https://coinmetrics.substack.com/p/state-of-the-network-issue-225

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A Glimpse into Coinbase through Coin Metrics’ Data

By: Kyle Waters and Matías Andrade Cabieses

Introduction

In the nascent digital assets industry, Coinbase stands out with a legacy tracing back to 2012, with its roots as an early Bitcoin-focused platform which passed through the renowned startup incubator, Y Combinator. More than a decade on, Coinbase is today best known as an exchange to buy and sell crypto assets, and has maintained its position as the top US-based exchange by volume. 

But recent developments prove Coinbase is working to diversify its reach beyond a trading venue, stretching out across the full stack of blockchain technology, from wallet infrastructure to staking services and on-chain scaling solutions. Last month’s launch of Coinbase’s layer-2 (L2) rollup Base—a low-cost, Ethereum-compatible smart contract environment—stands as a perfect example. Through the lens of Coin Metrics, a wealth of market and on-chain data allows us to build new insights into Coinbase’s market stance. In this week’s issue of State of the Network, we highlight pivotal data underscoring Coinbase’s current market position.

A $COIN Tossed, But Not Sunk

Unsurprisingly, one of Coinbase’s most important sources of revenue is based on trading activity on their exchange. Looking at the last quarterly earnings report in which Coinbase reported total revenue of $707M, spot volume remained the largest component of the business, with transaction volume on exchange constituting $327M. In 2022, a share of over 77% of their total revenue came from trading fees, down from 92% in 2021. For these reasons, taking a close look at spot trading volume can be very helpful to understand Coinbase’s health and how their revenues are holding up compared with previous years. 

Sources: Coin Metrics Market Data Feed & Google Finance

As we can see from the chart above, Coinbase’s stock price ($COIN) has tracked spot volume very closely since the company’s April 2021 IPO. Although we can expect this correlation to weaken over time as Coinbase’s revenues detach purely from trading fees, it should remain a useful gauge of how their business is performing. A difficult risk-off environment for tech stocks coupled with a challenging past year for digital assets has led to a large slump in Coinbase’s share price from its IPO at over $300 a share. However, 2023 has delivered a respectable rebound, with the stock up 145% YTD.

Coinbase Spot Volume Deep Dive

We can further examine spot volume trends at Coinbase by looking at the distribution of volume broken down using Coin Metrics’ datonomy™, which serves as a digital asset taxonomy and categorizes assets based on their functionality. On this basis, we took Coinbase’s traded volume and measured the proportion attributed to each different asset sector as illustrated below. One noticeable fact is that by far the two most important asset sectors consist of Value Transfer Coins and Smart Contract Platforms, which include Bitcoin and Ethereum, respectively. Another noticeable trend is a greater proportion of trading volume for stablecoins. Since Coinbase trading pairs are generally denominated in USD this is indicative of a greater demand for stablecoins as a share of overall digital assets. Looking at last week’s issue of our State of the Market report, a weekly look into market data and on-chain trends, shows that the share of volume derived from trading in Tether (USDT) has increased as of late on Coinbase.

Source: Coin Metrics Market Data

As Coinbase’s exchange business has grown and more assets have been added to be traded, the relative importance of these assets has changed over time. As we can see in the previous chart, towards the end of 2021 and into 2022, the Metaverse asset sector became increasingly popular as Facebook rebranded into Meta and a big hype wave caught hold of the market. As we can see in the chart below, Coinbase now trades over 600 asset pairs on the exchange.

Source: Coin Metrics Market Data

However, at least as far as exchange volumes go, earlier assets remain the most popular, with an overwhelming majority of the volume traded being attributed to assets that were listed earlier in Coinbase’s history, along with BTC and ETH. 

Source: Coin Metrics Market Data

This shows that simply adding new assets isn’t a guaranteed way of generating trading fee revenues, even if new assets tend to trade heavily right after they are listed on an important exchange like Coinbase. It turns out there is no magic bullet when it comes to generating trading fee revenues. Further, the impending decisions around a spot ETF in the US may have significant implications for the exchange: would-be buyers of BTC may prefer to purchase the ETF as an easier (and possibly cheaper and tax-efficient) way of gaining exposure. It’s a complicated equation though, because Coinbase may also stand to benefit from an ETF launch as the custodian for the BTC held in the fund.

Another important consideration is Coinbase’s position within the US market for crypto exchanges, which has increased lately amid Binance US’s ongoing contraction in trading volumes. But trading fees aside, Coinbase has been diversifying into different businesses across the crypto ecosystem, including staking and layer-2 networks, as we will see below. 

On-Chain Footprint

We can go beyond “off-chain” market data and track Coinbase’s many activities on-chain. As an exchange, Coinbase continually handles deposits and withdrawals of crypto assets from its users. However, from the vantage point of an on-chain data analyst, Coinbase has historically proven to be a difficult entity to examine as it has taken sophisticated actions to secure user funds across many accounts. This can make tracking down wallet addresses difficult, especially on Bitcoin where change outputs muddy the picture. To be sure, the exchange is audited as a public company in the United States. But the complete set of its wallet addresses is not widely publicized. However, on certain blockchains like Ethereum, where account re-use is more common, we can examine trends more easily.

Using an early version of Coin Metrics’ tagged addresses, we identified a particularly active address that appears to be currently handling a large portion of activity for Coinbase—labeled “Coinbase 10” on Etherscan. Below, we plotted the hourly change in ETH sent and received by this account over the last week. With close to 150K ETH sent and received,, this account is one of the top accounts by ETH volume in that same time period.

