TL;DR
Introduction
In our post exploring Ethereum’s Network Economics, we laid out a simplified model to gauge whether the network as a whole is “profitable”. Specifically, the oft-used calculation of network profitability = base fees – priority fees – token issuance as an aggregate view to answer the question: is the network as a whole generating enough revenue to offset the dilution of a holder?
This is a shorthand way to get a sense of the broad strokes of a network’s sustainability but lacks a lot of the nuance of the underlying tokenomic model. Specifically for Ethereum, this view treats both priority fees and token issuance as net costs to the standard token holder. While this is not wrong per se, it ignores the fact that native assets like ETH are fundamentally productive and allow holders to be active participants of the network. As we described in our April 26 post, the ability to participate via staking provides the user yield:
“… in exchange for contributing to the network. These features make ETH undeniably a cash-flow generating, productive asset – but only through active contribution, not passive free-riding”
Why do we bring this up again? Because this differentiation of passive holding vs. active contribution is incredibly important when evaluating the value of Ethereum and its token ETH.
The Actual Economic Equation
Holders and stakers face very different financial realities when it comes to Ethereum. We’ll use some loose analogies to try to make this distinction clear. Owning tokens of a blockchain network can be viewed similarly to holding shares of a pass-through entity like LLCs or S-Corps in the US (without any of the associated legal implications, of course). That is, a token’s economic proceeds are simply passed on to the holders, who then face their own associated costs such as taxes or administration burdens. Any disbursed proceeds that are ultimately passed through are net of the LLC/S-Corp's own expenses. With this analogy in mind, let’s define some terms for Ethereum:
Protocol Revenue = The totality of all base transaction fees, priority fees paid to validators, realized MEV, and network issuance. Base transaction fees are what the Ethereum network automatically burns and are more often cited as ‘revenue’ in simple models. We include MEV here because at long-term equilibrium, rationally, MEV bots will be willing to pay priority fees to validators to the point that those payments equal the amount they can expect to earn from the transaction, meaning validator priority fees capture 100% of MEV profit (i.e. MC=MR for MEV bots), or efficiency improves to the point that profitable opportunities no longer exist and are thus fully captured through other mechanisms.
“Allowances” = A parallel to more traditional businesses, we define allowances as the amount of MEV that is still extracted from the network and not yet captured by validators. At equilibrium, this will be minimized but remain positive for the foreseeable future.
Net Protocol Revenue = Protocol revenue net of allowances. Specifically, these are base transaction fees, priority fees, and network issuance that ultimately flow to ETH token holders.
Network Burn = Much like in traditional finance corporations can issue dividends or buyback shares to return value to shareholders. Ignoring taxes, both methods are theoretically equivalent in returning value. In Ethereum’s case, burning all of the base transaction fees are akin to a share buyback. Blob fees are also burned but at the moment are essentially zero following EIP-4844.
Network Issuance = The programmatic distribution of ETH tokens to validators as rewards for validating the network.
Up to this point, these metrics are the same for both straight token holders and token stakers. However, whether one holds or stakes impacts access to these flows and the resultant economics begin to differ wildly. Most importantly, the flow of economic value bifurcates, dramatically favoring stakers. Further, the ‘operational expenses’ that holders are subject to are far heavier than for stakers. This is because they incur the entirety of the cost of the network issuance, whereas stakers receive that issuance for participating in the network.
Network Issuance to Stakers = The share of network issuance paid to ETH stakers. Though not exactly the same, a comparison can be made to the additional dividend rate that participating preferred shareholders might receive above and beyond common shareholders. In our comparison, that common dividend is the fee burn of the Ethereum network, and the preferred dividend is the network issuance paid to validators and thus stakers.
Priority Fees = Beyond the base fee burn, stakers earn priority fee payments from users seeking preferential inclusion in the blocks produced on the network. These are not included in the network’s fee burn and accrue entirely to validators.
So, on the ‘revenue’ side, where does that leave us? Simple holders earn only their share of the network’s overall fee burn whereas stakers/validators earn their share of the fee burn in addition to all priority fees and network issuance paid out. On the expense side:
Net Issuance = This is a cost to those simply holding ETH. It can be viewed as a tax levied for the use of the network and for receiving the security provided by the 1M+ validator set. As we described above, this is a positive value flow for stakers.
Node Operator Payments = This is an explicit cost for delegated stakers on the network. In exchange for having 3rd party node operators run a validator on their behalf, stakers share 5-10% of the total yield earned by their validator. This includes both a share of the net issuance received as well as the priority fees paid to the validator. Holders do not directly have this cost as they are not staking but indirectly pay this via the net issuance tax that flows to validators.
Importantly, holders have profitable stakes in the network when the transaction fee burns more than offset the network’s new issuance, putting net new issuance at or below zero. Until this point, from a holder’s perspective, Ethereum is operating at a loss.
