Architecture of the Modular Synthetic Blockspace by Hedgehog Protocol
In previous articles, we have introduced several key concepts about the Hedgehog ecosystem to help you understand what we’re building and what is about to be launched. On What is Hedgehog, we give you an overview of gas prices and how and why Hedgehog is a solution to gas prices and volatility.
In Introducing Modular Synthetic Blockspace, we talk about the complexities of blockspace, explaining how hedging physical blockspace delivery — hard-settled — on the Ethereum network embodies a unique challenge due to its decentralized architecture. The absence of a central authority means securing future block space requires navigating through a network of over 900,000 nodes. Innovations like Proposer Builder Separation (PBS) and mev-boost make negotiating with block builders possible, but in a forever-changing ecosystem, it is still a very complex endeavor.
This article is about the architecture of Hedgehog’s modular synthetic blockspace, an elegant solution that abstracts complexity away and allows for the creation of several new markets, including the gas fees derivatives, which we’ll start with.
A Dive into Price as Information and the Modular Synthetic Blockspace
In a free market, price acts not just as a number but as a beacon of information. It is a synthesis of the complex dynamics intrinsic to an asset and its relation with the world, alongside many other factors that affect market structure. The principle, famously articulated by Milton Friedman — prices communicate information more effectively than any centralized planner could — not only applies to guiding economic decisions with unparalleled efficiency but everything market-driven that can be priced.
This concept holds particularly true in the innovative approach of Hedgehog Protocol to creating a modular synthetic blockspace. Engineering a synthetic blockspace becomes overengineering when the price synthesizes all the rich information about demand, scarcity, and blockspace dynamics. It emphasizes that the price, dictated by the base fee, is all needed to create a market.
Blockspace is a finite resource by its very nature, dictating the limited availability of transactions in each block. This inherent scarcity makes a market mechanism possible where users bid for transaction space, with gas prices serving as the information for this competition.
Precisely in this vein lies the essence of price as an information carrier: it reflects real-time supply and demand, but its significance runs deeper. It encapsulates expectations, technological advancements, you name it — everything affecting the blockchain ecosystem will be reflected in the prices.
At the core of Hedgehog’s approach to creating a cash-settled marketplace for Modular Synthetic Blockspace is the principle of simplification, summarized below. It focuses on refining the complex interactions of blockchain economics into an asset, the Base Fee token:
Core Simplification: At its heart, the protocol simplifies the complex. Focusing on the Base Fee at the time of each block strips away extraneous details, leaving behind the pure essence of price information.
Price as a Signal: This distilled price information serves as a signal, encapsulating not just the immediate supply and demand for blockspace but also broader, more nuanced market dynamics. It reflects the aggregated intelligence and anticipations of market participants, from miners and validators to end users.
Dynamic Adaptation: Base Fee, in blockspace, is inherently dynamic, adjusting in real-time to shifts in demand and supply, technological innovations, and external shocks. This fluidity ensures that the synthetic assets minted by Hedgehog remain accurately aligned with the underlying realities of the blockchain environment.
Strategic Decision-Making: For stakeholders such as rollups, wallets, validators, and service providers, this price information becomes crucial. As much as it guides their daily costs, it’ll guide their hedging strategies, enabling them to make informed, strategic decisions based on a nuanced understanding of gas price movements and market trends.
With all that said, in the context of Modular Synthetic Blockspace, price transcends its role as a mere number figure. It embodies rich information, serving not only as a crucial decision-making tool but it becomes tradable.
Even though we showcase Hedgehog’s solution as a way to simplify the complexity of blockspace, building a modular synthetic blockspace isn’t trivial at all. The solution goes beyond Base Fee; it can be applied to virtually any onchain metric, on several blockchains. With that in mind, we’ll share the architecture of Hedgehog Protocol and how we make it possible.
Let’s start with our Oracles.
Oracles
Oracles are pivotal for accurately determining and validating base fee prices in the Hedgehog Protocol architecture. We have developed our own oracles to maintain data integrity and reliability.
The entire process is described in Image 1:
- Data Collection: Hedgehog oracles source Base Fee data from several significant Node Providers via RPC, ensuring a diverse and comprehensive data pool.
- Data Processing: This data is then refined using a 50-block logarithmic moving average (LMA), smoothing out short-term volatility to base fee wicks and more reliable base fee metrics.
- Data Submission: The processed data is then securely submitted onchain, ensuring transparency that the protocol operates with accurate fee information.
By establishing a system of secure, precise, and reliable data collection and submission, the Hedgehog protocol not only ensures operational transparency and efficiency but also creates a solid base for markets to be built on top of this infrastructure.
Collateralized Debt Positions (CDP)
Once we have a synthetic BaseFee price being sourced, treated and submitted onchain by Hedgehog, now we need to create a way for individuals to hold an asset referenced by this synthetic Base Fee for the market to exist.
