Revisiting Ethereum and Avalanche

Posted on May 20, 2022June 30, 2026 by io-fund

Given our high allocation to crypto and specifically Ethereum, we want to track any progress (or lack of progress) towards The Merge to Proof of Stake, and also Shards and Rollups. We’ve also recently placed Avalanche into the LTBH category and this analysis looks at why we plan to trim ETH slightly and re-allocate what we trim to Avalanche.

In 2019, we wrote that the catalysts for Bitcoin trading at higher price levels (and holding those levels) would be economic uncertainty, the Lightning Network for mobile payments and institutional adoption. These three things came to fruition and Bitcoin has held higher prices.

The upcoming catalyst for Ethereum to expand its network and host more apps is well-known, which is The Merge to proof-of-stake. We discussed in March of 2021 that proof-of-stake would be necessary to lower gas fees and to help realize Ethereum’s full potential as a network for decentralized apps (d’apps), which would ultimately function like an operating system. The issue is not what Ethereum needs to do to realize it’s vision rather the question is when will Ethereum do it? When will Ethereum complete The Merge?

The delays on The Merge are one reason we are diversified with a Layer 1 in LTBH. It’s likely you see us add more Layer 1s pending technical analysis, such as Solana. We discuss below the additional delays that Ethereum faces on PoS and the upcoming timing issue in June when Proof of Work is scheduled to “freeze” over a period of five months.

Quick note regarding crypto selling off, I had discussed how OpenSea received a 10X valuation right before crypto sold off. You can read the full forum post here:

“The Series C was led by Philippe Laffont of Coatue Management, who has successes on the public markets such as Anaplan, Snap, Spotify and Databricks not yet public [..] Certainly, OpenSea would likely go for a lower valuation today given the Luna bust and all altcoins being down in sympathy. However, rather than stress over a 4-month bad timing decision, private investors will simply hold until market conditions are favorable for their investments and then go for the exit. Private investors assume their timing will not be entirely perfect and instead they make their exits perfect.”

The reason we have been dollar cost averaging into the crypto selloff is that timing a bottom is futile. It’s much easier to time an exit. According to industry analysts, blockchain should scale rapidly between 2025-2030 from $176 billion to $3 trillion. I imagine we will see Coatue and others exit through IPOs around the later part of this time frame, and as early-stage investors in crypto, we will want to consider doing the same. This doesn’t mean we won’t trim, etc., rather it provides a nice timeline for an exit on middleware like Chainlink and also Layer 2s. I’ll touch more on those in an upcoming analysis.

Ethereum Network Delays on PoS

The primary difference between Ethereum and Bitcoin is that Ethereum is not trying to compete as a currency. The focus of Ethereum is on its network, not the coin. Vitalik Buterin’s vision is to create an open network for decentralized applications and smart contracts based on the Turing complete programming language Solidity.

Ethereum faces constraints in transactions per second (TPS) and how to overcome the high energy costs of mining that comes with decentralized security. The network simply can’t scale without the upcoming release of Ethereum 2.0.

In our premium analysis last year on Ethereum here, we discussed the difference between Proof of Work (PoW) and Proof of Stake (PoS). In addition to the Proof of Stake merge that Ethereum must complete, the network must also launch shards. In last year’s analysis, we said: “Shards are another critical improvement for network bandwidth and the low transactions per second (TPS) as Ethereum 2.0 (ETH2) allows for improved data processing. Nodes in the previous network must download a transaction, calculate it, archive it and read every transaction in Ethereum’s history, which is terribly inefficient. Shards create a subset of the network where nodes are dispersed for more efficient processing. The Beacon Chain ensures the nodes are synchronized and the validators are reporting the blocks of transactions.”

We went into great detail on ZK Rollups, as well. The quick summary on ZK Rollups is they allow for hundreds of transfers to be rolled into a single transaction. This will replace Plasma, the current option where only a single transfer is made per transaction. In this case, the smart contract will verify all of the transfers in the Rollups. The goal is to reduce computing and storage resources by reducing the amount of data held in a transaction.

In November, we wrote another update on crypto and Ethereum, stating that the expectation was for Proof of Stake to merge in late 2021 with Shards and Rollups expected by late 2022 or early 2023. The timeline for PoS is delayed yet again until Q3 2022, which puts Sharding and Rollups out another year potentially to Q3 2023.

Update on Proof-of-Stake (PoS) Merge

In August of 2021, Ethereum went through the London Hard Fork. This was a step towards PoS as Ethereum Improvement Proposal (EIP) 1559 changed the management of transaction fees on the network. Previously, the transaction fees would go to the miner directly. The London upgrade introduced a fixed-per-block transaction fee that is burned. This results in more predictable gas fees and also helps the blockchain network prepare to eliminate miners by Q3 of this year.

According to Statista, the average gas fee in August of 2021 was 136 Gwei. In January of 2022, the average gas fee was 122 Gwei. There have been some lower months for gas fees both pre-London upgrade and post-London upgrade, yet ultimately EIP 1559 will not resolve gas fees by any means and The Merge is still (badly) needed.

Gas fees reflect the fact that blocks reach their maximum capacity during peak transaction periods. However, this can actually work to increase the price of Ether in the event that transaction fees are prohibitively high to transfer ETH. The London Hard Fork also helps to create scarcity as ETH is burned with each transaction.

Ethereum’s Difficulty Bomb is Ticking…

The “Difficulty Bomb” refers to a deadline where Proof of Work (PoW) will become more difficult by impacting block times. The Bomb refers to the exponential difficulty that PoW will face, which will cause block times to implode similar to a bomb.

According to Tim Beiko, the block time will increase 487% from 12-14 seconds to 64 seconds about five months after the difficulty bomb is released. This is achieved by making it more difficult for miners to crack the cryptography, and the result is that it becomes too time-consuming to be profitable. This is referred to as the “Ice Age” when PoW will be effectively frozen and miners will be deterred from minting more blocks.

