The Evolution of Blockspace Economics - TOKEN2049 Singapore 2022

hi everyone my name is Leo I'm the founder of El Camino we're building a D5 protocol for decentralized Capital markets for Block space users and as well as producers uh and today my presentation is on the evolution of block space economics so you probably heard ridiculous claims made by VCS that the block space is the most interesting commodity to sell in the 21st century and it's a foundation of metaverse blah blah blah but block space is a very basic component of the blockchain we use it for every single unchain interactions and it's been there since the Genesis block so why all of a sudden it has become such an interesting topic and while sudden and what do we really mean when we talk about block space economics in this context so first and foremost uh the blog space itself is a marketplace right so there are producers the supplier of the block space are the miners and thinking about it there's the expense kind of resources whether it's electricity or Hardware depreciation or uh the opportunity cost of the the coins that it staked or for in some of the other staking validators cases for example Solana the hardware requirement is extremely high almost as expensive as running a Bitcoin mining operation so on the supply side they expand the resources and periodically pre out of and produce block space at a at a predetermined schedule and on the demand side when we talk about the user or block space uh we mean anyone who's initiating an unchain action and this could be your Mev Searcher a service company or exchange or anyone that's moving from one address to the other so the blogspace has pretty interesting market dynamics too so on the supply side for the miners and sticky validators this is a classic commodity production business this is the same as producing precious metal making coffee beans and so for them they have a relatively more predictable costs and this is more fixed month to month or basis that you know how exactly how much you're paying for electricity for labor costs how much you acquire those Stakes for initially and how much you have to pay to make to maintain the hardware however the income the revenue component of the stake invaliders as well as miners that is utterly unpredictable all right because you're exposed to the price of the coin over the period of time you're exposed to difficulty or a validation share in for the state's case and in ethereum a large component of your income comes from the fee which is highly highly volatile so these three factors uh the the coin price the difficulty slash validation share as well as fees there are cross-correlated but with a lack what that means is that you can't just simply create write a linear projection to collapse the other factors into one so if you want to hedge by just shorting the perf you can't really create establish a full Hedge so as a result the expenses for the black space producers is predictable but the revenue is not so for uh Bitcoin mining specifically the game has become incredibly incredibly competitive and you it takes you know at least 30 40 USD a million US dollar to start even a small mining operations so in the last bull market we saw a lot of mining companies they put on a lot of Leverage they over purchase the machines and uh and there are a lot of spec deals a lot of companies going public but in when the market changed very quickly they they are unable to service their loans a lot of consolidation happening in this business so for staking the uh the problem is less severe because uh their business model is less uh required with leverage and require less upfront payments but still block space production is an extremely cyclic business and now on the demand side the Hallmark of the the key characteristics of the demand side of block space is the time value so what do we mean by the time value of block space so a block space that you can secure right now is far more available than the block space that you may secure in the future and this is because any transactions on the blockchain you don't actually know the final execution price until this transaction gets included a block and appended to the blockchain and you know any any time between your transaction can get front run can get sandwiched or simply fail as the the gas becomes more expensive so and the reason that anyone needs to pay this a fee to get your transactions included and be able to interact with the block space you know permissionless matter is that all transactions no matter how complex or simple they consume certain resources and these resources can be computation can be storage can be bandwidth and so right now all these different ways of consuming resources our meter by one single metric which is gas so there are some Explorations on okay perhaps making different transactions uh use uh the different resources uh differently um but this uh so this is under the scope of uh multi-dimensional eip1559 it's probably not going to happen until I don't know five years later with um anyways that's that's that's a different topic but anyways so gas uh is is often bounded due to the block size uh this way that um otherwise it's impossible to run a full note so and because the block size limitation block space itself is a scarce resource so uh for Bitcoin it's produced once every 10 minutes for ethereum 12 seconds and so this makes it the closest thing to a digital to a crypto native digital real estate right anyone who wants to produce any kind of economic activity on the blockchain need to purchase a share of this land so due to this imbalance of the supply and demand uh which and again the supplies is finite it's capped at 12 seconds per block and whereas the demand it can scale to Infinity so we can observe some very interesting patterns on the Block space particularly how people use the block space so we can study the uh some of the behavior patterns on block space through the lens of uh Financial microstructure um so first of all the most common usage of box base are the exchanges this which shouldn't be any surprise to anybody but however because the first price auction nature even after switch from first price auction to eip1559 we still see gas as the single metric the single expression of the collective urgency of using the block space itself so for example the chart on the on the on the right so this is during the time of the Yuga Labs other Deeds mint so as you can see uh the the the gas price increased significantly almost instantaneously but it took about a thousand blocks after the mint happened for the gas price to revert to normal