Thoughts, stories and ideas.

Do NFTs make sense at all? TL;DR, oh yes.

Would you pay $3.9M to be the official owner of this image? Not a print, not a painting...this exact image. Right-click → save, and anyone has it on their computer...but only you are the actual owner.

Would you pay $3.3M for this?

Or $270k for this?

Most people's first reaction to NFTs is disbelief. Obviously. But most people don't invest in art regularly. For those involved in the industry of art and collections, NFTs make sense. They might love it, or they might hate it. But they understand it. Even those who hate it do so because they get it. They mean something to them.

Love and hate belong to the same side of the coin, and the other side is indifference.

When Sotheby's auctions Bored Apes (literally, illustrations of bored-looking monkeys), they understand what’s going on. They have been selling perfectly easy-to-copy pieces by Warhol for decades. They know art is a marketplace for unique stories, experiences, and ideas. So who cares if they are made of paint, bronze, ink, or pixels?

It's been a long time since art stopped being about raw talent and technical prowess. Especially when it behaves like a product within a market, its added value is sending a message. Oftentimes that message is as simple as "I own this" Art is an asset that shares many properties with other financial products (it can be traded, exchanged for fiat, it re/devaluates...) but with the incorporated feature of conveying prestige to its owner, thanks to its intellectual significance.

NFTs so far is foreign to traditional investors. They are the flexing ground for crypto holders. A natural destination for capital generated within the frontiers of digital currencies that don't want to leave the space but wants to do something special. NFTs are crypto native, and therefore there are some new characteristics it displays that are not to be taken lightly.

"I own this" is still the prevailing message. And ownership gets a brand new meaning when the piece you own can be showcased publicly to a global audience through social media avatars and other bragging websites. But there is another significant message crypto is constantly sending. It says, "we are not like you" Every time someone resentfully says, "I don't get it," crypto giggles and goes, "I know."

Headlines like this increase traffic to OpenSea

Don't underestimate the power of passive-aggressive humor in crypto. It is a billion-dollar industry. Just take Dogecoin as an example.

This zombie belongs to the original collection of 10,000 cryptopunks minted in 2017 by Larvalabs. It's not even the most expensive! Punk #7523 was sold for $11.8M, but this was on the news more recently.

Cryptopunks will probably go down in history as the first crypto native art piece-slash-collectible to get mainstream attention. Jay Z, Steve Aoki, Logan Paul... have one. They were the first real NFTs to get traction. Punks already belong to the history books, and crypto inhabitants have a special place in their hearts for them as a symbol of identity. Hear this: $3.9M is a bargain.

This is a Fidenza. Fidenza is a collection of algorithmically generated pieces created by artist Tyler Hobbs. There are only 999 Fidenzas, all of unquestionable aesthetic value. It looks like adults' art, but with a crypto twist. Machine-generated, unique, beautiful, tradeable,..." and you don't get it."

This is the first-ever NFT minted on FTX. It was created by its founder, Sam Bankman-Fried, and probably took him less than 10 seconds to produce it. Sam is one of the most charismatic leaders in crypto industries, and his company, FTX, is an example of ambition and good execution. FTX is a centralized exchange valued at $18B as per its last investment round. It recently launched a brand new NFT platform, and that TEST jpg was the first piece ever to be created and launched on it.

Sam Bankman-Fried is one of the world's youngest billionaires. He's smart, innovative, and articulate. You can find him interacting with users on Twitter every day and often being interviewed on the TV or niche podcast. He's "one of us,” and he is most likely going to make it.

When people buy NFTs, they are purchasing a statement and a piece of history. A future piece of valuable memorabilia. It is not only a .jpg file in their computer, an annotation in their wallet, or their Twitter avatar. It is an investment in a cultural revolution, a statement of endorsement, a hilarious joke on old-fashioned folk...and who knows? It might pay for their dream house not far from now.

The other halving: Ethereum's block reward, cut in half after EIP-1559

The other halving: Ethereum's block reward, cut in half after EIP-1559

One month after the London hard fork went live, on August 5th, Ethereum has gone through two milestones.