Source: Coin Metrics ATLAS

This is just a small anecdote to help corroborate the exchange’s significant presence in the ecosystem. Tracking exchange activity over a longer time frame may help shed light on more trends such as user behavior and their favored assets. As Coinbase has expanded beyond a simple exchange into staking and as an L2 rollup operator, we are presented with new opportunities to explore this activity on-chain.

Staking

Staking is a fundamental component of Proof-of-Stake blockchains and an increasingly bigger component of Coinbase’s business. After Ethereum’s move to PoS with The Merge, the staking landscape has grown considerably and Coinbase has been involved in this burgeoning space. Through its liquid staking token, Coinbase Wrapped Staked ETH (cbETH), Coinbase allows ETH holders to lock their assets in a smart contract, receiving cbETH as a liquid representation of their stake. Unlike Lido’s stETH, which uses a aToken model, cbETH employs a cToken model based on a floating conversion rate, thus representing ownership of the underlying plus rewards accrued on the principal amount (minus penalties like slashing). This ensures cbETH is ERC-20 compliant and widely compatible with dApps, though not at a 1:1 ratio.

Source: Coin Metrics ATLAS

Despite facing SEC scrutiny earlier this year via a Wells notice, Coinbase’s staking service has proven resilient. Following a temporary dip after withdrawals were enabled, cbETH’s supply rose to under 1.3 million, primarily driven by higher staked balances—including a significant increase in institutional staking adoption after the Shapella upgrade. Despite not being the largest liquid staking provider in terms of market share, Coinbase charges a relatively higher staking commission of 25%, which contributed 13% to net revenue from “Blockchain Rewards” and 4% of reward adjusted net revenue as of Q2–2023 (after accounting for rewards passed to customers).

L2 Operator: BASE

Coinbase has recently ventured into native on-chain solutions, notably with the introduction of its Ethereum layer-2 (L2) network, named Base, which went live just last month after being announced earlier this year. A rollup is effectively a separate blockchain, but with some essential added benefits and trade offs. Broadly, rollups help create the conditions for cheaper transaction fees by moving computation off-chain, but also with weaker guarantees of decentralization. The Base network was built on the open source OP Stack, the same stack that powers the other Ethereum L2, Optimism.

Putting technical details aside, there are a number of important considerations stemming from the launch of Base. First, Base introduces a low-cost and familiar environment for Ethereum smart contract developers to build applications, and an easy on and off ramp from the Coinbase exchange to move funds to and from Base. Base may also help expand USDC adoption, and subsequently interest income, which has grown considerably for Coinbase with rising rates. Finally, Base also represents a new potential revenue stream in its own right, which came up in the most recent earnings call:

“So, how will we monetize it [Base]? Well, the short answer is that Base will be monetized through what are called sequencer fees. These are—sequencer fees can be earned when any transaction is executed on Base and basically, Coinbase can run one of these sequencers as others can over time. Now indirectly, it helps us monetize as well because it helps us grow the size of the pit. It helps us grow the ecosystem.”

It’s important to understand the economics of a rollup operator, which consists of costs (mainly in the form of posting data on L1) and revenues from transaction/sequencer fees. We can track the Base Batch Sender address which sends a batch of compressed transactions from Base to Ethereum. This ensures data availability and integrity that transactions were executed as expected on Base. But posting large amounts of data to Ethereum is expensive, and as we can see below, this address has consumed a considerable amount of gas so far, at times almost hitting over 1% of all ETH fees paid per day.

Source: Coin Metrics ATLAS

However, heightened activity and fees on Base (mainly stemming from the popular socialFi application friend.tech) have more than covered these data costs so far. Base is still very much in its infancy, and its role in Coinbase’s business merits close observation moving forward. How Coinbase plans to maximize decentralization on Base also remains an open question.

Conclusion

Despite a lingering high-profile regulatory battle with the SEC, the data above shows that Coinbase has continued to maintain its strong position in the digital assets industry. The adoption of cbETH and Base are evidence of a commitment to an on-chain future beyond the exchange, and other developments like an agreement with DeFi protocol Maker to custody USDC on behalf of the DAO, and push into derivatives also demand attention. But things haven’t been flawless along the way, as seen by the modest launch of Coinbase’s NFT platform. Yet, one of the most exciting aspects of these new business lines is the new ways in which we can use real-time data to examine a publicly-traded company. This report only touches on a few of the analyses which are made possible through the power of on-chain data.

Network Data Insights

Summary Metrics

Source: Coin Metrics Network Data Pro

We saw an increase in active addresses for Bitcoin and Ethereum even as the price stayed mostly flat, with a 6% and 24% increase, respectively. On-chain activity remains constrained across the board after a week with little price change.

Coin Metrics Updates

This week’s updates from the Coin Metrics team:

• Check out the latest issue of Coin Metrics’ State of the Market for more market data on Coinbase and other exchanges.

• Last week marked the one year anniversary of Ethereum’s Merge. Check out our research report Mapping out The Merge to understand the significance of this event.

• Explore the digital assets ecosystem through our entire catalog of original data-driven research.

As always, if you have any feedback or requests please let us know here.

Subscribe and Past Issues

Coin Metrics’ State of the Network, is an unbiased, weekly view of the crypto market informed by our own network (on-chain) and market data.

If you’d like to get State of the Network in your inbox, please subscribe here. You can see previous issues of State of the Network here.

© 2023  Coin Metrics Inc. All rights reserved. Redistribution is not permitted without consent. This newsletter does not constitute investment advice and is for informational purposes only and you should not make an investment decision on the basis of this information. The newsletter is provided “as is” and Coin Metrics will not be liable for any loss or damage resulting from information obtained from the newsletter.

https://coinmetrics.substack.com/p/state-of-the-network-issue-224

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One Year Since The Merge

By: Matías Andrade Cabieses and Kyle Waters

Introduction

This Friday will mark one year since Ethereum’s landmark upgrade, dubbed The Merge, was grafted onto the timeline of the first smart contract platform’s continued evolution. Crafted from years of intensive research and development, The Merge brought Ethereum to a Proof-of-Stake model, redefining the network’s security and economics on a fundamental level. This shift represented the most significant update to Ethereum since its launch in 2015. 

