Ethereum: Designing the infinite economic machine
1
Barnabé Monnot
Robust Incentives Group (RIG), Ethereum Foundation
2023 NYU Stern Fintech Conference
Ethereum is our best shot at:
2
📈 Maximal satisfaction of user preferences
3
What can you do on Ethereum?
Everything! Smart contracts provide general computability
🪙 They power tokens, NFTs and all kinds of digital assets
🏦 They power DeFi services such as payments, decentralised exchanges, lending and others
🏛️ They power other services and institutions such as domain names, identity, decentralized science, DAOs, games…
4
How do you do it?
Users send transactions ⇔ “Recipes” for what they want to do �Transactions trigger code, updating the state of Ethereum
Examples:�Bob pays 10 ETH to Alice�Alice swaps 10 ETH for 10,000 USDC�Carol registers carol.eth�David votes on a DAO proposal
These are valuable to users!
5
Maximum expressivity of preferences
⇒ Maximum (potential) user welfare
6
🌐 Over a public, cost-efficient network
7
Who runs the network?
Ethereum requires consensus over state of the chain�This is done with Proof-of-Stake-based mechanism
Validators are first-class protocol operators
Responsible for maintaining a single view of the ledger� Produce blocks, are accountable for safety faults
8
How to become a validator?
Validators put money at stake, in the native token, min. 32 ETH
Protocol pays them for good performance (~block rewards)
Failure to maintain the network properly ⇒ Penalties
Permissionless entry and exit from the validator set�Anyone can become a validator*� *or pool money to provide capital for the network
9
beaconcha.in, retrieved 19/04/2023
🧮 Data point: ~35 billion USD staked
Proof-of-Stake costs
The Merge: Ethereum runs on less energy�Main cost: Capital (stake) lock-up cost
Tensions�Lowering cost of capital (e.g., liquid staking, re-staking)�⇒ 📈 Increase demand for staking�⇒ 📉 Dilute Ethereum security
Still, potentially easier to target optimal social cost,� as a function of Ethereum security
10
Scalability opportunities and limits
Higher welfare is realised with scalability ⇒ high tx throughput
Constraint: verification throughput > tx throughput� Ultimate validator failure is backstopped by community� But honest users must be able to verify operator work!
Ethereum roadmap: Scale the system with rollups�Dependent chains secured by the Ethereum validator set
11
Public, cost-efficient network
⇒ Maximum scale and operator accountability
12
📉 Minimum rent for operators
13
Value flows
While users transact on Ethereum, three types of value settled:
User surplus ⇒ Maximise for user
Externalities ⇒ Internalise for network
Operator rent ⇒ Minimise for operator
14
Rent 1: Congestion pricing
Operators pack blocks, but block space is scarce�⇒ Users express inclusion preferences via fees
Monopoly without a monopolist (Huberman, Leshno, Moallemi, 2021)�Operators cannot enforce monopoly pricing (Bitcoin-type TFMs)
Ethereum with EIP-1559 fee market (Roughgarden, 2021)�Fees / Congestion costs are internalised by the protocol�🧮 Data point: ~6 billion USD captured and removed since EIP-1559 (Aug. ‘21)
15
Rent 2: Operator privilege
Operators include user transactions in the blocks they make�Last look ⇒ Operators capture value from externalities
⚖️ Arbitrage�User makes a swap order for token A against token B on a market 1� ⇒ Creates price imbalance with another market 2�Operator buys B low on 1 ⇒ Operator sells B high on 2� ⇒ Price imbalance is resolved, Operator pockets the difference
16
Rent 2: Operator privilege
Operators include user transactions in the blocks they make�Last look ⇒ Operators extract value from users
🥪 “Sandwich” attack�User makes a swap order for token A against token B�Operator places: 1) Order for A/B before user swap� + 2) Order for B/A after user swap�Operator buys low ⇒ User buys high ⇒ Operator sells high
Permissionless [operators + programmability] ⇒ No “outlawing”
17
Rent 2: Operator privilege
Maximising extractable value for operator is hard�Requires sophistication and/or access to exclusive order flow
Division of labor: Validators source their blocks from builders�~ Procurement auction, builders extract value, bid it away
Future: Protocol is the auctioneer, permissionless auction�Bid values are captured and internalised ⇒ Minimum rent
18
Ethereum protocol
Network of validators
Builders
Users
Recovering max user welfare
Protocol captures operator rent, but user is still hurt 🥪😖🥪
Question: How to protect user, without hurting coordination?
Tensions�Permissionless programmability ⇒ Max coordination value�Defensive “protections” add constraints ⇒ May destroy value
Are we lost?
19
Recovering max user welfare
Operator may have last look, but user has commitment power!
Examples
This is the most exciting place to do research in!� mevconomics.wtf ⇒ 7 hours of great content :)
20
Externalities
⇒ Reduce/rebate what you can�Internalise otherwise
21
Thank you!
Go further:
Get in touch! barnabe@ethereum.org
22
Scaling Ethereum
Ethereum roadmap: Scale the system with rollups�Dependent chains secured by the Ethereum validator set
23
🧮 Data point: Today, rollups process ~4x as many transactions as Ethereum
EIP-4844 (ETA 2023, “Dencun”)�Provide more scale for rollups
Danksharding�Subcent costs for rollup txs