Original Authors: Matthew Sigel, Patrick Bush, Denis Zinoviev, VanEck
Translated by: 1912212.eth, Foresight News
We anticipate that an ETH spot ETF will soon be approved for trading on US stock exchanges. This milestone development will allow financial advisors and institutional investors to hold this asset under the custody of qualified custodians and benefit from the pricing and liquidity advantages of ETFs. In response, we have updated our financial models and reevaluated the fundamental investment case for ETH. We have also conducted a series of quantitative analyses on how ETH interacts with BTC in a traditional 60/40 investment portfolio, focusing on the balance between risk and return.
Key points of this article:
The Ethereum network is expected to continue rapidly gaining market share from traditional financial market participants and an increasing number of large tech companies. If Ethereum can maintain its dominant position in smart contract platforms and achieve the expected growth, we have reason to believe that by 2030, its free cash flow (CFC) will reach $660 billion, its market cap will reach $2.2 trillion, and the price of each ETH will reach $22,000.
Adding a moderate cryptocurrency allocation (up to 6%) in a traditional 60/40 investment portfolio can significantly improve the portfolio’s Sharpe ratio with relatively minimal impact on drawdowns. An allocation close to 70/30 between Bitcoin and Ethereum in a pure cryptocurrency investment portfolio provides the best risk-adjusted return.
Evaluating Investment in Ethereum
ETH is the native token of Ethereum, a new type of asset that exposes investors to high-growth, internet-native business systems that have the potential to disrupt existing financial businesses and large tech platforms like Google and Apple. Ethereum has attracted approximately 20 million monthly active users in the past 12 months, settling $4 trillion in value and facilitating $5.5 trillion in stablecoin transfers. Ethereum has over $91.2 billion in stablecoins, $6.7 billion in tokenized off-chain assets, and $308 billion in digital assets. The core asset of this financial system is the ETH token, and in our updated fundamentals, we believe that by 2030, ETH will reach $22,000, with a total return rate of 487% and a compound annual growth rate (CAGR) of 37.8%.
We forecasted the valuation of ETH in 2030 based on the projected $660 billion in free cash flow generated by Ethereum, attributing it to the ETH token. We estimate a price-to-earnings multiple of 33 times for these cash flows. As Ethereum is an application platform, we began by estimating the market size of the industries that blockchain applications will disrupt. We estimate the total addressable market (TAM) of these industry verticals as follows:
Financial, Banking, and Payments (FBP) – $10.9 trillion
Marketing, Advertising, Social, and Gaming (MASG) – $1.1 trillion
Infrastructure (I) – $1.8 trillion
Artificial Intelligence (AI) – $1.4 trillion
Using TAM data, we estimated the market capture by Ethereum and other blockchains for these revenues. The penetration rates for FBP, MASG, I, and AI are 7.5%, 20%, 10%, and 5%, respectively. We predict that Ethereum will charge a fee to application users, which is essentially the “cut” of revenues that these applications receive, calculated to be between 5-10%. We recently updated the ETH model for Spring 2023, adding the AI terminal market to reflect Ethereum’s significant potential in that area. Other influential adjustments to the previous model include increased consumption of ETH supply, higher market capture in terminal markets, and greater acceptance rates for underlying economic activities. We believe these changes are reasonable given the latest innovations that make Ethereum more accessible and the shifting political landscape in the United States.
We believe that ETH is a revolutionary asset with almost no comparison in the non-crypto financial world. ETH can be considered “digital oil” as it is consumed through activities on the Ethereum platform. ETH can also be seen as “programmable money” because the financialization of ETH and other Ethereum assets can occur automatically on the Ethereum platform without any intermediaries or reviews. Additionally, we consider ETH as a “yield commodity” as it can be staked in a non-custodial manner to earn ETH rewards by validators who secure the Ethereum network. Finally, we view ETH as an “internet reserve currency” as it is the foundational asset pricing all activities and most digital assets, involving over $1 trillion in the Ethereum ecosystem and its more than 50 connected blockchains.
Regardless of its classification, ETH benefits from the growing usage on the Ethereum platform. Ethereum is a vibrant economic platform that can be seen as a digital marketplace, with user growth increasing by 1500% and revenue soaring at a compound annual growth rate of 161% since 2019. In the past year alone, Ethereum has generated $34 billion in revenue. Since ETH must be purchased to use Ethereum, all ETH holders benefit from demand-driven currency inflows. Furthermore, 80% of these ETH revenues are used for buybacks and burning of circulating ETH to permanently remove it from circulation. This is similar to irreversible stock buybacks.