  • Ever since the EIP-1559 rollout 1ETH is being burned on average in each new block.
  • September 3rd was the first day more ETH was burned thant created.

EIP-1559 added deflationary features to the Ethereum blockchain, by including a mechanism that burns ETH in every transaction. The amount of ETH has been increasing steadily and has currently reached half the ETH minted since EIP-1559.

Carbono.com/deflationary-blocks (Sept 4, 1pm CET)

Currently over 10% of the new blocks created in the Ethereum blockchain have been deflationary. Deflationary blocks are those where the amount of ETH burned exceeds the 2ETH block reward created.

September 3rd was the first day since the London hard fork that the amount of ETH burned exceeded the number of ETH minted.

Carbono.com/deflationary-blocks (Sept 4, 1pm CET)

In the last weeks of August, the activity in the NFT space increased the rate of deflationary blocks to an average of 1,400 per day, peaking at 2,861 on September 3rd. The record amount of ETH burned in one single block was 73.46ETH ($288k in current price)

Carbono.com/deflationary-blocks (Sept 4, 10am CET)

About EIP-1559

EIP-1559 was an update to Ethereum's fee market mechanism. From a first-price auction system, where the highest bidder wins, to a more predictable fixed price sale.

Before EIP-1559, users would estimate a fee price that they would append to their transactions. After the London Hard Fork the fee is established by the protocol. Users pay the given base fee, to which they can add a tip to have their transaction prioritized. The base fee is predefined, varies predictably depending on the demand, and gets burned after being paid.

EIP-1559 was initially conceived as an improvement in user experience, but it has ended up becoming a de facto monetary policy for Ethereum. The update brought two important things:

  • Every new Ethereum block is both creating ETH (in the current rate of 2ETH rewarded to miners per block) and destroying it. Which brings up a new type of blocks: deflationary blocks: those where the amount of ETH burned exceeds the number of ETH minted.
  • The rate at which ETH is destroyed depends on the activity on the blockchain. The bigger the demand of block space, the higher the base fee, meaning more burnt ETH.

The London Hard Fork linked activity on Ethereum to the value of its currency. When projects running on the Ethereum blockchain go active, such as DeFi trades of NFT launches, the whole community of ETH holders sees their assets increase their value.

The number of deflationary blocks increased in the second half of August following the NFT mania. Since August 24th, there hasn't been a day with less than 600 blocks burning more ETH than the amount created, and the number has gone as far up as 2346 on September 1st.

About Deflationary Blocks

Deflationary Blocks is an analytics platform developed by Carbono to monitor and understand the evolution and impact of the deflationary features incorporated to the Ethereum protocol after EIP-1559.

https://carbono.com/deflationary-blocks/

A primer on blockchain scalability

A primer on blockchain scalability

While most bystanders think CO2 emissions, criminal use, high volatility, or Elon’s opinion are some of the fundamental flaws in crypto, the truth is that for insiders, these are either water under the bridge or problems with a solution underway. For them, there are more pressing concerns. Ones that can really jeopardize the future of the ecosystem. Scalability is one of them.

Every blockchain has a limited ability to process transactions. Bitcoin’s blockchain, for example, writes a new block every ten minutes containing ~1MB of information with the details of the transactions. As bitcoin has grown in popularity, this capacity has been proven insufficient.

If the blockchain’s capacity does not grow proportionately to demand, the frictions of use become too big. You have to wait too much for your transactions to be approved, usage fees skyrocket, and all of this lifts a barrier to access the advantages of cryptocurrencies and blockchain-based applications. Crypto would never make it into a worldwide financial solution, and it could be bound to die of success, should this problem not be solved.

For newcomers to crypto, let us take a little break to share an explanation about how blockchains work and why this is important. There’s one metaphor that comes in handy. It takes place on a nice sunny tropical island, and it helps explain the technology, at least from this particular angle.

