Gas fees hedging is the future of blockchain businesses
Just a little over 10 years ago, almost everything in crypto was just about Bitcoin. Everything was Bitcoin blockspace, 144 blocks per day, mainly transactions, people (and some exchanges) moving funds around. The landscape expanded quite significantly with the advent of Ethereum and its turing completeness allowing for smart contracts and virtually anything to be built on top of a blockchain. This ecosystem flourished, and later, saw the emergence of various flavors of roll-ups and various ecosystems like Polygon, Avalanche, Fantom, Cosmos and Polkadot (to name a few).
Today, blockspace is abundant, every single new chain, new rollup, new dapp it’s all blockspace — with over 100,000 blocks processed daily across multiple chains, with varying degrees of demand between them. With so many available blockspace it might seem that infrastructure is in place, now we need to make it easy to onboard users to actually fill them up. That’s precisely what everyone was talking about in the latest EthCC, we are now transitioning to a phase where Account Abstraction and Chain Abstraction will streamline the blockspace market and reduce barriers to generate demand for this abundance of blockspace. It is opening up new opportunities, but it also presents significant challenges, particularly for businesses operating in this space.
The Importance of institutional Hedging
Managing operational costs is crucial for sustainability and growth of any business. In the blockchain industry, if you have an audited code up and running, there are two significant expenses: payroll and gas fees. Gas fees, required to execute transactions and smart contracts on various blockchain networks, are among the most volatile and unpredictable costs. These fees can fluctuate wildly, impacting the predictability and stability of a business’s expenses. This is where the concept of gas cost hedging comes into play.
Hedging is a risk management strategy used by businesses to lock in costs and protect themselves against price volatility. By using hedging strategies, companies can ensure that their operational costs (or revenue) remain predictable, regardless of market fluctuations. This predictability is vital for budgeting, financial planning, and maintaining smooth operations. For instance, during periods of high network congestion, gas fees can spike dramatically, potentially crippling a business’s ability to function efficiently. By hedging these costs, businesses can avoid such disruptions and maintain a steady, predictable, operational flow.
Additionally, Account Abstraction has enabled businesses to sponsor gas fees for their users, enhancing user experience and adoption. However, for this sponsorship model to be sustainable beyond short-term campaigns, hedging these costs is crucial. By hedging gas fees, businesses can continue to sponsor user transactions over the long term, making the sponsorship model a viable and lasting strategy.
Hedging in Traditional Markets
To understand the significance of hedging, let’s look at a real-world example from a different industry. Consider an airline company like Delta Air Lines. Fuel costs constitute a significant portion of an airline’s operating expenses. To manage the risk of fluctuating fuel prices, Delta engages in fuel hedging. This involves entering into contracts that lock in fuel prices for a certain period, protecting the company from price spikes. By doing so, Delta can predict its fuel expenses accurately, which helps in budgeting and financial planning, ultimately leading to more stable profit margins.
This strategy is not limited to the airline industry. Large corporations across various sectors — such as manufacturing, agriculture, and energy — use hedging to manage costs related to raw materials, commodities, and currencies. These companies understand that profit margins are not solely driven by sales; cost minimization plays a critical role. Hedging operational costs allows these businesses to stabilize expenses, protect profit margins, and invest in growth and innovation.
To further illustrate, natural gas and electricity futures contracts were introduced in the early and mid-1990s. Today, market participants can access a wide range of contracts, covering various delivery points, quantities, and time spans, from major exchanges like the New York Mercantile Exchange and the Intercontinental Exchange. Regulatory scrutiny of utility hedging intensified after severe natural gas price spikes, such as those reaching then-record highs of $10 per million British thermal units (MMBtu) in late 2000, and peaking at $15/MMBtu in 2005 post-Hurricane Katrina.
