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Dominic Weibel
Head of Research, Bitcoin Suisse
Bitcoin’s blockspace demand, Fee switches, Ripple here, Ripple there
May 19, 2023 - 7 min read
1. Bitcoin’s high-fee-season continues to receive mixed reactions
The Facts:
- Glassnode reports on a “Bitcoin Blockspace Boom” triggered by high demand for Ordinals and BTRC-20 tokens, which is provoking further debates in the community. While Ordinals mainly used images, BRC-20 tokens are text-based. While they made the average size of a transaction to collapse close to an all-time low, the average number of transactions per block exploded from 2000 to 4000. Despite that increased throughput, the backlog of unconfirmed transactions still stands at around 267’000 at time of writing, which would take more than 11 hours to fully clear.
- Lightning Labs, critiquing the technical approach taken by Ordinals and BRC-20, announced version 0.2 of the Taproot Assets Protocol (formerly ‘Taro’), emphasizing the efficiency gain when issuing assets on Bitcoin and Lightning by avoiding writing “directly into block space.”
- Another source of demand for Bitcoin, the asset, will come from Tether. Tether International Ltd. announced that, starting May 2023, they will allocate up to 15% of its net realized operating profits towards purchasing BTC. Tethers 23Q1 net profit was $1.48b, which would mean a bitcoin allocation of ca. $222m (8283 BTC) per month, starting May 2023, with a current reserve in BTC of $1.5b as of March 2023.
Our take:
- The recent developments highlight once more the underlying core question about the security of the Bitcoin network: What will happen many years in the future when the block subsidy for miners will have further dropped towards zero? Will the incentive for miners to continue securing the network and processing transactions be enough?
- The path to solve the security problem is to have demand for transactions and thus for blockspace. Sceptics worry that users will not be doing a sufficient regular amount of transactions over time because Bitcoin as a non-inflationary cryptocurrency aligns economic incentives differently. With most users “hodling”, i.e., stacking satoshis but not spending them in transactions, miners may face insufficient economic incentives to continue mining, which will put the security model of the network in jeopardy.
- Where does additional demand for transactions come from? Well, from functionality – new features, users do make use of. In that sense, proponents of Bitcoin should welcome the recent high-fee season caused by Ordinals, BRC-20 tokens and the like as the fees have massively increased because of the high demand and the respective high amount of new transactions. Miners have experienced an extra boost through fees – up to the point where the sum of fees per block nearly equaled the block subsidy (approaching 50% miner revenue from fees).
- The problem is that the technical choices made to implement Ordinals and BRC-20 tokens are clogging the transaction queue in the mempool, causing transactions to be delayed. A much better approach would be to use Layer-2 solutions as the Ethereum ecosystem is experimenting with (Arbitrum, Optimism, etc.). An early-stage yet promising approach are validity rollups on Bitcoin, a topic we will explore in the upcoming Decrypt.
- Finally, Tether’s move to further diversify its reserves by increasing the Bitcoin share by 15% each month, is remarkable. Overall total reserves consist of cash, cash equivalents, and short-term deposits (85%), gold (4%) and Bitcoin (2%). Tether does what some central banks should be doing: diversifying and strengthening their reserves with a non-fiat bearer asset that is designed as a store of value for the digital age – they even self-custody these large amounts with their own wallets and keys.
(DATA) MESSARI, (CHART) BITCOIN SUISSE RESEARCH
2. The fee switch discussions ramp up amidst proposals on Lido, Uniswap and Arbitrum
The Facts:
- A proposal by GFXLabs sparked new discussions as Uniswap's community around the most adopted and liquid decentralized exchange is discussing implementing a fee switch proposal, a dormant DAO-controlled mechanism.
- The proposal will be tested initially on Uniswap v3 Polygon, and if successful, a subsequent proposal will determine whether to activate the fee switch on Ethereum.
- An approved proposal would charge liquidity providers (LPs) a fee equivalent to one fifth of the pool fees in Uniswap v3 and redistribute the earnings to the UNI community for various purposes such as grant-giving or funding of protocol development. A follow-up proposal is then needed to decide how to allocate the revenue generated by the fee switch.
- Notably, over a six-month period at one fifth of the pool fees, the Uniswap protocol would have returned $52m to the treasury given there was a fee switch implemented.
- The latest proposal does not address the distribution of collected fees, and the author suggests autonomously distributing them in a programmatic way.
- A previous fee switch proposal introduced in July last year did not proceed due to concerns about US tax laws and the implications on the DAO.
- Uniswap's community governance has provided mixed reviews of the new fee switch proposal as concerns about legal risks, increased competition, and the effectiveness of DAOs as businesses do still apply.
- The proposal will undergo a temperature check on snapshot after one more week of community governance discussion.
- Meanwhile, similar proposals were submitted on Lido and Arbitrum. For instance, Arbitrum sends all surplus revenue generated by transaction fees (3,352 ETH as of writing, 582 ETH from L1 fees, ~1’308 ETH from base fees and a 1’462 ETH surplus from L2 fees) to their respective DAO.
Our Take:
- Implementing a fee switch would have a range of implications and might significantly impact the value of the underlying protocol token UNI.
- Revenue Redistribution: The fee switch would enable the redistribution of a portion of the fees collected from liquidity providers to the UNI community. This could incentivize more community participation and provide financial benefits to token holders.
