According to the latest Pantera Capital Blockchain Letter, the crypto market may finally turn a corner after a brutal bear market in 2022, and leading Ethereum layer 2 solution Arbitrum is emerging as one of the biggest beneficiaries.
As Pantera’s letter illustrates,
“Arbitrum is a massive share taker within the Ethereum ecosystem, and Ethereum, in turn, has itself been a massive share taker across all of crypto.”
Furthering this point, Pantera reports that Arbitrum has single-handedly fueled 100% of the incremental growth in Ethereum’s transaction volume this year, even as other layer 2 solutions and competitors stayed largely stagnant.
Pantera’s fundamentals-based investing.
Principally focusing on fundamentals-based investing, Pantera acknowledges the significant bottlenecks Ethereum has grappled with due to its scalability constraints. Reflecting on Ethereum’s predicament, the letter indicates that layer 2 solutions like Arbitrum are surfacing as preferred solutions, promising faster and cheaper transactions while retaining Ethereum’s robust security measures and wide-ranging application support.
Drawing from Pantera’s analysis, Arbitrum’s critical edge lies in its capacity to process transactions that are 40x faster and 20x cheaper than the base Ethereum layer. This superiority has propelled Arbitrum to considerable growth, both in absolute terms and in contrast to its peers, making it one of the fastest-expanding layer 2 solutions on Ethereum and enabling it to seize a substantial proportion of Ethereum’s transaction market share over the past year.
Pantera notes that Arbitrum has consistently grown in transaction volume despite a bearish trend across the crypto market this year. Citing available data, Pantera’s letter reveals that Arbitrum has been instrumental in the Ethereum ecosystem’s growth this year, contributing to 100% of its incremental growth.
Arbitrum growth and expanding user base.
The letter further explores the driving factors behind Arbitrum’s growth, spotlighting its expanding user base and the subsequent rise in developers keen to build new applications on its platform. This virtuous upward spiral, as Pantera notes, is critical to Arbitrum’s continued evolution. However, the firm underscores that the pivotal concern for fundamental value investors resides in the potential revenue from this increasing activity.
Amplifying its distinctiveness in the market, Arbitrum stands out as a profitable protocol in Pantera Capital’s analysis. The platform generates revenue by amassing transaction fees on its network, assembling these transactions into larger bundles, and consigning them to the Ethereum base layer. This mechanism implies a gross profit of about 10 cents per transaction for Arbitrum.
With a product that has found a market fit and a viable unit economics model, Pantera Capital deems Arbitrum’s valuation as defensible. Per Pantera’s letter, the protocol has consistently grown quarter-over-quarter since its launch, with transactions nearing 90 million per quarter and revenue hitting $23 million in Q2. The gross profit for the same period approached nearly $5 million, equivalent to an annualized $20 million.
The letter illustrates that Arbitrum, with about 2.5 million monthly average users and roughly 350 million transactions yearly, is nearly a $100 million annual revenue business, generating around $50 million of standardized gross profit.
Arbitrum market capitalization.
Regarding market capitalization, Arbitrum currently boasts a $5 billion figure on an issued shares basis. This represents an appealing prospect to Pantera, particularly when compared to similar market capitalizations of other layer 1 and layer 2 protocols, given Arbitrum’s superior usage, revenue, and profit statistics.
From a growth and valuation perspective, the letter suggests Arbitrum could potentially scale to a transaction run rate of over 1 billion at 10 cents profit per transaction over the next year. This projection implies about a hundred million in earnings and, at a $5 billion market capitalization, infers a valuation of roughly 50 times forward earnings. Despite appearing expensive on an absolute basis, Pantera considers this valuation reasonable for an asset still growing in the triple digits.
Pantera Capital’s Blockchain Letter presents Arbitrum as a rapidly evolving protocol that has found a product-market fit, demonstrates profitability, and trades at a reasonable valuation relative to its growth, other crypto assets, and traditional financial assets.
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