So we’re on that remote tropical island, hundreds of years ago. An island a few families scattered across a few villages within the island, peacefully coexisting. They usually trade goods between them, but as families get bigger and more families and villages appear, trade becomes more and more complex. To save time transporting goods from one point of the island to another, they build an immense hut in the middle of the island. They will take all the goods there, and instead of handing every item to each other, they will track who owns what through a ledger. The ledger says, for example, that family A has purchased 40 coconuts from family B in exchange for 10 pounds of fish, and family C has purchased a boat from family Din exchange for 400 coconuts (it’s not a very nice boat, tbh). By the end of the day, everyone will check the books, take home what the ledger says they bought, and let go of what the books say they sold.

Initially, that ledger is managed by a single person—a man who tracks transactions and writes them down in order. But over time, this man becomes corrupt. He starts messing with prices, accepting bribes, taking unfair commissions…

The islanders decide to act. There will be no central ledger anymore. Every family will have their own transaction book, handled by a ledger keeper from each who will act as a scribe. A stage is built in the middle of the hut, and every transaction is proclaimed out loud for all the scribes to write down. There’s not one single copy of the ledger, but as many as there are families, which makes bribing or tampering with records so costly it becomes virtually impossible to manipulate the market. By the end of the day, the villagers will compare all notes, and the information contained in the majority of them will be written down in one final book, which will determine who takes what home.

This solution decentralizes supervision, and therefore provides more security to the whole system, but it also makes it slower and less scalable. The more families involved in the process, the more scribes taking notes in their notebooks. More time writing down every transaction and more time, in the end, comparing the final notes.

Back in the real world, in current times, Vitalik Buterin coined the term “the blockchain trilemma” when describing the problem with scalability. It basically says the current state of affairs in crypto can only give you two of these three items: decentralization, security, and capacity. You want as many nodes (=ledger keepers in our island) as possible to guarantee the lack of a centralized, corruptible authority. Plus, an abundance of nodes makes messing with the system increasingly difficult. But also slower. Any tradeoff that makes things faster would require some concessions in terms of the degree of centralization or risk to security.

Many have warned of a Malthusian catastrophe impending over crypto: you can only grow to a certain extent before the whole system collapses. But technology always has some answers, and one of them, or more probably a combination of several, will probably help kick the problem away. Let’s take a quick tour through some possible solutions.

  • Increasing block capacity. It’s the easiest solution: it immediately creates more space, but what will happen when the current block size becomes too small again? Besides, bigger blocks require better hardware to run a node, hurting decentralization. It is a short-sighted solution that can’t be repeated many times because it would bring back the problem.
  • Optimizing the blockchain. Bitcoin was already able to trim down the information that entered every block, moving some non-necessary info outside blocks (SegWit, Segregated Witness). Something like allowing ledger keepers in our island to write down only the initials of the names instead of the full names of people involved in transactions. Nevertheless, this looks more like basic maintenance and good table manners. Scalability needs more of a shove.
  • L2, or second-level solutions. Every Bitcoin or Ethereum transaction pays the same fees, regardless of whether it is a $5 coffee in BTC or a $100 million transaction between wallets on Ethereum. One possible improvement could involve layering blockchains: a slightly less decentralized blockchain that sacrifices a bit of decentralization for very cheap transactions, and the main blockchain would only be used, for example, for daily summaries, limiting the number of operations. This is the approach chosen by Bitcoin’s Lightning Network or Ethereum’s rollups.

If there's a Layer 2, what's Layer 1? Layer 1 solutions are blockchains in and of themselves. While Layer 2 projects are scalability solutions designed to improve the performance of a current blockchain, Layer 1 are blockchains built from scratch. Many of them have been designed with scalability as one of the top priorities.  Check out Solana, Terra or Avalanche, as examples.
More, here
  • A blockchain of blockchains. Instead of having the main blockchain and several sidechains, we can have a mesh of different blockchains with a protocol that connects them to send messages and transactions. It’s a technologically challenging solution, really difficult to implement, but it improves capacity by several magnitude orders. This is the approach followed by Ethereum 2.0 and shards, Polkadot and parachains, and Cosmos and zones.

The implications of scalability are huge, and they can prevent crypto from becoming a global solution. But Malthus was wrong about humans, so maybe there’s hope for crypto.

Can we go back to the island?

