October 21, 2024
This New L2 Can Bring Big Changes to the No. 2 Crypto
Dear Subscriber,
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| By Marija Matic |
Speed and efficiency are the two critical components for any blockchain.
That’s why you should watch projects that promise both. And the networks that race to improve their own offerings.
There’s a new entrant into this arena that I want to introduce you to today.
However, this isn’t just another competitor vying for users.
This one could potentially revolutionize the decentralized finance ecosystem.
Let me explain …
Earlier this month, decentralized exchange giant Uniswap (UNI, “C+”) announced Unichain to the world.
Set to go live in the coming weeks, Unichain is a groundbreaking Layer-2 network that promises transaction speeds of just 250 milliseconds.
That’s even faster than the 390 milliseconds it takes for Layer-1 Sei (SEI) to settle.
But speed is just one selling point.
Unichain will introduce painless cross-chain swaps. It also aims to elevate the DeFi experience in two ways. One, by enhancing market efficiency and two, by mitigating the losses caused by malicious bots.
In short, this innovation has the potential to make trading fairer and more fluid.
However, with such advancements come pressing questions about the implications for Ethereum’s (ETH, “A-”) ecosystem.
Remember, Uniswap operates on the Ethereum network. If successful, Unichain could impact Ethereum’s broad ecosystem in two big ways.
Change 1: A Shift in Rewards Dynamics
Staking is the backbone of Ethereum’s security. It ensures the integrity of the network while rewarding those who invest their assets for the greater good.
When stakers commit their ETH, they don’t just lock it away. They actively participate in a system that verifies transactions and fortifies the entire blockchain.
In return for their commitment, they earn rewards from transaction fees, new ETH issuance and maximal extractable value (MEV).
With the advent of liquid staking — which gives stakers a derivative token that can be swapped or staked itself — this process has become more dynamic.
Today, users no longer have to choose between staking and liquidity.
This means that, while stakers contribute to network security, they can also tap into the broader DeFi landscape and maximize their earnings beyond traditional staking rewards.
As more ETH flows into staking, the network's security strengthens as it becomes increasingly resistant to manipulation.
But as the stakes rise, so do the complexities.
While higher rewards for staking naturally draw in more users, the diminishing returns law can quickly kick in. As competition for rewards intensifies — whether from mining in Bitcoin (BTC, “A”) or staking in Ethereum (ETH, “A-”) — the payouts can start to shrink.
This competitive landscape is typically offset by long-term asset appreciation. This has historically fueled growth in both BTC mining power and the amount of ETH staked.
Related story: What’s Going on With Ether?
Currently, an impressive 28.24% of all circulating ETH is staked. That’s a testament to the community's confidence in Ethereum's long-term potential.
However, recent data indicates a dip in the annual percentage rate (APR) for staking ETH to just 3.11%.
Naturally, stakers are less than thrilled by this development. Especially as, for most, the APR they can target is even lower.
For many, the route to staking isn’t through becoming a direct validator, which is expensive and complicated. Instead, they use platforms like Lido (LDO, Not Yet Rated). This decentralized solution handles the nitty-gritty of validation on behalf of its users for a small fee.
But those fees can be much higher if you choose to use a centralized service. For example, if you stake on the Coinbase exchange, you are now facing a maximum APY of just 2.18%. That’s down from 2.58% in the past month.
This highlights the rapid pace of diminishing returns, compounded by the higher fees that centralized platforms often impose.
Given this shifting landscape, I’ve been closely monitoring the behavior of ETH stakers. Especially in the wake of Uniswap's announcement.
What I’ve found is striking: In the past two weeks, there’s been a significant net outflow of -267,355 ETH.
This withdrawal marks the largest since the Shanghai upgrade in April 2023. That was the moment when stakers were first allowed to unlock their funds:
Most of the unstaked ETH has come from Coinbase, and the reasons are clear: As staking yields continue to decline, many users are reevaluating where to allocate their assets.
While Unichain isn’t operational yet, it promises to further complicate the staking landscape.
Considering Uniswap is Ethereum's largest fee contributor, the switch to Unichain may further diminish ETH staking rewards, leading to lower payments for validators.
That said, Ethereum already has a couple of cards up its sleeve related to future upgrades. These should alleviate many issues relating to staking.
Change 2: Unichain Could Lighten ETH Burns
Transaction costs on Unichain are expected to be over 95% cheaper than those on Ethereum. That means users may be tempted to migrate their liquidity to this new chain.
This shift could also ripple through other cost-effective Layer-2 solutions like Arbitrum (ARB, “B-”) and Base, which currently thrive on Uniswap.
Moreover, Unichain has the potential to redirect nearly $500 million in transaction and MEV fees that would otherwise flow to Ethereum each year.
Almost 13% of Ethereum's gas consumption comes from Uniswap. So, this transition could have profound implications.
This shift could also pave the way for slightly higher inflation of ETH in the months ahead. That’s because Uniswap serves as the largest source of ETH burn — coins that are permanently removed from circulation:
The burn mechanism is an automated scarcity tactic — ETH supply decreases when more ETH is destroyed through fee burns than is created through issuance.
Although ETH has seen inflationary trends recently, it has generally been deflationary since the Merge, thanks to sufficient fees supporting this burn mechanism.
A Peculiar Situation for Ethereum
Right now, Ethereum is in a delicate and strange position thanks to its use of Layer-2 scaling solutions.
This strategy has always been part of Ethereum’s vision. Today, it boasts over 100 Layer-2 and Layer-3 networks. These allow more users to transact on Ethereum-compatible dApps and platforms without overloading the main Ethereum blockchain.
But the cost of that is the decreased activity on the Ethereum mainnet. It now sits at No. 7 in terms of transactions per second (TPS) within its own ecosystem:
Clearly, Layer-2s — like Unichain — are crucial for scaling Ethereum’s ecosystem! Otherwise, we’d be stuck with a slow and even more costly Ethereum blockchain.
However, their contributions to the overall network’s security remain somewhat limited. They do generate some fees for Ethereum. But because they batch transactions, these amounts aren’t substantial enough yet to meaningfully influence rewards or inflation dynamics.
Ethereum's built-in mechanisms help maintain security balance, but they can also lead to slightly increased inflation under certain circumstances.
The arrival of Unichain further complicates that delicate balance.
I, for one, will keep a close eye on this new Layer-2 as it gains traction. After all, it has the potential to become the largest contributor of fees among all Layer-2 solutions.
As such, it will be fascinating to see how these dynamics evolve and how Ethereum adapts to the changing landscape.
I urge you to keep up with my updates here so you can stay in-the-know.
I also suggest if you are staking your ETH for the first time … or recently decided to stake … to carefully consider the staking dynamics first.
Finally, I encourage you to watch my colleague Juan Villaverde’s latest briefing.
No matter what happens with Ethereum, his Crypto Timing Model will identify the key levels traders should be aware of in its cycle. It’s this tool that has allowed Juan and his Weiss Crypto Investor members to target impressive gains of 673% … 826% … and even 1,148% on Ethereum.
Not to mention the gains they were able to harvest in Bitcoin and other top-performing blue-chip cryptos.
Juan explains how his model works and what he sees on crypto’s horizon in his briefing. You can watch it all here.
Best,
Marija MatiΔ
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