Crypto Update: Ethereum Gas Fees Skyrocket to Yearly High

Please note that VanEck may have a position(s) in the digital asset(s) described below.

Digital assets underperformed other risk assets in May as trading volumes slumped to a 2-year low, breadth narrowed, and leverage remained muted. For the month, Bitcoin fell 8%, and Ethereum fell 1.5% vs. the S&P 500 +1% and the Nasdaq + 6%. Bitcoin’s annualized 30-day volatility slipped below 30, a 5-month low, while BTC’s weekly correlation with the Nasdaq Composite fell to 20%, an 18-month low.

Small and mid-cap coins continued to underperform, down 12% and 11%, respectively, vs. large-caps, down only 4%. We observe a similar ‘consolidation’ theme in both protocol activity & centralized exchange fundamentals: ETH monthly fees and fee share of all smart contract protocols both hit 12-month highs; meanwhile, Coinbase & Kraken aggregate market share of US centralized exchange trading rose to 83%, a YTD high. We count 16 centralized exchanges closing or exiting certain jurisdictions year-to-date, half of whom are leaving the US. Overall, centralized exchanges’ aggregate market share fell to an all-time low vs. decentralized exchanges, a topic we will discuss further below. We think this reflects an acute lack of traditional financing available to crypto exchanges, reduced counterparty exposure appetite by speculators, tougher compliance standards, and improved functionality in DeFi.

• Layer 1s
• DeFi
• Metaverse & NFTs

Layer 1s

The total market cap for Smart Contract Blockchains (SCB) fell 4% in May from $346B to $333B. Ethereum (-1.5%) and Tron (+11%) outperformed dramatically. Every other token amongst major SCBs was down between 5-35% for the month. The weakest performers in our coverage zone for the month of March included Optimism (-35%) and Avalanche (-15%). Still, despite the muted performance of SCB tokens, fundamental usership was strong as daily active addresses across all SCBs grew 8% from 4.3M to 4.7M. Solana and Starknet, who grew by +75% and 160%, respectively, in May, were the largest relative gainers in daily active users. Likewise, value accrual also showed strong gains, with total fees by SCBs growing 41% from $368M to $518M.

Average Daily Active Users

Source: Token Terminal as of 5/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Ethereum was again a notable outperformer, posting exceptional on-chain usership metrics for the month. Additionally, positive news events materialized that improved the Ethereum supply picture by attracting millions in newly staked ETH. At the same time, Ethereum cemented its status as a usage-driven, deflationary monetary system. On the economic activity side, over $438M in fees were generated on Ethereum in the month of May, and this total represents Ethereum’s highest level of fee generation since May 2022. This fee bonanza drove Ethereum’s market share of smart contract blockchain fees to 80%, which also happens to be the highest fee share of Ethereum since May 2022. While overall crypto price volatility was muted, most of Ethereum’s fee increase resulted from meme coin speculation as Ethereum daily fees surpassed $30M a few days in early May. As a result of the trading melee, the average fee for transactions on Ethereum ballooned from $6.15 in April to $9.79 in May.

Smart Contract Platform Fees vs Ethereum Market Share of Fees

Source: Token Terminal as of 5/31/2023.Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

While Ethereum increased its market share of fees and set a yearly high in monthly fees, its usage feats were accomplished amid the inauspicious backdrop of potentially substantial ETH token unlocks. Because Lido, the leading liquid staking provider on Ethereum, enabled its validators to both exit their ETH staking positions as well as unlock their stacking rewards, there was tremendous FUD about the potential for over half a billion dollars of staked ETH to be withdrawn and sold. There was also concern that Celsius, the troubled crypto lender, would be dumping an additional 428k ETH worth $781M into the public markets.

However, while 949k ETH were withdrawn from staking in the month of May, this figure was dwarfed by the 3.7M ETH that was staked during the same time period. The supply picture in May was further improved by a burn of 200.4k ETH which contributed to an overall reduced total supply of ETH by 140k ETH in the month. If May’s pace of ETH burn is maintained, it will result in an annual drop of 1.4% in the total supply of Ethereum. Circulating supply, or ETH, which is not locked in staking contracts like Lido, also decreased in the month of May, moving from 100.64M to 96.85M ETH. At the time of writing, 19.4% of all ETH is locked in staking contracts.

