Grayscale Research: Ethereum Spot ETF Limited Upside, Solana Emerges as Strongest Competitor

Grayscale Research analyzes various aspects of the current state of Ethereum, stating that the launch of a spot ETF would greatly help the public understand the "smart contract public chain." While the current valuation of ETH may have limited upside potential compared to when the Bitcoin ETF was launched in January, Grayscale remains optimistic about both. However, Grayscale specifically mentions Solana, believing that SOL is most likely to capture market share from Ethereum.

L2 Active Users Account for 2/3 of Total Activity

After experiencing a major upgrade in March, Ethereum is facilitating the transition to a modular network architecture, where different types of on-chain infrastructure are designed to work together to provide the ultimate user experience. Over time, more activity is expected to occur on Ethereum L2.

L2 settles and publishes transaction records to L1, benefiting from the security and decentralization of the mainnet. Gray Research points out this contrasts sharply with blockchains designed with an overall design concept, such as Solana, where all key operations - execution, settlement, consensus, and data availability - occur on a single L1.

From an on-chain activity perspective, the upgrade has been successful, with a significant increase in active addresses on L2, currently accounting for about two-thirds of the total activity in the Ethereum ecosystem.

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L2 Leads to Decrease in Ethereum Mainnet Revenue

However, the shift of on-chain activity to L2 has also impacted Ethereum's token economy.

When Ethereum's on-chain revenue is high, the amount of tokens burned often exceeds the speed of new coin issuance, leading to a decrease in ETH total supply. However, as on-chain activity transitions to L2, the fee revenue on the Ethereum mainnet decreases, and the ETH supply begins to increase again.

Although L2 still requires fees to publish data to L1 - the so-called "blob fees" and other transaction fees - the amounts are often relatively lower.

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Ethereum Mainnet Revenue Needs to Increase

Gray Research believes that to see ETH rise over time, the Ethereum mainnet will likely need to see an increase in fee revenue. This can be achieved by:

1. Moderate growth in L1 activity, paying higher transaction costs,

2. Significant growth in L2 activity, paying lower transaction costs.

Gray Research expects that both L1 and L2 on-chain activities need to continue growing for Ethereum to benefit, possibly in a combination of low-frequency, high-value transactions on L1 and high-frequency, low-value transactions on L2.

Currently, about 70% of tokenized U.S. bonds are on the Ethereum chain - see below. NFTs with higher value may also remain on the Ethereum mainnet because they benefit from its high security and decentralization, and are less likely to change hands. For similar reasons, Bitcoin NFTs are also expected to continue growing.

Ethereum Spot ETF

An Ethereum spot ETF can help increase ETH demand and price.

Gray compares Ethereum ETP trading products outside the U.S. with BTC, showing that Ethereum ETP accounts for about 25%-30% of Bitcoin ETP. Therefore, the net inflow of an Ethereum spot ETF is expected to be 25%-30% of the net inflow of Bitcoin since January, which is $13.7 billion.

Although in the U.S. market, ETH futures account for only about 5% of BTC futures, Gray Research believes this does not represent the potential relative demand for an Ethereum spot ETF.

50% of ETH Supply is Long-Term Locked

Gray lists that about 50% of ETH in circulation is in a long-term locked state:

• 27%: Staked,

• 11% locked in multiple smart contracts,

• 6%: Unmoved for over five years,

• 3%: Held in ETH ETP form,

• 0.7%: Held by Ethereum Foundation, Mantle, Golem Treasury.

Gray Research states:

The above limits the available supply for an Ethereum spot ETF, and future ETH net purchases will come from the remaining circulating supply, so any increase in demand could have a greater impact on the price.

Solana to Capture Ethereum Market Share

The report concludes with two points less favorable to the ETH price.

Gray references the MVRV-Z indicator, which shows that when the Bitcoin spot ETF went online in January, its MVRV-Z score was relatively low, indicating moderate valuation and potentially larger room for growth; whereas ETH was overvalued, with less room for growth after ETF approval.

Gray Research concludes by mentioning that crypto investors may pay more attention to the competition between ETH and other smart contract platforms, particularly the SOL/ETH exchange rate, considering Solana is the second-largest project in that market. Gray believes SOL has the best chance in the long term to capture market share from Ethereum.

Last year, SOL outperformed ETH significantly, and the SOL/ETH price is approaching the previous high. In the short term, Gray expects the SOL/ETH exchange rate to stabilize, with the Ethereum spot ETF supporting ETH prices. However, in the long run, the SOL/ETH exchange rate will depend on the growth of their on-chain revenues.