In addition to pushing miners to move away from PoW, the difficulty bomb also removes the ability to create centralized currency on the Ethereum network, prevents a blockchain fork that could occur if miners continue PoW, and also forces node upgrades.

There have been five delays on the Difficulty Bomb with the current deadline extended to June of 2022. For obvious reasons, it’s ideal if the Difficulty Bomb “goes off” after The Merge occurs otherwise the Ethereum network will be frozen without an adequate replacement for the consensus mechanism. As of early May, however, Ethereum developers have decided to ignore extending the Difficulty Bomb in favor of remaining focused on proof-of-stake.

I believe the (current) decision to ignore the Difficulty Bomb reflects the lack of patience that is growing across ETH investors and also Ethereum users (due to high gas fees) on the Proof-of-Stake Merge. This is the first time that the Ethereum Foundation has decided to forego delaying the ticking bomb as they must heavily weigh the pros/cons of delaying PoS again.

There’s a chance that the All Core Devs meeting on May 27th reverses this decision and chooses to focus on delaying the freezing of PoW. However, it seems that Vitalik Buterin, the co-founder of Ethereum, is prepping expectations that block time increases temporarily: “We have to evaluate the pain of doing an extra delay hard fork versus the pain of living with 21 or 25 second blocks for a while, which is something we have done and the world didn't end.”

Ethereum’s delays with the PoS Merge is one reason we added a second Layer 1 to the LTBH portfolio. To complicate matters, the Difficulty Bomb is now weeks away from detonating (sounds like we need Batman).

Although it’s hard to give up any allocation on Ethereum given its concentration in d’apps and developers, it’s also important to acknowledge that if other Layer 1s want to compete alongside Ethereum, June-September is their chance to lay some serious groundwork on building a developer and app ecosystem because Ethereum will be juggling two hot potatoes – The Merge to PoS and the Difficulty Bomb.

A Member shared the A16Z Crypto Report which helps to illustrate Ethereum’s dominance.

The decision that Ethereum must make between prioritizing Proof of Stake or the Difficulty Bomb is not lost on popular apps on the Ethereum Network as a slowdown in Proof of Work before The Merge would result in higher gas fees and more congestion. Investors should keep an eye out for popular apps diversifying their Layer 1 network due to high gas fees.

In our previous write-ups, we discussed how Time Magazine’s TIMEPieces resulted in exorbitant gas fees where 10 NFTs were priced at 1 ETH for $2500 or $2800 yet due to gas fees, one buyer paid as much as $70,000.

Yuga Labs is the creator of the Bored Apes Yacht Club and is a leading NFT creator. There are 10,000 apes with traits and unique characteristics, which you may recognize such as this:

Three weeks ago, Yuga Labs held a digital land sale that drove $285 million to the company yet resulted in $176 million in gas fees on the Ethereum Network. The average gas price was around 800 Gwei early Sunday and spiked to 6000 and 7000 Gwei during the sale, which equates to $3,000 or more per transaction in gas fees. In fact, there was one $25 NFT that carried a $3,300 transaction fee and complaints abounded on Twitter.

Yuga Labs issued an apology and publicly stated they are going to turn the lights off on Ethereum for a while.

In this high-profile decision, Yuga Labs is reportedly considering other Layer 1s.

Avalanche

The I/O Fund added a new LTBH position in Avalanche last month. We did a deep dive on Avalanche here.

What other Layer 1s will popular Ethereum apps choose to diversify with? We think Avalanche could be a top choice given it’s Ethereum Bridge, application-specific subnets and the launch of a consumer-facing app over the next few months/quarters. Avalanche also has a high Nakamoto Coefficient, which is a number that designates the number of nodes that would need to be corrupted to slow or prevent a chain from functioning properly.

Last quarter, Avalanche launched GameFi subnets with DeFi Kingdoms participating. The bridge protocol Synapse saw volumes surge from a previous high of $157 million to a record $330 million. This accounted for 82.5% of total bridging volume on Synapse.

Recently, the popular game Crabada migrated from Avalanche’s C-Chain to a subnet. This will help prove viability of subnets’ ability to scale and potentially attract more games as Ethereum goes through its growing pains over the next few months. Crabada draws in high daily volume of up to $1.5 million with transactions of up to 400,000 per day. The application has a total value locked of $50 million by the end of the quarter.

Avalanche launched with three chains. Per our YO/LO write-up: The X-Chain is for creating and exchanging assets including NFTs, the P-Chain validates and creates subnets, and the C-Chain is for executing Ethereum Virtual Machine (EVM) contracts. The C-Chain offers interoperability with Ethereum, which is why the Avalanche bridge is the most popular ETH Bridge currently. The P-Chain is what is used to create and manage subnets. The coordination of Avalanche validators occurs on the P-Chain and it can support thousands of subnets and millions of validators.

Subnets are important to reach scale. The customized chains allow blockchain verticals to have enhanced function by grouping together like-kind applications. Gaming d’apps are separate from Decentralized Finance apps (lending, borrowing, payments), which is key because these d’apps have different requirements.

As we stated in the AVAX write-up: “Ethereum is running into issues with 500,000 to 1 million daily active users. Meanwhile, a single mobile application sees hundreds of millions of users, such a Twitter or Spotify. What Layer 1 can handle this level of adoption? That is a platinum-level question for investors to answer. To be clear, it could be Ethereum in 2023 if the developers and users prefer to not migrate. However, if the ecosystem runs out of patience and seriously looks for an alternative, then Avalanche is a candidate.”

Avalanche came to market in 2020 yet in terms of total value locked, started to gain traction in August of 2021. The chart above by A16Z helps visualize how strong Avalanche has been out of the gate in terms of growth. I’ll repost it here for quick reference:

According to Messari’s Q1 report, Avalanche’s average daily transactions grew 82.8% sequentially and total revenue grew 72% from Q4 to Q1 2022. During this time, the market cap was flat at (5.4%) and price relative to revenue went from 160X to 91X (note: AVAX is two years old and very early stage).

