Solving congestion, what will Solana’s future fee market look like?

Original title: "Solana's fee-market fork on the road"

Original author: ZHEV

Original translation: Ladyfinger, Blockbeats

Editor's note:

With the rapid expansion of the DeFi field, the Solana blockchain is becoming a new hot spot for decentralized applications with its high-performance architecture and innovative technology. However, with the surge in economic activity, Solana's fee market and maximum extractable value ( MEV) issues have gradually become the focus of community attention.

This article delves into Solana's fee market design, the challenges it faces, and the potential impact of MEV on its ecosystem, while comparing Ethereum's related experience and strategies. We’ve invited technical expert Zhev, who has previously written deep technical explanations of AMMs and other DeFi primitives on his Substack, to provide us with unique insights into Solana’s fee markets and the future of MEV. Through this post, we’ll look together at how Solana can address the growing MEV challenge while maintaining its high-performance advantage, and explore where its fee markets might be headed.

Introduction

The rise of Solana has expanded the DeFi space. We’ve always watched from a distance, but never provided a fresh perspective. However, the frenetic activity on Solana over the past few months has given us a new opportunity to observe where it fits in the market, and how it might evolve. Zhev has previously written about technical explanations of AMMs and other DeFi primitives on his Substack. This month, we teamed up with him to take a deep dive into Solana’s fee markets. MEV has dominated the fee market discussion on Ethereum, and as Zhev explores below, it will soon dominate on Solana as well.

Transaction fees are necessary to support the most basic activity on the blockchain, as they enable a user's transaction to gain validity and be included in a block. The primary purpose of these fees is to discourage spam; it also forms part of the subsidy paid to validators to build/validate blocks. In a sense, these network fees are akin to rent; users pay a fee to access a finite commodity per unit of time. The commodity here is "blockspace," that is, space on a block.

Here, we evaluate blockspace on two of the largest smart contract blockchains, Ethereum and Solana. As we delve deeper, we learn that fee markets, both designed within the protocol and organically developed from the ground up, enable validators to leverage their access to blockspace.

Solana’s fee market is optimized for high performance and is designed to avoid the issues seen in Ethereum’s approach. However, while Solana’s market may ultimately be more efficient than Ethereum’s, it will still need to go through a similar MEV revolution as its peers (validators begin to leverage their privileged position). Solana doesn’t have to go the Proposal Builder Separation (PBS) route that Ethereum has chosen, but it will need to identify a comprehensive approach to stabilize its fee market in the long term.

The Basics of Blockspace Valuation

Before we dive in, let’s try to understand how blockspace value is roughly determined.

There is both a technical aspect and a social one (basically the coordination of parties that give value to a blockchain). From a technical perspective, blockchains can adjust block size, block time, and block production and propagation mechanisms. The chart below provides a more detailed description and comparison of Ethereum and Solana’s approaches.

The social aspect refers to the coordination of blockchain stakeholders to achieve the technical and fiscal goals of the chain. It can also be viewed as the social status of a blockchain, which, while subjective, is an important metric. Social pressure is as effective as establishing a specific culture of problem solving, which both Solana and Ethereum have established. Recent examples of discussions around the social layer include the debate over whether to increase Ethereum’s gas limit and issuance per epoch, and the recent shutdown of Jito’s mempool on Solana .

Now, let’s examine and contrast Ethereum and Solana’s fee markets in more detail.

Summary of Ethereum’s Fee Market

Ethereum’s popularity is largely due to its execution environment: the Ethereum Virtual Machine (EVM), which makes smart contracts possible. Another factor is that Ethereum’s permissionless nature has spawned multiple cycles of various innovative applications: the ICO boom in 2017-2018, the DeFi Summer in 2020, and the NFT mania in 2021-2022. The continued existence of these applications creates value for validators, who provide block space for these activities.

Soon after the surge in economic activity on Ethereum, miners (this was several years before the move to PoS) began exploring how to leverage their position as block proposers to insert their own transactions when arbitrage opportunities arose.

Phil Daian was the first to document this activity (which we now call MEV) in his seminal 2019 paper (Flash Boys 2.0). At the time, Ethereum’s fee market only allowed for higher gas prices as a way to incentivize transaction inclusion. These Priority Gas Auctions (PGAs) clogged the Ethereum network and drove up gas prices until Flashbots (co-founded by Daian) were introduced. This created a market for miners to pay for transaction inclusion via searchers, which are on-chain arbitrageurs. Ethereum researchers subsequently realized that MEV extraction could be more powerful than in-protocol fees.