Play-to-earn

Play-to-earn

Getting paid for playing video games has been every kid's dream since 1990 and an actual thing for a lucky few YouTubers and streamers in the last decade. Today, gaming is a real income source for thousands of people, especially in Southeastern Asia and South America, thanks mainly to Axie Infinity.

Introducing your new bosses

The gaming business has done nothing but grow in the last decades, devouring larger and larger chunks of people's attention and leisure time and challenging more traditional sectors like movies or sports. Gaming business models have evolved too at high speed, from buying the actual physical games to everything that can happen in Steam to all kinds of in-game purchases. And then there's that grey area where gaming meets gambling (i.e., loot boxes) or where people build a black market of in-game assets.

Crypto economy is providing the infrastructure that allows all of these activities and business models to play out in the same place, in a frictionless, usable way. And it has added a secret ingredient: wealth distribution. Users can now earn tokens inside a game and, without leaving the ecosystem, convert them into money they can spend. Play-to-earn is a reality. Probably not the rosy dream people first think of when they hear the expression (the one where you just get free money for having fun), but certainly a great evolutionary step in the progress of the metaverse.

Amy Wu calls pay-to-play "the world's most fire new user acquisition strategy", in a thread where she also points out that play to earn is not a standalone monetization model, but another ingredient of a bigger business model.

"Right now, there is a largely untapped economic opportunity in emerging markets to provide jobs by building a virtual economy in the digital world,” says Andreessen Horowitz in the blog post where they announced their $4.6M investment in Yield Guild Games. Calling the opportunities surrounding play-to-earn a virtual economy is not far-fetched. Gaming companies that want to tap into the new wave need to learn how to succeed as fintech companies, social networks, consumer platforms, as well as game developers.

Success in the blockchain gaming industry will probably need a perfect storm of excellent gameplay, great tokenomics and the team's ability to create a community.  

Smart contracts explained

Smart contracts explained

Smart contracts are self-executing programs, written in code, appended to blockchains that launch blockchain-based operations when certain conditions are met. Thus, they are yet another step towards decentralization. Because of them, different parties can interact without knowing each other or relying on a third party since the terms and conditions of their relationship are transparently and immutably written in code, and they execute automatically.

Silly example: imagine you need a logo for the new business you want to open. If you could express the professional relationship between you and a hypothetical designer in a programmable sequence of steps, you could write a smart contract that would unlock payments along the way.

  • Step 1. The client and the designer sign a digital contract where the price for the final logo is established, and the timeline is defined. The agreed amount is locked in an intermediary wallet where neither the designer nor the client can touch it.
  • Step 2. The client provides a detailed description of the business activity, the design needs (a logo for a website, stationery...), and visual references.
  • Step 3. The designer provides 3 initial proposals in the established time, let's say one week. A 15% initial payment is automatically unlocked when the images are sent.
  • Step 4. If the client was unhappy, they could end the relationship and retrieve the remaining 85%. But if the delivery is satisfactory, they would accept the submission and unlock a further 15%.
  • Step 5. The client then picks one of the three proposals and provides detailed feedback in a checklist.
  • Step 6. The designer goes through the feedback and checks all the boxes
  • Step 7. The client approves the changes that were satisfactorily made and requests further changes in some others within the approved timeframe or cancels the work and parts ways. If she decides to go ahead, another 20% is unlocked, and now half of the payment is made.
  • Step 8. The designer provides a final set of changes. If the happy customer approves it by clicking a button, the rest of the payment is finalized.

The example is a tad silly because the design can be subjective and tricky. The human factor is very prevalent in the design process. This hypothesis leaves too much room for either the designer or the client to behave fraudulently or take advantage of the situation. This is just an explanation on how a "real world" professional task can be broken down into steps that trigger transactions. For a case like this to succeed, you would need a very complex platform that was able to host and validate the steps automatically, without human interference (Fiverr is doing its best in some ways). The platform should be able to check that images were sent, changes made, etc.

But token exchanges, loans, etcetera, are already verifiable by software. Especially since crypto has an underlying infrastructure that offers unmatched amounts of transparency and interoperability that help a machine understand wether users have what it takes (balance? collateral?) if they want to enter a financial transaction. And this is how DeFi was born.