In the first week of January, Avalanche had more active users than all of October 2021. The network averaged 70,000 daily active addresses, which grew to 92,000 in Q1. Average daily transactions rose from 473,000 last quarter to 865,000 in Q1 compared to Ethereum’s daily transactions of 1.17 million.

As stated above, some transaction fees on Ethereum were up to $3,000 during a popular NFT sale in the hundreds of millions. Avalanche surpassed $1 million in daily NFT volume for the first time with transaction fees of $0.67 per transaction. This helps illustrate the importance of Yuga Labs shopping for a new Layer 1 as one popular app can raise daily NFT volume substantially during auctions, helping to prove the ability scale for a competing Layer 1.

Perhaps most important for investors, there is an increasingly stronger correlation between revenue and market value for Avalanche. When daily revenue spiked in November, fully diluted value saw a similar spike. As Messari shows below, the spread between revenue and the fully diluted value had a tighter correlation, which helps prove fundamental value as the revenue has a closer relationship with network value.

Source: Messari.io

Why Terra Crashed

An analysis on crypto this month would be remiss to not include a note on the Terra crash. TerraUSD (UST) or “Terra” is an algorithmic stable coin that automatically tracks the price of other currencies, in this case the United States dollar. The idea is that transactions will be predictable and investors can hold their assets without the level of volatility seen across fully decentralized currencies.

Luna is the native token of the Terra Layer 1 blockchain that is used for governance and mining. Luna is staked to validators to record and verify transactions on the blockchain in exchange for rewards and fees.

As a stablecoin, Terra was designed to use supply and demand to balance its price. If demand for Terra goes up, then Terra’s price increases, and if demand for Terra is low, the price decreases. The two cryptos, UST and LUNA, have an arbitrage-type relationship as the Layer 1 is made up of two pools. Atomic swaps are made possible through a market module.

Arbitrageurs sell LUNA for UST when the price is below $1 and they buy LUNA when UST is worth more than $1. If UST is priced at $0.90, then traders would buy that coin and sell it for $1 of LUNA. The prices were propped up by the protocol burning both UST and LUNA as they were being minted and converted, which helps bump up the price of the burned tokens due to the restricted supply.

Expansion occurs when Terra is higher than the pegged dollar, and the protocol incentivizes users to burn Luna and mint Terra. The new supply creates a larger pool for Terra, and users mint more Terra from the burned Luna until it reaches its target price. Contraction occurs when Terra is priced too low and supply exceeds demand. The protocol incentivizes users to burn Terra and mint Luna, which causes scarcity and an increase in Terra’s price to be more aligned with the dollar.

The arbitrage relationship between Terra and Luna is important to understand in terms of the Terra crash that occurred. However, the primary use for UST was not for the arbitrage opportunity but rather to earn yield on the Anchor DeFi platform.

Anchor is a DeFi protocol with $16.16 billion total value locked at the end of April, which included 72% of all UST. There was an additional $3.2 billion in UST on DeFi Llama and $152 million on Avalanche.

The reason Anchor had three-quarters of total value locked for UST is that the DeFi platform required funds to be held in UST to earn an interest rate of 19.46%. That yield drew a lot of attention and helped prop up Terra’s success as a Layer 1 blockchain. Between November and the May 2022 crash, UST’s market cap grew from $2.73 billion to $17.8 billion.

Expansion occurred because Terra was in high demand due to the attractive yield from UST. In addition to the expansion, the yield attracted a ratio of 4:1 lenders to borrowers. This meant Anchor’s reserves were becoming increasingly vulnerable to a “run on the bank” in terms of risk that an outsized number of lenders would withdraw their principal and yield. Basically, theoretically, if too many lenders withdraw at once, Anchor would not have enough reserves.

As this incredibly prescient article points out, there were warning signs.

The first was in February when the founder of Terraform Labs, Do Kwon, added $450 million into reserves with Arca CIO Jeff Dorman stating that Anchor would require more capital infusions to maintain the current yield. In late March, a proposal was passed to change the yield. Proposal 20 stated that the rate would change by a maximum of 1.5 percentage points once per month and would be a variable rate.

Here is what the Decrypto.co article stated at end of April in regards to the February cash infusion from Terraform Lab’s Founder and the subsequent decision to allow for lower interest rates:

“Without a clear, long-term solution, though, the rate will continue to decrease. After a certain threshold, which the market will decide over time, investors will generate returns elsewhere. This could lead to withdrawals from Anchor and investors potentially abandoning UST for another stablecoin that can be used for more lucrative opportunities in some other DeFi protocol. If this rotation were to happen en masse, it could be catastrophic for the health of UST as well as LUNA.”If this rotation were to happen en masse, it could be catastrophic for the health of UST as well as LUNA.”

We are not concerned about Terra in regards to our crypto holdings because on a granular level, the risk was unique the arbitrage relationship between Terra and Luna, plus the high yield of 20% on Anchor that was ultimately unsustainable. We will write an update on Aave soon.

Conclusion:

We have a large position in Ethereum that will likely be trimmed over time as we want to be prudent about the issues the leading network must overcome. This doesn’t mean we will exit entirely rather it means that 8% is too high when some of this can be allocated to an up-and-coming Layer 1, such as Avalanche. What we trim from Ethereum should be seen as diversification to lower risk during the transition to PoS and in anticipation of whether the difficulty bomb timeline is extended or not. We believe what happened with Yuga Labs and also the Axie Infinity sidechain hack (which was Axie Infinity’s solution to high gas fees covered here that ultimately hurt the company) could create a window of time where Ethereum sees heightened competition.

Avalanche Premium Analysis: LTBH

Posted on April 7, 2022June 30, 2026 by io-fund

We’ve initiated a new position in Avalanche in the LTBH portfolio as we believe the Layer 1 network can compete with Ethereum long-term due to its ability to scale with application-specific subnets. We also like Avalanche for its ability to address security across subnets by leveraging the Primary Network’s validators.

Note: we are eyeing Solana and Aave for new Momentum positions, so keep an eye out for that analysis coming soon.

