Beyond Layers

Rambling On Blockspace

This article took almost a year to write. The market conditions have changed dramatically since the first draft yet the underlying theme and thesis played out. After sitting on this for a while we have decided to revise and go ahead in publishing.

Below we will discuss:

1. What is blockspace
2. Why it is important
3. Blockspace as a Veblen good vs. Giffen good
4. Jevons blockspace
5. The future of blockspace allocation

What Is Blockspace

Blockchains are also known as state machines. In computer science the state refers to software’s ability to remember. Today the internet runs mostly on private and closed state-keeping. Behind the walls of websites and applications, the gatekeepers own our shared memories.

As the information on the internet, either human or machine-generated, can flow freely and is in abundance, the credibility of the information will be in high demand while the truth will be in short supply. Blockchains enable us to outsource our shared memory-keeping onto a machine.

Truth becomes a matter of block finality as blockspace is our time capsule. These memories are highly specific and limited in expression. They get uploaded into our collective memory based on market participants' willingness to pay for it.

Dennis Nazarov wrote about Web2:

“The business model of internet services is predicated on monetizing state. State is a competitive advantage, and is defended by keeping services proprietary and closed.”

Blockchains are effectively unbundling applications’ monopoly on state-keeping. Since the amount of updates a blockchain can remember for a given time is limited, the machine auctions off its capacity to remember. This capacity to remember is defined by blockspace.

Rob Habermeier contextualized blockspace as a key ingredient for unstoppable applications:

“Unstoppable applications rely on decentralized systems for payment, consensus, or settlement. As such, the application layer is a prime consumer of blockspace as a good. As with any business, both applications and their developers should be concerned with both the quality and availability of goods in their supply chain.”

Blockspace Is a Fuel

For blockspace to become a reliable and credible source of coordination it has to be organically scarce, or at least instill some sense of urgency for market forces to play out in acquiring it.

Just like the invention of refining crude oil into petroleum, the invention of shared state-keeping (blockchain) refines time into a standardized fuel of blockspace. Time is our crude, blockchains are refineries and applications are gas stations. All this is powering the new information highway of value transfers.

Technology is a substrate on which society takes place. As technology evolves, society changes its ways. The internet of the future will run on blockspace, fueling applications that offer services coordinated by the state machine.

Mechanical clocks helped facilitate the Industrial Revolution by offering universal coordination of “nine to five”. Blockspace can help facilitate the next information revolution by offering universal coordination of value transfer. We are refining time into blocktime to outsource keeping the tab thereby extending markets into places it could not reach before as the tabs were gated.

Hayek framed markets as machinery for registering change; a price system facilitating the coordination of resources and knowledge in society. Blockspace is an extension of markets because it is an invention that facilitates resource coordination. It bundles trust with state, allowing us to compute/validate information without thinking about it.

Blockspace as a Veblen Good

Some revolutionary inventions begin as a luxury. Let’s take the invention of universal timekeeping. Mechanical clocks dating back to the 14th century were expensive to produce and maintain, rendering them accessible only to the wealthy. Only several centuries later the pendulum clock made time-keeping more scalable and widely available.

Early automobiles were too reserved for the wealthy. The transition of electrification from luxury to widely accessible took several decades and some have seen electricity as a fad.

Blockspace today, despite at times being cheap and widely available across the chains, resembles properties of a luxury good. Especially in times of gas spikes on Ethereum, using the blockspace is almost a status symbol. Is blockspace today a Veblen good?

Investopedia summarizes Veblen goods as follows:

• A Veblen good is a good for which demand increases as the price increases;
• Veblen goods are typically high-quality goods that are well made, exclusive, and a status symbol;
• Veblen goods are generally sought after by affluent consumers who place a premium on the utility of the good;
• The demand curve for a Veblen good is upward-sloping.

Source: Wikipedia

The demand for Ethereum’s blockspace could be considered conspicuous consumption even if it, at times, determines economic rewards. Mostly used as an innovators' casino, blockspace is still searching for a new, high-utility, product-market fit.

In the Ethereum ecosystem applications were slowly priced out to other blockchains or rollups ultimately rekindling the interest in app-chains; applications running their own state-machine. But there is still expensive and valuable activity happening despite it being possibly cheaper elsewhere. Composable high-yield products like Ethena, Pendle, Gearbox, and their capped vaults entrench Ethereum’s blockspace as Veblen good.

In the past we could have speculated that prestigious NFT mints became prestigious by virtue of simply being minted during expensive gas spikes, thus via the endowment effect and the reflexive nature of being initially more expensive they become a subject to a flywheel that deems them more valuable.

Whether the memecoin mania of 2024 or the NFT craze in 2021, the increased demand for lottery tickets makes blockspace globally more desirable. Given the high cost per lottery ticket on ETH and the wealth effect of SOL’s rapid appreciation, Solana has become a memecoin Schelling point.

Blockspace as a Giffen Good

Not all blockspace is created equal. It is almost a class thing. Not everyone can afford the caviar that is Ethereum. Some have to settle for rice and potatoes which are the cheaper blockchains.

For the non-prominent blockspace, its properties potentially resemble Giffen goods. Giffen goods are considered essential and non-luxury. In theory similar to Veblen goods as they have an upward-sloping demand curve, meaning that their demand increases with price.