Potentially the biggest change to the Ethereum fee market is EIP-1559 , which creates a base fee (dynamically determined per epoch, to discourage spam, and burned), and a priority fee (used to show urgency or specify preference, and paid to block proposers to include transactions). An important takeaway is that a "priority fee" is functionally different from a "tip." The former ensures inclusion and is mediated by the underlying chain, while the latter ensures ordering as well as inclusion and is mediated by the fee market.

Ethereum’s approach has been evolving; see our two-part deep dive into MEV last fall. This is happening through a combination of a social level, which is trying to decentralize a centralized MEV industry, and a technical level, where MEV is now a key part of the technology roadmap (Vitalik calls this part of the roadmap “The Scourge”).

Solana’s Fee Market Mechanics

Solana takes a radically different approach to blockchain architecture, particularly in terms of scalability.

Some of Solana’s notable innovations include:

1. No Universal Memory Pool: In Solana, transactions are forwarded directly from the initiating client to the Leader currently responsible for generating blocks, so there is no need for a memory pool. This theoretically reduces the latency of transaction confirmations, but in practice this is not always the case due to the presence of “jitter” (i.e., the different processing times experienced by different validators when processing transactions or blocks).

2. State Isolation: The lack of a memory pool extends to make transactions on its dAPPs more independent of each other. This approach is similar to the concept of “adding more lanes to ease traffic”; different types of transactions on Solana must follow specific “paths” from user to Leader before they can be added to a block. This article provides more details.

3. Parallel Execution:Solana is able to process non-overlapping transactions in parallel in the same block at the same time. This is due to two factors:

- Solana's block production is (roughly) sequential, as Leaders are expected to add transactions to blocks as they are received.

- Slot Leaders are fixed, as they are scheduled in a queue in advance, and these Leaders are also responsible for producing four blocks in a row.

These two factors, combined with Solana's state isolation, make transactions "multi-threaded". This is when the leader of the current epoch schedules multiple bundles of transactions to be confirmed at roughly the same time (provided that transactions in the same thread do not change the same state) in the same way and at the same time.

Solana’s Fee Market: Cheaper ≠ Better

Network fees on Solana are typically very low (although they have risen with recent demand). In contrast to Ethereum, Solana has a static base fee measured in lamports . It then has a priority fee measured in micro-lamports per requested compute unit.

This means that while fees algorithmically scale with increasing complexity and demand on the EVM, the SVM only needs to increase its priority fees with simple demand. The technical issues with the resulting non-dynamic nature are here in detail, but the gist is that pricing a commodity with wildly volatile demand and a deterministic supply in a static manner is not ideal.

Solana’s Fee Market: The Inevitability of MEV

Solana’s social consensus considers its low fees to be its unique advantage over other blockchains. This approach invites spam, so some have called for higher fees or a dynamic base fee during periods of high activity (similar to EIP-1559). Solana’s approach to date has been to implement a localized fee market in response to increases in demand. Because states are isolated, it is easy for the network to identify “hotspots,” or states that are experiencing a surge in demand. This hotspot approach enables the blockchain to algorithmically price higher target transaction fees for transactions in other, less-demand states than in other, less-demand states. This approach is similar to how the block builder role on Ethereum is fulfilled by the scheduler, who helps place transactions in consecutive blocks based on priority fees.

As part of implementing a native fee market, Solana built an in-protocol scheduler that natively schedules transactions for execution based on a first-in, first-out algorithm. Transactions are continuously streamed to slot leaders, which then order them based on the hints they provide.

The algorithm also requires slot leaders to share the shards they are building with some of the nodes they are connected to, based on the latter’s stake. However, as mentioned earlier, this process is disrupted by jitter. Specifically, scheduler jitter (due to Solana’s random assignment of incoming transactions to execution threads) and network jitter (from P2P relay delays for incoming transactions and shards).

These “jitters” cause transaction ordering on Solana to be uncertain, which makes blockspace auctions economically viable. In other words, every time there is jitter, validators have an economic incentive to insert or reorder transactions. For users, this means MEV leakage, and for validators, it means MEV profit.