The crypto landscape changes quickly and owning crypto requires a more active stance. We cannot remove the volatility of crypto for an investor, and we also want to acknowledge that crypto is sheer speculation at this stage. With that said, blockchain is well worth the effort and can be an area where retail has a rare advantage over institutions. There are over 18,000 cryptos on the market as of March of 2022 and we hope narrowing down these names is helpful by showing you where we are invested and our conviction level.

A potential Solana momentum position would be for similar reasons as Avalanche, which are outlined below. To summarize, we want to diversify our Ethereum holding with more Layer 1s. If we enter Aave, this would be in response to Voyager’s most recent regulation as we are bullish on lending and Aave allows us exposure here without the regulatory pressure that Voyager and Coinbase must overcome. We will keep you in the loop on this.

Avalanche Layer 1 Network

As discussed in our YO/LO write-up in November and then our Crypto Webinar which focused on Layer 1s, the Ethereum network is struggling to keep up with traffic and this is illustrated through the network’s exorbitant gas fees.

The term “gas” refers to the computational effort required to execute specific operations on the Ethereum network. Each transaction requires that a fee be paid called “gas” to offset the costs of computational resources.

The market price for gas is determined by demand. If you want your transaction executed quickly or if you have a larger contract, you’ll pay more gas. As of August, the London Upgrade has changed how transactions are charged with every block having a base fee and a minimum price per unit of gas that is calculated based on demand for the block. Users also tip to compensate miners for executing the transaction.

Up until now, Ethereum has been using proof-of-work, which is an algorithm that requires a miner and large amounts of computational power to create blocks and to confirm transactions. Due to the proof of work (PoW) lacking the ability to scale meaningfully, the network can max out during peak traffic, which causes it to become very costly for the transactions being made during peak usage.

Regarding how exorbitant the gas fees have become; we used the example of TIME magazine’s NFTs in our YO/LO report. The NFTs were called TIMEPieces with a price for 10 NFTs costing around 1 ETH or $2500 to $2800. Due to gas fees, one buyer paid as much as $70,000 (?!) In addition, the wait time to transact ranges from 30 seconds to 16 minutes.

This is why Ethereum is merging to Proof of Stake (PoS). Instead of a large consumption of energy, PoS requires a financial commitment of 32 ETH to become a validator. With that said, for the full benefits of Proof of Stake to be realized, shards and rollups need to go live.

Rather than every node downloading every transaction, calculating it and replicating it, shards create a subset of the network where nodes are dispersed for more efficient processing. Rollups allows for hundreds of transactions to be rolled into a single transaction. This replaces Plasma, the current option where only a single transfer is made per transaction.

PoS is set to go live in 2022 while shards and rollups are set to go live in 2023. This provides competitors with an open window of opportunity through 2023 as competing Layer 1s launched with PoS and/or the ability to scale. We’ve covered these in more depth in the past so our Members would be aware that diversification is needed in terms of holding more than one Layer 1 position.

Grayscale recently added Avalanche to their large cap fund, announced April 6th.

YO/LO write-up
Crypto Webinar

AVAX: Application-Specific Subnets

We like Avalanche for its application-specific subnets, which has the potential to scale better than other Layer 1 networks. We also like Avalanche for its endeavor to tackle the single largest issue that the blockchain faces, which is consumer accessibility. The power users for the blockchain today are niche groups: developers, gamers, NFT collectors. We believe Avalanche is attempting to break into a more mainstream audience through its Core Browser and mobile application. These are the main two points we cover below.

Avalanche currently holds the number four spot for Total Value Locked (TVL) at $10 billion yet there is very little separating AVAX from the others in overtaking the Layer 1. When we first covered the crypto, Polygon (MATIC) and Solana (SOL) both had higher TVL. Currently, Terra (LUNA) is in the number two position with $30 billion TVL.

Avalanche was founded on the idea that subnets are the proper way to increase speed and reduce network congestion and gas fees. Avalanche launched with three chains. Per our original write-up: The X-Chain is for creating and exchanging assets including NFTs, the P-Chain validates and creates subnets, and the C-Chain is for executing Ethereum Virtual Machine (EVM) contracts.

At the time, we had said the C-Chain was most critical for AVAX’s growth due to its easy interoperability with Ethereum. The C-Chain is also where DeFi apps are supported, such as Aave and Trader Joe (more on this below). However, in recent months, it seems the P-Chain is helping to carve out a permanent place as a Layer 1, as this chain is what is used to create and manage subnets. The coordination of Avalanche validators occurs on the P-Chain and it can support thousands of subnets and millions of validators, should this scale be needed.

The three primary chains are known as the Primary Network. Avalanche has taken a similar view towards subnets, which is that one chain cannot provide for all applications/use cases, and is encouraging developers to build out application-specific subnets.

Subnets are not an entirely new concept by any means. Ethereum has what is called sidechains. However, there was a major hack on an Ethereum sidechain on March 23rd and this is partly why we are tracking Avalanche more closely.

You can think of subnets as customized chains that allow blockchain verticals to have enhanced function by grouping together like-kind applications. Gaming d’apps would be separate from Decentralized Finance apps (lending, borrowing, payments), which is key because these d’apps have different requirements.

The benefit of subnets is scale. Ethereum is running into issues with 500,000 to 1 million daily active users. Meanwhile, a single mobile application sees hundreds of millions of users, such a Twitter or Spotify. What Layer 1 can handle this level of adoption? That is a platinum-level question for investors to answer. To be clear, it could be Ethereum in 2023 if the developers and users prefer to not migrate. However, if the ecosystem runs out of patience and seriously looks for an alternative, then Avalanche is a candidate.

To summarize, subnets will allow each application to have its own subnet, and subsequently scale without affecting other applications on the blockchain.

Axie Infinity’s Hack on Ethereum Sidechain

Before we talk more about Avalanche’s subnets, I think it would be good to talk about Ethereum’s sidechains. Recently, there was a major hack on an Ethereum sidechain operated by Sky Mavis.