In the last six months, 541,000 ETH worth $1.58 billion (0.4% of total supply) has been burned. Therefore, ETH holders benefit from dual revenue streams from Ethereum activities, including user-driven ETH purchases and supply burning. ETH users can also earn returns of approximately 3.5% by staking ETH. This is achieved by staking ETH to validators of the Ethereum network, providing collateral for running the Ethereum network.
Compared to Web2 applications, Ethereum’s revenue ($34 billion) exceeds that of Etsy ($27 billion), Twitch ($26 billion), and Roblox ($27 billion). Ethereum’s 20 million monthly active users surpass Instacart (14 million), Robinhood (10.6 million), and Vrbo (17.5 million). Additionally, the average annual income of Ethereum’s monthly active users is $172, comparable to Apple Music at $100. Netflix is $142, and Instagram is $25. We classify Ethereum as similar to the Apple App Store or Google Play platform business. However, Ethereum has significant advantages over Web2 platforms as it provides unique value propositions beyond cryptocurrencies for users and application developers.
The most attractive aspect of using Ethereum is saving potential costs for businesses and users. Apple and Google take around 30% of hosted app revenues, while Ethereum currently takes about 24% (non-DeFi applications at 14%). Additionally, we anticipate that as activity shifts to cheaper Ethereum L2 (current fees ranging from 0.25%-3%), Ethereum’s adoption rate will decrease to 5-10% within the next 18 months. From a payment perspective, credit card processors and other payment applications like PayPal charge fees of 1.94% for all payments (2.9% for commercial transactions), while Visa charges 1.79-2.43% or more.
Compared to data-centric social networking platforms like Facebook, we believe that Ethereum may offer entrepreneurs more powerful and profitable applications. Ethereum allows applications to deploy in a permissionless environment and freely interconnect and innovate with open-source data. As a result, anyone can create applications and leverage significant data, including data on all on-chain user activities—similar to Visa providing customer payment data for free. For example, the social media app Farcaster currently generates $75.5 in monthly active user revenue, compared to Facebook’s $44. More appealingly, the open-source incentive structure fosters more attractive applications, with Farcaster users averaging 350 minutes of daily usage compared to Facebook’s 31 minutes.
The outcome of Ethereum’s properties is that some profits earned by big finance, big tech, and big data can be transferred to consumers in the form of benefits. As more data is generated in public spaces and more business shifts from expensive, closed financial tracks, business moats will be eroded. The result will be a potential low-profit economy built around open-source. Consumers and application builders will migrate to Ethereum. We believe that in the next 5-10 years, 7% to 20% of Web2/big finance business revenue, amounting to trillions of dollars, may be squeezed by systems like Ethereum and primarily fed back to users and application builders. Additionally, Ethereum’s unique ownership properties allow for uncensored digital existence on social media and gaming applications. These features will become increasingly valuable if government censorship of information continues to strengthen.
There are compelling reasons to believe that public chains like Ethereum will become crucial backend infrastructure for AI applications. The rapid growth of AI agents and their economies will require unrestricted value transfers, explicitly proven humaneness, and clearly defined data/model sources. These unique properties are available on blockchains but bypass existing technical infrastructures. We estimate that by 2030, the TAM for global AI productivity enhancements could reach $8.5 trillion. Based on assumptions of a 66% business adoption rate, 25% AI software value capture, and 72% non-hardware value capture, we believe that by 2030, the potential revenue TAM for crypto and AI could reach $911 billion, with $45.5 billion from open-source AI applications and infrastructure, of which $1.2 billion in revenue may flow directly back to ETH holders.
Currently, most activity on Ethereum is financial in nature. Decentralized exchanges and banking protocols account for 49% of Ethereum revenue, while 20% is allocated to simple value transfers. These revenues are categorized under Financial, Banking, and Payments (FGP). Meanwhile, Infrastructure (I) occupies the second largest share at approximately 19%, related to decentralized businesses and creating software to service decentralized applications. Lastly, activities related to social media and NFTs are classified under Marketing, Advertising, Social Media, and Gaming (MASG). MASG contributes 11% of these revenues. Currently, AI plays a very minor role in generating revenue for Ethereum.
