addresses are not double-counted.
Illustration 4: Total and active addresses over 5 years
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SOURCE: (DATA AS OF AUGUST 16, 2022) COINMETRICS, (CHART) BITCOIN SUISSE RESEARCH

We can therefore derive that Bitcoin seems to be primarily used for high value transactions while Ethereum is settling more transactions on lower value that likely results from ERC20 transactions.

Considering the most important metric for network security of a PoW network, Bitcoin dominates by a huge margin. The processing power needed to validate blockchains and the performance of the mining equipment is reflected in hashrate, that is measured in solutions per second. The higher the hash rate, the more validators are safeguarding the network, making it more secure.

Illustration 5: Hashrate over 5 years
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SOURCE: (DATA AS OF AUGUST 16, 2022) COINMETRICS, (CHART) BITCOIN SUISSE RESEARCH

As Illustration 4 shows, Bitcoin is several magnitudes ahead with 207M TH/s while Ethereum resides at 0.9k TH/s, reflecting the overall performance of all miners in the network. However, it is important to note that these values are not comparable as both protocols use different hash functions, Bitcoin SHA-256 and Ethereum Ethash. The energy cost of performing a hash in Ethash is way higher than in SHA-256 as for instance, Bitcoin at 253.986 PH/s operates at 6.98 GW while Ethereum at “only” 861 TH/s already operates at 2.05 GW. For Bitcoin and Ethereum, one can utilize fundamentally different mining hardware though. Bitcoin uses Application-Specific Integrated Circuits (ASICs) optimized to compute just a single function or set of related functions and thus in that case optimized for the sole purpose of mining BTC. Ethereum mining often runs on Graphics Processing Units (GPUs). Currently, Bitcoin and Ethereum are almost on par regarding miner revenue with Ethereum being slightly ahead. Miner revenue takes into account block subsidy as well as transaction fees and MEV.

Another interesting aspect regarding network contributions is the developer activity, another metric were Ethereum managed to overtake Bitcoin, see Illustration 6. As Ethereum was the canvas for many upgrades in the recent years, it is not surprising that this metric has been flipped. However, Bitcoin keeps innovating in its known and robust fashion e.g. with its latest Taproot upgrade.

Illustration 6: Developer activity based on Github repository
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SOURCE: (DATA AS OF AUGUST 16, 2022) SANTIMENT, (CHART) BITCOIN SUISSE RESEARCH
Conclusion and Outlook

Overall, the metrics observed paint a heterogenous picture. As indicated by option markets or the ETH/BTC chart, there is no doubt that ETH is currently benefitting from the approaching Merge, being one of the most significant events in crypto history. With some of the metrics already flipped in Ethereum’s favor, Bitcoin still maintains a significant lead when it comes to market cap, hash rate and active addresses Moreover, Bitcoin’s high value throughput measured in adjusted on-chain value and its trading volume on exchanges remain unchallenged. Moreover, one must consider that both networks serve diverse purposes that hamper comparisons. Both networks appear to be strong after the last few months of macro pressure and micro issues. One thing is certain, the next few weeks heading into the Merge will be volatile.


Disclaimer: at the time of writing, the author held ETH

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Dominic Weibel

Crypto Researcher