However, The Merge wasn’t the end goal of the Ethereum core development team. Rather, it forms the foundation for the evolution and future development of the Ethereum network, bringing together more stringent economic security, as well as paving the way for greater inclusion of the L2 scaling paradigm. In this issue of the State of the Network, we revisit the predictions we made about Ethereum’s now-defunct mining operations, take a look at critical network data to help us understand how Ethereum’s PoS ecosystem continues to evolve, and consider new directions and future upgrades that are currently being worked on.

The Fall of Ethereum Miners

Toward the dusk of Ethereum’s Proof-of-Work era, the end of mining was certainly one of the more impactful outcomes of The Merge. At its peak in May 2022, the Ethereum network was secured by more than 1,000 TH/s in compute. It is not surprising, since Ethereum mining was a multi-billion dollar industry, bringing more than $2B a quarter in revenues and accounting for over $40B in cumulative revenues, $30B from block rewards and $11.3B from fees. 

Source: Coin Metrics Formula Builder

However, it was all going to come to an end with The Merge and Ethereum’s transition to Proof-of-Stake. Last September, we discussed the prospect of a cascading effect on GPU miners and prices as a result of The Merge, and we forecasted decreasing hardware prices and a dismal landscape of profitable mining opportunities for GPU miners. 

Unlike Bitcoin ASICs (special purpose hardware), Ethereum was ‘mined’ with GPUs which are general-purpose devices, with applications in gaming, video editing, graphics design, 3D animation, CAD, and (most recently in vogue), artificial intelligence acceleration. As we explained last year, there was a dearth of comparatively lucrative options for ETH miners. While a few larger industrial-grade miners with higher-quality chips were able to hop seamlessly over to the new AI-driven gold rush for compute resources, this has proven to be the exception, and most smaller enthusiast miners are still left with limited options. 

Other PoW chains mineable by GPU, like Ethereum Classic (ETC) or ETHPoW, are chains with much lower activity and applications compared to ETH, leading to a lack of demand for prompt transaction inclusion and thus low fees, as well as a lack of MEV (or, as it is now called, REV) infrastructure. Illustratively, the decoupling trend of ETC’s hashrate and price underlines the decreasing attractiveness of this alternative, even though the surge in hashrate after The Merge suggests that miners flocked to this network even though they are hardly likely to break even and profit over the electricity costs to power their GPUs.

Source: Coin Metrics Formula Builder

Ethereum’s Validator Landscape

Since The Merge, validators have become the principal driving force of the Ethereum network. It is thus crucial to understand the validator ecosystem and its evolution if we are to evaluate the health of Ethereum in its Proof-of-Stake paradigm. 

One of the first things to notice is that the largest validator pool by far is under the Lido umbrella, which currently accounts for 30.6% validators out of the total pool of nearly 787,755 currently active validators. A wave of new validators have rushed into Ethereum after the implementation of withdrawals in the “Shapella” upgrade this past April.

Source: Coin Metrics Network Data

Liquid staking has been one of the most popular ways to participate in Ethereum staking for those individuals unwilling to stake independently—either due to a lack of funds totaling 32 ETH needed, a lack of technical knowhow or willingness to run your own node, or simply an interest in keeping these funds liquid instead of locked up in staking, especially until recently before withdrawals were enabled. Lido staked ETH (stETH) is also one of the most important forms of collateral, which brings economic utility to the staked ETH in addition to securing the network. 

Source: mevboost.pics, elaborated by Coin Metrics Research Team 

However, Lido’s preeminence in the staking ecosystem is not without controversy. There are serious questions regarding the security and threat of a large conglomerate of stakers coming under control of a single entity. This is because, in principle, they could be subject to certain attacks that exploit their large footprint on the Ethereum network, including time-bandit attacks (exacerbated by MEV) and other coordinated attacks. However, this impression is exacerbated by the belief that Lido is a single entity, whereas in fact it is composed of multiple staking operators that run their nodes independently, while selling access and conforming to Lido’s requirements, which also include additional economic protections against coordinated attacks on top of Ethereum’s correlation penalty. 

Source: mevboost.pics, elaborated by Coin Metrics Research Team 

As we can see from the image above, the distribution of Lido stakers is pretty evenly distributed among different node operators. This further demonstrates that Lido is not inherently centralized but is rather composed of many different parties, without a single node operator surpassing even a 5% stake of Lido’s validator pool. Furthermore, Lido’s node operator distribution is capped at a maximum that is set by the Lido governance mechanism, allowing users to track and decide whether individual node operators are allowed to operate over a specific threshold. Nevertheless, such a single large provider could introduce novel risks to a still-nascent staking ecosystem. This will continue to be a subject of debate as Ethereum continues its evolution. 

Ethereum’s Roadmap

Despite notching many successes so far, user and developer ambitions for Ethereum extend far beyond its current set of applications and adopters. The hope has long been that billions may transact and develop decentralized applications on the platform. However, the journey to this grand vision is paved with a series of additional technical upgrades. These upgrades might be highly technical in nature but have clearly understandable goals.

