Bankless - 170 - Burning MEV with Justin Drake and Dom

Starting point is 00:00:00 We have this positive feedback loop going on because the more economic bandwidth we have, the more decentralized table coins we have, the more economic activity we have, the stronger the shilling points become of scarcity and security. There is going to be, in my opinion, one asset that's going to win the beauty contest, basically, of being the most attractive asset. And right now, ether the asset is the number one contender to winning this. duty contest. Welcome to bankless, where we explore the frontier of internet money and internet finance. This is how to get started, how to get better, and how to front run the opportunity. This is Ryan Sean Adams,

Starting point is 00:00:41 and I'm here with David Hoffman, and we're here to help you become more bankless. Did you know, bankless listener, that in the not too distant future, it's likely, not 100%, but very likely that Ethereum is going to get yet another economic upgrade that will burn even more ETH. David, did you know that before this episode? I do now. I mean, we learned a lot in this episode. This is going to be the biggest potential upgrade to EIF since EIP 1559, at least when it comes to the burn. Of course, you remember EIP 1559.

Starting point is 00:01:11 We talked about it a lot on bank lists in the days before the burn and in the days after the burn. But that was the first of two potential burns that are coming. We're going to talk about the second today. This is called the M-E-V burn. And the guests today call this Ethereum's second business model. A few things we're going to cover. Number one, why MEV, that is maximal extractable value, is so annoying to protocol devs.

Starting point is 00:01:36 Number two, why ETH is not only money, but it's also like oil. Justin uses the analogy of crude oil and petroleum and jet fuel. You'll find out what that means. Number three, why Justin Drake says all validators are losers, but there's a way we can fix it. And number four, we talk about this metaphor, birds, bread, and the MEV burn. What do they all have in common? What is Ethereum's second business model? David, just when you thought you couldn't learn more about ether and the economic potential,

Starting point is 00:02:03 you couldn't get more bullish on ether the asset. Of course, Justin Drake comes in with another episode. This time he's accompanied by another protocol dev whose name is Dom. David, why is this episode so significant? This episode is going to apply a lot of previous bank list content. So we are going to layer on the lessons here in this episode. And I think we did a pretty good job of referencing seeing those lessons that we talk about in the episode. So some previous episodes that we are going to need for the bankless system in order to understand the episodes about EIP-1559, either with Justin Drake in the Ultrasound Money episode or the one that we did about EIP-159 with Hazu. Understanding EIP-159 as a mechanism will be a core building block for this. Also, Matt

Starting point is 00:02:48 Cutler's blockchain supply chain, how a block comes to be mined on Ethereum or minted on Ethereum, which leads into the conversation of proposer builder separation. There's a lot of pre-existing knowledge that culminates in this new upcoming EIP. I don't think we have a number for this yet, but this new protocol change to Ethereum, that is what Justin and Dom say is a logical continuation of EIP 1559. And so there are two main patterns, two main mechanisms of EIP 1559 that are being continued. One about EIP 1559, it actually places an or. of Ethereum into itself. What do I mean by that? Through EIP-159, Ethereum is actually able to see

Starting point is 00:03:31 how much block space is being demanded. It is providing itself with information about how much demand there is for its own block space. And through that mechanism, EIP-1559 allows Ethereum to price itself, a very important mechanism. And then, of course, the second is the burn. These two mechanisms are being extended here in MEV burn to great benefit for many different parties in the Ethereum ecosystem, but primarily the eth holder. And so really the significance here is about the economics of ether. And the other thing to pay attention to is this part of the conversation where we focus on how ether is actually the most decentralized part of that stack. And so the choice to place emphasis on ether is a choice in decentralization. So these I would say are the

Starting point is 00:04:19 themes of the episode to really pay attention to. And if the banklessness or need to pause and go acquire some knowledge from other bankless podcasts before diving into this one, I would definitely recommend you to do that because they are all very valuable podcasts. Yeah, I would definitely say this is maybe 300 level content. And, you know, we thought we were going to do one ultrasound money episode with Justin Drake, but it turns out this is like the ultrasound money never stops because we keep improving the protocol. So if you only gets more ultrasounds. I mean, if you're curious about what this MEV burn is, how much ETH per year it might burn. You know, Justin Drake comes in with numbers, so he's got estimates of that. When is it coming? We have all of that information in the podcast.

Starting point is 00:04:57 And David, I am super excited to actually do the debrief with you after this episode because I learned some things about a theorem I didn't know. And I want to pick your brain about those. So of course, our debrief episode is the episode we record right after the episode. It's on the bankless premium feed. You can access that if you're a bankless citizen. And some citizens have told, me recently, that this is actually their favorite part of the bankless podcast. Some of the episodes, they're just like... Rough, uncut, no agenda, no curation. Sometimes we don't even talk about the episode. I know. We just kind of ramble, and people enjoy that, but maybe the debrief, that's a good addendum to the episode. Anyway, that is available for you. Click the link in the show notes to

Starting point is 00:05:36 upgrade. Guys, we're going to get to our episode with Justin and Dom on M.E.V. Burn, but before we do, we want to thank the sponsors that made this possible, including our number one recommended crypto exchange. That is, of course, the one, the only, Cracken. Go check it out. Cracken has been a leader in the crypto industry for the last 12 years. Dedicated to accelerating the global adoption of crypto, Cracken puts an emphasis on security, transparency, and client support, which is why over 9 million clients have come to love Cracken's products. Whether you're a beginner or a pro, the Cracken U.S. is simple, intuitive, and frictionless, making the Cracken app a great place for all to get involved and learn about crypto.