Sky Mavis is the gaming studio that created Axie Infinity, a play-to-earn game that rapidly scaled from 35,000 users in May of 2021 to 3 million daily active users last Fall, representing 3200% growth. The game is especially popular in Southeast Asia. Per our note above, Ethereum has about maximum 1 million DAU, and therefore, Axie Infinity is quite the success story.

Axie Infinity has in-game economics, where you pay to play, and then play to earn. It costs a few hundred dollars to get started on Axie Infinity with game mechanics that are similar to Pokemon Go, except with creatures that trade through NFTs. Axie Infinity ranks third in overall NFT sales at $4.17 billion, second to Opensea’s $23 billion and LooksRare’s $18 billion.

The game is popular for its play-to-earn rewards that allow gamers to earn income from playing the game and building a virtual economy. Gamers have virtual pets that battle and breed, and gamers also raise kingdoms for their virtual pets.

Axie Infinity exploded after the launch of Ronin, an Ethereum sidechain, which removed Ethereum’s congestion issues and reduced transaction costs. Ethereum d’apps that need to scale have taken to sidechains, such as Axie Infinity with the 3200% growth from 30K to 3M users.

Sidechains require validator nodes to review transactions and to confirm that the inputs and outputs match. If any transaction is deemed not valid by the nodes, it will be rejected. However, sidechains are not fully decentralized and the validators can become compromised across both Proof of Authority (PoA) and Delegated Proof of Stake (DPoS). Sidechains are best used for smart contracts that do not hold or require large sums of money on the sidechain.

The unfortunate news last month was that Axie Infinity’s sidechain was hacked around March 23rd with over $600 million in Ethereum and USDC stolen from the Ronin Network. The issue with sidechains is they have fewer nodes validating transactions and this can become a security risk if the majority of the nodes become compromised. In this case, a hacker was able to compromise four of Sky Mavis’ nodes and one community-owned Axie DAO node.

By hacking five out of nine nodes, the hacker was able to override transaction security and withdraw funds. This brings up the discussion of what is decentralization if Sky Mavis operated nearly 50% of the nodes internally.

How Subnet Validators Are Different than Sidechains

Avalanche’s subnets have access to a set of validators already verified and ready to validate subnet blockchains. This is done by adding the subnets ID to a node configuration and by downloading the virtual machine binary. After this, the validators will sync to the subnet and start to validate.

Avalanche validators must validate all three primary chains – the X-Chain, the C-Chain and the P-Chain, also known as the Primary Network. By requiring all validators to validate the Primary Network, the subnets will benefit by instantly having access to a set of validators. In theory, this is more secure than Ethereum’s sidechain as Sky Mavis created their own validators for the Ronin Network.

Avalanche’s Primary Network and subnets are secured by the full staked value of the network. The consensus is inclusive and can be scaled to millions of validators. Subnets can improve the validation process by allowing validators to remain with their chosen applications (i.e., trading NFTs is very different from decentralized finance and validators may have a strong preference towards one over the other). This is an advantage as subnets can require validators meet certain criteria, as well, such as supporting trusted execution environments, which is a hardware isolation mechanism that provides a higher level of security than an operating system alone.

Subnets can also require higher validator uptime, which ideally is close to 100% unless the validator is doing an upgrade. Know Your Customer (KYC) may also become a required standard to where decentralized finance apps disallow full anonymity. In the case of Avalanche, a subnet could require validators adhere to KYC.

Subnets also allow for permissioned subnets to where a decentralized finance subnet could allow for more privacy and regulatory compliance, which is separate from gaming, which does not adhere to financial regulations. For process-intensive applications, rollup-based subnets can be created to process many transactions at once, which would benefit gaming. In this way, application-specific subnets can leverage customization.

Regarding Rollups, this article here points out on #17 something we have covered in the past, which is that time to finality is faster on Avalanche at less than 1 second compared to competitor Solana at about 13 seconds. The point in #18 the author is making is that time to finality becomes quite important for security purposes in the case of Rollups, which roll up many transactions into one. To summarize the author’s thesis: “Avalanche is not reliant on hoping someone checks every transaction afterwards, the entire network checks the validity of the transaction as part of consensus as it’s added to the chain, with sub second finality that can scale to millions of nodes offering incredible security.”with sub second finality that can scale to millions of nodes offering incredible security.”

AVAX’s Core Browser and Mobile App

We believe the best Layer 1 investment will help solve for accessibility around decentralized apps and put the benefits of the blockchain literally into people’s hands. The Core Browser and mobile application will both be live by Q2 of this year, although it’s important to note that Core also functions similar to an operating system.

Our three-part Bitcoin thesis included mobile payments as one tier for Bitcoin to reach its maximum market cap. This is a similar thesis for Layer 1s which is that to reach maximum market cap, the Layer 1 must break outside the niche power users to reach a wider audience for daily transactions and/or daily usage.

I believe Avalanche is attempting to solve the accessibility problem with the Core browser and the Core mobile application. It’s being called a wallet, yet functions as an operating system for d’apps. Metamask is currently on the market and is used for this purpose, yet Core will not be agnostic and will instead attempt to outperform Metamask by offering a cohesive Layer 1 experience for Avalanche chain users.

The customized wallet for the Avalanche chain will enable higher speeds and for subnets to be built out for a better user experience. In turn, more developers may build for AVAX similar to a proprietary iOS/app store. Avalanche is certainly not unique in these ambitions, rather it’s the first to release a browser/app as a means of reaching more users.

The browser extension will launch in March (this month) and the mobile app is expected to launch in Q2. This means Avalanche is moving quickly while Ethereum is stumbling. If Ethereum can’t match Avalanche’s speed and lower gas fees before 2023, then this leaves a year or longer for Avalanche to gain traction on its Core browser and application.

The company has stated specifically that they are going for “mass-adoption of Web3 systems with a smooth user-experience that has never been seen before.” Obviously, this is marketing language yet the statement is true that a great UX has not been seen before and this launch could connect a few critical dots in terms of blockchain users, developers, and the proliferation of the blockchain across devices.

