Blockspace - The most important economic model in the crypto market

Right within the nature of blockchain's operation, there exists an economic model called blockspace - where demand and supply parties participate in exchange.

During the past three decades, the software-as-a-service model has emerged as a result of the revolution that is technology and the Internet. The emergence of blockchain technology creates conditions for a new model to emerge: blockchain-as-a-business.

Blockspace is like a commodity

Blockspace, also known as block space, is the actual data storage capacity of a block on the blockchain. Besides transaction data, blockspace also contains other information such as headers, nonce, block creation time and information related to the block validation and construction process.

On-chain activities in the blockchain space, such as money transfer, token deposit, swap, mint nft, smart contract approval, revoke,... all require a blockspace to store and ensure ensures immutability of data.

Inside a block

Current blockchain platform models are considered companies that provide blockspace services (blockspace-as-a-service) for dapps building the above onchain services. Users who use services on blockchain must pay network fees similar to service fees for blockchain platforms.

Therefore, blockchain is considered a main type of exchange commodity in the value chain of a blockchain platform. The value chain of this commodity will include three main roles:

Blockspace provider (supplier) - Validator for PoS blockchain or miner for PoW blockchain. They will use resources such as energy and the opportunity cost of staked tokens to ensure the block creation process.
Blockspace distributor (distributor) - blockchain platforms such as Ethereum, Solana, Base, Optimism,...
Blockspace users (users) - dapps need blockspace to build above services such as Uniswap, Opensea, Aave, Flashbots,...

Value chain in the Blockspace economy

Similar to the law of supply and demand of products, when demand increases, the price of the product will increase and vice versa. For example, as Ethereum network users increase, the price of the blockchain increases. Users will have to pay additional fees (priority fees) to validators to validate transactions faster. Conversely, when on-chain activities are quiet during a bear market, network usage costs will be kept low.

Supply and demand for a blockspace

In the section below, the article will evaluate the effectiveness of the blockchain economic model in different blockchain groups, through analyzing the revenue, cost, and profit indicators of each type.

Blockchain economy on Layer 1 blockchain

Total blockspace market capacity is measured by block usage demand, which is calculated based on total transaction fees from users on blockchain platforms. In 2023, the capacity of the blockchain market on Layer 1 will reach 2.7 billion USD - gradually decreasing from 10.8 billion USD (2021) and 4.86 billion USD (2022). (data table below)

The first half of 2024 witnessed a rebound with more than 2 billion USD of blockchain consumed, of which Ethereum accounted for 81%, followed by Solana (11.7%) and BSC (5.6%).

Solana and Ton Network are two blockchain companies with positive growth rates of 842% and 905% respectively compared to the whole of 2023. In contrast, Polygon and Avalanche are showing a significant decline with 70% growth respectively. % and 83% in the context of the market being in a difficult period regarding the need to use blockspace.

·      Need for blockspace on Layer 1 blockchains
·      The financial model of an L1 blockchain will have the following components:
·      Revenue comes from user transaction fees;
·      The cost will include block reward and network fee for the blockspace supplier (here validator for PoS blockchain, or miner for PoW blockchain);
·      Profit will be equal to revenue minus costs. Normally, profits will be accumulated for token holders under many different mechanisms.

Economic model of Layer 1

Looking at Layer 1 blockchain revenue data in 2023, Ethereum is leading with 2.4 billion USD, followed by Binance Smart Chain - BSC (179 million USD) and Avalanche (64.7 million USD). Among them, Ethereum and BSC are showing the most positive signs with profit margins up to 25.9% and 9.83%.

For Ethereum, after The Merge event, the cost of block rewards has decreased from nearly 9 billion USD (2022) to only 1.39 billion USD, helping this blockchain accumulate 25% of profits for token holders. Blockchains are still in their early stages, having to spend a lot of resources, especially block rewards, to attract and maintain validators.

Financial data about blockchain business on Layer 1

It can be seen that the blockspace business model in the form of L1 blockchains requires a lot of costs to attract validators (blockspace suppliers) as well as dapps (users) in the early stages of development. When these blockchains reach the stage of finding killer apps that will attract more users and create a sustainable revenue source. From there, developing and maintaining a network effect (demand-driven growth flywheel) brings a stable revenue source for validators.

Blockchain economy on Layer 2 blockchain

Currently, Ethereum is the most secure and decentralized blockchain provider on the market, making the demand for blockchain use always high. When this demand grows large enough, large-scale expansion and development will be hindered (blockchain trilemma).

Layer 2 or Rollup is currently the solution chosen by the Ethereum Foundation to allow expansion by distributing additional blockspace outside of Ethereum, while still maintaining security through authentic proofs.

Layer 2 Economic Model (Rollup)

The blockspace economy of Layer 2 blockchains also shows demand for more than 40 million USD in Q2 2024 (as of June 25, 2024). In particular, Base is currently leading with 23 million USD (56.33%), followed by Optimism (21%) and Arbitrum (17.5%).

Compared to Q1 2024, demand for L2 blockspace has decreased by 60.65%, with L2s such as Arbitrum, Optimism, Starknet and Zksync all seeing a significant decrease of more than 50%.

The financial model of the project group providing blockspace in the form of Layer 2 (Rollup) has a difference in operating costs compared to the Layer 1 project group. In which:

·      Revenue will come from transaction fees;
·      The cost will include 2 items: operating cost and cost for L1 (Ethereum);
·      Profit will be equal to revenue minus costs.