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Starting point is 00:08:44 And while you're there, sign up for the web app wallet experience as well. So thank you, Ambire, for pushing the frontier of smart contract wallets on Ethereum. Bankless Station, I would like to introduce you to Justin Drake. He is a cryptographic beam lord, a researcher at the Ethereum Foundation and creator of Ultrasound. Dot Money, a website that illustrates the metrics and data around the world's most interesting financial asset, ETH. Justin has helped the Bankless Nation navigate the world of cryptography, crypto-economics, and today he returns to Bankless with a brand new course of study to teach us this time in the world of MEV. Justin, welcome back to Bankless.

Starting point is 00:09:16 Thanks for having me again. And we also have Dom, aka Domithy, the Robin to Justin's Batman, also a researcher at the Ethereum Foundation, and has a comfy sea aboard the ultrasound train as well. He's also played a big role in today's subject behind M-EV-Burn research. Dom, welcome to Bankless for the first time. It's an honor to have you. Yeah, I'm happy to be here. I'm really excited for this conversation, especially when Justin gave me the line that MEV burn is simply the logical continuation of EIP 1559. We've got a great conversation mapped out for you, Bankless Nation. But first, I think we really need to start at the highest of levels

Starting point is 00:09:52 before we map out that conversation just so we can set the stage. Justin, what is MEV burn? Okay, so MEVBern is a very simple idea. Is this idea that all the excess MEVEV that's being generated on Ethereum that is currently going to proposers through what are called MEV spikes, no longer go to the proposers in the form of MEV spikes. Instead, these spikes get kind of smoothed out. So that's one aspect of MEV burn is this smoothing of the spikes. And then the second aspect is the redistribution, meaning that the EF is burnt and it's essentially redistributed to all the if holders. Justin, can we really quick for people who even MEV was too much for them. I think we have to define what this acronym actually means. M-E-V.

Starting point is 00:10:41 So if you're deep in the crypto weeds, you've probably heard crypto folks talk about this a lot in different contexts. Can you define what MEV is for us and tell us why it's important? Why are crypto people always talking about this acronym, MEV? Right. So MEV stands for maximal extractable value. It's basically the value that can be. be extracted by the participants that are running some sort of economic system from the participants, the activity on top of that economic system. So in the case of Ethereum, we have a blockchain, that's the economic system. The participants behind it are the proposers, the attestors, the block builders, the searchers, etc. And the activity is transactions. And it turns

Starting point is 00:11:26 out that these participants that are making Ethereum move forward, block by block, have the opportunity to extract value from the transactions. Now, I'd kind of distinguish two forms of MEV. One is what I call congestion fees, is the more people want to use the chain, the more you have to pay in terms of base fees for EIP-1559. And that is the most common use of Ethereum,

Starting point is 00:11:54 and it leads to, again, these so-called congestion fees. But there is a second thing going on, which is contention. So sometimes you don't, only care about getting your transaction confirmed, getting your transaction included on chain, you also care about specific ordering. And this is for very sophisticated actors, for example, arbitrages that, for example, want to be at the very top of the block. And it turns out that what EIP 1559 did is that it took these congestion fees that were previously going to the consensus

Starting point is 00:12:28 participants to the proposers and now is giving it to the system itself to the EFIF. holders. And what M.V. Burn is all about is basically continuing this story of EIP-1559, but for contention. And so now, you know, we have this potential opportunities to have two separate business models for Ethereum, both in terms of revenue from congestion fees, but also revenue from contention. And it's not just about all sorts of economic advantages that we get from that, but there's also security benefits from the smoothing that I was talking about. Justin, we're definitely going to talk about the smoothing and the security benefits and all of those things. But really quickly, while we're still on the topic of MEV, and bankless listeners, there's a library of previous MEV episodes if you still need to catch up on MEV itself.

Starting point is 00:13:17 But just the Ethereum posture from a protocol perspective on MEV, what is MEV? Is it good? Is it bad? Is it something we're trying to squeeze out of the system? Is it something we're trying to harness and manage? Trying to form an opinion on MEV if it's good. or if it's evil. Right. So, MEV just, it's an emergent behavior. So it's something that emerges from the economic activity on top of this economic system. And from the perspective of a protocol designer, it's kind of annoying. And the reason it's annoying is because it distorts the incentives that we put in place.

Starting point is 00:13:52 Right. So we have these crypto economic incentives, you know, for example, issuance is this thing that we control as a designer of a blockchain. And the MEV comes and distort. these incentives. And so on the one hand, from the perspective of the protocol, we kind of want to tame and we want to mitigate the MEV. But it turns out that not only can we mitigate some of these negative externalities of MEV, but we can actually embrace them. We can harness them. And MEV can actually make Ethereum stronger. It can provide more economic security. It can provide more

Starting point is 00:14:26 economic bandwidth. And ultimately, it can help Ethereum succeed in its mission of becoming a settlement layer for the internal value. As a podcaster, one of the reasons why I love doing a podcast with Justin Drake is because he provides very robust agendas, which makes my job very, very easy. So, Justin, we've got four parts that we're going to walk through. Just part zero, the intro, setting the stage, part one, the mental model, congestion and contention, which you've already established. And then after this, we go into smoothing, which are talking about the security benefits for Ethereum and then redistribution, which are the economic benefits. And so the way I see this conversation going forward is we're just going to start to say,

Starting point is 00:15:02 set the stage, continue to define some terms a little bit. And then we're going to really unpack that mental model of what Justin calls congestion versus contention. And both of these are block space demand, but one is just congestion is just like basal block space demand, the average transaction. And then contention is the demand to be first in a block. And these different demands have different properties. Smoothing is MEV smoothing and redistribution is MEV burn, redistributing it to all eth holders. But Dom, I'm wondering, where do you fit inside of conversation. Where have you specialized? What's your role here when you do a lot of the Ethereum research? What are you specifically researching? And what should we know before we go through

Starting point is 00:15:40 this conversation? Yeah, I'm mostly interested in the way we quantify MEV. We're working with the auction model or having proposers, like impose their view of bids from block builders. So this is like step one of MEPBURN is actually quantifying the bids and the because MEPV is very subjective when you think about it like an RP trudgeer using putting a transaction first the block to extract like one E from like two different decentralized exchanges. That's not something the protocol can be aware of because that's all application level stuff. So we have to use the subjective view of block builders and how much they're willing to bribe proposers. And if we can intern that in the protocol, then that's a way for the protocol to be aware of what's going on like the most objectively it can, even though it's still application level. And once we have this way of establishing the biz in the protocol, then we can proceed to the burn and doing whatever we want with it.

