The blockspace market is the foundational plumbing of the decentralized architecture but it also turns out to be the biggest bottleneck in the path to sustainable growth.
The Web3 ecosystem will grow if adoption increases, adoption is a function of better user experience and UX is presently constrained by outrageous gas fee. The inefficiencies that plague the gas market originate at the blockspace level. Solving for blockspace will propel the ecosystem to it’s next run up.
The medium and long term solutions to the blockspace problem are—
fostering a derivative market for blockspace allowing speculators to absorb the volatility of gas fee
Scaling solutions (rollups/subsidiary chains and likes)
innovations in the IC/GPU markets- decentralized IoT
Notwithstanding the importance of a multi/cross/inter chain future, better/smoother UX, interoperability and composability, it is crucial to not lose sight of the base level architecture that enables a decentralized ecosystem- the miners, the incentives that drive them and the computing infrastructure that supports all of it.
Among the different variables that influence the ecosystem’s growth- blockspace turns out to be the biggest bottleneck. Often overlooked in the debates around better onboarding, security, price led growth flywheels etc, blockspace should become the first point of discussion for anyone serious about the long term prospects of Web3.
What is blockspace and how does the blockspace market work?
Blockspace can be considered the space a user’s transaction gets in a new block (group of transactions) that gets added to the distributed ledger.
💡 Apple sells iphones, facebook (meta) sells attention, what do blockchains sell?
BLOCKSPACE
It is blockspace that ensures that incentives are aligned across the board to promote decentralization. Miners run independent nodes to validate transactions and keep the system running 24*7.
💡 Bandwidth : Web2 : : Blockspace : Web3
Blockspace is to Web3 what bandwidth was to Web2. As bandwidth expanded, the adoption of web and mobile apps exploded, the same can be expected in case of Web3.
Put simply, whenever a user wants to interact with the chain, or a new transaction or activity has to be recorded on the ledger, the user deals with the blockspace market.
Think of it as a train that runs b/w station A and B, you want to travel on the train but there are limited seats, so you are added to a waitlist by the train operator (this waitlist is a ‘mempool’). See the diagram below to visualize the steps.
Now the remaining seats on the train are allocated to the person who can pay the highest fee to shift from the waitlist to actually sitting on the train.
This can also be considered a queuing problem- like planes waiting to land on a runway or trains queued to enter the station. In case of trains, it might be a nationalized system in some countries (ex: India), so it’s a public good, but your local McD is not a public service. You need to wait in line. Now imagine if someone was willing to pay more for jumping the queue to the burger and McD would service them before others. That is how transactions on the blockchain networks work.
Let supply of blockspace be Sᵦ ,
then, Sᵦ= *f(*machine type, location, temperature, maintenance, mining strategies, energy prices)
The variables listed are not exhaustive but cover the ones that affect blockspace supply the most.
“supply of hardware and the cost it takes to set up the infra determines the real extent of decentralization ”
The supply of hardware can be traced back to companies such as AMD and NVIDIA (hence, graphic card manufacturers and related companies will benefit from the growth in the ecosystem,.
All other factors constant (ceteris paribus) it is the type of hardware that determines how much energy will be used and what it will cost a miner to maintain the infra. So, our new supply function becomes-
Sᵦ= f(machine type)
If you ask a user what typically defines their experience with on chain activities and what determines whether they continue to transact, gas fee will come out on top as a limiting factor.
The timing of a transaction matters significantly in swaps/trading/leverage/borrowing/NFT flips etc, and thus users are continuously trading off between high gas and a smooth transaction experience.
Users are at a disadvantage because of information assymetry. Gas fee also ends up becoming a major roadblock for wider adoption for users who might want to transact in smaller amounts, those who are entering the space now/ want to experiment/ growth of user base in general.
The state of the blockspace market impacts the entire ecosystem in the form of
fluctuating gas prices→ hence, transaction volume, miner revenue, dApp adoption and usage..
preference for certain proposals over others depending on what will benefit miner earnings (EIP 1559 that went live in august 2021 with the london hard fork was heavily contested on the battleground of miner fees)
Hardware infra cost = f(geo-political landscape, IC supply, logistics)
The pandemic and now the Ukraine crisis have wreaked havoc for supply chains and exposed a broken fragile architecture. Hardware manufacturers face supply backlogs that in turn leads to time lags between demand and availability of GPUs used by miners running full nodes, ultimately rippling through the ecosystem.
