Ethereum is plagued with issues, resulting in a new generation of Layer-1s emerging to fight for the crown. Using data such as Total Value Locked (TVL), development activity and on-chain metrics, we can determine which L1s are still undervalued versus the rest of the market! Here’s why the L1 narrative is so important, and how you can take advantage.
- Ethereum’s failures have led to a new breed of “Eth killers” which are rapidly gaining pace.
- These tools can help you identify the most undervalued L1s.
- Portfolio allocation is key when it comes to L1s. Spread your bets across your highest-conviction L1s plays, and explore their ecosystems.
The problem (and the solution)
Layer-1s are the essential infrastructure of crypto which supports applications, protocols and networks. L1s are the backbone of crypto, and thus, have seen some of the strongest returns in crypto. In the past 12 months, Fantom is up 1,172%, Solana 765%, Terra 735%, Avalanche 155%, etc.
Ethereum, although dominant in terms of transactions and volume, has been plagued by scalability issues which have severely limited its ability to grow. This is because the Ethereum blockchain uses a proof-of-work consensus mechanism (POW) instead of proof-of-stake (POS). Transactions on the Ethereum network can cost hundreds of dollars, and this has led to most retail users abandoning the chain as it is simply unaffordable for the average participant.
We can see this reflected in the TVL data, with a large percentage of liquidity flowing into other L1s with cheaper gas fees and higher APRs.
Even with ETH 2.0 on the horizon, the growth of the crypto space has evidenced that there is a massive need for Layer-1 power. Thus, identifying the top future Layer-1 ecosystems today can set you up for massive returns over the next few years.
How to identify the most undervalued Layer-1s
In order to identify which L1s are undervalued, there are multiple key metrics to consider:
Total Value Locked: As DeFi is a key use case of L1s and a massive narrative in crypto, it is crucial to consider the growth of a chain’s DeFi ecosystem. The best way to measure this is through TVL on DeFi Llama.
For example, we can see that Elrond (EGLD) and Fantom (FTM) have been some of the strongest performers over the last month, with Terra (LUNA) leading the pack for the week. Monitoring changes in TVL daily gives us insight into which chains are gaining traction.
Fully Diluted Valuation: The FDV indicates the marketcap of a project if all future emissions and unlocks are factored in. Marketcaps can be misleading as they only consider the current token supply.
For example, an L1 like FTM already has 80% of its tokens circulating at a $6 billion FDV, whereas AVAX still has 70% of emissions yet to come (FDV: 68 billion). This puts AVAX at a 10x premium to FTM by FDV. As layer 1s are still relatively speculative (you’re betting on the tech leading to future adoption), it makes sense to compare L1s to other L1s to justify valuations.
On-Chain Metrics (scanning sites): Blockchain explorer websites, such as Etherscan (ETH), FtmScan (FTM) and SnowTrace (AVAX), can help us quantify a Layer-1s growth, by providing on-chain metrics on transactions, wallet addresses, etc.
By using this data, we can see which Layer-1s are gaining traction ahead of the curve. Price often lags behind key indicators, so having your finger on the pulse in regards to regularly reviewing this data gives you a huge advantage.
For example, we can see AVAX exhibiting strong and steady growth in daily transactions which indicates that the chain is gaining traction. Real user growth will always underpin price growth.
How to structure your portfolio to maximum gains
Crypto Banter recommends choosing between 5 and 10 Layer-1s which you have a strong belief in, and size your positions accordingly. It’s better to have high conviction in a few Layer-1s rather than owning too many. However, diversification is still key to ensure you don’t expose yourself to excessive risk. Some of the Layer-1s with huge scope for growth are: FTM, LUNA, AVAX, SOL, MOVR, NEAR, ATOM etc. FTM could be the best risk-reward play on this list given its relatively low marketcap vs user and development growth.
Then, once you’ve identified your favorite Layer-1s, you can start diversifying into their ecosystems. For example, if you own FTM, it makes sense to own tokens like BOO, LQDR, and BEETS, as they are the projects which underpin its DeFi ecosystem. Otherwise, for AVAX, you might want to consider JOE, MELT, and PTP. Ecosystem projects are riskier due to their smaller marketcaps (more scope for growth but more potential downside too). Your allocation will depend on your risk tolerance. A 60/40 split between a Layer-1 and its ecosystem is a respectable allocation, but this can be tweaked either way depending on your goals.
The insatiable demand for Layer-1s is why we’ve seen genuine Ethereum competitors emerging in the past 12 months. By using the research methods outlined in this article, you can identify undervalued Layer-1s ahead of the pack, and invest in their ecosystems to generate outsized returns in this market.