CONTRIBUTORS
Christopher Jensen
Head of Research,
Franklin Templeton Digital Assets
David Alderman
Research Analyst,
Franklin Templeton Digital Assets
A version of this article was first published on CoinDesk on March 21, 2024.
Most investors are familiar with the business model of the entrenched platform economy, in which a set of powerful tech companies rely on the network effects that they generate to obtain proprietary data, goods, or content from their users. These tech giants dictate terms that are favorable to their own businesses yet often limiting to users’ interests. One of the most exciting and perhaps underappreciated aspects of blockchain technology is that it has enabled a new business model – what we call the protocol economy. A blockchain, in its simplest form, is a secure digital ledger that, without the use or need of intermediaries, records new activity to its ledger in exchange for a fee, while adhering to its protocol (rules for how the process works). Why does this matter? Blockchains enable digital property rights. Digital scarcity and ownership can now, for the first time, be enforced through software and code rather than organizations and people.
However, not all blockchains function the same way. The Bitcoin network is an application-specific blockchain. It essentially does one thing – records wallet addresses and BTC amounts – but it does this very well. It’s secure, transparent, and permissionless. Ethereum, on the other hand, is a general purpose blockchain. Its programming language, along with the introduction of self-executing smart contracts, allows for more complex “if-then” activities. This innovation transforms blockchains from mere distributed ledgers into powerful, global virtual computers. These virtual machines enable developers to create comprehensive applications across various domains securely and autonomously, from marketplaces and financial tools to social networks and even other blockchains.
Ethereum's robust security layer and broader functionality paved the way for new digitally native economies to be built on top of its infrastructure layer. Tokens in such ecosystems are not just currencies but essential incentive mechanisms, encouraging coordination and integrity within the decentralized system. Holding Ethereum’s ether token ($ETH) signifies more than transactional utility; it represents an ownership stake in Ethereum's network, offering both participatory and economic benefits aligned with the ecosystem's growth. Moreover, the fundamentals of Ethereum’s network can be analyzed in a similar fashion to non-digital companies, which may help inform what $ETH is worth (similar to a stock, albeit with some different metrics and nuances).
The protocol economy of Ethereum currently has over 120 million token holders and this has grown at double digit annual rates over the past four years. Monthly active users grew 44% YoY last month and now stands at 7.1 million. If users on Ethereum Layer 2s (blockchains built on top of Ethereum to help scale the ecosystem) are included, that user base is over 12 million.1 Total value locked, i.e. the amount of capital stored in Ethereum’s DeFi smart contracts, rose to ~$54B, but this figure still massively understates the total economic value that the chain secures, which is estimated at $0.64 trillion.2 And, while Ethereum’s developer count is down YoY, most of that attrition is due to new, part-time developers while the ecosystem’s established developer base continues to rise.3
Ethereum’s financial state is likewise robust with YTD total fees and gross profits are both up roughly 100% YoY and Last Twelve Months (LTM) Total Fee Revenue currently stand at $3.1 billion. Furthermore, the network has an 85% gross margin and is profitable (23% net profit margin) even when accounting for the non-cash token incentives.
So how does one get exposure to this breakthrough technology asset and, just as importantly, the $0.64 trillion value built on top of the chain? Assuming a protocol’s tokenomic design has a value accrual mechanism that allows value of the network to flow to, and be captured by, the value of the token, then there’s a case to be made for holding the token. When any kind of economic activity happens anywhere in the Ethereum ecosystem, fees (revenues) are generated. A portion of those fees fund the network’s security costs (COGS) while the remainder support token value through strategic buy-and-burn mechanisms (akin to share repurchases). This approach highlights the advantages of protocol economies over traditional platform economies. Rather than buying stock in a company that built a platform that attracted a network, investors and users alike can now own a direct stake in their network’s success.
Endnotes
- Source: Mastering Ethereum Layer 2s. Grow the Pie website.
- Sound: Ultra sound money website.
- Source: 2023 Crypto Developer Report. Developer report website. January 17, 2024.
WHAT ARE THE RISKS?
All investments involve risks, including possible loss of principal.
Blockchain and cryptocurrency investments are subject to various risks, including inability to develop digital asset applications or to capitalize on those applications, theft, loss, or destruction of cryptographic keys, the possibility that digital asset technologies may never be fully implemented, cybersecurity risk, conflicting intellectual property claims, and inconsistent and changing regulations. Speculative trading in bitcoins and other forms of cryptocurrencies, many of which have exhibited extreme price volatility, carries significant risk; an investor can lose the entire amount of their investment. Blockchain technology is a new and relatively untested technology and may never be implemented to a scale that provides identifiable benefits. If a cryptocurrency is deemed a security, it may be deemed to violate federal securities laws. There may be a limited or no secondary market for cryptocurrencies.
Digital assets are subject to risks relating to immature and rapidly developing technology, security vulnerabilities of this technology, (such as theft, loss, or destruction of cryptographic keys), conflicting intellectual property claims, credit risk of digital asset exchanges, regulatory uncertainty, high volatility in their value/price, unclear acceptance by users and global marketplaces, and manipulation or fraud. Portfolio managers, service providers to the portfolios and other market participants increasingly depend on complex information technology and communications systems to conduct business functions. These systems are subject to a number of different threats or risks that could adversely affect the portfolio and their investors, despite the efforts of the portfolio managers and service providers to adopt technologies, processes and practices intended to mitigate these risks and protect the security of their computer systems, software, networks and other technology assets, as well as the confidentiality, integrity and availability of information belonging to the portfolios and their investors. Any companies and/or case studies referenced herein are used solely for illustrative purposes; any investment may or may not be currently held by any portfolio advised by Franklin Templeton. The information provided is not a recommendation or individual investment advice for any particular security, strategy, or investment product and is not an indication of the trading intent of any Franklin Templeton managed portfolio.