The Core Wallet/OS will have the following features:

Enabled with Ledger, the leading hardware crypto wallet
Dashboard for cryptos and NFTs personally held by the user
Token swap powered by ParaSwap
Buy AVAX from the wallet with Moonpay
Address book for token addresses

Rather than challenge Ethereum head-on, Avalanche is being more courteous than other networks with the Avalanche Bridge. The Avalanche Bridge launched in July of 2021 a two-way token bridge that enables ERC-20 (fungible) transfers to Avalanche’s C-Chain. This allows ETH to be easily transferred and used on Avalanche. To help illustrate the demand for a new network that supports ETH, the Avalanche bridge has facilitated a total of $43 billion in asset transfers since last summer, eclipsing nearly 3X the total value locked on Avalanche.

The company has now launched a Bitcoin bridge to allow BTC to be used on the Avalanche’s Layer 1 network. This allows for more functionality across decentralized apps on the Avalanche network and also reduces the number of tokens a user needs to manage. Previously, a user would need to wrap ETH or BTC to be used on a network like Avalanche, which creates friction between new Layer 1 networks and these widely held tokens.

The issue that Bridge and Core will solve is that wallets do not function like operating systems so there is a need to transfer the tokens to/from networks for d’apps, and this creates an opportunity for hacks and also creates more friction. Avalanche will now compete with wallets such as Metamask while improving its functionality over other Layer 1 networks by becoming a one-stop shop. Being Ledger-enabled, the wallet should function securely with larger amounts of crypto easily held in cold storage.

Avalanche has a few popular apps, such as Aave which we have held in our YO/LO Fund in the past and we may initiate a new Momentum position. Aave allows users to earn interest by lending assets to creditworthy borrowers and has $21 billion in liquidity locked across 7 networks. As stated above, the #2 Layer 1 has slightly less than this in total value locked (TVL).

Trader Joe is a platform on the Avalanche network that could see a spike of interest when Avalanche releases Core. It includes an automated money maker to help stabilize tokens, allows for yield farming or the staking of tokens for interest, and allows tokens for lending/borrowing. There is $1.5 billion in assets staked to the platform.

Risks:

We’ve noted the sheer competition that all emerging technologies must overcome, with blockchain perhaps seeing more competition than most emerging technologies due to developers being naturally drawn to the philosophy and virtual economies of decentralization.

However, there are additional risks specific to Avalanche which a Member pointed out on our forum, which is the inflation rate of the AVAX token often being in the 20%+ range. It’s important to pay attention to this. The Member pointed towards this source:

https://youtu.be/e6VeFz-Aw8M?t=593
https://youtu.be/e6VeFz-Aw8M?t=795

It’s well worth the time to watch the video with some key points, such as:

Avalanche has over 100% inflation rate over the past 12 months with near doubling of circulating supply. This required $8.4 billion to keep it even.
The max supply has disappeared from Coin Market Cap, although as the comments out Ethereum and Solana also have no max supply listed. I also checked out Terra (Luna) and it has no max supply listed at this time. It could be due to the deflationary aspects of burning as to why max supply is missing, which is that the total number of tokens will decrease over time at an unknown rate. In Solana’s case, it is potentially missing because the circulating supply has no cap. That’s my best guess.
The next 144 million tokens will be released until September of 2024, which will require $450 million or roughly $6 billion per year to keep the token afloat.
The presenter expects inflation of 23.5% over the next 12 months.

The one counterpoint I would provide is that Avalanche has the max supply of 720 million (last on record) yet Cardano has low inflation of 1% and max supply of 41 billion. Considering AVAX has a decreasing supply, all things equal, I would prefer the first scenario. This is not a comment about Cardano, it’s only a comment about inflation relative to max supply.

Avalanche has heavyweight backers, such as Andreessen Horowitz and Naval Ravikant. This comes at a cost with insider shares, yet potentially lowers risk if the crypto is attractive to those who are typically very successful in early-stage tech.

Conclusion:

Certainly, crypto is speculative and carries risk, yet we believe this risk will normalize in the near future. The information above discusses why we believe Avalanche has staying power from a product perspective and how it could potentially outpace competitors on decentralization, security and scalability. In our original write-up, we discussed how every blockchain must compromise within these three requirements, and therefore, investors should be looking for which Layer 1 has to compromise the least. There is no simple answer, yet we appreciate (and accept) the challenge in analyzing cryptocurrencies as we believe the rewards will far outweigh the effort this asset class requires.

Ethereum Network: Premium Analysis

Posted on March 25, 2021June 30, 2026 by io-fund

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Ethereum Network: Premium Analysis

We began covering cryptocurrency and the blockchain after a month of launching our premium site because we felt it was an important component to any tech portfolio. The debate around crypto/blockchain is distracting investors from the opportunity that the blockchain will deliver.

Below is a full-length analysis on Ethereum as the Ethereum Network is going through extensive iteration that will propel the platform to become the backbone for crypto payments and decentralized apps. If you like my Nvidia thesis on the CUDA platform for AI development or if you understand the Apple thesis over the past ten years which centers around developers supporting the iOS ecosystem (rather than only the iPhone) – then you should like Ethereum.

The blockchain is coming … and debates over Bitcoin can’t stop the blockchain from maturing. If you don’t like Bitcoin, then that’s okay. But it shouldn’t deter you from considering blockchain investments. Ethereum is another choice and Chainlink is one I’ve been particularly keen on. In fact, Chainlink was my choice for the inaugural LTBH one-hour webinar because I think there could be notable upside and I don’t want my subscribers to overlook the technology because it trades as a crypto.

In my opinion, Ethereum also has notable upside and we want the I/O Fund to have some allocation here. As many of you know, we lean heavily on Knox for entering, exiting, or trimming crypto as it’s especially volatile. We will not necessarily enter right away — and also be prepared for Knox to require more than one entry if the crypto market turns. However, it’s well worth the effort as its early days for the blockchain.