Ethereum’s revenue comes from the aforementioned terminal markets, which constitute the revenue streams of Ethereum, including transaction fees.Transaction fees, Layer 2 settlement, Miner Extractable Value (MEV), and Security as a Service are crucial components of the Ethereum ecosystem. Transaction fees are the charges users (and future autonomous agents) pay for using applications or transferring value on the Ethereum network. Layer 2 settlement refers to the income Ethereum L2 pays to Ethereum for settling transactions. MEV is the revenue generated from fees users pay for the right to sequence a set of transactions. Security as a Service involves using ETH as collateral to support permissionless applications that require this value to execute their business functions. In the past year, approximately 72% of Ethereum’s revenue came from transaction fees, with MEV accounting for around 19%, Layer 2 settlement approximately 9%, and Security as a Service yet to be formally launched.
We believe that Ethereum’s strongest value proposition lies in the financial sector, so we anticipate that by 2030, 71% of Ethereum’s revenue will come from Financial Services and DeFi (FGP). Due to the advantages of experimentation and open-source financial and data systems on Ethereum, we expect MASG to grow to 17%, slightly displacing infrastructure, providing 8% of the revenue. Overall, AI will account for 2% of Ethereum’s revenue. However, if decentralized AI software demonstrates its significant potential, AI revenue contributions could double or more.
From a revenue perspective, we estimate that individual mainnet transactions will only account for 1.5% of revenue. Layer 2 settlement, bundling transaction data on the mainnet, will significantly increase to about 76% of revenue. This is because we expect most activities to occur on Ethereum’s Layer 2 blockchain, but the majority of the value of these transactions will accrue to Ethereum. Meanwhile, MEV will maintain its importance, accounting for 18% of revenue, while Security as a Service will represent 4.5% of Ethereum’s revenue.
Bitcoin and Ether: Optimal Investment Portfolio Allocation
Analysis Overview
We conducted a study to evaluate the impact of including BTC and ETH in a traditional 60/40 investment portfolio from September 1, 2015, to April 30, 2024. The analysis was conducted through five main sections:
Optimal constrained allocation in a traditional 60/40 investment portfolio: We assessed the ideal weights of BTC and ETH in a 60% stock and 40% bond investment portfolio, with a maximum combined allocation limit of 6%. We completed 169 sample portfolios with incremental exposure to cryptocurrencies.
Drawdown and Sharpe ratio analysis: We examined the drawdown and Sharpe ratios of 16 representative portfolio subsets to understand the risk-return trade-off. Adding a moderate allocation of cryptocurrencies (up to 6%) in a traditional 60/40 portfolio can significantly enhance the portfolio’s Sharpe ratio, with a relatively minor impact on drawdown. For investors with high risk tolerance (annualized volatility up to ~20%), allocations of up to 20% can further improve the portfolio’s risk/return. Between BTC and ETH, we believe a weight of about 70/30 provides the optimal risk-adjusted return.
Optimal BTC and ETH allocation in a pure cryptocurrency portfolio: We analyzed every permutation of BTC and ETH weights in a portfolio consisting solely of these two cryptocurrencies to maximize the Sharpe ratio and determine the ideal BTC/ETH ratio.
Calculating the efficient frontier using the optimal cryptocurrency portfolio: We studied the optimal weights of the ideal BTC/ETH portfolio to maximize returns at different volatility levels to demonstrate part of the efficient frontier when adding cryptocurrencies to a 60/40, with reasonable volatility levels.
Time-dependency of efficient frontier results: We considered the impact of different starting points on the study results. Larger cryptocurrency allocations allow for higher risk-adjusted returns across all available time periods.
Conclusion
In conclusion, including a small amount of cryptocurrencies (up to 6%) in a traditional 60/40 investment portfolio can significantly boost the portfolio’s Sharpe ratio with a relatively minor impact on maximum drawdown. In a portfolio consisting solely of cryptocurrencies, the allocation ratio of Bitcoin and Ethereum close to 70/30 provides the optimal risk-adjusted return.
Investors should consider their individual risk tolerance, but the data suggests that a balanced inclusion of BTC and ETH can offer significant return enhancements relative to the incremental risk introduced. These findings underscore the potential for cryptocurrencies to improve portfolio performance in a controlled and measurable manner.