What are Layer 1 and Layer 2 solutions

What are Layer 1 and Layer 2 solutions
In the decentralized ecosystem, a Layer-1 network refers to a blockchain, while a Layer-2 protocol is a third party integration that can be used in conjunction with a Layer-1 blockchain (Gemini).

Scalability is one of the biggest challenges blockchains face. While Bitcoin can handle 7 transactions per second and Ethereum ~30, VISA claims to manage 24k. Blockchain's throughput numbers are still far from those of traditional finance, and they will need to improve if they want to become a really mainstream alternative. The consequences of lower transaction speeds are often felt, especially in Ethereum's transaction fees.  

Layer 1 and 2 are two different approaches in which the industry is attempting to increase the throughput of blockchains.

Layer 1 solutions are brand new blockchains designed with optimization as a main goal. In contrast, Layer 2 solutions are protocols built on top of prior blockchains that provide extra services to help make the chains more efficient.

Imagine the blockchain was like a concert ticket sale. A ticket sale done in a single booth, with payments were only available in cash, tickets printed on the spot and handed on paper...in other words, imagine we were in the 90s again. A long queue would form in front of the ticket booth, full of frustrated people blocking the streets.

A Layer 1 approach to solving the queue would consist of redesigning the ticket booth to make the queue move as quickly as possible: bigger spaces to attend two lines, more people in the booths, credit card payments, mobile phone wallet integrations...

A Layer 2 approach would be sending off credited salespeople to approach people in the queue to write down names and addresses of buyers and sell them IOUs that they would later exchange for actual tickets in the main ticket booth and send them through regular mail.

Layer 1 platforms include Solana, Terra, Avalanche, Binance Smart Chain... They have recently been in the list of best performing assets, showing the increasing interest from investors in smart contract platforms alternative to Ethereum. Some like to call them ETH killers, because their virtues build on Ethereum's flaws, namely transaction speed and its impact in transaction fees. An impact that has been recently felt strongly, with NFT summer pushing the boundaries of block performance. These layer 1 smart contract solutions are slowly maturing in all the aspects needed to guarantee success. The virtuous cycle of projects, funds, and talent is spinning, pushing the performance of the underlying assets (SOL, LUNA, DOT...) upwards. Layer 1 is finally the home for thriving communities of developers building DeFi and NFT projects with all the perks of new, optimized blockchains beneath them.

Layer 2 scaling solutions take work off the main blockchains through different techniques. For example, by breaking down tasks that can be settled in alternative chains and minimizing the effort put on the main ones. The Lighning Network is the most famous Layer 2 solution built on top of Bitcoin's blokchains. LN opens the door for small, quick BTC payments. Optimism or Arbitrum are some examples of successful Ethereum Layer 2 solutions. The recent onboarding of Uniswap and 1Inch on Optimism has brought great UX improvements to the exchanges.

 For a more technical, in depth, view:


How does Proof of Work (PoW)...work?

How does Proof of Work (PoW)...work?

Proof of work is the consensus mechanism that happens during the mining process, and that guarantees that the Bitcoin blockchain is really decentralized, p2p, and secure. If you understood this sentence clearly...congratulations, you are way past Bitcoin 101 and can move on to the next sections.

But with this next piece, we want to help the rest of the people know their way around the Bitcoin protocol. Indeed, you don't need to be a watchmaker to read the time, but if you're trusting some of your money and your future to crypto, you're better off knowing about the nuts and bolts of blockchain.

To understand the initial sentence, we need to climb a ladder of concepts: some blockchain basics and an approach to what miners are and what they do, and then a closer look at the block validation process, which is where Proof of Work happens.

Blockchain first! What Satoshi Nakamoto proposed in 2009 was a solution to several long-standing conundrums that had prevented decentralized digital money from happening. All attempts to exchange value over the internet required a central authority -banks, governments...- supervising the process.

Nakamoto solved the problem of digital scarcity and double-spending. Any asset shared digitally creates two copies. For example, think of a pdf sent through email. The receiver gets a copy of the pdf, while the original still exists in the sender's drive. This creates double-spending.