ETH Supply Dynamics

Source: Dune as of 5/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Ethereum’s month was not without its blemishes as an unusual bug in the consensus software caused network issues causing significant block production lapses, resulting in temporary delays in finality on May 12th. In fact, 47 and 149 blocks were not produced in the two incidents, which caused the validators who would have held those leadership slots to miss out on block rewards. The roots of the problems were traced back to a coding error in one of Ethereum’s three consensus clients. But, because Ethereum has three, the network was able to progress past the incidents without terminal consequences for the network requiring drastic intervention by core developers. These issues and their quick resolution may prove to be strong testaments to Ethereum’s potential as a global financial settlement system. The existence of multiple clients helped Ethereum remain resilient throughout the issues as no funds were lost, and block production quickly resumed without issue. Bitcoin and Ethereum are the only blockchains with more than one client to run their networks.

In summary, an unforeseen surge in economic activity on Ethereum driven by speculation, coupled with vastly improving tokenomics and removing ETH liquidation FUD, enabled ETH’s price to outperform despite technical issues and other SCBs faltering. For more in-depth research on Ethereum, check out our most recent Ethereum valuation.

Market Share of SCB Fees ex Ethereum

Source: Artemis.xyz as of 5/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Tron, the only other major SCB whose token was positive for the month of May, continued its trend of market share gains. For May, Tron grabbed 77.2% of the fees ex-ETH, and this dominance was up from 75% for April and 50% in June 2022. For example, Tron’s fees in May were 4.7x those of Tron’s most similar competitor – BNB Chain. Tron appears to have carved out a market niche, particularly in emerging markets, as an inexpensive access point where users can cheaply send and interact with stablecoins like Tether (USDT). At the time of writing, Tron held around $45B worth of Tether on its blockchain, which is about $9B more USDT than is secured by Ethereum. As a result of growing adoption, Tron hit an all-time high for monthly daily average transactions at 8.58M, which edged out the second-highest total ever, which was April 2023, with 8.47M transactions per day. This makes Tron the second most active blockchain, in terms of transactions, behind Solana. Though, Tron’s figures can be considered even more impressive because the vast majority of Solana’s transactions are either consensus vote transactions, oracle updates, or arbitrage bot trading orders “quote-stuffing” to capture arbitrage opportunities.

Market Share of Transactions of SCB ex Solana

Source: Artemis.xyz as of 5/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Additionally, Tron is the most used Smart Contract Platform, by daily active users, with an average daily user base of 1.8M unique users for the month of May. This is also the highest it has ever been in Tron’s history, and this number overtakes the previous all-time high set for Tron that was set in the month of April. Additionally, Tron’s daily active user base is more than 4x that of Ethereum and around 40% higher than BNB, its closest competitor. Tron’s usage is most likely driven by funds transfers between users’ wallets rather than a more complex financial activity like swaps, trading, and loans. Tron, for example, averages around 50-60% of its transactions as transfers of stablecoin USDT, while 89.7% of all its on-chain activity are simple wallet transfers. Ethereum, by contrast, averages around 8-15% of its transaction volume in stablecoin transfers, and 30-40% of its transactions are wallet transfers. To further highlight the differentiation of Tron’s product market fit, despite having $45B in stablecoins to BNB’s $5.8B, Tron’s DEX volumes average 1/60^ththat of BNB’s in 2023.

Optimism showed dramatic under-performance in the month of May as it was the worst-performing token, not only among our set of smart contract blockchains but also among the top 100 tokens by crypto market capitalization. The biggest dark cloud hanging over Optimism was the substantial token unlock of OP tokens that more than doubled the circulating token supply. On May 31, more than 386.5M tokens were unlocked for investors and core contributors, with some of these early investments up 10,000%, including seed round funders Paradigm and IDEO. This unlock brings more than $550M worth of OP tokens to the market that can be sold. Additionally, the underperformance of OP can be attributed to decreased on-chain activity and operating income declines. Despite a slight increase in the market share of DEX volume, absolute DEX volume was down 34% between April and May, and the total transaction count was also down 28% for the month of May.