Despite the recent trend towards a lower fee regime, Ethereum’s Layer 1 (L1) fees remain a hurdle for high-frequency, low-value transactions. Over the past month, the average transaction fee hovered around $4. While such a fee might be inconsequential for a million-dollar stablecoin transfer, it becomes a significant barrier for applications like gaming, micro-streaming payments, and mainstream consumer-facing apps. The need for a more affordable fee structure is an ever-present nagging pain.

https://charts.coinmetrics.io/crypto-data/?id=7967

Central to Ethereum’s current scalability strategy is the “Rollup-centric roadmap.” This approach emphasizes the use of rollups, a layer-2 scaling solution, to enhance the network’s throughput. The future introduction of EIP-4844, referred to by close Ethereum watchers as “Proto-Danksharding,” offers a specialized “blob” data space and a distinct fee market tailored for rollup data. This upgrade is poised to reshape the fee dynamics, especially as rollup solutions like Arbitrum, Optimism, and Coinbase’s newly launched Base L2 gain traction.

Simultaneously, Ethereum is not just scaling in terms of transaction capacity but is also refining the user experience. Account abstraction, another forthcoming upgrade, promises to simplify the often daunting task of managing seed phrases and private keys. By making these cryptographic necessities more user-friendly, Ethereum aims to lower the entry barrier for the average user, potentially ushering in a new wave of adoption and enticing novel use cases.

From an analytical standpoint, these developments will not just be technological milestones but also introduce fresh dimensions in evaluating Ethereum fundamentally. EIP-4844, for instance, will influence the fee market economics, and the subsequent reduction of fees on Layer 2 solutions will necessitate a recalibration of cost analyses, and the economics for rollup operators. Furthermore, the rise of smart contract wallets might alter traditional metrics of adoption, compelling analysts to seek new on-chain indicators.

Following previous customs of naming execution-layer upgrades after cities, the next upgrade on the line is called “Cancun.” The EIP-4844 upgrade is not the only improvement in the Cancun upgrade. Other EIPs include EIP-1153, which aims to reduce fees for storing data on-chain and improve blockspace; EIP-4788, which seeks to improve designs for bridges and staking pools; EIP-5656, which adds minor code changes related to the Ethereum Virtual Machine; and EIP-6780, which aims to eliminate code that could terminate smart contracts to increase contract security. These upgrades have no firm release date as of today, although developers are already busy testing early versions of each improvement proposal. The Cancun upgrade will happen on the execution layer, where all protocol rules reside, while the consensus layer, which validates blocks, will go through its own fork known as “Deneb”. The name “Dencun” is a portmanteau of the names of these simultaneous upgrades. 

Conclusion

As Ethereum continues to evolve, it’s clear that the network is making strides towards its vision of enabling billions of users to transact and develop decentralized applications on the platform. One year has allowed us to evaluate how the change to Proof-of-Stake has affected the network, including changes such as Shapella’s withdrawals, Lido’s dominance in staking, validator returns and Ethereum’s overall stability in the face of these profound changes. With so many important upgrades in the horizon with the potential to tremendously improve the Layer-2 scalability scene, we must keep an eye out.

Network Data Insights

Summary Metrics

Source: Coin Metrics Network Data Pro

Continuing our coverage of Ethereum, active addresses on the network averaged about 471K per day last week, slightly down from the average of just over half a million at this time last year. But with more activity moving to L2s, active addresses on L1 should remain somewhat flat. Despite a more quiet period of activity in recent weeks, Ethereum continues to boast a strong stablecoin ecosystem that consistently settles billions of dollars per day, as seen in the summary above. About $3B of USDC per day was transferred on Ethereum last week.

Coin Metrics Updates

This week’s updates from the Coin Metrics team:

• Check out the latest issue of Coin Metrics’ State of the Market featuring a new page with novel DeFi Balance Sheet metrics to keep tabs on lending protocol health

• Explore the digital assets ecosystem through our entire catalog of original data-driven research.

As always, if you have any feedback or requests please let us know here.

Subscribe and Past Issues

Coin Metrics’ State of the Network, is an unbiased, weekly view of the crypto market informed by our own network (on-chain) and market data.

If you’d like to get State of the Network in your inbox, please subscribe here. You can see previous issues of State of the Network here.

© 2023  Coin Metrics Inc. All rights reserved. Redistribution is not permitted without consent. This newsletter does not constitute investment advice and is for informational purposes only and you should not make an investment decision on the basis of this information. The newsletter is provided “as is” and Coin Metrics will not be liable for any loss or damage resulting from information obtained from the newsletter.

https://coinmetrics.substack.com/p/coin-metrics-state-of-the-network-issue-215

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Spot On: From Trusts to Spot ETFs

By: Matias Andrade Cabieses

A significant evolution in the realm of digital assets investment is the anticipated introduction of spot Exchange-Traded Funds (ETFs). The arrival of spot ETFs could substantially simplify investment in digital assets, broadening the scope of investment products on offer, particularly for American investors. Currently, investment options are predominantly futures-based. These instruments carry inherent intricacies, including fixed expiration dates and an established term structure, which can inadvertently impose unanticipated costs on investors. Alternatively, investments may be managed through a trust, as exemplified by Grayscale’s offerings, which have some quirks of their own.

In this edition of the State of the Network, we delve deeper into Grayscale’s digital asset trusts, comparing their operation to that of a potential spot ETF. Moreover, we discuss recent market trends ignited by the buzz around the imminent possibility of spot ETFs finally receiving approval from the SEC.

A Trust Product for Trustless Assets

The desire for exchange-traded products within the digital assets domain has been steadily growing among investors for various reasons. A critical one centers on the differentiation between tax-advantaged accounts and self-custody of assets. The process of self-custody, while granting complete control over the assets, involves significant complexity and requires extensive technical knowledge to ensure safe and successful implementation. Additionally, investments made in this fashion are subjected to substantial tax obligations, proportional to capital gains tax and income tax, where applicable.