Starting point is 00:16:37 The same way, EIP 1559 has this on-chain Oracle for the base fee. This is what we want for MEV. This makes me really excited because one of the beautiful things I think that got a lot of the Ethereum community excited about MEV was the elegance in the mechanism of actually being able to instantiate what is the market rate for gas on chain. so that now that that kind of becomes like an on-chain oracle of sorts. Like the Ethereum protocol knows something about itself because of EIP 1559. And that thing is, what is the net demand for my block space? That becomes an output that is what the output of EIP 1559, the mechanism is. And I think what you're saying is that we've got this new mechanism.

Starting point is 00:17:20 And this new mechanism actually allows the Ethereum protocol to come up with some quantification of what the level of MEV is going on on top of it. Is that my understanding, Dom? Yes. Cool. It's all external demand that the protocol can be aware of and then do whatever we want with it and tweak the incentive for security

Starting point is 00:17:39 and economic properties, which is all exciting stuff. And this is a really important part of this conversation because when we talk about the two things that are downstream of that, the smoothing and the redistribution, it first starts with understanding how the Ethereum protocol actually quantifies MEV because we need to know how much to burn and how much to smooth, correct? Yes. So where should we start here?

Starting point is 00:18:01 Justin, do we have any more definitions that we need to get through before we get to congestion and contention? I mean, on the topic of congestion and contention, I kind of have this metaphor that I came up with this morning. Let's see how well it sticks. So I kind of think of three forms of oil for e-fready assets. So this kind of crude oil, which is the unrefined format. And this is what you're holding in your wallet in large quantities, you know, in barrels and barrels of oil, you know, stored in cold storage and you're not using on a regular basis. And then you have this more refined form of oil, which is petroleum, that you use on a day-to-day

Starting point is 00:18:40 basis to go drive your kids to school or to go to the grocery store. And what happens there is that basically you take a few liters of crude oil and then there's this digital refining process. which turns it into petroleum and then you go burn it. And this petroleum can go in like most engines for most transactions. So that's the transaction base fee that gets burnt. And now basically MEV is this ultra refined type of oil, this high octane rocket fuel, jet fuel or Formula One fuel,

Starting point is 00:19:12 that is used to fuel a very sophisticated engine, which is this MEV engine, which has this very high performance pistons that are driven by searchers and builders. And really what MEP burn is all about is about recognizing that there's this ultra-refined form of oil that you can harness to improve Ethereum's economic bandwidth, that Ethereum itself as a system can be aware of and can have an oracle for M-E-V. And not only that, but we can remove a lot of negative externalities from kind of leaving this super-refined oil just explode nilly-willy and potentially affect chain stability. Okay, so to put that, I really like that metaphor. So like the average consumer, the average operator of a combustion engine uses the average gas. And when I send ether from David Hoffman.eath to Ryan Sean Adams.combe, that's actually not Ryan's Ether.

Starting point is 00:20:06 I just use normal oil. And that's fine. That's great. That's what I need to do to get from point A to point B. What you're saying is like the contention part of a block, which is that first slot in the block, is a insanely efficient. place in the block because of this, what you're calling an engine, because the reason why you're using that word is because you're looking at the MEV landscape as a system as a whole. We have transactions, and then we have transaction bundlers, searchers who search through the transactions to make a bundle, and that bundle gets conversion to a larger bundle, and that ultimately becomes a block. And we have MEV bots. We have liquidation bots. We have people that are micro-arbitraging uniswap. We have everything, all of the MEV that's all happening, a massive industry, and they're all fighting

Starting point is 00:20:51 for that one slot that in the block, the top transaction slot, because that is where they fight for. They fight for all of that economic activity. And you're saying that that one slot consumes ether to get into that one slot and that's just a highly refined version of ether. Even though it's the same ether that we all use, it's still highly refined because of the net output of that one slot is this massive explosion of economic activity inside of that one block. That's the metaphor, correct? Right. That's correct. So ether is oil. It's money to purchase oil. I suppose. And then there's a flip side, which is just congestion. But I think that's not the subject of this podcast. That was the subject of our older podcast that was just about EIP-1559, right? So this podcast about MEV burn is just primarily about the activity in the contention part of the block space, correct? Right, that's correct. Okay, so we've defined congestion. We've defined contention as well. Congestion is sort of the basal level of block space demand. That was EIP 159. It burnt that. Now we have contention. which is the desire to be the number one transaction, and any MEV burning is going to solve this.

Starting point is 00:21:58 I'm wondering if you could get us to the higher level, because in the next part, we're going to talk a little bit about smoothing and redistribution, so the actual burning of MEV itself. But why are we doing this in the first place? Like, what problem is MEV smoothing and burning actually trying to solve? Justin, you were talking about earlier that the desire of the protocol is a protocol of researcher, MEV is this annoying thing that we have to tame at the protocol level. So MEV smoothing in the burn is one way to sort of tame MEV, but describe to us, what problems are we actually trying to solve at the highest level here as we get into these next sections? Right. That's exactly right, Ryan. So when I first came into this problem, I was trying to fix

Starting point is 00:22:44 some of the negative externalities of what I called MEV spikes. What is an MEV spike? It's basically when you get randomly chosen as a proposer and you receive some unknown amount of MEV. You know, it could be a very small amount of EMI, it could be like 0.01 if, or it could be a massive block. It could be hundreds of EF of MEV. So you participate in this lottery, and that's why we say it's spiky because there's these big spikes and the small spikes. Now, what are some of the negative externalities of MEV spikes? Well, one of the first ones is this chain instability. So the metaphor that I have in my mind is you have a piece of bread and you throw it in the park or you throw it in the pond. And then you have like ducks fighting for it or birds fighting for it or fish fighting for it.

