the gang structures blockspace derivatives
Is there anything on this planet we don’t speculate on?
The gang structures blockspace derivatives
Blockspace. Who hasn’t heard of it? Me, actually, up until a few weeks ago. Anyway, since I am now enlightened (not really), I’ll pay it forward through this article.
Let’s talk about the increasing demand for blockspace, what it actually is, blockspace derivatives, and how to speculate on gas fee markets through platforms like Hedgehog Protocol (soon™).
A special thanks to Esko, co-founder of Hedgehog Protocol, for his contribution to this article. Hedgehog Protocol allows you to hedge and speculate on Ethereum & Bitcoin gas prices, and will offer on-chain native derivatives in the future.
Blockspace 101 - what are we talking about?
Think about your favorite blockchains like Bitcoin and Ethereum. The core business model of these blockchains is selling blockspace. Let’s expand on that:
When you perform a transaction on Uniswap, and you include a certain amount of gas, all you’re doing is indicating that you are willing to buy a certain amount of blockspace.
Meaning; that you want your transaction to be processed and subsequently included into the latest block, and that you are willing to pay a certain fee for it.
Each block within these networks can only carry a limited amount of user activity. When user activity grows, the demand for blockspace grows.
Because each block has a limited capacity, users are willing to pay fees to include their transactions into a certain block. The more active users, the higher the fees. Think of it like a bus on a busy road:
> Bus comes
> There is a large queue of people who want to get on the bus
> Once the bus arrive, everyone starts placing competing bids in order to get their spot on the bus
> The highest bidders win and get to ride this bus
> The lowest bidders will have to wait for the next bus
In the case of Bitcoin, the next bus comes in around 10 minutes.
The growing demand for blockspace and the impact on gas prices
So, to recap, blockspace refers to the finite amount of user transactions, data, and computation that can be contained within a single block.
Combine finite supply with large demand, and you get yourself a bidding war.
That’s what happens during really popular NFT mints. All the gamblers want to be first in line to buy this silly picture of an animal before they are all sold out. During times like these, there is a huge demand for blockspace.
This results in what we call gas wars: a bunch of users bidding increasingly higher amounts in gas to get their transaction included in the current block.
I do sympathize with those who complain about high gas fees on Ethereum. Any DeFi user knows the feeling of funds being “stuck” somewhere, simply because it’s not worth the gas that it would cost to retrieve them. Not fun.
Or the feeling of having to pay 400$ in gas for an NFT mint. Yes, I’ve been there. And no, it was not worth it.
But as we attract a growing amount of active users, the demand for blockspace continues to rise. This presents a perfect segway to the following chapter: ‘high gas prices: a feature or a bug?’
High gas prices: a feature or a bug?
Nic Carter – partner at Castle Island Ventures – explains:
“What was once an idle supposition is now concrete. Public blockchains are destined to privilege the largest, most fee-tolerant transactions, at the expense of non-financial uses.”
Nic Carter draws the conclusion that due to Ethereum’s gas fee mechanisms, it has to pick between being a world computer or a financial network. Though you can make an argument for either of them.
Limited capacity block size combined with transaction fees acts as an anti-spam mechanism and provides a long-term incentive for miners to continue securing the network. Even when a max supply has been hit, miners will earn transaction fees.
On the contrary, a blockchain with unlimited blockspace would have to rely on an infinite token supply in order to keep incentivizing miners to secure the network. Why? Because in that situation, fees are extremely low (near-zero).
This means there has to be another way to incentivize the minders, Or, the foundation reverts to securing the network themselves. Neither infinite supplies nor permissioned validators are acceptable, or even desirable.
gas fee as an anti-junk mechanism
The anti-spam mechanisms of Bitcoin and Ethereum (limited blockspace and gas fees) prevent them from being stuffed with “junk data”. Low-fee environments lead to bloat and irrelevance, as Nic describes.
Blockchains that get filled with junk data, will have difficulties to deal with in the longer term.
At some point, it becomes practically impossible to run nodes. Or node operators will be forced to discard data, which kinda goes against the whole ‘immutable ledger’ thesis.
While finite blockspace inevitably leads to higher fees, it protects the network from arbitrary, non-transactional data on-chain.
“ETH killers” who boast about low fees introduce long-term risks that will have to be dealth with at some point.
Layer 2 networks are the main scaling solution for blockspace scarcity, rising gas, and network congestion.
Layer 2 networks compute transactions off-chain and subsequently post their new states to the layer 1 chain. The adoption of L2s takes some of the traffic away from Ethereum.
It’s clear these will play a tremendous role in the long-term scaling of the Ethereum network, and its growing demand for finite blockspace.
Structuring blockspace derivatives
What if I told you there is a way to speculate on blockspace through blockspace derivatives?
On this topic, I really enjoyed the article by Drew Van der Werff and Alex Matthews which provided a holistic overview of commodities like oil and other commodity markets, and how we can apply the logic from those markets to structure blockspace derivatives. Designing blockspace derivatives is definitely not an easy task.
I don’t have much to add that hasn’t been described in the article by Drew and Alex, it was a great read.
Speculating on gas fees: introducing gas markets
Gas fees have been a real pain for many of us. Who hasn’t been rekt before by high fees when trying to make a move?
Imagine putting 2 clips in a shitcoin, and starting with a 10% loss due to gas fees. And when the time for selling comes, you’ll have to pay it again.
Now imagine if we could speculate or even hedge on these fees, much like how investors speculate on commodities in traditional markets.
How interesting does that sound? Enter the concept of gas markets.
EIP-1559 was an update to Ethereum that fundamentally changed the way gas fees work. Which gave Ethereum the possibility of becoming a deflationary powerhouse.
Now, with each user transaction on the network, a small chunk of the gas fees are burned. Meaning; that with each transaction, the amount of available ETH decreases. If the burns outpace block rewards, you get yourself a deflationary supply.
Since its implementation, over 300,000 (!) ETH has been burned.
This has shaken things up in the gas market, making it more interesting for those looking to make some money off it. And we all like making money, don’t we?
Gas Markets: A New Frontier
The concept of gas markets centers around speculating on the future prices of gas fees.
Just as traders speculate on the prices of oil or gold, they can now speculate on the price of blockspace — introducing a new layer of complexity and opportunity.
Platforms like Hedgehog Protocol are making moves within this space, aiming to provide tools for users to engage in gas market speculation.
Beyond the speculations around Ethereum gas fees, they’re branching out, offering hedging solutions for institutional players like Layer 2 rollups, paymasters, and companies keen on sponsoring the gas fees of their users.
The Bigger Picture
The Ethereum network heavily centers around the concept of gas fees. These fees, which are essential for transactions and running smart contracts, have evolved into a market of their own.
With constant changes in demand, network activity, and token values, gas prices can fluctuate significantly. This volatility has led to challenges for both everyday users and larger platforms trying to predict and manage their operational costs. As a result, solutions that offer ways to hedge against these price shifts or even speculate on them will become crucial.
This broader perspective on gas markets helps us see how managing gas fees effectively is key to the continued growth and stability of Ethereum and the adoption of blockchain.
The focus that leading figures like the Ethereum Foundation and Vitalik Buterin place on improving the user experience by addressing gas fees highlights the scale and importance of this quest.
I hope you enjoyed this article! Are you just as interested in this topic as I am? Come talk about it in our group: t.me/rarestonecompass
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