Ethereum’s Decline: Dissecting the Causes and Prospects for Recovery in 2025

As the first quarter of 2025 wraps up, the crypto market has taken a hit, with Bitcoin and Ethereum posting grim returns. Ethereum, in particular, suffered a significant slump, recording a price drawdown of over 45%. This downturn, which has been ongoing since the Dencun upgrade in March 2024, seems driven by the rise of Layer 2 protocols which have been accumulating large transaction volumes and passing only a fraction of the revenue to the ETH chain.

Ethereum, originally envisioned as the world’s decentralized computer, has seen a shift in its role to a more security-focused infrastructure and the underlying blockchain for Layer 2 protocols. This scaling of the crypto ecosystem has been at the expense of Ethereum’s value. The largest altcoin has thus raised questions among traders and investors about its future relevance and value accrual.

A significant catalyst for Ethereum’s price decline has been its Layer-2 centric scaling model. The Dencun upgrade, which reduced transaction costs for Layer 2 chains, has altered the ecosystem dynamics of Ethereum. This upgrade has made it cheaper for Layer 2 and Layer 3 projects to use Ethereum as a base chain. As a result, these projects have amassed large profits with only a fraction paid to Ethereum. For instance, Base by Coinbase has generated a profit of $94 million while only paying $4.9 million to Ethereum.

This disparity has sparked debate about whether Layer 2s are leeching value from Ethereum or fostering a symbiotic relationship where they derive security and pass on revenue to the ETH blockchain.

The Dencun upgrade, while beneficial to Layer 2 settlements, has inadvertently led to a decline in Ethereum’s transaction revenue and value. Ethereum’s goal of becoming “deflationary” has been undermined by the lower volume of fees collected by the network. Despite not being deflationary, Ethereum’s supply is projected to grow less than a percent a year, according to the Ultrasound Money tracker.

Ethereum’s value proposition has come under scrutiny in light of its shifting business model. The upcoming Pectra upgrade, however, could potentially restore Ethereum’s value if it can stimulate demand.

The manner in which Ethereum is valued has also changed. Previously, metrics such as the total value of assets locked on the chain and the transaction volume were used to determine ETH price. Now, Ethereum’s value is increasingly tied to the fees it generates, the token burn, and the net revenue generated.

The decline in fees and the migration of value and transactions to Layer 2s have led to a steep drop in Ethereum’s transaction count. Furthermore, institutional interest in Ether has waned, likely due to the pivot in Ethereum’s business model. The Ethereum Foundation’s consistent selling of ETH over the past few months has also raised concerns among traders.

The Pectra upgrade, which is expected to impact validators and stakers in the Ethereum ecosystem positively, could potentially drive higher value to Ethereum. This upgrade introduces Ethereum Improvement Protocols that streamline validator management, reduce congestion on the chain, improve validator deposit efficiency, and give more control to stakers over the exit of validators.

Experts have weighed in on the situation. Marko Ratkovic, CTO of Graphite Network, believes that the Pectra upgrade is a significant advancement for Ethereum, particularly in growing the user base of the L2 network. Dr. Sean Dawson, Head of Research at Derive.xyz, warns of continued volatility in the market and advises traders and investors to brace for uncertainty in the coming weeks.

As Ethereum navigates these turbulent waters, the Pectra upgrade could offer a beacon of hope in restoring its value. However, only time will tell how the altcoin will fare in the face of evolving market dynamics and escalating competition.