Ethereum, the second-largest cryptocurrency by market capitalization, has long been regarded as the backbone of decentralized applications (dApps), smart contracts, and the burgeoning DeFi space. While Bitcoin continues to be seen as a safe haven for long-term investors, Ethereum offers a more dynamic ecosystem, powering everything from financial services to NFTs. However, despite its broad utility and innovation, Ethereum has recently faced a steep decline in value, with its price dropping by over 31% since the launch of the ETH-ETF in July 2024. This unexpected downturn has left many investors and enthusiasts wondering: what’s driving Ethereum’s fall?

In this article, we explore the key factors contributing to Ethereum’s recent struggles, from network upgrades and inflation concerns to shifts in market dynamics and DeFi liquidations.

Key Reasons for Ethereum’s Going Down:

Network Upgrade Impact

In March 2024, Ethereum introduced a major network upgrade known as Dencun, which was designed to improve the scalability and efficiency of the network. One of its core features was to reduce transaction costs by optimizing data handling and creating a new type of transaction that efficiently processes large binary data sets. This upgrade primarily benefited Layer 2 (L2) solutions like Optimism, Arbitrum, and zkSync by significantly lowering their transaction costs.

However, this improvement in user experience came at a price. While lower fees made transactions more affordable, they also severely reduced the income for validators and network operators, as a large portion of Ethereum’s revenue traditionally comes from transaction fees. As fees decreased, so did the financial rewards for securing the network. This led to a massive drop in Ethereum's daily revenues— from a peak of $30 million per day in March 2024 to just around $400,000 by August and September 2024.

Although the upgrade achieved its technical goals of scalability, it inadvertently undermined Ethereum's financial structure, reducing the incentives for network participants. This sudden drop in revenue sparked concerns about Ethereum's long-term sustainability and market value, as lower earnings diminished the economic appeal of participating in the network.

Inflation

One of the key attractions of Ethereum is its deflationary potential. Since the London upgrade in 2021, Ethereum has implemented a mechanism that burns a portion of ETH during each transaction, which theoretically helps reduce the overall supply of ETH and creates deflationary pressure during periods of high network activity. This mechanism was supposed to keep Ethereum's supply in check, balancing out new issuance from staking rewards.

However, the Dencun upgrade has led to a reversal of this deflationary trend. As transaction fees dropped, less ETH was being burned, and inflation began to rise. For the first time since Ethereum’s shift to Proof of Stake (PoS) with the Merge in 2022, the supply of ETH has been increasing. As of September 2024, Ethereum’s inflation rate has climbed to approximately 0.7% per year, meaning around 69,000 new ETH (~$162 million) were added to the market in just the last 30 days.

This rise in inflation is putting downward pressure on the value of ETH. In contrast to Bitcoin’s fixed supply cap, Ethereum’s expanding supply creates concerns about its long-term value, especially as it floods the market with new tokens that outpace the demand created by DeFi and staking.

Staking

Despite Ethereum’s price decline, staking within the network remains robust. Staking is a process where ETH holders lock up their tokens to help secure the network and earn rewards in return. Since the launch of Ethereum’s staking mechanism, the total number of validators and the amount of staked ETH have both seen steady growth.

By September 2024, over 34 million ETH had been staked, with more than 1.07 million validators securing the network. What's significant is that most of these stakers entered at prices below $2,300 per ETH, meaning they are still in profit or haven’t yet felt severe losses. This has kept the staking ecosystem resilient, as many participants have not yet reached their pain threshold, even as the price dips below $1,600.

However, there are concerns that if Ethereum's price continues to fall, more stakers could begin to exit, leading to potential sell-offs. For now, though, staking remains one of the stabilizing factors for Ethereum, providing a buffer against the worst effects of the price decline.

Market Shifts and Macroeconomic Trends: Ethereum's Shrinking Dominance

Another factor affecting Ethereum's price is its declining market dominance. In recent years, Ethereum's share of the total cryptocurrency market has been shrinking, particularly as other projects gain ground. From June 2023 to September 2024, Ethereum’s dominance fell from 20% to 14.6%, while Bitcoin’s share increased from 48% to 56%. Additionally, alternative platforms like Solana have grown rapidly, with Solana’s market share rising from 0.6% to 3% during the same period.

This decline in dominance signals that Ethereum is facing increased competition, not only from newer platforms but also from Bitcoin, which has solidified its reputation as the preferred store of value in times of market uncertainty. Additionally, the broader crypto market has become more closely correlated with traditional financial markets like the S&P 500 and Nasdaq. As a result, Ethereum is now seen as a riskier asset, more susceptible to fluctuations based on global economic trends and U.S. monetary policy shifts.

The correlation with traditional financial indices means that Ethereum, like other cryptocurrencies, is now more vulnerable to macroeconomic forces, including interest rate hikes by the U.S. Federal Reserve and investor sentiment in global markets.

DeFi Liquidations and the Long Squeeze: A Dangerous Feedback Loop

One of the most immediate triggers of Ethereum’s price decline has been a series of DeFi liquidations. Ethereum is the most widely used collateral in decentralized finance applications, making it particularly vulnerable when market conditions turn sour. In August 2024, the DeFi market saw a wave of liquidations, with over $436 million in collateral liquidated, the highest level since May 2021.

This cascade of liquidations was driven by falling ETH prices, which forced DeFi platforms to liquidate collateral in order to cover loans and margin calls. The most significant wave of liquidations occurred on August 5, 2024, when Ethereum and other cryptocurrencies lost significant value in a single day. This set off a long squeeze, where the forced selling of ETH led to even more downward pressure on its price, further triggering additional liquidations.

This type of market action is particularly dangerous because it creates a feedback loop: as ETH prices fall, more collateral gets liquidated, which in turn leads to more sell pressure, driving the price down even further. This cycle has been a key factor in why Ethereum’s price dropped so sharply compared to other top cryptocurrencies.

Conclusion:

While Ethereum’s recent struggles may seem alarming, they are largely the result of market dynamics and speculative behavior, rather than a fundamental flaw in the network itself. As Ethereum continues to evolve and adapt, the long-term outlook remains promising, but for now, investors must navigate through the turbulence and uncertainty surrounding the market.