We call double-spending the possibility of spending twice the same money. This is impossible with physical money (you cannot hand out a coin and also keep it). In the case of digital money, it´s the responsibility of banks and payment processors to make money disappear from the sender's account.

In other words, Bitcoin is the first system where a digital file can be transferred without generating copies.

Avoiding double-spending and creating digital scarcity without intermediaries is the single, most revolutionary contribution of blockchain technology to the world. This is achieved through true decentralization. The Bitcoin blockchain is the result of a complex puzzle of technologies and solutions working together to create trust between people who don't know each other.

At its core, a blockchain is nothing more than a database—an uber-Excel spreadsheet where the information of all transactions is recorded. But instead of there being a central authority, a bank, writing down that sheet and keeping a copy safe, it is a community of miners who is in charge of management. Miners are special actors in the system: they are people running the Bitcoin protocol in their computers and keeping a copy of the validated database. Anyone can become a miner if they have the will and the hardware to do it; some stats say there are around 1M people worldwide mining bitcoin. One million copies of the transaction list. Imagine trying to hack that.

Now it's time to see Proof of Work in action. Every time two people make a transaction in bitcoin, this is the process:

Let´s say Abe and Betty want to exchange BTC. Their transaction enters the mempool (comes from Memory pool), a waiting room of sorts where transactions wait to be validated and approved.

Abe and Betty’s transaction meets a lot of friends in the mempool. They all patiently wait to be bundled.

https://cdn.substack.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2F4b768e4b-e67d-4c06-b75a-855aec122802_1291x725.png
Abe and Betty´s transactio meets their friends in the Mempool

Every miner then accesses the mempool, makes a bundle out of many transactions, and proposes this bundle to the community. That block, aka "candidate block," is each miner’s proposal of what the next block in the chain should look like. At this point in the process, hundreds of thousands of candidate blocks could be validated. But, just like in Highlander, "there can only be one."

Each miner makes her own version of the next block in the blockchain with the transactions they decide. Abe and Betty´s transaction waits in some of them.

https://cdn.substack.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2Fe2939ecf-3aa7-466a-941f-f48c91977f02_1297x728.png
Abe and Betty's transaction gets added to some candidate blocks

And here’s when proof of work kicks in.

Bitcoin needed a process to pick one block out from all the possible candidates -to find “the chosen one.” To make validation automatic but also fair, Satoshi Nakamoto decided two things: one, miners who got their candidate block picked would be rewarded in bitcoin to incentivize them to participate; two, to get their block picked, they should prove their interest by putting effort into the process. Miners’ computers have to solve a complex mathematic puzzle that requires consuming computer power and energy.

In other words: when miners bring forth their candidate blocks, a race starts between them, where the first one to solve a super-sudoku and show it to the rest wins. Their block then becomes the chosen one. Finally, it is appended to the official blockchain. The resulting database is then spread across all computers that participate in mining, thus setting it in stone forever and ever, amen. And… the process starts again.

The sudoku competition winner gets her block approved, the rest of the miners applaud, and the block gets added. Abe finally sends 1BTC to Betty.

https://cdn.substack.com/image/fetch/w_1456,c_limit,f_auto,q_auto:good,fl_progressive:steep/https%3A%2F%2Fbucketeer-e05bbc84-baa3-437e-9518-adb32be77984.s3.amazonaws.com%2Fpublic%2Fimages%2F7722fb80-6e03-4ddf-911d-2611e7828815_1293x729.png
Abe and Bett's transaction is in the approved block. The operation is complete now

Satoshi Nakamoto's genius was designing a structure where a huge network of anonymous miners are incentivized to work cooperatively, validating and adding new blocks to the blockchain. And a huge community of miners cooperating is the defensive moat against hacking. Proof of Work is the automatic process where miners agree on what transactions are valid, add them to the database, and update the database copies on their computers.

Proof of work is the consensus mechanism that happens during the mining process, and that guarantees that the Bitcoin blockchain is really decentralized, p2p and secure.

Does the sentence make more sense now?