Solana vs Ethereum

A quick recap of MEV-Ethereum: On Ethereum before Flashbots, MEV activity squeezed out regular blockchain activity, driving up gas prices for all users via PGAs. On Solana, fees don’t spike because it doesn’t have a shared state and a global minimum price like Ethereum, but when activity increases, it becomes difficult for regular users to complete transactions on Solana. Flashbots released MEV-GETH to handle PGAs, creating a separate channel for MEV value that is auctioned outside of the in-protocol fee mechanism. In the case of Solana, Jito launched a similar product for validators, providing them with a pseudo-mempool and a custom scheduler to order transactions in the most advantageous way. Jito's mempool is attractive to users, providing them with a guaranteed right of inclusion in being front-run (aka having their MEV withdrawn).

While a popular product, Jito’s mempool came under social pressure and shut down last month. This was likely for the same reason that over 20% of Ethereum transactions run through private mempools: users got tired of being sandwiched. Spam is now once again the only mechanism on Solana that (probabilistically) guarantees execution of time-sensitive transactions. The lack of an efficient mechanism to bid for block space leads to uncertainty during periods of high demand.

Since transactions on Solana are now streamed directly to the slot leader, and the priority model has been broken, topology (and the resulting latency) is the most important component that users will consider for time-sensitive transactions.

A user's topology in the network can be understood as how "far" they are from the leader, as determined by their stake weight and/or the stake weight of the nodes they are connected to. Therefore, rational agents will seek to connect to nodes that already control high stakes, leading to centralization.

As a short-term consequence of spam, Solana is now so congested that it is virtually unusable for less sophisticated users due to failed transactions . Therefore, addressing the long-term consequences (co-location and centralization of network stake) becomes even more important.

A More Well-Structured Market?

Solana’s original design philosophy centered around removing user friction and allowing validating networks to fulfill demand in any way they wanted. What they overlooked was that markets work best when there is some certainty in how they operate. Fee markets offer a way to democratize inclusion by requiring users to pay more, shifting the problem from a topological perspective to an incentive-based one.

While this changes the user experience, embracing fee markets, and particularly their relationship to MEV, is the best path forward for Solana and its users. Arguably, providing a cost-intensive method of parceling while maintaining the integrity of the chain is much better than having no method at all.

In reality, on-chain activity is almost always time-sensitive, especially when agents seek to extract value at little or no economic cost. Overly deterministic execution is better than cheap probabilistic execution.

(Small sample size, but still!!)

Professionalization of the fee market allows the bargaining and auctioning of blockspace to occur at a higher level, away from consensus and execution. Validators can therefore perform their duties without worrying about optimizing for the best outcome of accumulating blockspace value.

Solana’s Coming MEV Revolution

Solana is in the middle of a chain-wide discussion about how its fee market should be restructured (something Ethereum has been pondering for years but still hasn’t resolved).

Solana has yet to undergo the necessary MEV transformation. While the recent increase in on-chain activity has attracted MEV players like Jito and Ellipsis to begin building MEV infrastructure, major validators have yet to make the leap and start running their own Solana MEV strategies. In stark contrast, all of the major staking providers on Ethereum are running MEV. The Solana validator community is not as adversarial as the Ethereum community, so in order to prioritize the end-user experience, the two sides reached a handshake agreement not to extract MEV (so far).

This situation will not last; the social layer cannot police behavior forever. Blockchains must operate in an adversarial environment of self-interested actors. Solana may fare better than Ethereum because it can solve some of the MEV problems without being as severely constrained by decentralization as Ethereum. However, it will also have to answer some tough questions, such as whether all staked SOL should receive MEV rewards, as Ethereum does with MEV boost?

To solve Solana's congestion problem, we are already exploring some minimization mechanisms. These mechanisms include dynamic fee structures, upcoming changes to the local scheduler spec, stake-based limits, and other application-level optimizations. Things are moving fast. Jito’s CEO recently admitted that “a small group of operators/seekers are sandwich-running private mempools.”

MEV is a hallmark of economic growth and is therefore inevitable. In fact, even Bitcoin, whose simplicity is often hailed as its greatest feature, is beginning to undergo a reinvention after rise of economic activity . Choosing to ignore solutions because negative externalities (like in Jito's case) do not eliminate said externalities, it simply results in an uncoordinated market.

The social layer is an effective tool to deter predatory behavior, but only for a short time. Ethereum is experiencing social undermining with the rise of time gaming , a strategy where block proposers intentionally delay publishing their blocks for as long as possible to maximize MEV capture. This weakens the security of the chain but makes economic sense from a validator perspective. Shame can linger for a while, but protocol research is the only long-term solution.

It’s too early to say what Solana’s MEV supply chain will look like in a few years. But one thing we can be sure of right now is that most of the value will be captured by a large number of validators.

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