This is also a much needed reminder that regulations are not the only political factors affecting the ecosystem. Each segment in the space is inextricably linked to the present economic systems and blockspace is no exception. Anything affecting hardware manufacturers (such as NVIDIA), will trigger a butterfly effect through the ecosystem albeit in different degrees and manifestations. So, while the miner network may be decentralized, this backbone itself is dependent on the overall economy.
For miners, gas fee trends matter as much as currency price, perhaps even more. So a congested network is good for miners and bad for users in the short to medium term. While that holds true from an incentive perspective now, the same cannot be generalized in an extended timeline as seen below-
There is no way to predict gas price in advance or accurately, owing to information asymmetry. A proposed solution (medium term) apart from scalability is to allow users to express willingness to get their transaction included over multiple blocks when and if gas is minimum.
When btc block size exceeded 1mb, users began to migrate to ethereum, this was in 2017, now that ethereum is experiencing it’s turn of increased congestion, users are migrating to L2 scaling solutions (Polygon) or other chains that prioritize blockspace for speed rather than security/decentralization (Solana). While these are near term options, both btc and eth networks are working on scaling solutions, and it is to be seen which scaling solution will come out on top.
💡 Just like externalities lead to black markets in conventional economic systems, the information asymmetry and market distortions have led to the creation of MEV markets.
Here’s a summary on why we need to start and end at blockspace -
limited blockspace→ txns stay in mempools waiting to be processed→time lag and fluctuating price→ arbitrage→bots→market inefficiencies
One inefficiency that leads to arbitrage opportunities in the market is the concept of Slippage. Slippage is the minimum price change a user is willing to accept between submitting a txn and that txn being included in a block. For instance in case of a swap, if a token costs 10 USDT and the user sets slippage as 2%, the user is instructing the dex to go ahead with the txn as long as the price is within $10.20. Slippage is opposite of stop loss in case of a sale, this is essentially setting a ceiling.
Slippage gives rise to arbitrage opportunities and this is where bots come into the picture. Just like quant/algo traders live off arbitrage opportunities in forex markets, bots feed off off unaware users/users in a hurry.
These bots lurk in mempools to make good on arbitrage opportunities, also giving rise to sandwich/atomic attacks/time bandit attacks (but this is beyond the scope of the present discussion). Since bots know the slippage at which txns have been placed in the mempool they manipulate the gas auction by placing gas price bids. Now there is not one or two bots, naturally there are many bots and hence this is a bot race, where bots compete in a PGA- priority gas auction.
💡 Bots getting involved in auctions gives rise to more and more profitable opportunities for miners. These bids can go up to the total possible profit as well. This bot race gives rise to a sporadic new revenue stream for miners: MEV- Miner extractable value.
The MEV market has exploded over time-
MEV has given rise to new services such as “Dark pools/dark forests”
Dark pools are analogous to skipping the boarding pass queue at an airport and being escorted through a private premium lounge like a diplomat/celebrity without the public finding out that you were there. Only in case of a dark pool, your txn gets included on the chain and can be seen once it’s part of the block.
Needless to say a retail user loses in this MEV incentivised market. One solution here is to create a separation of MEV and non MEV txns, allowing gas price to be less volatile in the non MEV mempools. Users can choose where they want to send their txns and miners can choose which mempool’s txns they want to process. Other solutions would involve drastic changes to incentive alignment and will be difficult to get passed if the miner community is not aligned.
Here’s an example of a solution adopted by the **Flashbot research team-**
GitHub - flashbots/mev-inspect-rs: Discover historic Miner Extractable Value (MEV) opportunities
Over time the MEV market will become more nuanced and miners’ considerations will undergo changes accordingly. Miners will also have to ensure that the race to higher MEV does not end up negatively impacting the overall user experience of a particular chain.
Derivative market for blockspace, powering a new asset class for DeFi
A probable direction for the MEV market might be the emergence of deFi instruments catering to traders who want to speculate in via hashpower based derivatives. This would give rise to a new asset class and bring more structure to this base layer of the ecosystem. It would also introduce new incentives from a user standpoint if more traders begin to deal in such derivatives. It will turn into a flywheel with users retrieving the MEV loss made initially. This would also symbolize maturity and sophistication in the ecosystem between users and miners, forming a full circle.
As information on MEV becomes more mainstream, more revenue streams will emerge giving rise to more nuanced applications and solutions. Data led insights and platforms that supply cutting edge tools to research and draw patterns will find a foothold as the new practices emerge in the hashpower x mining x blockspace market.