For Ethereum Layer-2s, their net margin before incentives is an important component of their financial picture. While Layer-1 blockchains count transaction fees as a revenue item and security fees, paid to validators, as a cost, Layer-2s have a slightly more complicated setup. Since L2 blockchains do not have validators and consensus mechanisms but instead have sequencers to process and order transactions, they must pay their host Layer-1 security fees to settle transactions. Essentially, they must bundle their transactions into a compressed piece of data and post that as a transaction to Layer-1. This transaction must still compete in the gas auction for blockspace, subjecting it to wildly varying transaction costs. A rough measure of L2 profitability can be termed “Operating Income Before Incentives” (OIBI) as it is derived as the transaction revenue earned by an L2 less the settlement fees paid to the L1 for posting the rollup data.

Ethereum L2 OIBI

Source: Token Terminal as of 5/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

While the fees generated on OP were up in the month of May, the OIBI accruing to Optimism was down 13% month to month. This is because the fees paid to Ethereum spiked as the demand for Ethereum’s blockspace surged. When competition for blockspace is high, the cost of settling transactions increases, and L2 OIBI margins will decrease. As the month of May was one of the great demand for Ethereum blockspace, L2s like Optimism saw OIBI drop significantly. Of course, Optimism was not alone in declining profitability due to Ethereum gas costs; Arbitrum’s OIBI declined 63%, while Polygon saw the same line item decline 33%.

Considering the OIBI margin of these L2s, Optimism margins have historically been slightly lower than those of Arbitrum or Polygon. Because Polygon is not a true L2 but rather a side chain, its settlement fee structure from Ethereum is much lower. Polygon, because it has its own validator set, uses a technique called state sync to send a snapshot of Polygon’s blockchain state to Ethereum. On the other hand, Arbitrum has achieved higher margins than Optimism because it uses a better-designed virtual machine to process transactions and a more data-streamlined fraud-proof mechanism. As a result, in its current form, Arbitrum has a slight margin advantage over Optimism. From a cost standpoint, rollups like Optimism and Arbitrum have two costs embedded in their fee structure – the cost to roll up all the transactions and post to Ethereum and the cost to transact on the L2. More detailed, the cost for transactions on Optimism breaks down as such:

Optimism Transaction Fee = [ Fee Scalar * L1 Gas Price * (Calldata + Fixed Overhead) ] + [ L2 Gas Price * L2 Gas Used ]

Despite the massive token unlocks, the future for Optimism still looks bright to us. With the announcement of the OP Stack, a software development kit to create Layer-2 blockchains, projects such as Coinbase’s Base and Kinto intend to build using Optimism’s technology. While these projects may not directly add value to the OP token, the OP token will act as a governance token of the whole ecosystem, which will govern the progression of the SDK software updates going forward and the process towards a decentralized, shared sequencer. This sequencer set will utilize the tokens for governance and potentially even for staking. Additionally, Optimism is on the cusp of releasing an update called Bedrock which will reduce transaction costs by up to 90% through better data compression to minimize costs. Bedrock also reduces deposit times and enables the separation of the roll-up node and the client to create a modular L2 set-up.

L2 Monthly Margin

Source: Token Terminal as of 5/31/2023.Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Avalanche was the other noteworthy underperformer for the month of May, as declining blockchain fundamentals and a large token unlock dragged down AVAX price by 18%.

The fundamentals of Avalanche paint an initially deceptive picture. Though monthly active users posted an all-time high on Avalanche, further inspection of the activity driving that figure suggests that the activity is “astroturfed.” Of 732k monthly unique active users recorded on Avalanche in the month of May, 470k, or 64% of the total, interacted with Stargate. If these Stargate users were removed, the MAU total would be only 302k Avalanche monthly active users, which would be the lowest number for Avalanche since September 2022. Despite being the second highest in the last twelve months at $1.34M, monthly fees on Avalanche were a 34% decline from April’s fee total.