Starting point is 00:23:33 Yeah. And it's complete chaos. And it's a lottery because, you know, if you throw the bread slightly to the right, then, you know, this bird gets it. And if it's slightly to the left, this other bird gets it. Justin is clearly from Britain. I used to do this all the time. You didn't do this, David. I would always target the, you know, that, you know, that. one bird or that one duck that seemed a little weaker than the rest and try to throw the bread directly in front of that one. The benevolent MEV bot, yeah. Yeah, that's what I tried to do. Sorry, I love this metaphor, Justin. Continue, please. And what it means in practice is that these various participants that try all sorts of attacks. They're going to try dedossing each other. They're going to try eclipse attacks. They're going to try chain reorgs and propose their equivocations. And they're going to try anything to basically catch the MEV. So some birds have teeth and claws that the other birds just don't got. Yeah, exactly. You're incentivizing people to come in with their teeth and

Starting point is 00:24:25 their claws and their guns to try and hit each other. But, you know, if there isn't a reward, you know, we don't need to be hitting each other. We can all live in peace and have a stable chain. And like one maybe vivid example is, you know, what happened historically with Binance. Binance got hacked for many, many, you know, hundreds of Bitcoin. It was, I forget the exact amount. And one of the things that they were considering doing is revealing the private keys for those Bitcoin. thereby incentivizing the miners to go back in time, to reorg the chain, and to basically fight the attacker, take a cut for themselves, and return the bulk to Binance.

Starting point is 00:25:00 And the Bitcoin community was very scared about this because it would lead to potentially massive chain instability. Now, the good thing is that if an equivalent scenario happened, you know, Binance was hacked, but this time it was If, not BTC, and we had MV burn, then the mere fact of releasing these public keys would effectively burn all the EF. And so there wouldn't be anything to fight over. And this goes back to, I think, when I was just first trying to wrap my head around MEV,

Starting point is 00:25:27 a very clear articulation of why MEV can be fundamentally bad. My new instances of MEV, like you said, Justin, just is. But from a chain stability perspective, they can be massively chaotic. And I think the simple example is that, just to use nice round numbers, ether every single block, Ethereum every single block, issues two ether per block as a reward. And then there's MEV, like, gas fees on top of that. And because of Defi and smart contracts, we have these opportunities that oftentimes can be much larger than the value of a single block. And so if the rewards for

Starting point is 00:26:00 mining a particular block are like 10-Eth and Ethereum is only issuing two-eth per block, then that block that has a 10-Eth reward isn't actually considered secure until there's 10 more ETH issued in block rewards for the next corresponding blocks to lock that value into the chain. And so until if a very large block gets mine, and sometimes we've seen blocks in the Ethereum world get mine that are like 60 to 100 ether. And so you can't really consider these blocks finalized until there's a sufficient level of economic weight in front of those blocks to like embed the big blocks into the chain. And this was like the original way to understand the dangers of MEV. This is a mechanism just in what you're saying,

Starting point is 00:26:44 MEV burn and smoothing, that directly goes after this phenomenon. which takes MEV spikes and smooths it up, and hence MEV smoothing. Right. I mean, this is especially true with Bitcoin, where they only have proposers, not attestors. And so if there's a very, very large bounty to go back in time, then you need to take these bounties into account in addition to the issuance. In Ethereum, we have this other mechanism where the attestists come in, and they provide economic weight, and they don't really have a dog in the fight,

Starting point is 00:27:12 and so they're a little bit more neutral. And so Ethereum will converge eventually, even if there is. like this big MEV spike, but kind of locally it could lead to these chain and stability. So, Justin, back to the bird analogy, rather than just throw one big hunk of bird and then watch all the birds kind of fight, what you're doing with MEV smoothing is you're just dividing that chunk of bread into all of these bitty pieces and you're somehow letting all of the birds take it at once. Yes, for just being a bird.

Starting point is 00:27:42 Yeah. That feels very nice. That feels very egalitarian. It feels like the, you know, some of the weaker birds. actually get a shot at getting fed rather than the big birds, you know, the teeth and, you know, just plowing their way to the front, don't get all of the food. That would make childhood me very happy if I had that sort of protocol in bread distribution. And just to be really specific, the weaker birds are the lower capitalized hobbyist solo stakers. And then the big birds with guns and teeth

Starting point is 00:28:10 and claws are like the data center birds that have fiber optic connections, just to make that extremely specific. So Dom, I think this conversation now needs to turn to how MEP smoothing and burn actually happens. And this is, I think, where your role and your research at the Ethereum Foundation starts to play in here, because we're going back to, like, we actually, the protocol, Ethereum, the protocol needs to do this autonomously. Therefore, the Ethereum protocol needs to be able to measure the size of the breadcrumbs that are being thrown out to all of the validator birds. So can you walk us through that process? How does the Ethereum Protocol, come to understand the size of the bread.