Before the Dencun update, data publishing costs (L1 cost) accounted for the majority of the total costs of L2 blockchains. However, the EIP 4844 update introduced a new transaction fee format called blob-carrying transaction that allows data publishing costs to be reduced by up to 90%.

Economic model of Layer 2 before and after EIP-4844

After EIP-4844 (March 14, 2024), the average profit margin of Layer 2 blockchains has increased significantly from ~20% to more than 80%. It can be seen that currently the blockspace business model in the form of Layer 2 is bringing a higher profit source than traditional Layer 1 models.

Besides, the cost and process of creating a Rollup is increasingly easier with CDK, RaaS toolsets and middleware services.

·      Profit margin of Layer 2 projects after EIP 4844
·      Future blockchain trends
·      Layer 2 Blockspace is becoming product-market-fit

After the Dencun upgrade, the profit margin for blockspace business models in the form of Rollups is showing extremely large profits when compared to similar models in Layer 1 blockchains. In the analysis of the application Specific Chain model , the modular trend and the emergence of infrastructure development toolkits are important premises for the Rollup development trend.

Currently, most Rollups are choosing Ethereum calldata and blobs for L1 costs. However, these data storage spaces on Ethereum also have limited scalability. In the future, as more and more Rollups are launched, other DA solutions such as Celestia, EigenDA, NearDA will have more opportunities to develop with increasingly competitive DA costs. From there, operating costs for blockspace distributors will become increasingly lower.

Blockspace in Appchain, RollApp

Besides generalized Rollup, Application-specific Rollups (Rollapp) are being targeted by projects to exploit more profits from blockchain business besides service fees. Currently, there are 18/54 Rollups being developed for a specific purpose (according to L2Beat).

Rollap ecosystem

Take dYdX for example - a protocol specializing in perpetuals trading. For version v3, a Rollapp built on the zkSTARKS toolkit, the profit margin earned for dYdX Trading Inc. (parent company of dYdX) by more than 90% following a significant reduction in L1 costs (EIP 4844). In contrast, the dYdX chain version (v4) - the appchain built on the Cosmos SDK toolkit, does not earn any profit at all because it is completely shared with validators and dYdX holders participating in security.

The example of dYdX is just a simulation showing that the blockchain business model in the form of Layer 2 is bringing very high profit margins if this model creates a lot of onchain activities. The dYdX v4 version is not aimed at generating profits but focuses on creating value for the community and dYdX holders

MEV - An indispensable role in the blockchain economy

MEV (Maximal Extractable Value) is considered transactions related to the exploitation of values ​​in a blockchain economy due to its advantages in the role of block producer (supplier). This concept was first introduced by Phil Daian in Flash Boys 2.0 under the name miner extractable value (MEV) when ETH was still a PoW blockchain.

According to research from Galaxy Insights, transactions related to MEV account for up to 10% of total trading volume and up to 25-30% in highly volatile market situations, such as the collapse of FTX or SVB. In a blockchain economy, values ​​from MEV can be distributed to many different roles depending on the blockchain model.

MEV on Layer 1 - Ethereum

Currently, MEV can be mined on Layer 1 like Solana or Cosmos. However, in this section, we only focus on analyzing MEV on Ethereum - where there are the most valuable blockspaces (2.4 billion USD in 2023). After the Merge, the value chain creates an increasingly complex blockspace on Ethereum including searcher, builder, relayer and block producer.
Depending on the mining strategy and intention of MEV (good & bad), the MEV value will belong to different roles, which can be block searcher, block builder, user or objects outside ETH (bad). MEV). Normally, MEV will mainly take place DeFi dapps such as DEX or lending protocols.
For example, Searchers - independent parties looking for profit exploitation opportunities from MEV, will receive profits depending on the strategy at each different market moment. High profit margins can come from strategies such as liquidation (51.1%) or CEX-Arbitrage (62%) used in highly volatile market contexts. On the contrary, strategies such as Arbitrage (18.6%) or Sandwiching (14.2%) bring low but stable profits under normal conditions.
Conversely, MEV value can be minimized and shared back to users through prevention solutions such as Cowswap, MEV Block blocker, MEV-boost and SUAVE.

SUAVE's operating model

It can be seen that MEV value on Ethereum will be distributed in many different roles depending on the strategy and orientation of MEV. The revenue pie from blockspace on Ethereum includes not only validators but also the fiercely competitive economy between roles.

MEV on Layer 2

Unlike MEV on Ethereum - which is considered a dark forest that everyone can mine, MEV on Layer 2 is currently mainly in the role of sequencer. Currently, large sequencers on Rollup such as Optimism, Arbitrum or Starknet are still internalized (centralized) with private mempools to optimize performance and value for their blockchain.

With centralized sequencers, the value of MEV (intra-chain and off-chain) is exploited by Layer 2 blockchains as a new revenue source in addition to transaction fees. With low transaction fee networks like Rollup (after EIP -4844), MEV will be more likely to be exploited as spam in search of profit opportunities when the sequencer role is decentralized (shared sequencer). ).

Epilogue

Blockspace is currently one of the most important models in the crypto market that helps maintain an onchain economy. Blockspace models in the form of layer 1 are showing difficulties in the early stages with high operating costs.

Blockspace models on Layer 2 are gradually becoming product-market-fit with high profit margins and increasingly low operating costs, especially after the Dencun upgrade. Besides, MEV is gradually being seen as a new source of revenue in the block-as-a-service model of blockchains.