The latest crypto market correction has punished Ethereum more severely than Bitcoin and a few other rival altcoins, with ETH’s price down 30 percent compared to an 8 percent fall in Bitcoin and 10 percent in BNB from their local highs, further accentuating ETH’s lacklustre performance over the last couple of years. However, the billions lost to politically-tied memecoins has put Solana under pressure, sparking debates on insider trading and renewed calls for regulatory scrutiny. Some analysts suggest the recent string of memecoin failures could push investors towards more sustainable sectors.
Ethereum’s underperformance may not truly reflect its potential, but is a sign that the market is doubting its ability to move fast enough and stay competitive as Layer 2s continue capturing more fees. It is also a sign that other Layer 1 blockchains, most notably Solana and BNB Chain, are mounting a serious challenge to Ethereum’s years-long supremacy as the dominant smart contract platform.
Ethereum has flagged since the celebrated Merge in 2022, when the blockchain switched from a Proof-of-Work to a Proof-of-Stake validation model.
The Dencun network upgrade last year awarded extra data storage space for Layer 2 protocols, that sit on top of Ethereum, to “roll up” and process multiple transactions before sending them back to Ethereum for final settlement.
But this has sucked activity and revenues away from Ethereum and towards its Layer 2 offspring. A heated debate has broken out between researchers and developers, asking whether Ethereum has lost its path and questioning the value of the Ethereum Foundation and debating the best future roadmap.
Despite these pressures, the right drivers are still in place and point to likely tailwinds for Ethereum and the broader crypto industry this year:
- Major upgrades are in the works (Pectra hard fork – EIP-7702, EIP-7251 and Fusaka)
- Leading L2s and DApps are working together to unify the ecosystem (ERC-7683, RIP-7755)
- An uptick in demand for ETH ETFs and TradFi purchases
- Increased interest from financial institutions (tokenising capital market instruments)
- A potential shift towards economically viable projects under the new pro-crypto US administration
In this article, we take a look at Ethereum’s current predicament and the possible future outcomes for the world’s second largest cryptocurrency by market cap.
The state of play for Ethereum
In January, Ethereum founder Vitalik Buterin stated his intention to draw a line in the sand with a series of proposals to pull together the fragmented ecosystem, re-align interests for the benefit of the entire community, settle recent disputes and internal divisions, and revitalise the blockchain’s performance.
One of his goals is to overhaul the under-fire Ethereum Foundation, which hands out grants to developers and promising decentralised projects. This will include changes to the foundation’s leadership structure, improving communication between the foundation and developers, Layer 2s and the community at large.
Besides advocating a much-needed boost of cohesiveness and cooperation within the Ethereum ecosystem, Buterin wants to retain the best research and developer talent rather than see a brain drain to rival blockchains.
The upcoming Pectra upgrade has drawn some criticism for not being ambitious enough and has failed to move the needle on the underperforming ETH token. Even though the upgrade will bring a number of critical improvements to Ethereum’s scalability (including staking and gas payment features), the upgrade is not expected to have any outsized impact on ETH’s value, so the market’s anticipation remains underwhelming.
The key strength of Ethereum is its highly secure infrastructure, but finding consensus among a diverse network of independent validators and developers, who have different interests, remains a key challenge.
Projecting a dynamic future vision is another issue. The Ethereum blockchain is the foundational pillar of the whole ecosystem as it guarantees both security and property rights to the assets being built and traded on top. Maintaining its decentralised principles in the face of large, powerful staking pools is key to retaining credibility.
But Ethereum does not want to be viewed purely as a dependable bookkeeping system. It also needs to restore its reputation as a lively hub of innovation so it can keep attracting the best developers and projects.
The headwinds
Ethereum faces challenges from rival Layer 1 blockchains, ranging from Solana and BNB Chain to the newer Sui platforms, and from Layer 2 blockchains inside its own ecosystem.
For the time being, Ethereum can still boast of the powerful DeFi applications and protocols that interact with its blockchain, such as Uniswap, MakerDAO, Aave, Compound, and MetaMask, as well as Lido Finance, EigenLayer and ether.fi.
This unrivalled array of well-known services is unmatched by challenger blockchains. Memecoin trading executed by bots might dominate on rival chains, giving a distorted picture of superior transaction volumes, but this might change as other applications emerge and more economically sustainable projects start gaining traction again.
This shift could happen sooner than expected after a string of recent political memecoin disasters shook the sector. The Trump family’s memecoins (TRUMP and MELANIA), which generated a fair amount of criticism for displaying naked greed and insider trading allegations, have plummeted 78 percent and 91 percent from their all-time highs. Argentina’s USD 4.4 billion LIBRA collapse now has President Javier Milei facing fraud allegations, while Central African Republic’s CAR token immediately tanked over doubts about its authenticity.
Even so, the memecoin craze has accelerated the trend of Solana closing the gap on Ethereum protocol revenues. Ethereum revenues far exceeded the volume of Solana a year ago, but the difference has narrowed between the two platforms, with Solana outperforming Ethereum so far this year. Solana is also taking total value locked (TVL) market share from Ethereum.
At the same time, within the Ethereum ecosystem, Layer 2 networks are handling a significant share of transactions and earning more fees. These networks play an important role in Ethereum’s scalability plans, but if Ethereum fails to capture enough value, it risks being used as a mere backbone that Layer 2s profit from at its own expense.
Ethereum vs. Layer 2 transaction activity (monthly)
Source: Dune
The tailwinds
In a bid to show its commitment to the ecosystem, the under-fire Ethereum Foundation recently deployed USD 120 million worth of ETH into DeFi lending protocols Aave, Compound and Spark. This was the foundation’s largest DeFi allocation to date and was well received by the community.
Meanwhile, developments towards achieving real Layer 2 interoperability may be closer than we think. Polygon’s AggLayer, RIP-7755, and EIP-7683 are working to unify liquidity and improve cross-chain transfers between many siloed L2 networks, while executives from Optimism, Base and Taiko are backing based rollups that would hand transaction sequencing back to Ethereum’s own validators. Layer 2s would be giving up some of their revenue, but in exchange for a more decentralised and cohesive network with more settlement activity flowing back to Ethereum’s base layer.
The great hope for the broader crypto market is that the new administration in the US converts pro-crypto campaign rhetoric into concrete reality. The new AI and crypto taskforce is currently working on a framework that will set clear and reasonable policy to give the crypto industry regulatory certainty and room for growth.
Ethereum could be one of the main beneficiaries of this shift in regulatory approach as it is already the main blockchain of choice for projects that merge traditional finance with DeFi. Leading TradFi institutions like BlackRock and UBS have already tokenised money market funds on Ethereum, while PostFinance recently introduced ETH staking services to its customers. Clearer regulation could allow blockchains like Ethereum to unlock trillions of dollars of real-world assets (RWAs) onto decentralised financial rails.
There are also signs of large investors accumulating ETH, with BlackRock (USD 276 million) and the Trump-backed World Liberty Financial increasing their ETH holdings. Since the US presidential elections, Ethereum ETF inflows have performed in line with Bitcoin ETF inflows on a market capitalisation-weighted basis.
This can be viewed as an acknowledgment of the Ethereum blockchain being well-positioned to increase its already overwhelming market share of tokenised activity.
Opening the floodgates to Wall Street’s DeFi ambitions could well shift attention from the politically fraught memecoin craze to projects with more substantial economic value. This would be a better fit for Ethereum.
ENDS
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