Starting point is 00:28:46 Man, I love this metaphor. So today, there is no mechanism for that at all. All the MEV, the pro, we would need proposer, builder separation enshrined in the protocol. Because today we have MF Boost, which has this PBS, but out of protocol, with the relays acting as the brokers to receive bids between builders and relay them to proposers and then brokering their relationship and having all the trust to them. But what we wouldn't want is Enshrined PBS for not only removing this trust and having a fully trustless and unconditional payment between builders and proposers, but also having

Starting point is 00:29:25 protocol be aware of the bids. So one way to do that, well, first, there's all these designs proposed for Enshrined PBS, which is the first step for MEV burn. And there are a few mechanisms to do that, one of which is having simply. bids be a part of the beacon chain, having a structure for where builders are supposed to send their bids instead of relying on external protocol like MF Boost. And once we have that, then we can have the attestors impose their view of bids on the proposer so that if they say they're all hearing builders bid one-eath-two-eath, and then the proposer says, okay, I'm going to bid zero,

Starting point is 00:30:08 and then I'm going to just steal the MEP. Then that's not going to work because other attestors are just not going to vote for that block. So that's like one high-level overview of how we can have not only be aware of bids, but also impose this view on the proposer. Dom, are you saying that PBS, by the way, a bankless nation, if you're not familiar with that term, it's not the broadcasting network in the U.S. PBS stands for Proposer Builder Separation. We've done entire episodes on this, and we will include links in the show notes to get you caught up. But this is a future Ethereum Protocol roadmap item that we've been wanting to achieve.

Starting point is 00:30:42 And it's not going to happen this year. It's in the more distant future than this year. Proposer, builder separation. Are you saying, Dom, that PBS, some version of it? is a requirement to get us to M.EV burn and MEV smoothing that we're going to talk about in the rest of this episode. So first things first, we need PBS at the protocol layer. We need to deploy that. Then we'll have visibility into the MEV. Is that what you just said? Yes. Got it. And I think really the episode that we did with Matt Cutler from Block Native

Starting point is 00:31:11 talked about the Ethereum block chain supply chain, which is fun to say. And really the proposer builder separation proposers are people who are proposing a block. That's Ether. stakers, just and correct me if I'm wrong, but proposers and ether stakers are largely synonymous. And then before that are the block builders. So instead of the ether stakers, again, which we want the supply chain of the Ethereum blockchain, to be maximally accessible to the average retail individual. So we've separated the role of building a block from the ether stakers, and the block builders just compete by submitting bids to ether stakers as to which block to propose. And so the proposers select the highest bid block because they want to be paid the most amount of ether.

Starting point is 00:31:55 And all of the very computationally intensive and high resource constraining role of building a block, putting all the transactions in the correct order, running all the computation to make sure you're maximizing MEV. All of that is done by a very specialized entity that's hard to compete with. But they just bid for block inclusion by ether stakers. And I think, Dom, what you're saying is that through the process of proposer builder separation and then the also the earlier step of transaction bundling, there is a pseudo-orical process that is able to be contained step by step by step that ultimately becomes converged onto the actual block builder and block proposer. And because of the each transaction inside of a block has a small amount

Starting point is 00:32:39 of value associated with it, all of that gets aggregated into some sort of Oracle that gets passed along to the block proposer. And the Ethereum in blockchain actually can ingest that information and use that as an oracle. That was my best explanation at this. Yeah. So what happens is that enshrined PBS basically takes the bids and formalizes the notion of a bid in the beacon chain. So the beacon chain is aware of these values. So there's one value, one bid per block. It could be 10th, could be 1 if, could be 0.1 if, whatever. Now, the question is, how do we know that this value that is on the beacon chain is real, that it reflects reality? Now, there's two things. things that could happen. One thing that could happen is that the value is like artificially high.

Starting point is 00:33:27 Like someone says, okay, I have a bid of a thousand if when there really isn't a thousand if. And, you know, this is something that you can do today. Like I can create a transaction from myself to myself, you know, as a proposal. And I put a 1,000 if kind of tip. And, you know, it's kind of a no-up because I'm spending 1,000 if, but then I receive it as the proposer and the recipient of the tip. And what the burn does is that it makes it real in the sense that you're no longer incentivized to kind of cheat by artificially inflating the Oracle. But then there's this other thing that you want to prevent is people artificially putting a low value of the burn. And the way that you do that is you invoke the attestors. So anyone can observe this bid pool.

Starting point is 00:34:12 In particular, the attestors can observe the bid pool. And if you pick a value of the bid which is too low, which is not the high. is bid, then the attesters are just going to say, beep, your block is just not going to make it on chain. And so you lose any opportunity to build a block. So basically, we're enforcing the correctness of this bid value, the fact that it reflects reality as the highest paying bid using the attestors. And now that we know that this is a true Oracle value that reflects reality, we can go ahead and burn it. I would say there's another parallel with 1559. The way that the concession pricing is now enforced by the protocol itself.

Starting point is 00:34:49 Because we had, back in the day, we had mining pools that would, like, they would have side contracts or they would, since they're in control of the contents of the block, they could put in zero go-way as gas fees and just have free transactions. But now with 1559, everyone else is just competing for that space, including the block builder himself. So they can still have side contracts and say, you don't have to put a priority fee, but they still have to pay the base fee. like someone somewhere in the chain has to pay the base fee.

Starting point is 00:35:18 So this is the same idea with MEV burn. It's just to impose this contention pricing on everyone, including block builders and proposers, so that side contracts are not encouraged. And the shelling point is the protocol mechanism to capture most of the value. Right. And this was a big part of EIP-159 as a topic of conversation. There was just early thought experiments about actually you could strip out ether from being the native currency of a because miners could just use fiat payments or stable coins as the currency of account.