Currently, key tax-advantaged accounts accessible to a majority of investors, including Individual Retirement Accounts (IRAs), 401(k) plans, and Health Savings Accounts (HSAs), don’t allow direct investments in digital assets, with notable exceptions including Fidelity, public mining companies and, arguably, Microstrategy. This restriction inhibits the ability to defer or offset taxes associated with digital asset investments, a considerable disadvantage for investors. Even for those investors who opt for self-custody, these vehicles remain significant, since the potential to lessen capital gains tax payments, even slightly, can noticeably impact the overall performance of an investment (especially when the short-term capital gains tax rate applies, as seen below).

Note: Assumes 28% and 37% for the long-term and short-term tax rate respectively, considering the maximum short-term rate that applies within the U.S.

We can go even further and consider the fact that, for most people today, self-custody is simply not a feasible option, either due to a lack of technical knowhow or because regulatory or legal restrictions interfere with such ownership, especially for corporate entities. Given these obstacles, exchange-traded products are not just convenient alternatives but essential elements in the digital assets investment landscape. They fill a similar role to that in other asset classes, where self-custody might be possible but not practical, as is the case with precious metals.

However, it’s crucial to understand that not all exchange-traded products are created equal. Each has unique characteristics that could impact an investor’s portfolio differently. In this context, we turn our attention to Grayscale’s array of products. We aim to delve into the specific attributes of their offerings to better grasp their nuances. By doing so, we can gain a clearer understanding of why the potential introduction of spot ETFs is creating such a significant stir in the market.

The Grayscale Trust Products

Grayscale provides an array of investment products that give exposure to individual digital assets (like BTC, ETH, and others) or to various indexes tracking a portfolio of multiple assets. What all of Grayscale’s products have in common is they are structured as a trust, which means that the value of the shares is allowed to float with respect to the value of the underlying asset portfolio. Throughout its history, Grayscale’s Bitcoin Trust (GBTC) has seen the share value surpass the value of the underlying Bitcoin during the peak periods of the 2020-2021 bull run. At other times, shares have traded below the value of the underlying Bitcoin, even as low as 50% of its value. These variations are typically referred to as premiums and discounts.

Source: Coin Metrics Institution Metrics 

These trust product dynamics are consequential for two primary reasons. Firstly, as an investor, you are obligated to purchase shares at the current market price. This implies that you may acquire exposure to Bitcoin at a discount or a premium—based on the market conditions at the time—potentially altering the risk profile of your investment, and especially compared to spot investments which have no annual management fee. The second reason this is noteworthy is that sophisticated investors are capable of profiting off mispriced assets through trading strategies known as arbitrage. Thus, when GBTC was trading at a premium over bitcoin, a risk free trade was possible by selling or shorting GBTC while simultaneously buying bitcoin in spot or futures markets. Investors could then profit from the price convergence of these two positions, theoretically with minimal risk.

Source: Coin Metrics Institution Metrics 

If we take a look at the chart above, we can see that the various trusts set up for different assets have developed very differently. While ETH hovers around 50% discount, BTC, BCH, LTC,and ETC have trended closer towards parity, with LINK actually exceeding it, trading at a 270% premium over parity. This trend is possibly caused by investors that realize that, with recent news that Blackrock has filed to create a spot bitcoin ETF, since the price would match parity if Greyscale also got approval to convert these funds into ETFs. While we might think this sounds far-fetched (because it implies people are paying nearly three times the spot price), this can be quite common for investment vehicles that are particularly illiquid, especially when speculative fund flows predominate. We can see this same behavior over the other trusts offered by Grayscale, as seen below.

Source: Coin Metrics Institution Metrics 

Filecoin (FIL) and Stellar (XLM) are seen trading at 8x and 4x the spot price, respectively. These price dislocations are significant and are a good indication that these funds are very illiquid and that there is limited access to these assets within the U.S. since arbitrageurs could easily crush the premium while making a profit. It is, however, indicative that some people are willing to get access to these assets at a huge premium, an observation that will be interesting to consider as we keep track of these developments. 

Conclusion

In conclusion, the evolution of the digital assets investment landscape, especially with the anticipated introduction of spot ETFs, promises to bring transformative change. Currently, options such as futures and trust-based investments, like those offered by Grayscale, come with their unique set of challenges. The potential introduction of spot ETFs, however, could simplify these complexities, presenting a more efficient and straightforward way for investors to gain exposure to digital assets. As we continue to navigate this fascinating digital investment landscape, the adaptability and innovation demonstrated by investors, coupled with regulatory advancements, will undeniably play a pivotal role in shaping the future of digital asset investments.

Network Data Insights

Summary Metrics

After a slow week with low volumes and little to speak of in terms of news, transfer value and daily active addresses have languished across most assets, with Bitcoin and Ethereum transfer value metrics decreasing by 18% and 23% respectively.

Coin Metrics Updates

This week’s updates from the Coin Metrics team:

• Recently, we released a sweeping new report fingerprinting Bitcoin ASICs to derive better insight into critical issues like Bitcoin’s energy consumption and E-waste. Check out The Signal & the Nonce here.

As always, if you have any feedback or requests please let us know here.

Subscribe and Past Issues

Coin Metrics’ State of the Network, is an unbiased, weekly view of the crypto market informed by our own network (on-chain) and market data.

If you have any feedback or requests please let us know here.

If you’d like to get State of the Network in your inbox, please subscribe here. You can see previous issues of State of the Network here.

