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Ethereum’s Business Model: A Digital Mall, Validators, & On-Chain Commerce
To properly unpack our valuation approach to Ethereum, it is important rst to understand what Ethereum is, how it works,
and why it is valuable. At the most basic level, one can think of Ethereum as a mall that lives on the internet and provides
a secure place for internet commerce to take place. Users interact inside Ethereum’s mall by means of wallets, and Ethereum’s
mall businesses are made up of batches of smart contract code. The Ethereum software determines the structure and rules of
the mall, while validators ensure that the rules are followed, secure the mall, and maintain a ledger of all economic events that
occur within the mall. Ethereum also apportions the limited space within the mall by charging users for conducting business
and exchanging value.
Ethereum is free software that is hosted on computers distributed throughout the globe. It employs an array of logic,
called a protocol, to create a unied understanding of ownership, commercial activity, and business logic. This allows users
to engage in commerce without the need to trust any of its participants or counterparties. Ethereum code creates veriable
and unambiguous rules that assign clear, strong property rights to create a platform for unrestrained business formation
and free exchange.
The computers that run Ethereum software, called validators, receive inationary rewards and a portion of the fees remitted
by users performing activity on Ethereum. Businesses are created on Ethereum by deploying a series of smart contracts.
Smart contracts are computer code libraries that autonomously execute functions when called upon by users without
any intermediary. Using smart contracts, developers can build logic that replicates the function of businesses like banks,
auction houses, social media companies, video games platforms, cloud computing services, and commodities exchanges.
Using Ethereum, a business can keep its treasury entirely on Ethereum and enable smart contract disbursements to
employees, vendors, contractors, and suppliers who can also have wallets on Ethereum.
For users to perform on-chain actions to exchange value or interact with on-chain businesses, they incur fees paid to
Ethereum. These fees are relative to the computational intensity and spot demand for computation on the Ethereum
network. Curiously, unlike most enterprises where businesses pay the overhead of rent, electricity, and the rest, users directly
pay the overhead costs of interacting with the on-chain business to that on-chain business’s host and chief vendor – Ethereum.
Thus, users pay both the costs of hosting the business and the costs of Ethereum computation, on behalf of on-chain
businesses, through their transactions.
The principal medium of exchange on the Ethereum network is the ETH token. For users to conduct activity on Ethereum, they
must pay for the cost of performing their actions in ETH, just like at Dave & Busters, where one must buy “gaming points” to play
video games. To do anything on Ethereum, a user of Ethereum must utilize ETH tokens. Additionally, validators must post value,
in the form of ETH, as collateral against their honesty. If a validator cheats, the ETH is seized. Considering that ETH tokens are
the currency used to pay validators (who are selling ETH to cover costs), this marries demand with supply – Ethereum users buy
tokens to use Ethereum, and Ethereum validators sell tokens to “supply” Ethereum.
What does it mean to “supply” Ethereum? In essence, it means participating in the consensus mechanism of Ethereum that
veries value transfers, allows for the deployment of smart contract code, or enables calls to Ethereum’s software. All business
logic and exchange of assets occur as ledger entries on blocks. Blocks are simply the “to-do list” for the Ethereum computer to
complete, and every twelve seconds, the table of actions is executed. The list directs Ethereum to perform an action or a series
of actions on behalf of the users. These directions could be as simple as sending value or as complex as buying and selling
dozens of tokens simultaneously across dozens of dierent Ethereum-based token exchanges. Users gain inclusion on the
block for their actions by paying a base fee and an inclusion fee. If there is a lot of demand for Ethereum’s “to-do list,” users can
increase their inclusion fee, called a “tip,” to ensure their request is fullled. Additionally, Ethereum has created a marketplace
to auction o the right to order (and add transactions to) the action list on each of Ethereum’s blocks. This is done because
there is immense value in ordering the transactions. These two activities currently represent Ethereum’s core business – selling
blockspace and selling the right of others to order it. Distilled, Ethereum is selling secure, immutable blockspace that facilitates
internet commerce.
Ethereum Revenue Recognition: Exploring Transaction Fees, MEV, and Security as a Service
Because Ethereum is not really a business, we identify revenue as an activity where tokens are used in Ethereum’s core
business – the provision of immutable, decentralized computing through the sale of blockspace. As a result, we count
transaction fees, both the base fee and the tip fee, as a revenue line. Other analysts only count the base fee because it is
burned, which impacts all ETH holders, while omitting the tip because it only is remitted to each leadership slot validator.
In their construct, only staked ETH on validators receives the tip fee. However, we count both tip and base fees in addition
to base fees as each reects economic activity on Ethereum related to the sale of blockspace. Therefore, the economic value
of those actions ows through to Ethereum as a business.
Additionally, we subtract ETH burned from the base fee from the ETH total supply and derive token value from the end-year,
reduced supply total. Admittedly, unlike other components of our analysis, the yearly trajectory of ETH usage signicantly
inuences today’s token valuation through total token supply reduction. Additionally, we do not count inationary security
issuance as a revenue item as it does not relate directly to an outside entity buying blockspace.