The net result of these two value flows is what holders and stakers ultimately earn in the form of proceeds from holding ETH. Each may be subject to additional costs, such as taxes or their own operating expenses, but these are external to the Ethereum network flows, much like our pass-through structure comparison. Solo stakers and node operators have different economics but we will hold off on going deep on those in this post. In summary, the value structure of Ethereum looks somewhat like this:
Picture: Simplified Ethereum Value Structure
As one can see, the simple model of profit = network burn – issuance misses all of the nuance involved in valuing an asset like ETH. The value of ETH changes dramatically based on the amount one participates in the ecosystem: holding, staking via delegation, or validating directly are all very different.
Quantifying These Flows
We can use some rough estimates to get a sense of how much value ends up in the hands of holders and stakers. Roughly 28% of all Ether is currently staked, either directly or through delegation. That leaves 72% of ETH freely circulating to be held or used in other ways. For the purposes of this analysis, we treat 72% of this as simply ETH held.
Source: Author’s estimates, TokenTerminal, Blockworks, Dune (@hildobby)
Holders are simple. They earn their share of the network’s net burn of base and blob fees. In September, that was roughly $68M. As such, holders received $49M of ‘buybacks’ from the network in terms of net token burns. They receive no other inflows of value. So, the 72% of ETH circulating (~$231B worth) accrued $49M of value for the month.
The economics for stakers are far more interesting. Similar to holders, they receive a prorated share of the network’s overall burn, amounting to $19M in September. However, they also earn additional tips from priority fees and MEV activity. In September, these totaled roughly $35.4M and $11.5M respectively. However, MEV activity remains extractive and one can estimate that ~$3-5M is captured each month by bot activity, largely in the form of fees paid. That means that stakers receive ~$30M from priority fees and $11.5M from MEV activity, giving them pre-issuance revenue of $61M, almost 25% more than what accrued to holders despite representing just 1/3 of the respective share of the network.
Network issuance entirely flows to stakers and validators. In September, that was $193.2M in new issuance. This brings the total value flow to stakers to $254M for the month versus just $49M for holders.
We can break down the value within staking as well. Of all ETH staked, roughly 81% is staked through centralized exchanges, pools, or liquid (re)staking protocols, and the remainder is staked directly. For simplicity, we estimate that delegated stakers pay 10% to the node operators and protocols for staking on their behalf and are including solo stakers in this direct staking group. The weighted effective amount likely falls somewhere between 5-10%.
Thus, the 81% represented by delegated stakers earn their share of ETH fee burn ($15.4M) and 90% of priority fees ($30.5M) and issuance ($140.7M). In total, delegated stakers earned $186.6M in September. Direct stakers (19%) capture the remaining $67.6M of value, with $15.1M coming from fees and $52.5M from network issuance.
How does this all shake out? The ~23% of delegated stakers earn a disproportionally high 61% of all value flowing through the network. Direct stakers/node operators, accounting for 5% of ETH stake, earn 22% of all value. MEV bots extract just under 2%. That means holders, accounting for 72% of all ETH in circulation, receive just 16% of all value of the network.
Summary of economic flows on Ethereum
One way of interpreting this via yet another loose analogy is as follows:
In this mental model, the delegated stakers (shareholders) have ~60% margins on the network’s earnings. They lose just under 2% to MEV (“allowances”), payout 22% to node operators (“service providers”) for running and securing the network, and then spend 16% on user acquisition and marketing to attract and retain holders (“customers”).
On the flip side, a holder’s outlook is far less rosy. Revenues (e.g. network fee burns) reflect the entirety of their value capture, but they bear the entire cost of the network’s issuance given they receive none of that economic flow in return, as do stakers. Collectively, that inflation tax falls squarely on holders as a subtle toll for security and settlement services and as a result, holders require drastically higher main net fee activity to “break even”.
Conclusion
Blockchain networks put their own twist on what it means to hold ‘participating’ shares of something. In Ethereum’s case, by participating in the network through staking, a small subset of holders receive an outsized amount of the value flowing through the network in the form of transaction fee burns, priority fees, and network issuance. The only costs that delegated stakers incur are the share of rewards paid out to node operators that run their stake on their behalf, and the share of fee burn that goes to holders. Otherwise, much like a pass-through entity, all other costs for stakers are external to the network.
These structures also highlight why Ethereum, and digital assets more broadly, are viewed as being a major change from traditional web2 dynamics, allowing users of the network to benefit alongside the ‘owners’ rather than having that value flow in a single direction.
When viewed through this lens, Ethereum is undoubtedly a profitable network, but only if you are involved through active contribution, not passive free-riding (though this can itself potentially be profitable too). This dynamic exists only as long as the faction of stakers to holders is less than 1. As the stake rate approaches 100% the value imbalance tends to zero, and in that world where all holders are stakers, the only net value flows are to MEV extraction and the 10% cut that node operators take for providing validation services. Network issuance no longer becomes a toll but rather trends to a net-zero flow of funds and transaction fees are largely circular as Ethereum users (= holders = stakers) as a whole pay themselves for the use of the network. Within that closed loop, value through transaction fees gradually flows from active users to simple stakers over the very long term.