The theoretical existence of this type of good is predicted by a lack of substitutes and income pressures. An example of Giffen's good would be potato or rice during famine. Higher quality substitutes such as caviar or meat are so unattainable that even these non-luxury commodities become high demand.

“Since Giffen goods are essential, consumers are willing to pay more for them but this also limits disposable income which makes buying slightly higher options even more out of reach. Therefore, consumers buy even more of the Giffen good.”

Hence the analogy between Ethereum’s blockspace and the rest. The blockspace is an essential commodity if one wants to participate in the memetic economy built on blockchains. People are starved for quick gains. But for most ETH gas prices make ETH blockspace a very expensive lottery ticket - that’s why alt blockspace.

The alt blockspace came into prominence and high demand during the 2021 crypto bubble, and still continues to draw capital betting on its future demand. As the crypto market wakes up to a new bull run in 2024, much more of the economic activity happens outside of Ethereum.

Will this alt-blockspace continue to resemble properties of Giffen goods? Are new market participants priced out of Ethereum’s blockspace? What does this mean for the future of blockspace pricing?

We believe that economic activity around blockspace will display this Veblen/Giffen good behavior until there is a wider product-market fit for blockspace. What follows is Jevons paradox; the production scaling with the demand and price adjusting.

Jevons Blockspace

Jevons paradox is an economic paradox that says gains in efficiency lead to increased consumption. In the 19th century, Willian Stanley Jevons observed that more efficient steam engines led to higher consumption of coal and he was worried England would run out of coal. Could we at some point run out of blockspace?

It’s possible that with more efficient blockspace the demand for it will rise, especially as we discover novel applications that will predicate their utility on filling blockspace with information. But making roads wider does not stop traffic jams if people need to go places.

We posit that blockspace will not be entirely commoditized, as there will be degrees of blockspace quality or status. Similar to traffic jams being more severe in particularly high-density areas to which many have to commute, we will encounter hubs of more expensive blockspace.

There is always a way to add more blockspace as it is to build a highway in a desert. Who wants to drive to or through a desert every day? - Only those who are priced out of better areas. So it’s not only about adding more blockspace but also efficiently allocating the high-demand one.

Scheduling > Scalability

The global supply of blockspace is rising. It is likely that when the crypto industry experiences a period of high activity that is usually followed by mass-media coverage, we will see a global spike in blockspace demand.

During the period of heavy loads, the demand for blockspace surges, whether it’s the high-status (and quality) blockspace or the cheap blockspace. More sophisticated market participants require blockspace delivery guarantee. With the increasing economic value of certain transactions the scheduling of high-status blockspace will become much more important than the availability of any blockspace.

That is why blockspace will likely never become a pure commodity. Any use case that blockchains will be useful for in the future will involve a financial element (distributed consensus is not free), and hence savvy participants will pay for transactional guarantees. Citadel traders and Robinhood users play different games, and wealthy individuals use different banks than the middle class. Blockchain participants are no different.

In Blockspace Over Blockchains, the efficiency of blockspace allocation gets highlighted with the goal being to “...maximize the amount of blockspace that exists and ensure it is allocated to the state machines which need it most at any time: a constant generation and allocation of global consensus resources to those who need it the most. An enterprise without waste.”

Today we are stuck in an inadequate equilibrium of L2(3,4) mania – adding more blockspace with every new rollup. While this might be profitable (for investors and founders) in the short run, the long tail of isolated blockspace with extremely volatile demand is not a sustainable way to produce and allocate blockspace at scale.

The reason for this is that applications would require a more comprehensive and stable execution environment at scale. The current blockspace market is fragmented and unpredictable. The scaling mindset of adding more could be compared to adding more bridges between jammed intersections rather than building traffic lights and highway ramps.

This is a problem likely solved by a market-based solution. Blockspace as a primitive has been extending markets to many new use cases, but has lacked a marketplace itself. Until blockspace has proper markets (including delivery, and allowing hedging), its full potential might not be realized.

We have seen examples like this in the past. In the 1970s Ray Dalio helped McDonald’s hedge input costs for chicken nuggets via futures (a relatively new invention at the time), thus allowing for a stabilized cost and new product offering. Until this point, the costs of chicken nuggies were simply too variable to be a tenable product.

Blockspace needs markets themselves, and they might need true gas cost markets or an equivalent. Maybe the answer is not synthetic futures as in the case above but we expect a more sophisticated method for blockspace allocation to arise in the future.

As demand for the blockspace rises, so will the demand for specific execution guarantees and global blockchain allocation (rather than local - one chain). It is possible that in the Jevons future we will exist in a paradigm beyond layers when it comes to blockspace allocation. The existing blockchain obsession is just a symptom of an early stage.

It is hard to read the end game given the path dependence in crypto, the dynamic nature of design constraints and unpredictable compute pricing. Whether it is ideas around blockspace/gas exchanges, chain abstraction, or (Polkadot) coretime model, these all represent initial thoughts beyond the layered design.

What truly matters is blockspace and the actual end-user application. Everything in between is an investor-sponsored entertainment that will be abstracted away in time. This is how the industry roundtrips the narrative from value-extractive entropy to value-generating negentropy of application dominance.

Thanks to Ankit, Hasu, Rob, Luffi and long_solitude for comments and feedback.

Along these lines we have made high-conviction investments in Lastic - modular blockspace marketplace, undisclosed chain-abstraction project, backing Biconomy since 2020, and are holding DOT.