I would enter based on grade if that's what the contest administrators want you to do, or if it's clear from the rules that's the intent. I wouldn't worry about "fair" In any direction - from what I know of our local competitions, most of the kids who participate in them are kids who are very competitive and highly capable academically - my guess is your child won't be the only first grader (by age) studying 3rd grade math and beyond who participates in the competition.
Please note though - this is only my perspective based on what I know of other students' families... my own kids are highly non-competitive and completely non-interested in this kind of thing, so they haven't participated in any academic competitions.
Best wishes,
polarbear
