Elwood Research Newsletter

Ethereum Investment Memo Q4 2022

Ethereum (ETH) is the leading smart contract platform. This document outlines an investment thesis for exposure to Ethereum.

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Disclaimer: None of the following is investment advice. Please do your own research before making any investment.

Introduction

Ethereum (ETH) is the leading smart contract platform. This document outlines an investment thesis for exposure to Ethereum. To make this assertion, we explore key strengths, risks, and valuation models to develop a long-term bull case.

Tokenomics

Ethereum has an extremely low inflation rate. It's currently deflationary at -0.019%. This is made possible by EIP 1559, which introduced a burning mechanism where ETH is burned when transactions finalize.

The top 100 Ethereum wallets hold roughly 10% of the Ethereum supply. In comparison, the top 100 wallets of Solana (Ethereum's top competitor) hold over 30% of its supply. A lower percentage is considered better.

Decentralization

Decentralization, measured by the Nakamoto Coefficient, is essential for censorship resistance. Ethereum has a Nakamoto Coefficient of 34, making it the second most decentralized blockchain, after Bitcoin (7,349). It's higher than Solana (31), Avalanche (28), and Thorchain (27). Ethereum is secured by 473,565 validators. A blockchain with 1,000 or more validators is commonly believed to be “sufficiently” decentralized.

Throughput

Throughput, measured in transactions per second (TPS), is essential for keeping up with user demand and unlocking new DeFi use cases (like a 24/7 stock exchange, which would require a TPS of around 1 million).

Ethereum has a (very low) throughput of 15-45 TPS. To solve the scaling problem, new technologies like zkEVMs and sharding are being developed to scale Ethereum to 100,000+ TPS.