Ethereum faces pressing questions over its direction as a rejigged user experience saps activity and fees, stoking uncertainty about whether the blockchain will continue to underpin commerce in crypto.

Critics point to a growing reliance on so-called layer-2 blockchains, built on top of ethereum to improve otherwise clunky and costly transactions. Layer-2 operators like Arbitrum and Optimism have reaped the rewards. Since March, layer-2 transactions are up 430%, while fees collected by ethereum have fallen 87% in the same period.

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The performance of ethereum’s token, ether, underscores the muddy outlook. It’s up about 75% in the past year, a period when bitcoin more than doubled. Bitcoin lately also scaled record highs atop US President-elect Donald Trump’s embrace of digital assets, whereas ether remains far from all-time peaks.

“The layer-2 road map shipped without careful examination of the economics,” said Max Resnick, head of research at Special Mechanisms Group, which is owned by ethereum developer Consensys Systems. “It’s clearly a concern.”

Founded over a decade ago with the aim of creating a “world computer”, ethereum made it easier to build blockchain-based applications, turbocharging the decentralised finance — or DeFi — ecosystem where people trade, lend and borrow digital assets peer-to-peer using automated software.

The network supports more than US$72-billion in tokens locked in DeFi apps, as well as more than $100-billion of the nearly $190-billion stablecoin market, according to data from DefiLlama. But what has long been considered a dominant position is perhaps for the first time under threat.

Tepid reception

While the blockchain has “ceded some pricing power” in the short term, it has done so to allow “all the layer-2s to establish themselves and grow and flourish,” said Consensys CEO Joseph Lubin.

In the US exchange-traded fund sector, ether products have received a tepid reception, recording a net inflow of $242-million compared with a $31-billion flood into bitcoin ETFs in 2024.

Since the blockchain’s “Dencun” upgrade in March, ether supply has turned inflationary: the number of tokens in circulation is rising. An earlier upgrade, “The Merge” in 2022, was supposed to prevent that and lure investors.

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The loss of fees to layer-2 platforms has exacerbated the situation, because the supply of ether is kept in check through the permanent removal of tokens representing a portion of transaction fees.

There is now a live debate about whether bringing layer-2s into the fold was the right path for ethereum.

“Nobody understands the road map except for like a cabal of people and they’re not really doing a great job of telegraphing the view in a simplistic manner,” said Zaheer Ebtikar, co-founder of crypto hedge fund Split Capital.

Proponents had hoped layer-2s would be a net positive for ethereum, but the overall benefit to the network “is now less clear than it was initially”, Strahinja Savic, head of data and analytics at FRNT Financial, wrote in a note.

Ether suffers from middle-child syndrome, in that it’s underperforming bitcoin, but is still large enough that only a notable uptick in institutional inflows would move the needle on price, Split Capital’s Ebtikar said. Ether currently has a market capitalisation of about $400-billion.

Capital is flowing to rival networks like solana, which after ethereum supports the most assets locked on DeFi applications, DefiLlama data shows. Solana’s token is up 300% in the past 12 months.

More affordable networks such as solana appear to be catching up to ethereum in terms of their appeal for users, said Eliezer Ndinga, head of strategy and business development at 21.co.

One key figure whose conviction is unshaken is ethereum co-creator Vitalik Buterin. In an interview, Buterin said many layer-2 teams have expressed an interest “in finding ways to be more collaborative and supportive of the ethereum ecosystem”. Those ancillary networks are deeply integrated with ethereum’s community, he added.

Read: The bitcoin bubble isn’t all about Donald Trump

Resnick at Special Mechanisms Group struck a different tone, arguing that for the first time in its history, ethereum is in the “danger zone” in that it faces a genuine rival in solana. Ethereum must focus on scaling “in order to preserve its users and moat in the short term”, Resnick said. — Sidhartha Shukla, (c) 2024 Bloomberg LP