Brought to you by:

Thursday DIY Mailbag

Q: Should SOL be worth more than ETH?

Maybe!

For the first time this week, Solana passed Ethereum on daily Total Economic Value (TEV), the sum total of the fees and MEV (aka, front running) that a blockchain generates. That feels like a significant milestone to me.

If you haven’t heard of TEV before, it’s probably because my colleague Dan Smith only just made it up.

That shouldn’t stop you from considering this metric, however. Every financial metric had to be invented at some point, and when a new one catches on, it can be more than just another way to look at valuation — it can change the valuations themselves.

The entire US cable industry, for example, is arguably a product of John Malone’s success in popularizing EBITDA as a way to value companies.

Malone never would have been able to raise the huge sums of investment money required to build a nationwide cable network if investors only invested on the basis of traditional metrics like price-to-earnings or price-to-book.

Cable was a different kind of business that required a different kind of financial metric, and blockchains are an even more different kind of business. 

If TEV were to become the new valuation metric for layer-1 blockchains, I’d expect investors to increasingly question why ETH is worth 4x more than SOL.

Q: Why is ETH worth 4x more than SOL?

Good question!

But there are lots of possible explanations: Ethereum came first, it has more developers, more TVL, more mindshare, more institutional adoption, the code is more battle-tested, modular might be better than monolithic, it has more moneyness…plus a lot of other explanations that I’ll be politely reminded of after this email.

Q: Do fundamentals even matter in crypto?

Call me old-fashioned, but I think they do.

They may not appear to, because in the rare case of a protocol earning revenue, there doesn’t seem to be any correlation between revenue and valuation. More revenue doesn’t seem to get a higher valuation.

But that’s not how it works in TradFi, either.

The companies that make the most money don’t always get the highest valuation multiples — oftentimes, they get the lowest (ask any long-suffering value investor). 

But even where there is no correlation between earnings and price, valuation metrics are still useful information — if nothing else, they’re a way to backward engineer what the market is thinking about a stock (or token).

My takeaway from Dan’s TVE metric, for example, is that the market is putting a low value on current revenue and therefore a high probability on ETH becoming money in an ecosystem of Ethereum-aligned L2s. 

There’s no fundamental metric that will help you decide whether ETH’s moneyness is fully priced-in, but a metric like TVE does (I think) tell you that that’s what investors need to have an opinion about.

Q: What is an L2, anyway?

Thinking too hard about this one has always risked an existential crisis, (are L2s even real?) but I have good news: Ethereum L2s are simply blockchains.

L2s have been explained as “inheriting security” from Ethereum and “extending” Ethereum blockspace, but this appears to be mostly marketing — a useful narrative for both Ethereum mainnet (how it scales) and L2s (how they attract users).

The current thinking, if I’ve understood correctly, is that L2s won’t inherit Ethereum’s security until sequencers are decentralized (which appears to be a long way off), and they don’t truly extend Ethereum’s blockspace because they can switch away from Ethereum at any time.

L2s do, however, extend ETH the asset (as opposed to Ethereum the blockchain).

The typical L2 that uses ETH for transaction fees but is not immutably linked to the Ethereum blockchain (which I don’t think any are), is akin to Panama adopting the US dollar — it creates demand for the US currency, but Panama remains a sovereign country that can switch to some other currency at any time.

Your opinion on ETH as an investment should (I think) be mostly about how much demand for ETH the L2s will generate and how likely they are to stick around.

Q: Why do VCs keep dumping overpriced tokens on us? 

Have some agency!

I see a lot of complaining that market makers are artificially inflating the price of new tokens so that VCs can sell to retail before the price inevitably craters. But there’s an easy fix for that: Don’t buy at inflated prices!

The problem seems to be that people want to buy tokens of protocols they like without having to do any hard thinking about the price they’re paying.

That kind of works in equities where there’s an industry of analysts, investment bankers and hedge funds keeping prices somewhat reasonable.

If, for example, you think more people will start wearing Crocs, you can buy CROX without worrying too much about the valuation multiple you’re paying.

I mean, you should worry, but with equities, it’s less important — the market is arguably efficient enough that subsequent performance will be mostly a function of the company’s performance and not whether the multiple goes up or down.

In crypto, however, valuation work is DIY — no one is making sure prices are semi-reasonable for you.

If anything, market makers, VCs and an army of front-running bots are doing their best to make the prices you pay unreasonable.

But there’s two sides to every trade: They can’t sell to us at prices we refuse to pay.

Q: Is front running allowed in crypto?

Yes. Encouraged, even.

Unless you’re front running the front runners — that is not allowed.

Or so it seems from yesterday morning’s DOJ indictment of two brothers accused of “stealing” $25 million from MEV bots — which are arguably in the business of stealing from everyone else.

The TLDR appears to be that the attackers inserted themselves into the middle of a sandwich attack, which seems like fair play to me — aren’t the MEV bots always inserting themselves into the middle of everyone else’s trades?

I guess what makes it stealing (instead of allowed front running) is that the attackers “exploited a vulnerability” in their victim’s code to insert a “false signature” into the victim’s transaction.

Exploiting vulnerabilities in software is illegal and even if you think that front running is also stealing, it’s still illegal to steal from a thief.

It’s just unusual that a victimized thief would report the crime to law enforcement.

$25 million is a lot of money, so I guess I would have reported it too, but it’s maybe not the best look for crypto — a permissionless technology shouldn’t need the DOJ to play referee between its participants. 

Like crypto investors, crypto developers should have to do their own work.

― Byron Gilliam

Brought to you by:

Fulcrom Finance is a DEX for advanced spot and perpetual trading on Cronos and zkSync Era that allows users to create leveraged positions with up to 100x leverage, low fees and zero price impact whilst having the peace of mind that all trades and collateral are stored transparently on-chain. 

Fulcrom Finance is hosting croMania — a giveaway event from now till 28 May, 2024 on Cronos, designed for both traders and stakers. Here’s how to participate:

1. Connect your wallet on Fulcrom website to Cronos network and fund your account

2. Earn points by trading any pairs or staking $FLP

3. Reward distribution will be based on your share of the total points during the campaign

Ethereum's Staking Debate: Decentralization vs. Security vs. Yield

In this week's interview, Hasu from Flashbots and Vasiliy from Lido DAO discuss the current state of Ethereum's issuance and staking dynamics post-merge.

Watch or listen to 0xResearch on YouTube, Spotify or Apple.