Blockspace Derivatives

Allow users to hedge the exposure to fluctuations in gas prices.

There are many solutions attempting to build the best use cases of blockspace. There are many applications for blockspace derivatives, here some common use cases are given that already exist and could grow in the future.

Rollups. Rollups sell Layer 2 blockspace to their users before knowing the marginal Layer 1 gas costs that these transactions will impose. This means that rollups are exposed to the gas price of Layer 1 in the short-term. Thereby, they effectively become sellers of blockspace derivatives, a type of vertical integration that might not be wanted.

DApps such as aggregators. Some dApps like Cowswap give their users the guarantee that their transaction will be executed regardless of changes in the gas prices. They are thus also sellers of short-term blockspace futures.

“Once accepted the order is expected to be executed even if gas prices change” Cowswap Doc

By a similar argument, they may also want to use blockspace derivatives.

Wallets. Usually, wallets provide users with an estimated gas price. EIP-1559 has made this easier, however, it does not offer a guarantee. Wallets could provide the service that they sell blockspace derivatives to the users, thereby guaranteeing a fixed transaction cost for their users and creating a cash flow for wallets. Wallets could compete on how well they offer this service and how well they trade off time until inclusion and transaction costs.

Time-fixed transactions. There are also plenty of other, more traditional, use cases for these kind of derivatives. Some businesses that accept ETH as payment method for example, may need to liquidate their positions each month and do not want to be exposed to fluctuations in gas price, therefore they may want to enter into a swap contract, a derivative contract in which two parties exchange cash flows from two different financial instruments, for example base fees and a fixed notional amount.

Cross-domain MEV. When MEV searchers can guarantee that they control blockspace in certain blocks ahead of time, they can exercise cross-domain MEV opportunities. This presents an interesting use case as the payoff of the seller and the buyer of such a blockspace derivative is not zero-sum, because the existence of this contract makes the blockspace more valuable.

Cross-domain MEV is an underresearched field and its effect and magnitude still needs to be established. Cosmos has also worked on a form of blockspace futures enabling cross-domain MEV.

Current and past solutions

1inch GasToken. GasToken was an ERC-20 token functioning as a derivative on the gas price (This is before EIP-1559). A user would store data on the blockchain, thereby paying gas fees. The user could then later use the refund mechanism to delete the data from the blockchain and claim back around 50% of the gas fees, thereby effectively using Ethereum as a bank. This mechanism worked, even though a user would not be paid back for all of the gas units they consumed. GasToken is now outdated as the refund mechanism was removed from the protocol after the London hardfork.

Biconomy. Biconomy is a service that offers their partners fixed price transaction subscriptions. This is similar to a permissioned swap contract on gas prices. A user pays a fixed price to Biconomy in exchange for Biconomy consuming a pre-specified amount of gas on the user’s behalf. Biconomy then hedges their exposure to the gas price by entering into an agreement with an intermediary. For more details on this subject, have a look at this post. Currently, Biconomy only functions in a permissioned form. Furthermore, the gas price risk is difficult to hedge since the base fee is burned.

Pitch Lake. Pitch Lake implements base fee derivatives on a time-weighted average basis, meaning that the payoff of the option is determined by the average base fee in a pre-specified time interval. The advantage of this is that the average base fee is more costly to manipulate (although a manipulator does not have to manipulate a large part of the base fees to make a profit). The disadvantage is that as the time interval increases, the hedge the option provides, decreases. In their paper the interval is set to a month. The variance in base fee between months is not as substantial as the variance within a month, meaning this hedge only helps large buyers of blockspace who buy uniformly in a month.

Alkimiya. Alkimiya builds capital markets for blockspace. They allow consensus producers to hedge or monetize the premium on cash flow from blockspace and use the cash flow accrued from blockspace as financial legos to construct yield sources. Unlike most yield generating products collateralized by coins, the cash flow of these assets is secured by the underlying hashpower, which represents the economic activities accrued on the blockchain. Miners can sell hashpower as a swap to lock in an upfront payment for their hashrate over a period of time, or can sell call options to enhance the yield on their rewards.

Risk

Insider trading. Let’s say you have insider knowledge about the launch date of the next big NFT project. This increases demand for blockspace, meaning gas prices will spike during these mints. In this case, it would be beneficial for you to buy a lot of blockspace derivatives for said date.

It is very difficult to avoid this risk for sellers of these derivatives, yet it could lead to high losses. Having traders with insider information trade in the market could cause traders with less information to exit the market, eventually leading to a market for lemons.

If the time to maturity is short, it is less likely for many users to demand blockspace while the seller of a blockspace derivative did not know about this demand beforehand. For example, it is unlikely that a big NFT drop will happen in the next five blocks and that derivative sellers do not know about it. For shorter time to maturity, the risk of insider trading becomes smaller.

Block manipulation. Another risk is that the base fee is manipulable. As stated before, if a block is larger than the target block size, the base fee increases. It decreases if the block size is smaller than the target. A block builder has full control over how large to make the block, hence if it is profitable, builders will manipulate the size of the block and increase or decrease the base fee in the next block.

Whilst the block builder is the only one who can censor and supply an empty or smaller than target block, any user could manipulate the base fee by artificially increasing demand by simply sending very many transactions.

Overcoming this problem is related to the dynamics of the EIP-1559 fee market.

Finality risk. Let’s assume there exists a well-functioning market for blockspace derivatives. Even if a contract is executed as promised, there still remain finality problems.

Uncle Risk. What if a user exercises the blockspace derivative and their transaction is included in a block that is uncled? The seller of the derivative has satisfied the requirement of including the user’s transaction, however, the user is not satisfied since their transaction is not in the canonical chain.

Whether or not the contract has been honoured in this case, is a difficult decision to make as a block builder cannot avoid the uncle risk.

Re-org. If the value of blockspace derivatives becomes large enough, it may become profitable for a malicious actor to re-org the chain and thereby manipulate payoffs for the contracts. This means that even blocks that are a certain amount of blocks deep into the canonical chain do not guarantee that a contract is executed correctly.

Re-org attacks become more difficult as the length of the chain after the target block becomes longer. For contracts with a short time to maturity, re-org attacks could be a realistic risk.

Visualisation of a re-org. Block n+2 is thrown out for block n+1.

These finality risks are very difficult to overcome and therefore it is incredibly important to clearly stipulate what the exact agreement of the blockspace derivative is.

Currently, it seems the there’s no better way to hedge against transaction costs. As Ethereum scales, rollups, dApps and other users need to find a way to also hedge against gas prices moving against them. Creating on-chain, permissionless and incentive-compatible derivatives is the solution to this.

Thus, Gas.finance’s gas market, a permissionless, new market making algorithm based gas token trading protocol, is introduced.

Unlike 1inch GasToken, our idea is tracking the average gas prices of several blocks, and build a gas token trading places where users can actively speculate on network activities or passively LPing and short the network fluctuations. All the market participants are able to access the blockspace market and contruct the best strategies on their behalfs.

How could that be possible? In our next article, we will elaborate more on our new market making algorithm and our mechanisms. Salute.

Follow us:

Twitter: https://twitter.com/GasFinance

TG/Discord coming soon…