Scaling Solutions
With the onset of “The Merge” the Ethereum network will scale and gas will (if all goes as planned) drop significantly. tl;dr- Ethereum was a PoW network that is now shifting to the more energy efficient and scalable PoS, but both these systems were operating separately and with ‘the merge’, they will, well, merge—creating a robust switch from a miner driven ecosystem to a PoS system.
With the rise of L2 scaling solutions the Eth community has held back on diverting focus on scaling but that may change in due course depending on how the ecosystem advances.
So far the opinion on L2 solutions can be summarized as follows-
Multiple solutions can help reduce the overall congestion on any one part of the network, and also prevents single points of failure.
The whole is greater than the sum of its parts. Different solutions can exist and work in harmony, allowing for an exponential effect on future transaction speed and throughput.
And hence, multiple types and sources of scaling options will be needed to scale the ecosystem.
L2 scaling solutions enable a symbiotic ecosystem—they gain security from L1 mainnet consensus and in turn provide the infra to accomodate the growing tide of users.
Companies such as Polygon have already cemented their position in the ecosystem. Development of zk/optimistic proof based rollups is ongoing.
“The fact that Polygon flipped Ethereum in active user addresses, may be the best exhibit we have that scaling is an existential priority for the Ethereum ecosystem”
Paths to scaling: a summary-
L0 interoperability: networks sharing settlement layers
L1 optimization: innovations at mainnet level: Solana, Cosmos lead the way here
payment channels: example- btc’s lightining network
→ but this path has a major constraint that it is restricted to payments and transfers only and other use cases cannot benefit
sidechains: Polygon and similar L2 chains that attach themselves to mainnet
plasma: aka **child chains—**copies of L1 chains and connected via bridges
optimistic rollups: ‘optimistically’ assume that unless discrepancy found in challenge period, a transaction is correct and can be validated—innocent until guilty model
zk-rollups: extremely fast transactions, minimum energy consumption, best path forward for scaling—have use cases beyond DeFi and at a wider scale such as identities for government functions
“On a long-enough timeline, all crypto will converge to zero-knowledge crypto”
💡 It is important to note that symmetric cryptography (SHA 256 on which btc network and beyond are based) are resistant to quantum attacks only if long enough parameters are used. Over time the crypto community will have to move to SHA 384 and 512...and post quantum cryptography algorithms based on different math premises need to be adopted as quantum computing advances.
What this ultimately means— blockchains that have competitive allocations to R&D within the community and attract the best minds will be at the helm of innovation. This also means each network/Web3 company should strive to have a dedicated team keeping a tab on cutting edge research coming out of universities.
Finally, the hardware market remains a vital piece in solving for scalability and is a long term play with greater regulatory constraints.
Yet, with the right incentive design and tokenomics—even this arena can be conquered as was proven by Helium’s success.
Some up and coming scaling solutions to keep an eye out for-
Andrena and Althea (pre-tokens!) are hardware networks tackling the internet service provider layer by enabling communities to set up hotspots and antennas that bring internet access to nearby towns
Dusk Network just launched their testnet and are working to build a Proof of Blind Bid powered by zk proofs to preserve privacy in the network, and directly settle transactions within 15 seconds.
Panther protocol is building a privacy setup that allows builders to integrate privacy features within their dApps without needing a highly specialized team of cryptographers and privacy tech engineers to do so. Users can mint zero-knowledge zAssets by depositing digital assets from any blockchain into Panther vaults.
Aleo and Forte have partnered to bring zero-knowledge proof solutions to blockchain games to fuel low-energy transactions for on chain games.
Immutable X is already being used by popular games such as Gods Unchained to enable 0 gas minting.
Loopring is a zkRollup layer2. It allows for high-throughput, low-cost trading and payment on Ethereum.
CowSwap allows you to buy and sell tokens using gas-less orders that are settled peer-to-peer among its users or into any on-chain liquidity source while providing MEV protection.
HashFlow Each quote is cryptographically-signed by Hashflow market makers—prevents frontrunning or sandwich attacks.
Eigen Network provides anonymous payment, confidential dex and privacy-preserving computation network in any EVM-compatible protocol to allow transfer, exchange and aggregate privately.
it is imperative to maintain focus on blockspace, it’s feeder systems (beyond Web3 and across geo politics), on novel incentives that will arise as the market grows beyond the initial contained vision and the butterfly effect of these factors across the Web3 multiverse.