Starting point is 00:35:52 And EIP-1559 just completely eliminated that by actually enshrining ether as the enforced unit of currency to pay for transactions in Ethereum block space. And Dom, what you're saying is that this just now, because of this mechanism that we have, this pseudo-oracle, if you will, to understand the measure of MEV, we can extend that functionality to enforcing economic activity to also be known and quantified and verified and verified on chain. And so, Rhine and I like to put these systems into nation-state government and just nation-state law perspective sometimes. And, like, governments love, like, want all economic activity to be in the light, right? There's, like, black market activity. There's, like,

Starting point is 00:36:34 side dealings. There's untaxable economic activity, or not untaxable, but untaxed economic activity black market activity in every single part of the world. And same thing with Ethereum in this particular world where MEV people can route around the protocol and just do some back alley dealing to get blocks included. But now, Dom, what you're saying is that with this mechanism, Ethereum, the protocol has a way to actually measure the economic activity that's being expressed and to put that into an article and say, you must pay at least this amount to have your block included. Yes. David, you just reframed it. And so now I'm looking at Dom and Justin. I'm seeing IRS agents right here trying to tax all the transactions here. I mean, there's an element. That's a great metaphor,

Starting point is 00:37:16 because there's definitely an element that that's true. The protocol wants all of these black market off-chain sort of activities enshrined inside of the protocol. So it can be kind of measured, and so that the carrot and the stick incentive mechanisms that govern and make Ethereum work can actually be activated. So bankless listener, I know we've talked about a lot of things, but I just want to put a few ideas in your mind here, right? Because we're deep in the protocol of research. field of things, right? You know EIP 1559, okay? That is the protocol, the change, the upgrade to Ethereum that started burning Ethereum and helped solve the congestion issue. The basal level of blocks-based demand. Now we have a more efficient mechanism for partitioning that out. We created

Starting point is 00:37:59 this Oracle, so Ethereum becomes self-aware of how much block space is demanded, how much it's consuming. This does the same thing with contention. And remember, contention is that desire to be the number one transaction. So we are talking about at the highest level, something on the order of importance of EIP 1559. And if you were here, I think bankless talked about EIP 1559 about like for two years before it happened. That's how excited we were about it because enshrined ETH, it solved the auction mechanism, it made ETH more money. There were all of these fantastic properties. And so I want to get us to you. That's the context, though. That's how big this is. That's how important this is. I want to get back to defining smoothing and a redistribution of this MEV in a bit more detail.

Starting point is 00:38:48 So remember, our bird analogy, okay, so we're talking about rather than throw large hunks of bread out to all of the birds and watching them fight, as fun as that is, if you're a torture, you know, individuals as a child, we get to be much more egalitarian and fair, and we get to parcel all of that hunk of bread into all of these pieces and smooth it out across all of the birds, okay? Can you talk to us about the security benefits of this, Justin, right? So it feels nice. The birds all get fed and everyone's equal. That feels nice. But there's actually, I know you guys are protocol researchers, so you care most, not necessarily about the birds. That's important, but you care about the health of the network. You care about the upside benefit, the positive,

Starting point is 00:39:28 expected value. So give us the case, why does smoothing actually achieve greater economic security for Ethereum, Justin. Right. Okay, let's try and keep this analogy. We care about the health of the flock. Now, the first thing that it does to kind of give everyone an equal amount is that there's no more fighting, right?

Starting point is 00:39:49 Everyone gets a fair share, no more fighting. The other advantage is that you remove the lottery aspect, and so there isn't winners and losers. And it turns out that on Ethereum today, almost every validator is a loser. And what do I mean by this? that, I mean that the median reward that you get is much significantly lower than the average reward.

Starting point is 00:40:12 And the reason is that every once in a while, there's this mega block that comes in. So the highest MEV block so far has been around a thousand eath. A thousand eath? Yes, it was almost a thousand eif. What did they do to get that? They were just lucky. They bought a lottery ticket by, you know, being a validator. And every once in a while, we have this massive jackpot.

Starting point is 00:40:32 And so this one validator, he has like a huge amount of APR, whatever it is, like a thousand percent or 10,000 percent. The entire loaf of bread here is what we're talking about. Yes. And then everyone else who didn't get a cut of that 1,000 if is a loser. And it's just like when you're playing lottery, right? Everyone spends one dollar buying the lottery ticket and almost everyone loses the $1. But then there's this one guy who just happens to win, you know, $100 million. And so right now we're all losers.

Starting point is 00:41:02 and we're risking a situation with Bitcoin mining. So there's this incredible statistic with Bitcoin mining is that if you buy a Bitcoin mining rig and you run it for five years continuously plugged in, more likely than not, this mining rig will never produce a block. So we will never earn Bitcoin. And so Bitcoin miners are economically forced to join mining pools. Otherwise, they're just playing a lottery. They're just gambling.

Starting point is 00:41:29 It's forced centralization. It's forced centralization. And the same thing is happening with Ethereum to a low extent, but it's still happening. And so if we can give everyone the same APR, the same average APR, then we're kind of allowing solar validators to enjoy this average APR without having to join a pool. Yeah, to really drive this point home, I would say bring back the concept of MV spikes. And you can think of, let's say it spikes over the length of 10 blocks. So that first block is 1-E, then it's 5E, then 10-E, then 15-8, then it goes back down 5, 10, 10,

Starting point is 00:42:01 10 5-1 over the length of 10 blocks. If you're a solo validators with your 32Eat, you have like 1 in 500,000, however many validators there are. That's your odds of proposing a block and then times 10, which is still very low. But if you're a staking pool that has 30% of the stake, then you're going to get on average three out of those 10 blocks. So that MIV is more likely than not going to the pool.

