Vitalik Buterin (Ethereum Co-founder) – Ethereum Meetup (Aug 2018)

Chapters

Abstract

Analyzing Blockchain Economics: Insights from Vitalik Buterin on Transaction Fees, Block Size, and Storage Costs

Abstract:

The blockchain ecosystem, a cornerstone of modern digital transactions, faces critical challenges in terms of transaction fees, block size, and storage costs. Vitalik Buterin, a renowned blockchain expert, delves into these issues, offering insights and proposing solutions to optimize the efficiency and sustainability of blockchain networks. This article synthesizes Buterin’s analysis, focusing on the economics of transaction fees, the implications of block size limits, and the need for ongoing storage fees. By employing an inverted pyramid style, we present the most significant aspects first, gradually unfolding the complexities of blockchain economics.

Transaction Fees: A Balancing Act

Buterin spotlights the dual nature of transaction fees in blockchain systems. Private costs, incurred by miners or validators, and social costs, borne by the network, are critical considerations. He critiques the current first-price auction mechanism, where users bid for transaction inclusion, highlighting its inefficiencies and complexities. To address these, Buterin suggests second-price auctions, where all pay the same as the lowest successful bid, simplifying user strategies but complicating miner tactics.

Further, a hybrid mechanism is proposed, blending minimum fees with dynamic adjustments to maintain block occupancy at optimal levels. This approach promises a more balanced and user-friendly transaction fee market, reducing reliance on third-party services.

Fundamentals of Blockchain Transaction Fees:

Blockchain transactions bring private benefits to users but also entail private costs for the proposer and social costs for others, with the latter often being overlooked. These social costs act as externalities not accounted for in the decision-making process of which transactions to include. Buterin emphasizes the importance of addressing these externalities, possibly through mechanisms like Pigouvian taxes or cap-and-trade systems, which could incentivize behavior that aligns with the network’s overall health. The traditional method of controlling these costs has been through block size limits, as seen in Bitcoin and Ethereum. However, economic literature suggests that quantity limits might not be the most effective tool and that a broader range of mechanisms should be considered.

When measuring the social cost of transactions, studies, such as one from Cornell, show that increasing block size can significantly reduce the number of nodes able to process blocks. This reduction in nodes leads to higher social costs due to increased centralization and associated risks. Buterin points out the inherent trade-off between social cost and decentralization, where a reduction in the number of nodes diminishes the network’s utility, initially dropping steeply and then leveling out.

Block Size: The Decentralization Dilemma

Buterin explores the impact of block size on network health. He notes that increasing block size, while seemingly beneficial, can lead to a loss of full nodes, thereby risking network decentralization and security. The relationship between block size and social cost is complex, with a potential sublinear correlation. Buterin proposes a more nuanced approach than strict size limits, advocating for alternative mechanisms like dynamic pricing and auctions to manage these costs effectively.

Social Cost of Blockchain Block Size:

The social cost associated with increasing the block size on a blockchain is not linear, according to Buterin. A significant loss of full nodes may occur with an increase from small to moderately large block sizes, but the impact is less severe with further increases. This is coupled with the Ethereum encode rate, which measures the efficiency of transaction processing. As this rate increases, the network becomes more vulnerable to attacks and risks losing nodes, making it more susceptible to centralization.

The social cost curve for block size initially shows a high marginal cost, which becomes linear in the middle range, and then increases sharply due to the heightened risk of attacks. In setting block size limits and transaction fee rules, factors like social cost, network stability, and attack risks must be taken into account, along with the influence of auction mechanisms.

Storage Costs: Aligning Incentives

Storage costs in blockchains, often underpriced, lead to inefficiencies and misaligned incentives. Buterin introduces the concept of ongoing storage fees, where users pay for the storage they consume. This model encourages efficient storage practices and aligns user incentives with network health. Additionally, mechanisms like hibernation allow temporarily inactive contracts to be removed from the active state, reducing storage costs while preserving their history.

Inefficiencies of Current Storage Markets:

Blockchain transactions consume bandwidth, computational power, and storage, with storage often being underpriced, leading to misaligned incentives. Transaction fees are volatile, but storage costs remain constant, offering no incentive for early clearance and creating inefficiencies. Buterin proposes ongoing storage fees, paid per block per byte stored, to align incentives by requiring continuous payment for storage. Storage would be deleted when an account runs out of funds.

However, this approach presents challenges such as balancing a constant fee against storage size predictability and addressing the vulnerability of contracts to griefing attacks. Ongoing storage fees could also fund public goods. Additionally, hibernation allows contracts that cannot pay storage fees to be temporarily removed from the active state while keeping their history intact. These contracts can be revived later by providing proofs of hibernation.

Economic Layer Improvements: Enhancing Blockchain Usability

Buterin emphasizes that advancements in blockchain’s economic layer, such as ongoing storage fees and hibernation, are as crucial as technical innovations. These improvements, by providing better incentives, can discourage users from imposing excessive social costs and enhance blockchain scalability and usability. However, ongoing storage fees could complicate application development, presenting a trade-off between efficiency and developer experience.

Towards a Sustainable Blockchain Ecosystem

In conclusion, Buterin’s analysis underscores the need for continued research and development in blockchain economics. By optimizing transaction fee structures, rethinking block size limits, and implementing ongoing storage fees, the long-term sustainability and efficiency of blockchain networks can be ensured. These improvements, while complex, are essential for maintaining the health and resilience of the blockchain ecosystem, ultimately enhancing user experience and network stability.

Notes by: OracleOfEntropy