Proof of Work is the heart that pumps transactions into the Bitcoin protocol. And, as hearts do, it consumes great amounts of energy. Proof of Work requires participants to invest energy (and the money and time tied to it) if they want to participate in Bitcoin as miners. And, as we have seen, energy consumption is one of the most relevant reputational issues in the space. It has caused Elon Musk to back up from his initial pledge of allegiance, it might be behind China’s current hard position on Bitcoin, and it is frequently mentioned in press conferences by relevant political figures as a problem that, as long as it remains unresolved, will be an obstacle for governments to have a more welcoming position towards crypto.

Automated Market Makers (AMM) explained

Automated Market Makers (AMM) explained

Automated Market Makers are a key concept in DeFi: an AMM is a decentralized exchange protocol that allows settling transactions autonomously, without relying on an order book. Here's how it works:

Any transaction requires that two parties (a buyer and a seller) agree on a price. Traditionally, brokers facilitate this, managing an order book that contains both sides’ offers. However, in an AMM price is defined by a mathematical formula called bonding curve, which determines a price depending on that asset’s liquidity relating to another asset. And that price changes every time someone trades because liquidity changes too. Complex, we know, let’s try an example:

  • In our AMM, we only trade two assets: dollars and bitcoins. Initially, there are $100 and 100 BTC, so 1 BTC = $1.
  • A trader arrives and buys 10 BTC at $1, leaving 90 BTC at our AMM and $110.
  • Now the price is higher: our AMM has fewer BTC.

AMMs push decentralization even one step further. They are central in DeFi, and a leap forward in the automation of financial relations. AMMs and liquidity pools are two of the main cogs in the DeFi clockwork. Two simple inventions that embody the spirit of decentralization that fuels the crypto economy and that are likely to rock the traditional finance world.

What is Miner Extractable Value( aka, Maximum Extractable Value) or MEV?

What is Miner Extractable Value( aka, Maximum Extractable Value) or MEV?

In an ocean of acronyms, MEV has risen as one of the most relevant in recent times, thanks, in part, to the evolving role of miners and their incentives, especially in the Ethereum blockchain post-London hard-fork.

MEV stands for either Miner Extractable Value or Maximum Extractable Value. It is defined as the value some actors of the crypto space can obtain by benefitting from their privileged position in the blockchain processing sequence.

In other words, it is the money miners can make by deciding the order of transactions in the block validation process. It can, and has been interpreted, as a fair way of earning money for miners, a process that brings balance to the market, by arbitraging and compensating for inefficiencies, but also as a potential risk.

How do transactions work?

The mempool is the queue where valid transactions wait for miners to compose a block with them right before start the validation process. Traditionally, it was the fees that determined the order in which transactions were allowed in. But miners realized that occasionally there was money to be made manufacturing arbitrage opportunities, just by creating and reordering transactions in their block.

The most common form of MEV seen today is third-party bots performing arbitrage between two or more decentralized exchanges (DEXs). An arbitrage opportunity is created when the price of a crypto asset on one exchange deviates from another, typically caused by a large trade on one of the exchanges. Arbitrage bots profit from this opportunity by purchasing an asset on the exchange offering a lower price and selling it on the exchange offering a higher price, bringing both exchange prices back to an equilibrium while earning a profit . Chainlink

MEV can take many forms, some with fancy names such as “sandwiching” or “uncle bandit.” But in the end, it is a practice that questions the theoretical incentive to order blocks by fees or tips. It has been defined as a malpractice that artificially alters the unwritten rule that determines how to order transaction, and creates a negative situation for regular users who are either scammed or affected by increases in fees.

MEV used to stand for Miner Extractable Value because it described what miners could do with privileged information. Some are trying to change the M to Maximal, just because it´s no longer only miners playing the game. Anyone with access to the mempool can do it, and many people are. Some groups in the crypto-space are looking into ways of making this practice more transparent and accountable. Flashbots, a community of developers, leads the way by shedding light on the issue and making it transparent to the community.

EIP-1559: What it is, what it means

EIP-1559: What it is, what it means

On August 5th, Ethereum went through a much awaited software update: the London hard fork brought 5 Ethereum Improvement Plans, with all eyes set on one of them: EIP-1559.