- Financial Sustainability: By generating additional revenue through fees, Uniswap could improve its financial sustainability. The collected fees could be used to support development, security audits, marketing efforts, or other initiatives that enhance the platform's functionality and ecosystem.
- Increased Competition: Introducing fees might make Uniswap less attractive compared to other DeFi protocols that offer feeless or lower-fee trading. This could potentially lead to a migration of liquidity and users to competing platforms if they offer better incentives.
- There is a good amount of game theory behind the fee switch implications since Uniswap’s USP is its liquidity, liquidity attracts volume and volume creates revenue for LPs. If you break that daisy chain, it could induce negative flywheel effects. It is therefore key to not jeopardize Uniswap’s competitive edge.
- However, a multitude of protocols such as Sushiswap or GMX successfully redistribute fees to token holders already.
- The implementation of fees could moreover raise legal and regulatory considerations, particularly concerning tax implications. It is crucial for Uniswap to navigate these issues and ensure compliance with relevant laws to mitigate any potential risks.
- The fee switch proposal highlights the importance of community governance in decision-making processes. The implementation and management of fees, as well as the allocation of revenue, require careful consideration and input from the Uniswap community.
- The discussion around the fee switch also raises questions about the effectiveness of DAOs as operational entities. DAOs operate differently from traditional businesses and may face challenges in managing financial matters and addressing legal and tax complexities.
- Overall, Uniswap and other dApps are a completely new type of entity and it requires us to adapt our thought process around them. Implementing a fee switch to share revenue could bring financial benefits and community incentives in any dApp but requires careful attention to legal considerations, potential competition, and effective governance practices.
30 days and 10 hours
Estimated waiting time for new validators (56’197 pending) to finish the deposit queue to stake.
3. Ripple acquires Metaco, a specialist in custody and release new CBDC platform
The Facts
- Announced on Thursday, Ripple is launching a platform for CBDCs, enabling the full management of the CBDC lifecycle for governments, central banks, and financial institutions, including minting, distribution, redemption, and token burning.
- Ripple is partnering with the Hong Kong Monetary Authority and Taiwan's Fubon Bank to showcase the platform's capabilities through the e-HKD pilot program, including real estate asset tokenization and equity distribution.
- Financial institutions can use the platform for inter-institutional settlement and distribution functions related to the CBDC.
- Both wholesale and retail CBDCs can be issued, facilitating offline transactions.
- The new platform builds upon their Private Ledger and utilizes the XRP Ledger as its foundation.
- Also this week, Ripple revealed its acquisition of Swiss firm Metaco for $250 million, specializing in crypto custody for institutional investors.
- This acquisition marks Ripple's expansion into custody services as part of its product suite and aims to support customers in utilizing crypto and blockchain for real-world use cases by adding custody capabilities.
- Metaco stood out among other custodians due to its crypto-native team and reputable bank customers including Citi or BNP Paribas who integrated Metaco's Harmonize custody platform.
Our Take:
- As outlined in our wrap from last week, CBDCs will likely impose increased monetary control upon its users, this is especially true for CBDCs running on permissioned blockchains or ledgers.
- As such, the choice between a permissioned or permissionless blockchain for CBDCs like the e-HKD has significant security and privacy implications.
- While there are benefits such as efficiency (streamline transactions, making them faster and more efficient), financial inclusion (provides access to financial services for individuals who are unbanked or underbanked), innovation (fosters innovation in the financial sector, leading to the development of new services and products), cost reduction (compared to traditional financial transactions, such as printing physical money), the drawbacks significantly overweigh.
- Risks of CBDCs are manifold, among them are a lack of public input (raises concerns about democratic decision-making and the alignment of the CBDC with the needs and preferences of the population), security and privacy risks, centralization concerns and potential abuse of power and technical challenges as implementing a CBDC at scale requires robust technological infrastructure and expertise, posing potential challenges and risks if not properly addressed.
- Most importantly however, permissionless, trustless, decentralized and immutable blockchains such as Bitcoin and Ethereum come with all of the aforementioned benefits and almost none of the drawbacks.
- Despite its ongoing case against the SEC, Ripple’s recent steps might indicate a strategic shift into diversifying their product range as well as their jurisdictional. The outcome of the lawsuit might also have significant implications for the whole crypto industry.
Technically speaking it is and always has been possible to write firmware that facilitates key extraction. You have always trusted Ledger not to deploy such firmware whether you knew it or not
Ledger Support in a now deleted tweet, after unveiling their new recovery phrase service “Ledger Recover”.
Any action that interacts with a user's keys needs to be approved by the user through their Ledger. We cannot extract their keys, and will not extract keys," and that “using a wallet requires a minimal amount of trust. If your hypothesis is that your wallet provider is the attacker, you’re doomed.
Ledger’s CTO Charles Guillemet clarifying
In other news
- Competing stablecoin bills in House hearing (via DLNews)
- Dogecoin launches DRC-20 token standard (via CoinDesk)
- FTX sues Sam Bankman-Fried (via Bloomberg)
- EU council votes in favor of MiCA crypto regulation (via Council of the EU)
- In a first ever, consumer debt passes $17 trillion (via CNBC)
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Dominic Weibel
Head of Research, Bitcoin Suisse