Image 2 describes how the Base Fee market is built on top of Hedgehog’s modular synthetic blockspace. The process described in Image 1 creates a synthetic Base Fee, which is illustrated as the green line in the chart of Image 2.
The creation of the synthetic BaseFee token is also illustrated in Image 2. Users are able to mint and hold a market-driven asset that is derived from the synthesized Base Fee price; this token is called BaseFeeLMA and it is represented by the black line in the chart of Image 2. Here is how it is minted:
1. Collateralized Debt Position (CDP): Users can mint BaseFeeLMA tokens through a CDP mechanism, an ERC-20 token minted within the Hedgehog Protocol, a straightforward process that uses Wrapped Staked Ether (wstETH) as collateral. Here’s a condensed overview:
- Connect Your Wallet: Log into your Ethereum wallet through the Hedgehog Protocol’s interface, ensuring you have sufficient wstETH for collateral.
- Initiate a CDP: Use the protocol’s dashboard to set up a new CDP by specifying the amount of wstETH you wish to lock up as collateral.
- Mint Basefee Tokens: Depending on the value of your wstETH and sticking to the protocol’s collateralization requirement, determine and mint the desired amount of Base Fee tokens.
- Manage Your Position: Keep an eye on your CDP’s collateralization ratio to avoid liquidation, adding more collateral or reducing your debt as necessary.
- Close Your Position: To close your CDP, repay the borrowed Base Fee tokens plus any fees to release your wstETH collateral back into your wallet.
2. Value Derivation: The value of the baseFee token is tied to the on-chain logarithmic moving average of gas prices, securely updated every 50 blocks by the protocol’s oracles.
Collateralization Requirement
The first pool introduced by the Hedgehog Protocol will utilize wstETH as collateral. This choice supports the initial utility for the baseFee token, with plans to expand collateral options to include more LSDs (Liquidity Staked Derivatives) and other assets over time.
Image 3 describes users in three different situations. User 1 has a healthy position; User 2 has crossed the Critical System Collateral Ratio; and User 3 has crossed the Minimum Collateral Ratio. Here we detail what this means:
Minimum Collateral Ratio (MCR): Set at 150%, this ratio ensures that each trove (individual CDP) maintains a healthy collateral level to mitigate risk.
Critical System Collateral Ratio (CCR): At a threshold of 200%, the CCR acts as a safeguard for the overall system’s health, triggering Recovery Mode if the system’s total collateral ratio falls below this level.
Through these mechanisms, we allow anyone to engage with gas prices, whether for hedging, speculation, or earning potential. This approach may not only mitigate the impact of gas price fluctuations but also open up new avenues for trading and investment within the blockchain space.
Fees
Now that we have synthetic Base Fee prices being sourced, treated, and submitted onchain by Hedgehog, plus we have created a way for users to mint Base Fee tokens that are based on these prices, we now need to introduce our fee system.
In the Hedgehog Protocol, fees play a critical role in maintaining the ecosystem’s health and incentivizing behaviors that align with the protocol’s overall viability and security. Here’s a closer look at the types of fees within the protocol:
Redemption Fees
Applied when users redeem Base Fee tokens for wstETH, particularly at a discount. This fee structure is dynamic, adjusting based on the profitability of the transaction to the user.
Fees collected are strategically distributed between the HOG DAO and Stability Pool (SP), with the routing mechanism capable of updates to reflect the evolving needs of the protocol.
Liquidation Fees
During the liquidation process, liquidators are compensated for their efforts and the gas expenses incurred. This includes a reimbursement for gas spent plus an additional reward, incentivizing prompt and efficient liquidation actions.
These fees ensure that the protocol remains robust against undercollateralized positions while rewarding community members who help uphold its financial integrity.
Minting Fees
Imposed on the minting of new Basefee tokens, these fees contribute directly to the HOG DAO treasury.
Like redemption fees, mint fees adhere to a similar dynamic framework, reinforcing the protocol’s financial ecosystem and supporting its development and governance.
These fees are integral to the protocol’s functionality, ensuring that it operates smoothly while providing necessary incentives and safeguards. They support a balanced ecosystem where the interests of users, liquidators, and the DAO align.
Conclusion
The architecture and functionality of Modular Synthetic Blockspace is a sophisticated, yet elegantly simple solution to the complexities of blockspace. Hedgehog not only abstracts away the complexity but also creates new market opportunities.
These architectural innovations are what will allow users to hedge against gas price volatility, speculate on future prices, and participate in a market where they could only watch from the outside.
As we look to the future, the Hedgehog Protocol envisions a future where its modular architecture not only addresses today’s blockchain infrastructure challenges but also paves the way for creating new onchain markets across multiple blockchains. Our design ensures that the solutions developed are adaptable and applicable to a wide range of onchain market challenges.
Through a series of articles, we’ve been exploring the essence of what Hedgehog is and aims to achieve. As we get closer to the Testnet launch, make sure to follow us here on Medium, Telegram, and Twitter so you don’t miss anything!
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