© 2023  Coin Metrics Inc. All rights reserved. Redistribution is not permitted without consent. This newsletter does not constitute investment advice and is for informational purposes only and you should not make an investment decision on the basis of this information. The newsletter is provided “as is” and Coin Metrics will not be liable for any loss or damage resulting from information obtained from the newsletter.

https://coinmetrics.substack.com/p/state-of-the-network-issue-210

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Token Unlocks & Free Float Supply Shocks in Digital Asset Markets

By: Matías Andrade

Tokenomics—the economic models governing the issuance and distribution of digital assets—persists as one of the most important economic experiments taking place among digital assets. One intriguing aspect within this expansive domain is the mechanism of token unlock, where early investors and insiders like team members gain access to funds in a token that was previously locked to incentivize alignment with network interests. 

From the standpoint of a classical economist, the unlocking of tokens, as an increase in the availability of a commodity, should exert downward pressure on its price. Early investors, now with unfettered access to their holdings, are free to sell or trade these tokens on the open market, effectively increasing the supply. This increase in liquid supply, ceteris paribus, should theoretically precipitate a price decrease, as dictated by the law of supply and demand.

However, these token unlocks do not take place in a vacuum, but within an intricate ecosystem of market participants and speculators that are constantly preempting market events in order to exploit inefficiencies for profit. Based on this premise, speculators should exert a countervailing force when token unlocks take place. After all, token unlocks are events that should be disclosed far in advance, and by the theory of efficient markets, token prices should already reflect this public information.

In this edition of State of the Network, we put this topic under the microscope by selecting a series of tokens that follow token unlock schedules and analyzing network supply and market data around the events. With knowledge of the ever-impeding presence of confounding variables, we nevertheless seek to present the data for a broad sample as an introductory examination of this complex topic.

Optimism ($OP)

Optimism is a Layer-2 scaling solution for Ethereum that recently (May 31^st, 2023) had a token unlock of around 387M OP—equal to $396M and almost 60% of currently circulating supply. We can tell from looking at the trade volumes below that there is a period of high-volume activity preceding the token unlock, as well as bearish price action.

Sources: Coin Metrics’ Network Data Pro & Reference Rates

But this chart alone isn’t enough to quantify the characteristics and magnitude of token unlocks compared to other shocks to the circulating supply. To piece these together, we’re going to have to look at some on-chain metrics. 

Free Float Supply 

The free float supply of a currency is the freely-circulating supply that is detected to be “moving” by Coin Metrics methodology, based on on-chain analysis. This allows us to effectively exclude any supply that is locked up, either by investors, staked supply, or simply lost or burned supply. In combination with our other metrics, we can take a look at some examples to judge whether sudden changes in free-floating supply have consistent impacts on exchange prices. 

Polymath—$POLY

Sources: Coin Metrics’ Network Data Pro & Reference Rates

In this first case, the Polymath token had a large increase in free float supply, with more than 137M POLY supply being added to circulation. However, there doesn’t seem to be much volume being traded on the exchange. If we instead take a look at other on-chain metrics, we can see that a large number of transactions takes place on-chain, as seen below, which means this probably was not due to a token unlock. Indeed, we find that the new Polymath CEO was announced on this very date. 

Sources: Coin Metrics’ Network Data Pro & Reference Rates

UMA—$UMA

UMA is the case of a token where the free float metric rises in response to early investors getting access to their locked tokens as part of a 2-year vesting schedule, so there is no need to check for other confounding explanations. It is interesting to note that in this case there is a significant bout of trade volume for UMA across exchanges that follows the supply unlock, with significant price volatility as well. 

Sources: Coin Metrics’ Network Data Pro & Reference Rates

Balancer—$BAL

BAL is an interesting snapshot because this change in floating supply isn’t due to a token vesting schedule as with UMA (because BAL has a linear vesting schedule). However, the change in supply amount of ~4M BAL is above the ~2.1M BAL afforded to founders and early investors by Dec. 2021. In this case, we see very little price impact and not much volume clustering around the change in supply.

Sources: Coin Metrics’ Network Data Pro & Reference Rates

Testing the EMH using $1INCH 

One particularly interesting asset to consider is $1INCH—the governance token for the decentralized exchange aggregator 1inch Network—which has had plenty of steep cliff-like increases in its circulating supply. According to documentation released by the 1inch Foundation, the token follows a bi-yearly unlock schedule—only 6% of the token’s total ~1.5B of supply was released at its airdrop launch in December 2020. The remaining tokens unlock over a four-year period that culminates at the end of 2024. 

Given that the token launched back in 2020, there is plenty of price history to analyze. The chart below shows the progression of free float supply and the price history of $1INCH to date.

Sources: Coin Metrics’ Network Data Pro & Reference Rates

One of the first big $1INCH unlocks occurred in December, 2021, with a scheduled vesting of around 200M tokens being released to the team and investors. The upper chart below shows the Coin Metrics’ reference rate and reported spot volume for $1INCH, with the free float supply plotted below. Spot volume and price both increased rapidly before the unlock, before price fell a few days later. 

Sources: Coin Metrics’ Network Data Pro & Reference Rates

Another similarly-sized increase to free float supply was observed in January, 2022. The impact to spot volume was muted, as well as the immediate impact to spot price.

Sources: Coin Metrics’ Network Data Pro & Reference Rates

The history of $1INCH suggests a prior point that token unlocks are ultimately events taking place in a complex and fast-moving environment, where teasing out the idiosyncratic impact of a token-specific event requires careful analysis amid confounding factors. 

Price Change Analysis

After looking at some examples of instances where the free float supply can increase suddenly, we can try and measure the average difference in price for sudden and large increases in free floating supply. Compared to the overall sample, collected for approximately 3 YTD, the measure of the daily average price change increased by 0.7%. This result suggests that, on average, inflationary changes in circulating supply—even large ones—have a marginal impact on prices. However, it is worth noting that the impact in each specific case will be dictated by a variety of factors, including market conditions.

