Navigating Gas Markets and their solutions
In the complex world of blockchain technology, the Ethereum network stands as a pioneering platform, enabling a multitude of decentralized applications and smart contracts. Beneath its innovative framework there is a crucial economic mechanism known as the gas market.
In recent years, we have witnessed several attempts at solving issues related to gas markets. The goal of this article is to delve into a cohort of new tools that aim to provide trading of gas fees/blockspace and ways to hedge gas price fluctuations.
Of course, Ethereum is not the only chain that uses its native token to pay for blockspace. However, the level of adoption it has experienced makes it the perfect candidate for building tools and derivatives for its gas market.
Blockspace and Gas Fees
At the heart of the Ethereum network lies its transaction processing and smart contract execution. This capacity is limited as each blockchain block has finite blockspace. Gas fees are essential in this ecosystem. They represent the cost of using computational resources for transactions and smart contracts. They enable prioritization of transactions based on an actor’s willingness to pay.
Amid Ethereum’s surge in popularity, blockspace demand increased, causing congestion and high gas fees. Innovators immediately responded with interesting but not long-lasting solutions. Notably, gas tokens like “Chi” emerged in 2020, allowing users to buy and store gas during low network activity. In congestion, users had the possibility to burn these tokens by using the refund mechanism to delete the data from the blockchain and get back around 50% of the gas fees, enabling cost-efficient transactions.
Changes to Ethereum
However, EIP-3298 ended this game of refunds. The refund model increased the use of blockspace as it created additional transactions. Its removal resulted in the end of gas tokens like “Chi”. The industry had to face increasing gas fees in a new way. The growing popularity of NFT mints surely didn’t help.
The next substantial change in gas markets resulted from the EIP-1559 upgrade in 2021. It introduced a base fee that adjusts up or down in a stepwise function, making fees more predictable and avoiding sudden spikes. Users can add a priority fee to speed up transactions, basically like a tip to the network validators. Also, the base fee is burned, reducing Ether supply.
Baas: Blockspace as a service
What if we visualise blockspace as a precious commodity?
For instance, there are protocols like Alkimiya that address the challenges posed by volatile gas prices and limited blockspace. The product offers miners a way to lock in upfront returns by creating contracts that exchange upfront payments for mining rewards. On the buyer side, vaults are created enabling users to pool contracts and generate diverse yield-generating assets.
Apart from blockspace swaps, purchasers can also acquire contracts known as “gas swaps.” These contracts focus solely on the fee aspect and can be likened to safeguards against potential gas price surges. When you buy these contracts, the price you pay effectively “fixes” gas prices for the contract’s duration.
The idea of projects like this is to create new futures and swap markets that could give users the possibility to trade and hedge gas prices.
Moreover, there is infrastructure, like Biconomy, currently under production. It introduces the concept of fixed-price transaction subscriptions, which offer users a way to lock in gas prices over a certain period, thus mitigating the impact of gas price fluctuations. By acting as an intermediary, Biconomy allows users to secure fixed gas prices through contracts, enabling more predictable and smoother transactions.
However, we need deeper liquidity to enable whole ecosystems to achieve more stable gas prices based on sustainable gas markets.
Gas price derivatives
In recent months, we have seen a few new projects with interesting ideas emerge to tackle this issue. In this section we will explore the derivatives approach, where platforms give users the opportunity to directly trade and hedge gas prices based on the mean average of the Gas Price on the blockchain.
For instance, GasLockR, is launching a hedging platform. In particular, they are building a product called GasSubscribe, which they describe to be “to Blockchain what Mobile Data Plan is to the Internet”. They plan to provide a seamless gas-free experience for users engaging with DApps. Once users subscribe to the service, the protocol handles the gas fees incurred when they interact with DApps. This is achieved through their GasLockR protocol, where they hedge against fluctuating gas prices with their real-time pricing model utilizing account abstraction.
This seems to be a retail-friendly solution for this complex problem. Only time will tell if it’s suitable for our ecosystem. Other protocols currently under construction, such as Hedgehog, Gas Finance and Diva Protocol, are instead trying different approaches.
While the first is focused on creating a derivative gas market based on Time-Weighted Average Price, the second is building a Gas-specialized Asymmetric Market Maker and the third is introducing an insurance product with compensations for users when the gas price exceeds a certain threshold.
Hedgehog is a Liquity fork which creates a tokenized representative of Ethereum’s base gas fee which can be traded on their platform. This implies that they require collateral for the minting of the BaseFee token however, which is capital intensive.