Starting point is 00:42:29 So if you're a rational actor, do you want this variance with this near guarantee of having none of this 10 block spike? Or do you want to join this pool and be exposed proportionally to those spikes? So this is what we want to remove to get to a world where controlling X percent of the stake gets you X percent of all rewards nearly guaranteed. So, Dom, that's a great point. Justin, have you coined the phrase to describe this? I see this in our notes prior to coming in. rug pool protection? So not rug pull, but a rug pool? What is a pool that rugs or a rug pool? And how does smoothing protect us against that? Right. So this is a third way in which MEV smoothing can

Starting point is 00:43:10 improve the security of things on Ethereum. And the rug pool is a portmanteau of rock pulling a staking pool. And the way that a staking pool can get rug pooled is by operators. So imagine is taking pool like Lido or like Rocket Pool. You have operators. People can come forward as an operator and when they come forward they have collateral. In the case of Lido, it's reputational collateral. It's also legal collateral, legal liability. In the case of Rocket Pool, you don't have this reputation or this legal liability. You can come in anonymously, but you need to put in financial capital. You need to put in 4E for 8E for whatever it is. Now, let's imagine that an M.EV spike comes in, an enormous, you know, a metric ton of bread comes in. And this metric ton is worth

Starting point is 00:44:03 more than your collateral. Then what are you going to do? You're going to pick the metric ton and you're going to forego your little collateral, which is your little baguette. And so really, staking pools are in this dangerous and precarious situation whereby whenever a massive spike comes in, they could get rock pooled. And so when you do MEV smoothing, you are actually making it much, much easier to build decentralized staking pools. So this is also really important for staking pools as a whole. So the way rocket pool works now with their most recent upgrade, you can spin up a validator, a rocket pool validator with only a ether. And then you allow 24 ether from other people's ether to come into your validator. And then that's how our eth is vinted. The idea is that you can

Starting point is 00:44:50 actually take, if you have 32 ether because you're a solo staker, you can actually split that ether up into four rocket pool notes. But that actually gives you a four times larger net to cast, to capture the potential 1,000 ether block that comes in. And so this is actually like an exploit attack on something like a collateralized taking as a service provider like Rocket Pool, where somebody can just explicitly come in, spin up as many Rocket Pool, MiniNoze as possible, and then cast a wide as net impossible with the intention of rug pooling whenever possible. But now with MEV smoothing, this is a protection against that mechanism.

Starting point is 00:45:28 So this is also an economic upgrade for collateralized staking providers, correct? Exactly, right. Okay, so what I'm hearing from both of you guys in the benefit of smoothing, the security benefit of MEV smoothing, is basically decentralization, rather than the birds pooling together in these clusters of birds and becoming like super bird organisms and colluding with each other to get the hunks of bread proportionate.

Starting point is 00:45:55 Being the bigger bird to fight the littler birds. Yeah, or rather than being the bigger bird with the claws and the teeth to fight and trample over the little birds, we want all of the solo staking little birds to get their share. We want to keep the Ethereum network decentralized. We want to be a collusion cabal-resistant protocol for all the birds out there. So decentralization, that is the,

Starting point is 00:46:17 the big win here in MEV smoothing. In order to get to MEV smoothing, of course, we have to have proposer-builder separation, so PBS included, and then acts as an Oracle, and we're able to identify the MEV, and now we're able to partition it across everybody. So I think maybe we've captured that. You guys feel free to add, but let me tee up kind of the next question. So now don't we have to decide, don't we get to decide, okay, who gets the pieces of bread? Is it a particular set of these birds? Is it the ducks, or do the seagulls get some to? Or how about the swans?

Starting point is 00:46:56 They're very pretty. Which of the birds in our flock? And, you know, you guys are protocol designers. So you want to protect the health of the flock, not just the individual birds. So who gets the pieces of bread that we're partitioning out? And I think that gets into this third part, which is burn, redistributing all of the block rewards. The detail is basically, do we give the little crumbs of bread to the validators or do we give it to the eif holders? There's no spreading over time. It's actually kind of over space, right?

Starting point is 00:47:27 Yeah, that's kind of how I understood it. You just either give it to the validators or you give it to the eth holders, which are obviously eth holders. So do you give it to the whole flock or just do you only give it to the ducks? You know, it's kind of the question. Wait, so M. MV smoothing. Sorry, just sort of make sure I'm understanding. I always thought that like if there's a 1,000 ether block that's my minted from MEV, then that MEP, that ether that's captured, I thought that gets like trickled down over the next few blocks does not happen. Okay, so Ryan's question is like, where does that ether go? And then I interrupted him because I didn't understand it, but turns out that was the right question. I could get this one. Again, it's a highly parallel with 1559, the way the mental model for blockchains that we had before 1559 was you pay gas fees.

Starting point is 00:48:14 this is how much I want to pay to get my transaction in the block. Naturally, that goes to the miner. That was the status quo. And then 1-559 kind of changed that into the minor is getting paid with the block reward. The gas fees is a result of the blockchain providing like a value. So that value really should go to the blockchain. It should not go to the minor because that was, we challenged the status quo. And then this is what we're going to do with PBS and MEV burn is today the natural result.

Starting point is 00:48:44 Whether we use MIF Boost or not, the natural result is always going to be that proposers get MV because at the end of the date, they have a monopoly over the content of the blog. And whether they extract MBV themselves or have a side contract with the block builder, they're going to pick the highest bidder always and get this value. And we have to challenge this notion that proposers are entitled to this value because really it's still value that's being generated by the Ethereum ecosystem, the Ethereum economy on chain and everything. And it goes back to what Ryan was saying earlier, that me and Justin are like RRS agent taxing the economy. There's like two points on that. It is kind of like a tax, but we want to do it in a credibly neutral fashion. Like just like 1559, we could take the base fee and instead of burn it, send it to the Ayrn Foundation and promise to use that for public good. But we're building a permissionless, trustless system.

Starting point is 00:49:40 So we can't rely on having to trust like the tax authority. the same way the US has to trust the RS to properly redistribute this revenue to public goods and everything, because we're building a network state on Ethereum. And this tax, the most credibly neutral way to do it is simply burn it and redistribute it across all ethelder and make the ether asset more scarce to increase security of the blockchain. Okay, so I want to make sure I'm understanding this. And by the way, Dom, when you said proposers, right, some people will be thrown off by that. that is the same as validators? Yes, because the way I see it, the validator has two responsibility today is to attest, like voting on what they believe the current head of the chain is, and it's all set up so that it converges to one blockchain.