Additionally, though Avalanche's fees were relatively high, over 10% of the fees were incurred by Stargate, and another 29% were incurred by wallet transfers of AVAX. These figures corresponding to Stargate and the wallet transfers are notable, given that there is great speculation of a Stargate token airdrop. As a result, these figures, and, as a result, the topically positive figures for Avalanche on-chain activity, should be looked at with suspicion.

Likewise, there has been a tremendous decline in DEX activity in May compared to April and a drop in TVL. While TVL dropped 11.36%, DEX volume was down a whopping 46%. Avalanche TVL and DEX volume were the lowest monthly figures on record since the doldrums of July 2021 following the Chinese Bitcoin mining ban. The month-to-month drop in DEX volume for Avalanche was the worst among all tracked smart contract blockchains for the month of May, and the TVL decline was the second largest. Additionally, despite all the bridge activity generated by Stargate, bridged tokens to Avalanche fell $65M from $470M to 405M, losing 13.84% of the bridge’s value. To add salt to the wound of deteriorating fundamentals, on May 29, 9.5M AVAX, around 3% of supply, was unlocked, of which 6.2M went to the Avalanche Team and the Avalanche Foundation.

Some encouraging developments for Avalanche in the month included the deployment of a Euro stablecoin called EUROC, the announcement of AvaCloud to enable businesses to build no-code blockchains that launch in minutes, the creation of the GoGoPool, which will reduce the cost of operating a validator node, and the transition of the Avalanche X-Chain to the blockchain data structure to smooth the way to future exchange and asset integrations.

Avalanche DEX Volume and TVL

Source: Artemis XYZ as of 5/31/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

DeFi

MarketVectors Defi Leaders Index (MVDFLE) fell 9% in May as investors allocated to larger-cap coins amidst weaker overall price performance. Among constituents, UNI fell 3.5%, AAVE -7%, CRV -8%, MKR -9%, and YFI -19%. The total value locked (TVL) in DeFi fell slightly from $48.6B to $47.4B. This decrease can be attributed, in part, to the decline in the price of Ether (ETH), the primary collateral used in many DeFi protocols. As the price of ETH dipped, the overall TVL mirrored the trend.

One of the most developments in DeFi during May was the substantial rise in decentralized exchange volume compared to centralized exchanges. According to data from The Block, decentralized exchanges accounted for only 14.1% of crypto volume in April. However, they witnessed a significant surge in May, capturing just under 22% of the total volume. This shift was driven by a decline of approximately 30% in centralized exchange volumes, juxtaposed with a growth of around 10% in decentralized exchange volume. The increase in volume was mainly captured by PancakeSwap, which saw an 87% increase in volume this month. Despite the volume growth, the price of PancakeSwap’s governance token, CAKE, fell 36% in May.

DEX % of Crypto Spot Volume

Source: The Block as of 6/1/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

Lending rates in DeFi remained stagnant throughout the month, with the average stablecoin borrow APR hovering around 3.5%. Despite introducing new decentralized stablecoins, their development has not reached a level catalyzing meaningful increases in leverage across the space. This is primarily because these teams have intentionally limited the size of their initial products as a precautionary measure. For instance, Curve's crvUSD recorded $8.77 million in open loans at a 4.99% APR on $12.93 million of sfrxETH collateral. Similarly, Maker's newly released Spark protocol attracted just over $10 million of wstETH collateral and enabled $5.1 million in loans. As these protocols mature, they are expected to raise deposit caps and incorporate additional collateral types, thereby fostering wider adoption.

One emerging trend we monitor in the DeFi market is the release of liquid-staked ETH-backed stablecoins. This innovation essentially creates a self-repaying loan for investors, as the staked ETH generates yield above that which the investor is paying for their loan. With the growth of liquidity and increased confidence in the peg-resilience of liquid-staked ETH tokens, we think this trend may gain further adoption. We see Yearn (YFI) as one of the best protocols for building interest-bearing collateral due to its unique design. The project’s forthcoming yETH vault could capture a significant share of the liquid-staked ETH lending market. A forthcoming blog post will explain this thesis more fully.