Colorado Public Utilities Commissioner Matt Baker highlighted the importance of risk management from the planning stage. Utilities are encouraged to diversify their fuel sources and enter into long-term, fixed-price contracts to shield consumers from price spikes. For example, one utility signed a 10-year contract at $5.15/MMBtu to provide stability, despite current lower market prices.
In Texas, power markets were restructured to separate generation and distribution into distinct businesses, resulting in competitive wholesale and retail markets. Texas Public Utilities Commissioner Ken Anderson noted that this market design strongly incentivizes generators and load-serving entities to hedge their risks. More than 90 percent of power in the Electric Reliability Council of Texas (ERCOT) is sold through bilateral contracts between generators and retail providers, supported by over-the-counter hedging contracts to manage price volatility.
Now that the blockchain industry is becoming more professional with increased institutional involvement and sophisticated business operations, the need for effective cost management strategies, such as hedging, has never been greater. By adopting these practices, blockchain companies can achieve the same stability and efficiency that traditional industries have long benefited from, ensuring sustainable growth and enhanced competitiveness in an increasingly complex market.
Modular Synthetic Blockspace
Now we are witnessing the blockspace market becoming more and more streamlined through Account Abstraction and eventually being entirely absorbed by it. The critical need for businesses to hedge their operational costs effectively is evident. By creating a Modular Synthetic Blockspace, a platform is provided where different gas markets can operate efficiently. This approach enables the development of a comprehensive gas derivatives market, offering a wide range of activities such as hedging, insurance, and speculation.
But creating a market for blockspace is just a first step. Having the correct tools to interact with this market is equally important. For this market to be adopted by businesses, the interaction needs to be seamless and as automatic as possible. This is where sophisticated hedging tools become essential.
The Role of Sophisticated Hedging Tools
Automated hedging tools streamline the manual and often error-prone process of managing gas fees and other operational costs, allowing businesses to focus on their core activities rather than constantly monitoring and adjusting their gas fee strategies. This efficiency saves time, reduces the risk of human error, and leads to more accurate and reliable financial planning. Additionally, these tools provide a consistent approach to managing volatile gas fees through algorithms and predictive models, offering stable and predictable cost management solutions essential for effective budgeting and operations.
To gain widespread adoption, these tools must be user-friendly and accessible to businesses of all sizes, with interfaces and systems that are easy to understand and use, even for those without extensive technical knowledge. By lowering the barrier to entry, more businesses can leverage hedging and other financial strategies, contributing to a more robust and active market. This is our goal, we’re not only building a synthetic blockspace and a market on top of it, we’re going to make it as easy as clicking a button for businesses to interact with this market.
Conclusion
As the blockchain industry continues to evolve and mature, the importance of effective cost management strategies, such as hedging, cannot be overstated. Drawing parallels from traditional industries like airlines and utilities, which have long relied on hedging to stabilize expenses and protect profit margins, blockchain businesses must adopt similar practices to ensure sustainability and growth. The transition to a more streamlined blockspace market through Account Abstraction presents both opportunities and challenges, making the role of sophisticated hedging tools more critical than ever.
By leveraging Modular Synthetic Blockspace and advanced hedging tools, businesses can manage gas fees and other operational costs with greater efficiency, predictability, and stability. These tools not only automate the complex and error-prone process of cost management but also provide accessible and scalable solutions that can grow with the business. In doing so, they enable companies to focus on innovation and growth, while maintaining financial health and competitiveness in a volatile market.
Ultimately, the integration of these sophisticated hedging tools will be a key driver of success for blockchain companies, allowing them to navigate the complexities of the blockspace market with confidence and precision. As the industry becomes more professional and institutionalized, the ability to manage costs effectively will distinguish the leaders from the rest, ensuring long-term viability and success in the rapidly evolving digital economy.
About Hedgehog Protocol
Hedgehog is building an infrastructure for on-chain native derivatives, starting with Modular Synthetic Blockspace. Focusing on AA wallets, L2 rollups and similar 4337 paymaster use cases for hedging BaseFee.