Sources: Coin Metrics’ Network Data Pro & Reference Rates

Such a modest uptick starkly contrasts with prevalent expectations, which often predict drastic price corrections as a response to supply unlocks. However, further analysis might reveal effects across different time periods, or by categorizing market periods into bullish or bearish.

Conclusion

The data presented above shows that when taken at face value, it is hard to tell whether token unlocks should be viewed as cataclysmic market events. In this piece we’ve presented a basic primer to the data using Coin Metrics’ reference rates and network data. However, there are plenty of ways this analysis could be improved upon. For example, one could use a crypto market index to calculate excess returns and take into account the overall market performance. Different levels of granularity could be used. Finally, a deeper analysis of on-chain token flows could yield a clear breakdown of the percentage of tokens unlocked and sold on decentralized exchanges or sent to exchange wallets.

In many ways, the discussion of token unlocks is a reciprocal to the famously-debated impact of halving cycles in Bitcoin and its various forks, where the issuance of newly-minted bitcoin in a block is cut in half roughly every four years. With Bitcoin’s next halving just under one year away and Litecoin (LTC) set to experience a halving this summer, whether these supply events are priced in—or otherwise—will continue to encourage our objective data analysis, as well as a taste of philosophical inquiry into the behavior of underlying market participants.

Network Data Insights

Summary Metrics

Source: Coin Metrics Network Data Pro

Bitcoin daily active addresses rose 5% over the week while Ethereum active addresses rose 8%. With the high demand for ETH staking continuing to persist, the supply of Lido’s stETH token rose another 4% over the week.

Subscribe and Past Issues

Coin Metrics’ State of the Network, is an unbiased, weekly view of the crypto market informed by our own network (on-chain) and market data.

If you have any feedback or requests please let us know here.

If you’d like to get State of the Network in your inbox, please subscribe here. You can see previous issues of State of the Network here.

© 2023  Coin Metrics Inc. All rights reserved. Redistribution is not permitted without consent. This newsletter does not constitute investment advice and is for informational purposes only and you should not make an investment decision on the basis of this information. The newsletter is provided “as is” and Coin Metrics will not be liable for any loss or damage resulting from information obtained from the newsletter.

https://coinmetrics.substack.com/p/state-of-the-network-issue-203

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Ethereum’s Shapella Upgrade Goes Live

By Matías Andrade, Kyle Waters & Tanay Ved

Ethereum’s highly anticipated Shapella network upgrade went live last Wednesday without issue, ushering in a new era for the nearly $40B staking ecosystem and marking the first upgrade to Ethereum since The Merge. As we explained last week, the upgrade activated the important function of staking withdrawals, granting validators liquidity to their staked ETH and accumulated staking rewards. In this week’s State of the Network, we analyze the network impacts and economic ramifications of the Shapella upgrade through the data we have observed in the days after its activation.

Network Health & Impacts

The Shapella upgrade was completed as a hard fork—which, in simple terms, just means a planned change to the rules of the Ethereum protocol. Hard forks require node operators to update their client software to integrate the new changes. Clients can be thought of as software implementations of the rules of the Ethereum protocol. The Shapella upgrade included the “Shanghai” upgrade to the Ethereum execution layer (EL) and the “Capella” upgrade on the consensus layer (CL) or Beacon Chain (hence the handy portmanteau Shapella). To understand more about Ethereum nodes and clients check out our walkthrough on running an Ethereum node here.

Hard forks have been important events in Ethereum’s history because they have enabled the protocol to change, but they also can carry implementation risk. Although core developers rigorously test upgrades on “testnets”(test versions of Ethereum), there is always a risk of something going awry when the upgrade hits mainnet. But in the case of Shapella, things went off without issue. One observable impact to the network, however, was a short-lived rise in the number of missed block proposals from a normal rate of about 1–2% to around 10%. Every 12 seconds, a single validator is selected at random to propose a block and collect a proposal reward in addition to transaction fees. A rise in the number of missed slots suggests a subset of validators failed to upgrade their clients in time for Shapella and thus fell out of sync with the rest of the network. A few clients also needed to patch small issues to accommodate the upgrade. The chart below shows the higher density of missed proposals in red after Shapella went live at epoch 194048 (epochs are a time-keeping parameter for Ethereum and 1 epoch equals 32 slots at 12 second intervals).

Source: Coin Metrics Labs

Critically, though, a 10% rate of missed slots is tolerable for the network to continue to progress with new blocks and finalize. By Thursday, 97% of slots were back to containing blocks—a much healthier rate.

Source: Coin Metrics Network Data 

Turning to the Ethereum fee market, transaction fees rose only slightly in the immediate hours after Shapella. Because withdrawals are processed as state changes, and don’t require payment for gas like in normal Ethereum transactions, they did not directly cause congestion on the network as anticipated. The slight increase in the level of base fees was likely attributable to the slower rate of block production described above, leading to an effective decrease in throughput, and a demand to move newly withdrawn ETH around.

Source: Coin Metrics Network Data Pro

With the network humming along like normal after the upgrade, attention quickly turned to the economic impact of validator withdrawals.

Withdrawal Economics

Withdrawals have caused a stir in the Ethereum community due to the expectation of fresh supply entering circulation. While Ethereum has mostly been net-deflationary since The Merge, validator supply and rewards locked up on the Beacon Chain, since 2020, have further removed supply from circulation. Only after Shapella has this supply been made available to re-enter circulation and to be used or sold. 

A total of almost 1.06M ETH has already been withdrawn from the Beacon Chain, and it is projected that up to 1.2M ETH will be withdrawn in the next few days. This projection includes withdrawals from excess staked balances by validators who plan to continue staking in the future (304K ETH), as well as balances from validators who are in the process of exiting or waiting for withdrawal (899K ETH). Therefore, the total projected withdrawals amount to 1.2 million ETH. 