You could see us trim Bitcoin and add to Ethereum in an attempt to participate in the blockchain trend while having proper allocation as Bitcoin had neared 10% of our portfolio and it’s now at 7% through trimming. Ethereum also helps diversify us for decentralized applications and other tokens. Or, we could add more to LINKUSD.

You can read our previous analysis on Bitcoin here and on Chainlink here.

The analysis below describes what Ethereum is setting out to achieve and why some of the best blockchain investments are not likely to come from a traditional stock (they’ll come from crypto). In other words, if you want to participate in the early blockchain trend, then you’ll have to get comfortable with crypto.

History of Ethereum

In October of 2008, the markets came to the realization that the Lehman Brother’s bankruptcy was likely not an isolated incident. While the world was scrambling to discern the severity and extent of financial crisis, the stock market hit a new low that resembled a genuine panic. At the same time, a mysterious person or group of people, under the pseudonym of Satoshi Nakamoto quietly published a white paper. This report described a new monetary system that would rely on a decentralized network of computers to verify all peer-to-peer value exchanges through a digital token called bitcoin.

Largely unnoticed at the time, while the centralized banking system was in a full melt down, Bitcoin was suggesting a new monetary system that could make the centralized banking system largely obsolete. It wasn’t until January of 2009 that Bitcoin was released with an initial market price of $0.08/bitcoin. Still, it took just over 10 years, and over 15,800,000% appreciation before Bitcoin’s stated thesis gained public acceptance from institutional buyers.

Next to Bitcoin’s dominance, the undisputed runner-up is Ethereum, which is the second most valuable coin in terms of market cap, as well as public mindshare. Without a full understanding of why this is, most people would assume that Ethereum must have been launched soon after Bitcoin. This is not the case.

The second cryptocurrency to launch in April of 2011 is known as Namecoin. Nearly identical to bitcoin, including the same number of coins in existence, it’s stated goal was to improve anonymity for miners. Roughly six months later, Litecoin was launched and was able to take on the moniker of being known as silver to bitcoin’s gold. It also was similar to bitcoin, but offered double the number of coins, and allowed for quick mining transactions.

Most altcoins track a similar path – using the same, if not closely identical mathematics in an attempt to provide slight variation of bitcoin and compete as the dominant cryptocurrency of choice. We saw hundreds of these alt coins hit the markets prior to Ethereum’s launch in 2015, including Ripple, Monero, and Dash. Unlike the previous altcoins, what Ethereum offers is a network and platform for developers to expand the use of blockchain rather than to compete with Bitcoin as a cryptocurrency.

Ethereum Network 2.0

The primary difference between Ethereum and Bitcoin is that Ethereum is not trying to compete as a currency. The focus of Ethereum is on its network, not the coin. Butkin’s vision is to create an open network for decentralized applications (dapps[1]) and smart contracts based on the Turing complete programming language Solidity.

The main issue that Ethereum has had to overcome is the constraints in transactions per second (TPS) and how to overcome the high energy costs of mining that comes with decentralized security. The network simply couldn’t scale without the recent release of Ethereum 2.0.

To understand this further, we need to break down Proof of Work (PoW) and Proof of Stake (PoS). The previous method for decentralization was run through PoW, which is an algorithm that requires a miner and large amounts of computational power to create blocks and to confirm transactions. Due to the high costs in terms of both speed and energy, the Ethereum Network struggled to scale. Last November, Ethereum 2.0 was released and introduced PoS. Instead of a large consumption of energy, PoS requires a financial commitment of 32 ETH to become a validator. The network required 524.224 ETH or 16.384 validators by December 1st in order to start the new phase of Ethereum 2.0. As of mid-December, more than 1.1 million ETH had been staked from 33,000 validators. The most recent number is 1.6 million ETH.

The Ethereum that is staked in the new protocol receives interest with early yields up to 20%. The more Ethereum that is staked, the lower the interest. Interestingly, Ethereum has not built the algorithm that will allow you to unstake them, so this is a long-term bet on Ethereum for anyone that is staking their coins.

Shards are another critical improvement for network bandwidth and the low transactions per second (TPS) as Ethereum 2.0 (ETH2) allows for improved data processing. Nodes in the previous network must download a transaction, calculate it, archive it and read every transaction in Ethereum’s history, which is terribly inefficient. Shards create a subset of the network where nodes are dispersed for more efficient processing. The Beacon Chain ensures the nodes are synchronized and the validators are reporting the blocks of transactions.

The original Ethereum network will run in parallel with ETH2.

Phase 0 of Eth2 went live on December 1st and there are a total of four phases. Phase 0 included the launch of Proof of Stake Beacon Chain.

The most recent road map released by Ethereum does not show the subsequent phases. The shaded green shows the current progress in the link provided. Missing deadlines is an issue with Ethereum so perhaps the removal of these phases is to make it easier on the team/network.

The term Rollups refers to ZK Rollups, which allows for hundreds of transfers to be rolled into a single transaction. This will replace Plasma, the current option where only a single transfer is made per transaction. In this case, the smart contract will verify all of the transfers in the Rollups. The goal is to reduce computing and storage resources by reducing the amount of data held in a transaction.

In the ZK-Rollup scheme, a transactor and relayer are needed. The transactors create a transfer and broadcast it to the network. In this case, a shortened 3 or 4 byte indexed version of the address helps to reduce resource needs. The relayers collect hundreds of transfers and roll them up, essentially, to generate a hash that compares a snapshot of the blockchain before the transfers and a snapshot of the blockchain after the transfers. In most cases, the transfers will be recorded by a change in the wallet values. The hash that represents the wallet values or the delta to the blockchain is called SNARK proof. The changes to the hash are reported to the blockchain.

Relayers are established by staking a required bond, or token amount, in the smart contract. The result will be fewer transaction fees that are processed faster than the previous Plasma framework. In the ZK-Rollup framework, blocks are computed in a parallel computing model that lends itself to decentralization. There will be less data than the previous framework which increases throughput and scalability.