and so that that was about three to four hours so Yoga Lab was extremely sorry and they had to subsidize users uh gas expenditure uh for and they paid you know like 150 or 180 million from their treasury so this is extremely unpleasant for both the project team as well as for users or for people who don't even care about nft and just using the blockchain regularly so another huge factor that contributed to these interesting Dynamics on block space especially recently is the rise of Mev activities so um I so Mev activities inherently it's it's just not solvable it's no matter what kind of uh fences that we're putting there or remove it from one place to another uh it's just inherently bounded it's in currently I'm sorry unbounded due to the complexity of the layer once um so we fully expect that the most of the block space activities to be filled by Mev activities um and going forward and this phenomena is only going to get worse or better it depends on uh what exactly you do from here so if we look at Mev activities on a day-to-day basis it's extremely volatile and you can't really predict uh what any kind of like trends of of Mev income that mostly because there are a lot of factors exhaustion is to uh to the layer one itself that are influencing the profitability of Mev uh uh income so as a result the daily gas is extremely volatile as well this is particularly awful after uh the merge and it has nothing to do with the consensus mechanism itself it's just because the lower issuance rate uh so a higher percentage of the income for Block space producers is going to come from Mev activities so and as a result there's any influence any fluctuation of Mev uh activities is going to make the gas costs much more volatile so zooming in there are actually a lot of very interesting things that we can observe on the gas behaviors so first of all gas even though it's a single meter that measures all the resources but we can actually break it into different priority uh percent of of priorities and they're they don't often Behavior behave in a in a predictable way so for example this is during the time of the notorious UST meltdown um uh this is during the time of notorious USD meltdown so at that time there were a lot of uh Mev opportunities tons of liquidation and everyone's just trying to get out their positions so the 95 um percentile priority gas cost this was by far the most volatile uh uh piece of the of the gas cost and but this is not always the case usually when the when the the blockchain is more quiet uh we can see that this volatility started to Trend more into the middle and sometimes even to the lower priority uh uh percentile so anyways there's just tons of very interesting observations that we can make given the nature of um how this Market works so um it's it's pretty it's pretty obvious that the hedging needs of the block space producers and the block space users are are the opposite so for the block space producers and again these are minors and staking validators they have fixed costs but their revenue is a floating risk and for Block space users they want to pay a predictable or somewhat predictable uh gas and in order to exchange for uh to recycle the actual gas that is spent on chain so for companies like you know Circle or and nft means they're able to cancel out the floating part so here at alchemia when we think about okay what is the financial primitive to tie the hedging needs of the block space producers and block space users together the we think that the basic construction should be flow to fix swaps so for the block space reducers they can sell their floating risks to exchange for something that's fixed so for miners they can lock in their their production income uh at the beginning of every month for staking validators they can get rid of the more volatile components and for user or block space a frequent user or block space they can pay a fixed amount to better manage their gas expenditures if they know you know roughly how many transactions they're going to process over the course of you know X number of blocks so there are several interesting use cases so right now during a in a bear Market uh gas is sort of not a sort of afterthought but this is definitely not going to last very long especially as more interactions that have to start to pick up so for frequent user of the Box space they can use these type of instruments to manage their gas expenditure so if we think that more and more commercial activities are going to move on chain it doesn't matter if it's uh app specific Roll-Ups or on the layer one directly gas expert sorry cosmash is going to be a more and more important part for these companies treasury management and for this also they are a very interesting uh sort of like natural eel that occur that represents the the the economic activities accrued on the blockchain space itself right so uh you know looking across the D5 Universe uh in the past cycle um the most of activities are filled by uh cheap leverage lending activities and this is pretty much gone now especially as the the 10-year just hit four percent token inflation this party is gone now uh liquidity provisioning is getting less and less interesting as the token price uh is dropping so um in order to okay look to to build something that's sort of akin to okay what is the sort of natural yield of the sort of the closest thing to a risk-free rate that is native to the blockchain okay then uh lending your state to the protocol and gets that uh subsidy as well as the fees is the closest thing that we can uh we can source that natural yield so if we think that um more digital activities are going to be built on blockchain more commercial activities are going to happen on block space than the continuous and steady production of the block space as well as the steady uh predictable usage of the block space is incredibly important so and for similar to you know classic commodity production business most of these activities are are supported by large volumes of Futures and options and similarly we can expect that this commodity the the digital native commodity which is block space is production as well as consumption will be supported by its own version of fusions options and derivative of the market uh that's native to its uh its functionality so uh yeah and uh this is it uh so there are actually a lot of very interesting insights from how people use gas and sort of different behavior of gas and this is a too short of a presentation but uh we published a lot of research and if you're interested in this kind of stuff for some reason uh definitely check out the website thank you