I recently wrote an article that explores that investment case for Ethereum. While I think Ethereum (ETH-USD) is going to grow rapidly and mostly maintain their market leadership (~60% in 2022 down from 90%+ to start 2021) in the smart contract space, there are some attractive alternatives that may experience even more rapid growth. I plan to write the investment case for each one of the other major Ethereum competitors starting with one of my favorites: Avalanche (AVAX-USD).
Avalanche was launched in 2020 by Ava Labs as a proof-of-stake, smart contract platform. Avalanche is essentially a network of blockchains, allowing for users to create custom, specific blockchains to meet their needs. Avalanche is similar to other Ethereum competitors in that it aims to be faster, cheaper, and more flexible than the current network. Avalanche is unique in that it has three different smart chains under the hood. Each chain has a specific task allowing users that it was designed for. The X-chain creates and transacts tokens like its native currency AVAX. The C-Chain runs smart contracts similar to Ethereum (and is compatible with Ethereum) using the same code base called Solidity. The P-chain allows the creation of standalone blockchains.
Avalanche has unique advantages other smart contract platforms competing with Ethereum do not. The biggest advantage is AVAX is cross-compatible with Ethereum. Users can even deploy Ethereum contracts on Avalanche without any changes to the code, allowing for easy legacy Ethereum user and builder adoption. This allows easy portability from Ethereum and breaks some of the incumbent power it has on the market. Developers are reluctant to build a new product on a protocol if they are unsure if it will be around in 5 years; AVAX assuages those fears.
Tokens can be bridged between the Ethereum and Avalanche networks
Avalanche has higher transaction throughput and also is able to achieve finality faster than almost any other chain (Solana (SOL-USD) and ETH2.0 are actually projected to be faster). Finality is the time reached when a transaction is considered officially permanent on the blockchain. Avalanche achieves finality over 100 times faster than the current version of Ethereum.
Supply is always a topic of conversation in the crypto space. In the fiat world, supply is essentially limitless for countries that control their own currency; it is at the whims of the current government and what the market will bear in terms of price. In the cryptocurrency world, supply generally is baked into the protocol at the outset, though it can be changed if a majority of network participants agree. Bitcoin’s (BTC-USD) supply is fixed at 21 million. A large part of the investment case for Bitcoin centers around this scarcity. Ethereum’s supply is variable though likely to peak around 120 million before depreciating annually at around 2% after the Eth 2.0 upgrade. AVAX has a fixed supply of 720 million tokens. 360 Million tokens were minted at launch (with the vast majority locked up in vesting periods between 1 and 10 years discussed in our disadvantages below) whilst the other 360 million are used for rewards for staking, released over decades. A set number of tokens are burned by the network, similar to Ethereum, for transaction fees, creating a deflationary dynamic if network capacity increases to a level where more tokens are burned than issued.
Avalanche is more flexible than other layer one blockchains. Users can create their own custom blockchains that run on the AVAX network. Each chain can have its own token and fee structure. They may choose to pay their stakers in AVAX, their own token, or something else. Anyone can create their own blockchain on the network by paying a subscription style fee.
The team behind AVAX also gives them a unique advantage. Dr. Emin Gun Sirer is the founder and CEO of Ava Labs and was an early adopter of blockchain technology who helped in developing scaling for Bitcoin. The development team also has a strong background working at some of the most innovative and well-known institutions in the world (below). This sort of pedigree is almost unheard of in the space.
Avalanche has similar drawbacks to other Ethereum competitors, namely its current level of centralization. AVA Labs and an initial set of venture investors hold a significant amount of AVAX and have an outsized influence on its governance. In addition, their tokens have a set lockup schedule which releases overtime, potentially causing sell pressure.
Avalanche is fairly centralized. The top 30 Avalanche wallets hold over 30% of the total circulating supply of AVAX. These top 30 individuals have an outsized influence on the price. Below is a chart as of August 2021 of the top holders.
The protocol also isn’t as battle-tested as Ethereum under heavy network activity. AVAX has been around less than two years. We have seen similar impressive layer ones like Solana grow just as fast only to come crashing down under heavy network use. Solana, for example, has crashed twice in the 2nd half of 2021.
