The cryptocurrency of the Ethereum network, ether (ETH), which is experiencing significantly lower performance than bitcoin (BTC), could enter a scenario of greater difficulty.
According to Marija Maticspecialist in financial markets, “Ethereum is in a delicate and strange position.” Chalk this up to the use of layer 2 (L2) scaling solutions.
It highlights that, today, There are more than 100 layer 2 and layer 3 networkssolutions that are built on top of Ethereum to improve their scalability. They achieve this by reducing transaction costs and times, making it easier to use decentralized applications (dApps) and Ethereum-compatible platforms without overloading your mainnet.
While this favors scalability, the cost of that is decreased activity on the Ethereum mainnet. It is now at number 7 in terms of transactions per second (TPS) within its own ecosystem.
The ranking of the fastest networks currently in the Ethereum ecosystem can be seen below:
Specialist Matic warns that this has consequences for the ETH market and the security of your network. Because Layer 2 groups transactions together to be more efficient, they are not substantial enough to significantly influence staking rewards or inflation dynamics, he details.
There are two issues here that the specialist refers to. On the one hand, it is staking on Ethereum, the process of locking ETH in the protocol to validate transactions and maintain their security in exchange for rewards that create new ETH. This activity, which began in 2020, was consolidated with the Merge update in 2022. The issue here is that, given the increased use of L2, mainnet validators receive fewer rewards, which could discourage their participation and affect the network security.
On the other hand, it refers to the fact that, since the EIP-1559 update established in 2021, Ethereum has a transaction burning process. This allows, when there is high activity on the main network, the burning to exceed the issuance of ETH. Consequently, at a time like this, this asset is deflationary, which facilitates its price increase due to demand due to having less supply.
On the other hand, when there is low activity on the main network, as is now the case with the growing competition from L2, the issuance is greater than the burning of ETH, something that makes its supply inflationary, as the following image shows. Consequently, this can be detrimental to its priceby simple law of supply and demand.
It should also be noted that the increase in use in layer 2 networks brings with it another implication on the market, due to the cost of their transaction commissions. Because this is very small, they need less ETH unlike what happens on the Ethereum mainnet where you can pay tens of dollars for them. This causes lower demand for the cryptocurrency, which affects its price.
Unichain can bring big changes for ETH, according to the specialist
“The arrival of Unichain further complicates that delicate balance,” says Matic. This is layer 2 that the Uniswap decentralized exchange will launch in the coming weeks. This promises transaction speeds of just 250 milliseconds, outperforming existing networks on the market and improving the DeFi experience.
For Matic, “Unichain could revolutionize the decentralized finance (DeFi) ecosystem.” “It has the potential to become the largest rate contributor among all layer 2 solutions,” he highlights. Therefore, it warns that this network can bring big changes for ETH, the number two cryptocurrency in capitalization after bitcoin (BTC).
“This innovation has the potential to make trade fairer and more fluid,” says Matic. If successful, Unichain could impact the Ethereum ecosystem in two big waysin his opinion.
On the one hand, it highlights that it could imply a change in the dynamics of ETH staking rewards. It is noted that, following the announcement of the launch of Unichain at the beginning of October, there has been a significant net outflow of 267,355 ETH from stakers.
This withdrawal is the largest since the Shanghai upgrade in April 2023as the next graph shows. To put its relevance into perspective, it is worth remembering that this was the moment when stakers were first allowed to unlock their funds.
“Although Unichain is not yet operational, it promises to further complicate the staking landscape,” Matic predicts in this scenario. He further adds that Uniswap is Ethereum’s largest fee contributor, so the move to its new network may further decrease ETH staking rewards.
However, he maintains that upcoming Ethereum updates should alleviate staking issues. But, in the meantime, he sees the situation as complicated for the ecosystem.
On the other hand, it adds as a second potential change that The network that Uniswap will launch could further reduce ETH burns. Transaction costs on Unichain are expected to be more than 95% cheaper than Ethereum. “This means that users may be tempted to migrate their liquidity to this new network,” he warns.
Almost 13% of Ethereum’s gas consumption comes from Uniswap. Therefore, this transition could have profound implications, highlights Matic. He even considers that it could impact other layer 2 solutions such as Arbitrum and Base, which currently thrive with the exchange.
This change could also pave the way for slightly higher ETH inflation in the coming monthsconcludes Matic. This is because Uniswap is the largest source of ETH burning.
ETH is missing institutional demand
Finally, something that Matic does not mention but that is of vital importance, is the performance of the ETFs.
The growing competition experienced by Ethereum may be one of the reasons why exchange-traded funds are not raising capital (ETF, for its acronym in English) of ETH in the United States, the main economic power. Since their launch three months ago, these instruments have seen outflows of almost 500 million dollars (USD).
The ETF outflows, which can be seen below, come mainly from Grayscale Ethereum Trust (ETHE), a fund that was previously listed outside the exchange. This is something that, added to the implications of the proliferation of layers 2, has hurt the price of the cryptocurrency.
According to the research firm Kaiko, the approval of ETH ETFs months after those of BTC and its lack of exposure to staking have also been factors that discouraged its demand. This shows low interest in the market on the part of institutional investors, who are the ones who mainly access these types of instruments.
Meanwhile, as CriptoNoticias reported, ETH remains trading near USD 2,500which is 45% below its all-time high recorded three years ago. On the other hand, the price of bitcoin has shown an upward trend in the last two months, which brings it closer to surpassing its record reached seven months ago.