Zero-knowledge proof techniques use mathematical equations for authentication without requiring passwords or sensitive information. The words “Zero-knowledge” means that the verifier can prove the first party can be trusted without revealing sensitive information. This is done through probabilistic assessments where the validity has a high probability.

Zero-knowledge is essential to cryptocurrencies because a crypto transaction can be verified without revealing information about where the payment came from, where it was sent or how much currency was exchanged. Bitcoin does not use zero-knowledge as all of this information is revealed and recorded.

The Ethereum network has more security risks than the Bitcoin protocol. The initial setup of ZK-Rollups assumes a trusted state and relies on a small group of developers to establish this initial trusted state and one of the developers could manipulate the code. The initial setup is not a decentralized.

Quantum computing could crack ZK-Rollups if the correct hash is guessed by the computer. This is more likely than guessing an encrypted protocol.

Ethereum is becoming the blockchain of choice through the Enterprise Ethereum Alliance, which is a list of over 200 companies, including AMD, Banco Santander SA, FedEx, Intel, JP Morgan, Microsoft, and VMWare. These companies have agreed to build smart contracts on the Ethereum blockchain, further increasing the value of Ethereum. We think the number of endorsements as Ethereum 2.0 is built out.

Decentralized Finance (DeFi)

DeFi, or decentralized finance, began in a telegram chat between Ethereum developers in August of 2018. The term refers to the open ecosystem of financial applications built on the Ethereum blockchain. Peer-to-peer (P2P) is used interchangeably as the network is verified by peer computing systems rather than one centralized source.

The basic tenants of DeFi applications are:

1) No Custodian. In other words, there is no bank or custodian in-between transactions. Each individual controls access to their own crypto, transactions and data around their activity.

2) The network is Global. There are no borders, exchange rates, currency differentials, or waiting for global transfers. Everyone on the network, regardless of country, will be able to transact instantly with anyone else in the world with ease.

3) The network is open source. This allows developers to view the code of any and all applications on the Ethereum blockchain and for the ecosystem to evolve.

4) Decentralized network. The Ethereum blockchain is run off of thousands of “nodes.” These nodes are constantly computing the transactions within the blockchain from around the world, making it nearly impossible to hack as well as regulate.

There is $24 billion locked into DeFi projects as of 2020.

Decentralized applications (dapps)

We discussed the difference between centralized and decentralized in the Chainlink webinar and why decentralized results in a more secure protocol or transaction. Ethereum’s network is often called a platform or the “world’s computer” because it allows for decentralized applications. Rather than having backend code on a centralized server, backend code is run on a decentralized network when built for the Ethereum platform. Developers use the Ethereum blockchain for data storage and smart contracts for the app logic.

We also discussed smart contracts on the Chainlink webinar. Ethereum is primarily set up for currency right now while Chainlink addresses off chain data for non-currency smart contracts. However, the principal is the same where there is a set of rules which self-execute like a vending machine. Dapps will rely on smart contracts.

Dapps deployed on the Ethereum network are controlled by logic written into the smart contract and cannot be altered by the developer. Smart contracts function like APIs (we also talked about this in the Chainlink webinar). This allows applications to build on one another similar to the way applications use APIs today; except blockchain applications will build on smart contracts.

The front-end application can be written in any language with calls made to the backend. The main qualities are that the applications are decentralized, can perform any action given the required resources (whereas Bitcoin is not Turing complete) and are executed in a virtual environment such as the Ethereum Virtual Machine. The virtual machine acts as a buffer to where if the application is faulty, it does not affect the blockchain network.

There are a few key benefits to dapps:

• Dapps are more secure and inherently protected from denial-of-service attacks.

• Censorship will be nearly impossible as a single entity will not be able to block users from utilizing the blockchain.

• Fraud and other malice will be prevented as the data has complete integrity from the decentralized and cryptographic qualities of the blockchain.

• Because smart contracts are self-executing, they remove the need for a centralized institution. Realworld identities can also be anonymous with dapps.

There are also some drawbacks to dapps:

• Most developers do not want to relinquish complete control over their creation*.

• If there is a bug that need to be fixed, that developer is unable to take back control of the dapp once it’s launched onto the Blockchain*.

• Dapps will need Ethereum 2.0 to achieve its final phase as applications will create too much network congestion at the 10-15 transactions per second.

• User experience needs to evolve in order for users to interact with the blockchain in a secure fashion.

• Some developers may utilize centralized servers for the frontend or to store business logic which could eliminate many of the decentralized security/anonymity benefits of the blockchain.

There are some applications that are decentralized but not built on the blockchain, like BitTorrent for peer-topeer file sharing. Tor is open-source software that enables anonymous communication and is also decentralized.

Some of the early DeFi applications allowed for seamless swapping of coins for Ethereum and lending of collateralized loans with built in interest payments to the borrowers. Contracts can also be created between crypto and non-crypto assets like gold, silver, stock, currencies, etcetera. People are allowed to deposit what are known as “synths”, or synthetic coins that allows for the contract to be written and then exchanged. This allows individuals to trade assets on Ethereum without the intermediary of exchanges and broker/dealers.

There are even applications known as yield farms that allow investors to deposit their crypto into liquidity pools, which are loaned out, which allows them to receive yields on their crypto.

Conclusion:

The Ethereum Network is becoming the backbone for decentralized finance and decentralized applications. Ethereum 2.0 needs another year minimum or about three years maximum to reduce energy use and increase throughput for transactions per second (TPS). Once this is achieved, Ethereum will be able to process payments faster than Visa, Mastercard or Paypal combined– going from 15 transactions per second to 100,000 transactions per second. For reference, most major credit card companies process about 2,000 TPS with 5,000 TPS as the upper limit.

Cardano and Polkdot are competitors yet Ethereum is receiving global acceptance among developers and major endorsements from companies who are likely to be the first to develop dapps and embrace defi, as well. If Ethereum 2.0 delivers what it promises to, I believe ETH will become the backbone for the blockchain and this will be hard to disrupt.