AVAX also requires a high minimum to become a validator. It currently requires a minimum of 2000 AVAX or roughly $200k at the time of writing. The Ethereum network has developed solutions for validators to stake with as little as $100. You can “delegate” your AVAX to others to stake and earn some reward fees, but this goes against the decentralization ethos of many crypto advocates. Staking currently produces rewards of around 10% for AVAX. Eth staking is estimated to produce excess of that when ETH2.0 goes live.
Discounting a bit of that extreme growth, I don’t see why crypto can’t be at least $6T (3x from here, tracking user growth) by the end of next year given its growth path of adoption, continued investment by institutions and VCs, and the enormous amount of money already locked in apps. Excluding Bitcoin and just looking at the smart contract based blockchains, they are valued today at roughly $0.6T of the $2T crypto market cap. AVAX is roughly 5% of that $0.6T. Ethereum gas fees will continue to remain high into the end of 2022 when Eth 2.0 should be complete. I expect Avalanche and Solana to continue to gain market share against Eth. A 10% market share of a $1.8T market (expecting that the market grows 3x in 2022) is $180B, or more than 10x what Avalanche is today.
If you are a value investor, please shield your eyes. Avalanche has some eye-poppingly high valuations. On a price to sales basis, the protocol is currently valued at ~450x (granted this has come down overtime). Fee revenue was only about $43m in 2021, or <1% of Ethereum revenue.
The redeeming fundamental quality bulls can point to for Avalanche is the growth rate. Growth is strong across the board – from users, to developers, to apps. Avalanche is also launching NFTs, which could be a huge area of growth in 2022. Avalanche is actually growing faster than Ethereum did at a similar point in its history. Developers working on the platform grew 3x in 2021, and were the highest among players outside of Ethereum and Solana.
Total-value-locked (TVL) is an important measure to determine the use of a protocol. TVL measures the cumulative amount of assets that are staked or put at risk on a particular protocol. As you can see below, Ethereum is leader by a large margin. Still, when comparing the TVL to the market cap, we see some platforms are much more undervalued than others. To reach a similar ratio to Ethereum, AVAX would have to rise ~25%. It is also gaining assets at a much more rapid pace than most other competitors. As you can see, there are some other attractively valued platforms here in addition to Avalanche.
|Protocol||TVL||6M Growth in TVL||Market Cap/TVL|
Source: The Block and author calculations. Note rounded for simplicity
The Avalanche team wants to continue to drive DeFi and TVL growth on the platform. To do this, they recently launched Avalanche Rush, a program aimed at drawing builders into Avalanche’s network. Avalanche Rush’s $180 million fund provides DeFi primitives with token rewards. So far, Avalanche Rush has proven highly successful as Curve (CRV-USD) and Aave (AAVE-USD), the largest DeFi protocols by TVL on Ethereum, have launched Avalanche markets. This is a potential game changer in my opinion.
Risks And Considerations
We alluded to some of the main risks above in the disadvantages but I want to more clearly articulate them for the potential investor. AVAX is more centralized than Ethereum, with a large amount of its tradable float sitting in the hands of VCs and early investors. These individuals can have an outsized influence on price if they decide to sell or sell as their tokens unlock. Most have a cost basis well under $1, so it’s not unreasonable to think they would take some profits with the token sitting near $100 at the time of writing. Additionally, while the technology has performed well to date and looks very promising, it has not been tested under the extreme stress the Ethereum network has worked through over 6+ years. Regulatory risk also remains for the overall crypto space though I think this is less of an Avalanche-specific issue.
The fundamental picture in terms of cash flows and revenues certainly leaves a lot to be desired for AVAX. Still at less than 2 years old, growing at a breakneck pace, and with a ton of VC backing and developer interest, it’s hard not to see AVAX as a protocol worth betting on. The technology and approach are top notch, let’s see if the revenue follows as the suite of apps is built out.
As Ethereum goes, so goes the space. If Ethereum does indeed see the 3-5x growth I anticipate in 2022 based on the change from proof-of-work to proof-of-stake, “small cap” protocols have historically moved up and down at a high beta to BTC and ETH, therefore a 5x-10x AVAX would not be out of the question.