Metaverse & NFTs

Metaverse tokens lagged severely in May, with the MarketVectors media & entertainment leaders index down 17% and little user traction in most of the projects we track. Leading metaverse tokens experienced notable percent changes in May as APE declined by nearly 20%, MANA dropped by 13.2%, and SAND witnessed a decrease of 5.4%. Usership of the top metaverse platforms remained relatively stagnant throughout the month, indicating the need for further catalysts to drive growth and engagement. On the other hand, Apple's entry into the metaverse space with its upcoming headset has the potential to be a significant catalyst. As the release of Apple's headset draws near, interest in augmented reality (AR) and virtual reality (VR) has re-emerged, and this anticipation could reignite investors' desire to gain exposure to metaverse tokens once again. Apple's recent announcement, encouraging creators to prepare for building new worlds, has reinvigorated metaverse enthusiasts online and, if their product lives up to the rumors, could revive the “going to work in the metaverse” dream.

Among gaming projects, Illuvium (ILV) released its highly anticipated private beta 2, introducing a range of new features that sparked some renewed investor interest. ILV rallied off its mid-month low but still ended the month -3% with no significant increase in NFT trading volumes. We have been monitoring the development of this project for over a year now. While determining its viability is hard to make pre-release, the progress and thoughtfulness that we have seen from the team so far are impressive.

Overall, NFT sales volume rose 4% in May to $730M from $700M in April. Ethereum maintained its lead with $395 million, Bitcoin followed closely with $192 million, while Solana enabled $44 million in NFT sales volume. These figures highlight the continued dominance of Ethereum in the NFT market and signify the increasing interest and adoption of other blockchain platforms, specifically Bitcoin.

May NFT Sales by Blockchain

Source: VanEck, Cryptoslam! as of 6/1/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

However, the real standout was the booming NFT lending scene, with Blur’s Blend leading the way. Blend recorded over $335M in borrow volume and $130M in loan repayment volume. Blend's borrows accounted for about 80% of the ETH borrowed on NFT collateral in May. This surge in NFT lending showcases the increasing demand for leveraging NFT assets to unlock liquidity and create new financialization opportunities. In a move to compete with the existing NFT lending platforms, especially Blend, Binance announced the development of its own NFT lending marketplace. The platform, launched at the end of May, provides users with an alternative option for utilizing NFT collateral. Binance's entry into the market adds an exciting layer of centralized competition and is expected to bring further innovation and accessibility to the NFT lending space. Specifically, the cost and success of Binance’s user incentivization should provide interesting data compared to Blur’s airdropped rewards method.

Blend: First Month Results

Source: Dune: @ahkek, VanEck as of 5/29/2023. Past performance is no guarantee of future results. Not intended as a recommendation to buy or sell any securities named herein.

The conclusion of the month brought news of Kellogg's potential expansion efforts into the metaverse, as the renowned American cereal giant filed a dozen trademarks for its portfolio of brands. Documents revealed that Kellogg's has strategic plans to utilize its intellectual property by creating branded NFTs. This move signifies Kellogg's recognition of the growing significance of the metaverse and its intention to leverage its brand assets within this emerging digital landscape.

Overall, the Metaverse & NFT market remains highly dynamic, with Blend's success in NFT lending and Binance's entry into the space demonstrating the industry's drive for innovation and accessibility. And while Ethereum continues to lead in sales volume, other platforms like Bitcoin are carving their own paths in the NFT landscape. We are hopeful that Fortune 500 companies like Kellogg and Apple will eventually catalyze mass adoption of NFTs as a direct-to-consumer loyalty protocol or B2B as a ticket to unlock subscriptions and other services. Ethereum upgrades, such as account abstraction, should help unlock this utility. On the other hand, most gaming & metaverse tokens are plagued by lackluster user traction and still-inflated valuations. We are on the lookout for users before deploying more aggressively into this space.

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