Source: Coin Metrics Labs

The chart below presents the most significant flows of withdrawals from the Beacon Chain to validators’ Ethereum addresses, as of Monday afternoon ET. Out of the 1.06M ETH withdrawn, we see 380K ETH sent to ~21K addresses, which may belong to solo stakers or unmarked pools, followed by ~680K sent to the top 10 withdrawal addresses. The top two we believe to be associated with the Lido and Kraken staking pools, respectively. However, it is worth noting that withdrawals using Lido are not expected to go live until May after the liquid staking protocol undergoes additional testing and audits. Kraken is expected to bring a portion of its staking operations offline after being charged $30M to settle SEC charges for offering its staking-as-a-service product to US clients.

Source: Coin Metrics Labs

Validators process withdrawals in a round-robin manner, meaning that they are processed in the order that the validators joined the validator set. Our observation of the withdrawal amounts per hour reveal a downward trend, reflecting the larger average balance of older validators who have been staking for a longer time and hence have accumulated a greater reward. Interestingly, we also noticed a significant clustering of validators performing full withdrawals between April 15^th and 16^th, which can be tracked using the withdrawal address 0x210b3c… we believe belongs to Kraken.

Source: Coin Metrics Labs

During this period, the number of withdrawals processed per epoch remained constant. However, the variation in ETH withdrawal flows can also be explained by the prevalence of partial versus full withdrawals in the validator sample. This means that some validators chose to withdraw their entire staked balance, while others withdrew only the rewards portion of their staked assets.

It is important to emphasize that the rate of partial withdrawals is currently heightened as validators access ETH on the Beacon Chain for the first time since its December 2020 launch. Going forward, the average active validator will automatically withdraw just the rewards accrued from 3–5 days of participation (the time it takes to cycle through the active validator set) which currently should be somewhere in the range of 0.01 to 0.015 ETH—assuming good uptime.

Staking Ecosystem

With the activation of withdrawals, impacts across the wider staking ecosystem can also be observed. For instance, Coinbase’s liquid staking token—Coinbase Wrapped Staked ETH (cbETH)—can be redeemed by making an “unwrap” request, turning cbETH to ETH2 based on a conversion rate. Token wrapping is a process whereby the underlying ETH is locked in a smart contract and a wrapped token (cbETH) is issued to the user. Since the upgrade, cbETH supply has experienced a slight slump with 35.5K being redeemed on April 13^th. This decline in cbETH supply could be attributed to several factors, such as users seeking to arbitrage the cbETH discount to ETH, diversifying to other liquid staking solutions, or deciding to stop staking altogether.

Source: Coin Metrics ATLAS V2

Market Impact

The price of ETH remained relatively stable during the initial hours after the Shapella upgrade went live on April 12^th at 10:27 PM UTC. However, starting from 09:00 UTC on the 13^th, the price of ETH began to increase rapidly, eventually closing above $2,000 by the end of the day. This marked the first time that ETH had reached this level since May 2022.

 Source: Coin Metrics Hourly Reference Rates, Trading View

The ETH/BTC ratio was dropping leading up to the hard fork, meaning BTC price was outperforming ETH. But that trend reversed on the 12^th, and has been rising back in favor of ETH since then. As of April 16^th the ratio reached .07, its highest level in over a month. 

Conclusion

The success of the Shapella fork has brought significant changes to the Ethereum network. The introduction of withdrawals to the Beacon Chain validator staked balances has enabled validators to access their stake with greater flexibility and efficiency, providing greater liquidity and reducing barriers to entry for new validators. This has also improved the capital efficiency of staking pools and large validators, who will be able to either re-stake their proceeds or use them as they see fit.

As the Ethereum network continues to evolve, we should continue to monitor changes to the validator ecosystem, and keep track of improvements and innovations in the staking and governance mechanisms of validators—including Lido V2—as well as the effects of the SEC’s regulatory stance on the ongoing evolution of the staking-as-a-service industry. 

Network Data Insights

Summary Metrics

Source: Coin Metrics Network Data Pro

Keeping in focus with Ethereum, active addresses rose by 12% on the back of a successful hard-fork. A few ERC-20 tokens also experienced an increase in active addresses with Uniswap’s governance token rising 167%, as well as a few other stablecoin and DeFi tokens.

Coin Metrics Updates

This week’s updates from the Coin Metrics team:

• We invite readers to join Coin Metrics COO Katie Chase, Cryptoasset Research Analyst Matías Andrade, and Senior Data Scientist Uriel Morone for a live fireside chat moderated by Noelle Acheson, founder, Crypto is Macro Now on April 20^th, 2023 at 10:30 AM ET for a wide-ranging conversation about crypto pricing and markets, what asset prices don’t tell us, and why regulators are paying attention. 

• Explore our entire catalog of data-driven research on our revamped insights page on the Coin Metrics website, which makes it easier to browse through previous State of the Network issues, as well as our other original research.

• For the best in-depth discussion of CM data and research, come check out our research community on the web3 social media platform gm.xyz.

As always, if you have any feedback or requests please let us know here.

Subscribe and Past Issues

Coin Metrics’ State of the Network, is an unbiased, weekly view of the crypto market informed by our own network (on-chain) and market data.

If you’d like to get State of the Network in your inbox, please subscribe here. You can see previous issues of State of the Network here.

© 2023  Coin Metrics Inc. All rights reserved. Redistribution is not permitted without consent. This newsletter does not constitute investment advice and is for informational purposes only and you should not make an investment decision on the basis of this information. The newsletter is provided “as is” and Coin Metrics will not be liable for any loss or damage resulting from information obtained from the newsletter.