EIP-1559 started as a proposal to improve the user experience by avoiding excessive waiting times for transactions. However, the subsequent debates and suggestions brought features to EIP-1559 that have ended up turning it into a de facto proposition for a new monetary policy within Ethereum. And that is what had the community excited.

EIP-1559 changes Ethereum's fee market mechanism. From a first-price auction system, where the highest bidder wins, to a more predictable fixed price sale (with a couple of interesting side features)

Every new block written in the Ethereum blockchain was (up until until London) preceded by an auction. The highest bidders got their operations included in the block, and miners received the money from those bids. First-price auctions are prone to errors, inefficiencies, and a worse user experience. Users founds themselves often underestimating costs and seeing their transactions delayed; or overestimating them and paying more than they should.

Consensys compared it to Uber or Lyft rides. Imagine taking a ride was auction-based. How would you even calculate how much to pay? In crypto, it was wallets who aided users by estimating reasonable fee prices. But they were just that, estimations, and this created mistakes and friction in the system.

EIP-1559 solved this by establishing an initial fixed price, the base fee. Traveling from A to B should have a reasonably fixed price, and so should transactions. After EIP-1559 users can still speed up their transactions by adding a tip to their transaction cost and thus incentivizing miners to pick their operation first. But the cost of having your operation processed is now fixed.

There are several relevant things to say about base fees.

First of all, the price is indeed variable and linked to demand, but the variations are defined in the protocol (they go up or down in fixed percentages) and are therefore predictable. Wallets no longer had to guess and therefore now help users make the best decisions possible (and feel less dumb waiting for too long because their bid was too low, or because they paid too much because their bid was unnecessarily high).

Second, and most importantly, the base fee gets automatically burnt. Instead of reaching the hands of miners, the agreed ETH vanishes into the air like an unlucky Avenger. And this is where things got interesting.

Burning base fees was brought forth as a countermeasure to the hypothetical miner collusion to increase base fee price and extract even more value from users via fees. But the elimination of ETH via basefee burning ended up being the most wanted feature in EIP-1559. Ethereum was missing its own version of one of bitcoin's key features: supply control. EIP-1559 was considered by some as the most relevant manifestation of Ethereum's monetary policy, a mechanism to increase the value of the current circulating ETH and a possible boost for the currency's growth.

To sum things up:

What is EIP-1559?

A change in Ethereum's fee mechanism that will altered the incentive to miners, and that brought a burning mechanism that will probably contribute to making ETH deflationary.

What problem does EIP-1559 solve?

Improved UX. First of all, EIP-1559 makes fee calculation controlled. Base fees will be calculated by the protocol and will vary predictably.

And, as a welcomed consequence of the burning mechanism, monetary policy. Burning ETH will give deflationary powers to Ethereum. Peaks in Ethereum use will bring proportional decreases in ETH supply.

What problems does it not solve?

Many have pointed out that EIP-1559 was a solution to the problem of skyrocketing fees in Ethereum. EIP-1559 does not solve this, and transaction costs will still be highly dependent on demand, although, at least, less volatile.

Predictability and transparency might have the side effect of affecting user behavior: users might refrain from submitting operations if they see or foresee price increases.

What problems did it create?

The changes in the incentive structure brought questions about the implications for miners, who might see their revenue decrease. Happy miners make blockchains secure, and unhappy miners could make the hard fork fail.

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This outcome, nevertheless, is improbable for a bunch of reasons. To name just three of them:

  • Those users who are currently bidding higher for their transactions in the first-auction system will probably still be interested in getting their operations validated first. Tips are likely to become a relevant source of income, even if they are optional.
  • EIP-1559 might increase ETH's price. Miner revenue, calculated in dollars, can become higher thanks to EIP-1559.
  • ETH 2.0 is getting closer and closer. Ethereum has a very relevant upgrade coming up that will bring, among other revolutions, the change from Proof of Work to Proof of Stake. Are miners willing to make the system tremble when they are months away from a crucial improvement in Ethereum's history?