Instead, Gas Finance’s GAMM concentrates liquidity around the gas price, enabling convenient gas token trading for users. Unlike an AMM, a GAMM doesn’t maintain a consistent marginal price relative to the pool’s capital proportion. The primary objective of the GAMM algorithm is to readjust liquidity distribution. This aims to result in lower slippage for gas tokens when prices are stable and higher slippage when gas prices experience substantial fluctuations. The goal is to closely mimic the actual functioning of the gas market.
At the core of Gas Finance’s product is the GAT-N token, where ’N’ represents the moving average gas price of the preceding N blocks. In essence, GAT functions as a Gas Token dynamically tied to real-time market conditions. For example, GAT-10 calculates the average gas price over the past ten blocks. Whenever a new block is generated, this token promptly updates the average gas price. This flexible approach liberates traders from fixed trading prices, enabling GAT-N to adapt to evolving market dynamics and fluctuations.
The issuance cap of GAT is determined by the DAO through a voting process, allowing for a decentralized decision on the maximum supply of GAT. Users will be able to mint GAT at a price set at 120% of the reference price, ensuring a predictable minting process without encountering slippage. Upon minting, users will receive corresponding LP tokens.
Finally, Diva Protocol options which are arithmetically anchored to the mean of the average daily gas prices, so as to create a market in which writers can earn a premium over buyers. Doing so, purchasers of the insurance could offset gas price spikes in case Ethereum gets congested while a yield could instead be produced through the sale of these instruments if the situation remains calm.
Challenges
It’s interesting to learn about these innovations within our ecosystem, but will they be used in the end?
One of the things that has made this industry prosperous is speculation. This has given interest where before there was (only) a technological breakthrough. Gas fee trading may be more similar to insurance products, which so far have seen limited adoption. Perps on majors or alts with up to 1000x leverage, sports betting, or gambling have been more broadly adopted as speculation tools.
Is there a market for gas trading? Who are the users? We see a potential skew as there’s strong buy-side liquidity from sequencers, paymasters, etc. who want to hedge their gas costs. But who’s taking the other side? Protocols would have to account for this mismatch. For example, a liquidity pool model would need to add an adequate spread/fee to reduce the risk for LPs with a skewed long/short position. And then you also have to solve for market manipulation.
Biconomy and GasLockR aim to provide a simple service to developers but the above question still holds. Who’s taking the other side? If there’s no working market logic in the background, these providers have to hedge risk themselves by quoting high subscription prices which result in inefficient pricing.
The other key question is what type of product best serves the use case. Options? Futures? What’s the underlying pricing model? Do gas fees act similar to volatility indices, so we can be inspired by their design? Are the derivatives cash or physically-settled? The latter is more difficult as block builders would need to be involved. Do you take the base fee or the total fee? What’s the time frame for your TWAP?
These questions need answers. The industry continues to be interested in gas market solutions, but nobody’s created a winning solution yet. We suspect a few other contextual challenges need to be overcome to make this possible:
- Finding product market fit
- L2s development and dApps deployment vs Ethereum
- As in every pitch deck… why now? Projects have been trying to find a way to fix gas markets for a few years, so is this time different?
Finding product market fit
In the crypto bear market, where people are reluctant to take risk and no new capital is entering, the criticality of gas price solutions is muted because there isn’t much activity. Gas prices still spike occasionally, but it’s a stark contrast to bull markets where broad activity requires much blockspace. We hope that the solutions being built today are simple enough for retail to adopt them should they come back in droves, and robust enough to be embraced by institutional consumers like relayers. The current circumstances are tough to bootstrap such a market in however.
New speculative markets continue to have appeal however, and we believe it must be possible for a protocol launching in weaker market conditions to progressively bootstrap a healthy gas market. This will require long-term thinking from the founders, who must construct their protocols and token economies in a way that allows them to survive years ahead.
Will these products still be useful when the majority of dApps are launched on L2s?
With most dApps launching on L2s instead of mainnet, is it reasonable to expect that the need for trading and hedging gas prices will become more acute? We think that the use of blockspace will only increase with its decreasing marginal costs. But that gas market activity will revolve around L1s and is most important to parties with large hedging needs, which hopefully attract speculators.
Conclusion
Exciting new solutions to the gas market problem are worked on today, and while challenges remain, we think the combination of speculative opportunity and ability to hedge could result in a winner arising who achieves broad adoption. Logically, such a team will have to emphasize simplicity and user acquisition, beyond building a robust protocol with a token economy that can support it for years.
