Gas costs on Ethereum are on the up an up. Not the first time it happens. However, it's the first time that this is coupled with an explosion of present utility value on the platform.
Could this lead us into a new gas cost equilibrium, and what does it mean for the ecosystem?
To answer this question, it’s useful to first align on the context around past periods of high gas cost and network congestion, since Jan 2018.
The priors
In that time frame, there are 3 notable events, namely: (i) the CryptoKitties launch (ii) FCoin’s trans fee mining and (iii) Fairwin.
Source: glassnode.com
What these periods/events have in common is that high gas prices were driven by one entity at a time. The attention, engagement and useage these entities commanded inflated and then deflated fairly quickly. This time, however, things look different.
Fast forward to summer 2020
Contrary to those times, the present condition finds us with (i) several interconnected yet distinct from one another projects/contracts, (ii) a whole lot more stablecoin on Ethereum - which in turn multiplies the economic utility a user can extract from the ecosystem and (iii) more users than ever.
Total DeFi users (cumulative) - Richard Chen
As a result, it’s not a far cry to assume that the current high gas price and network congestion state will persist for much longer than it has in the past. There is no single Ponzi that will eventually collapse, or any other type of attention suck that will eventually totally and irrevocably implode. If we take that operating assumption to be true, then what should we expect for the future of DeFi on Ethereum?
Ethereum on a new gas equilibrium
At this point it’s useful to define the shape of the relationship between the demand for and supply of resource bandwidth on Ethereum.
A way to think about the current state of the platform, is that we are moving from one equilibrium where users accessed limited utility to another where users access enhanced utility. As demand for access grows together with added functionality, user tolerance for higher gas fees increases as their available surplus expands.
It is also reasonable to assume that the supply curve here is an exponential function that approaches perfect inelasticity as the platform output limit is reached (e.g. block space). At this point the surplus available to users (consumers and protocol/app publishers) is capped, and if demand persists, price tends to infinity, supplier/miner surplus skyrockets yet output remains capped.
Naturally, given that existing on Ethereum as an economic agent is not (yet) a necessity for most, users will start dropping off at the point where the cost of operating (gas) starts eating into user surplus. This is more true for consumers than it is for publishers - which likely have a higher pain threshold.
A house of cards
Now, there are several open questions here - namely: (i) have contract designers, architects and operators planned for a new equilibrium on Ethereum? (ii) If this is indeed a new equilibrium re: gas cost and overall activity on the network, how much room do current contract operators have to wiggle? (iii) How ready are L2's (and horizontal standards thereof) for primetime?
If the present trajectory holds and the assumptions above are true, then we will inevitably reach a point where output remains stable as we will be at max capacity (perfectly inelastic part of the supply curve above), but prices will keep rising. At some point price will be so high that it starts eating into user surplus. Users (in this case both consumers and protocol publishers) will likely start dropping off and the Ethereum economy will return to a lower equilibrium. It will first be the minnows and then the dolphins, leaving sharks and whales operating - albeit at margin compression, as the providers of the yield (minnows) will have been priced out at that point.
The way forward
Since Ethereum 2.0 won't be functional for the forseeable future, here's some ways in which we might end up avoiding the condition described above: (i) users will tolerate ever growing fees and network slowdown (unlikely), (ii) app builders and users move onto Ethereum killers, and (iii) Ethereum Layer 2 gets activated in a big way.
Option (iii) looks like the path of least resistance at the moment - but tread lightly, as this space if still fraught with a lack of standardisation that might make reconciliation of transactions across different L2 approaches a complex endeavour (to the extent that it might make L2 scaling unusable at scale for - at least - the short term).