G’day everyone.
I’ve spent the weekend trying to understand blockchains on an economic level. I’ve tried it once in the past, and it was a sad descent into economic incentive whitepapers (a path I refuse to tow, ever again).
This time around, I’m attempting to keep things simple. You’ll find this collection of links answers rather mundane questions like ‘how do blockchains make money?’ and ‘where do they sit on the layers of the internet?'. That second question is personally important because I’ve long suspected that there’s probably a more convincing way to present blockchain tech without saying ‘web 3 improves on the flaws of web 2.’
I’m experimenting with this new format (where I just share links to a thematically-connected list of things I’m reading at a given time), so I’ll appreciate as much feedback as you can give. This is relatively easier to write than my standard fare (since I’m going to read something anyway), so if it’s good, it’ll be a step in the right direction towards publishing consistently.
On with the show.
What I’m reading this weekend
On blockchains and profitability
Bankless’ “The First Profitable Blockchain”. It seems intuitive when you read it, but blockchains are in the business of selling blocks. What is the cost of creating (decentralized) blocks? Security.
The most secure blockchains are also the most valuable, but the cost of that security is issuing a lot of tokens to miners. The economic implication of this, so far, is that no blockchain is profitable.
There are two ways to become profitable:
Lower the cost of security
Increase the block utility (and thus, the block value)
Come for the simple mental model for thinking about blockchain profitability, and stay for the charts. The huge spoiler is that Ethereum is the blockchain most on its way to profitability, using some rather strict but reasonable parameters.
Reflections on the past: EIP-1559
Eric Conner’s Fixing the Ethereum Fee Market. What I encourage you to take away from this is that it’s a collection of thoughts that inspired the Ethereum Improvement Proposal (EIP) 1559. (Here’s a link to the actual proposal).
Newbies (like me) take it for granted today, the way that Ethereum gas fees are calculated, but there used to be a time when people transacting on the block chain had an all-out bidding war for the chance to be the first to be added to blocks. Naturally, miners would select the transactions with the highest fees. This was great for miners, I’m sure, but it caused such disproportionate pricing. Because nobody knew what the other blockchain customers (or users) were going to bid, there wasn’t even a correlation between gas prices. You had people bidding, like, 5 times more than the average bid because they were flying blind.
EIP-1559 was a stab at bringing some determinism to the blockchain, using a combination of network congestion, disincentivizing bad acting as well as fair use pricing in a way that ensured that the actual base gas fees were burned (rather than sent to miners), and that only tips went to miners. This has made it possible for your MetaMask wallet, for example, to be able to estimate the gas price on a blockchain, and — by checking the network congestion benchmark of 8 million gas, which is 50% of the network maximum of 16 million — take a stab at reasonably baking in the gas fees for that NFT you’re trying to buy on OpenSea.
Oldie: Joke repo is actually toxic
This, from Molly White’s blog.
(I have to admit, I binged most of the entire blog today — mostly because her crypto-skeptical sentiment is honest, thoughtful and asserted with the presence of mind of someone who sincerely believes they’re fighting for the soul of their industry. I respect it).
Eight years ago, Molly White (who also created Web 3 is Going Great, an important archive of all the mishaps that happen too frequently in web 3 ) wrote about a repository called C Plus Equality (which has now been taken down for reasons that will be apparent when you read).
It’s one of those childish yet repugnant things you see people get up to when they think they’re being The Onion. I’m sure humor was intended, but the snippets that persist through references on Molly’s blog just give you 4Chan vibes.
Yeesh.
Here’s crypto lingo for you: collaterized debt positions
I’ve been looking into how MakerDAO’s loan service works. Say you own a fair amount of Ether. You need cash for something else, but would rather not sell your Ether (because you, ser, believe Ether is certainly going to the MOON after the merge). In a nutshell, you want to retain your Ethereum exposure while being solvent today.
Just want to have it all, don’t you, you bug-eyed marsupial.
So you open a collaterized debt position (CDP) with MakerDAO. In a nutshell, this is what happens when you lock your Ether to generate MakerDAO’s native stablecoin (called $DAI). $DAI is backed by billions of dollars I hear, making it highly liquid and just as good as USDT for your purposes.
And here’s the thing about CDPs: on MakerDAO, your CDP needs to be at least 150% more than the value of the $DAI you get out of it. If you want $10,000 in $DAI, you have to have more than $15,000 worth of Ether locked up.
What happens if your collaterized debt position crumbles (say a huge drop in Ethereum price causes the value of your ETH in store to be less than 150% the $DAI you borrowed?). Instant liquidation, friends.
Also worth reading: how to value DeFi tokens, which gives a 10,000ft overview of MakerDAO’s business model.
See you next week!
you inspire me.