Starting point is 00:50:28 And their second responsibility is once in a while they will be irresponsible for proposing a block that other validators are going to attest to. So in the context of block building and MEV, we use proposers. You know Uniswap. It's the world's largest decentralized exchange, with over $1.4 trillion in trading volume. You know this because we talk about it endlessly on bank lists. It's Uniswap.

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Starting point is 00:53:57 of having to explain crypto concepts to your friends? Go to learn.menomask.io and add Metamask learn to your guides to get onboarded into the world of Web3. So proposers equals validators sort of the same thing. Those who stake, those who run a validator. Okay, so picture this. I refuse to be pulled away from the bird analogy here. So we have a flock of birds. There is one subset of those birds who are actually in the pond. The rest of those birds aren't around, aren't in the pond. Okay, the birds inside of the pond, those are the birds that are proposers. Those are the ones that are validating. Those are the ones that are staking. And so you guys, as the caretakers of the flock, you want to make sure that the entire flock is healthy and

Starting point is 00:54:38 supported and decentralized. And so you're saying, well, there are kind of two categories of birds we could give this reward to, this hunk of bread. One is we could just give it to the birds in the pond, those that are staking, essentially. Or in other categories, we could give it to all of the birds in the entire flock, whether they're in the pond, staking, run a validator, or whether they're outside on the edges of the pond, you know, somewhere in the kind of the, you know, the woods, somewhere else, the entire flock.

Starting point is 00:55:04 The mombirds that are still sitting on the eggs. Yeah, doing all the world. in the background. They don't know that there's a pond. They need some bread too. They totally need some bread. And so we care about the health of the overall flock here. And so the entire species. Yes. All the birds. We love them. What was decided by protocol engineers in EIP 1559 was we're not just going to give it to those who are staking. Okay. That would be the equivalent of a transaction fee. If you paid kind of the ether reward in a transaction fee, we're going to give it to the entire flock. And the way you give it to the entire flock in Ethereum, the entire network of birds is you burn it.

Starting point is 00:55:41 Why? Because that decreases the supply for anyone who holds eth. So essentially, you're giving kind of like a dividend, almost like a burn dividend to like all of the birds in the form of reducing total eat supply. And so you're saying, Dom, that the choice of MEV burn, an MEV smoothing, is effectively not to give the MEV just to the birds that are lucky enough. to be in the pool and validating and proposing blocks, but you're giving it to the entire flock. How? By burning it.

Starting point is 00:56:12 Is that inaccurate or have we stretched this analogy far too far, Dom? I think it's fair to say, like, the economic activity, the value extracted from all the economic activity. In a way, it belongs to no one and it belongs to everyone. And there's a caveat on that. It's like good MEV versus toxic MEV. Like in the case of toxic MEV, like getting sandwich your transaction, This is obviously value that's being extracted to one user.

Starting point is 00:56:39 So ideally we want to get rid of that and have the user keep that value by getting a good price, which is something we could get into later with the MEV rebates. But in the case of arbitrage between decks and decentralized exchanges, this is value that was generated by many, many people. So we can't really give that value back to these individual people. So the next best thing is just to burn it and give it to no one and give it to no one and give it to everyone. And to be clear, you're just burning all of it.

Starting point is 00:57:08 Because you can't tell the good versus the bads, you just burn it all neutrally. Yes. But there are other proposals to get rid of toxic MEPV, like encrypt and memples. But that would still keep the good MEPV, like being the first in the block to arbitrage all these decentralized exchanges. And that would still be MEP that gets burned and given back to everyone.

Starting point is 00:57:27 The endgame is that MEP that originates from a given user goes back to the user. basically users have sovereignty over the MEP. And there isn't the infrastructure right now to do the rebates, to do the refunds, but this is coming in a matter of months because multiple companies are working on it. And then once you've removed this toxic MEP and you've kind of rebated it back to the user, all the excess MEP, the latent MEP from arbitrage, this is what we're talking about. This is what we're going to burn. So I've got Hildobie's dune board up.

Starting point is 00:58:00 Great dune board for understanding Ether and Etherstakers. And right now we've got 15.7% of the supply of ether that is staked to the network. And I think the philosophical reason as to why MEV burn is good is simply answered by the supply of people who are holding ether. So if only 15.7% of all the ether is staked, that means the supply of ether that's unstaked is roughly six and a half times larger than the staked eth. So when we, instead of giving ether the MEV burn to ether stakers, and instead we burn it, we are implicitly giving it to all ether holders.

Starting point is 00:58:38 That's a supply of ether that is six and a half times larger than the supply of ether that is staked. Also, the people doing the ether staking are predominantly ether whales more than the rest of the ether. So the people that are owning the remaining 85% of all ether is everyone else, what Justin called the user. the transactors. And so the mere function of MEV burn is doing the thing that Ethereum has always been philosophically aligned with, which is maximally enabling the widest participant, the most marginal person in the whole entire supply chain. And that is the ether holder. So you as an ether holder are the person that can benefit from all of this robust supply chain. And that is the most accessible part of the Ethereum technological stack.

Starting point is 00:59:30 Because even if ether staking, which has the complexity of this, has been, like, extremely reduced down to its near theoretical minimum, buying and holding ether is always going to be easier than that. And so M.E.V. Burn, maximally enables the mere ether holder, the mere pleb of the world who can just hold some eth. I mean, most of the flock isn't in the pond, is basically what you're saying. And so it's really cool to be able to, like, secure the Ethereum network by what? Being a validator is a super class of this. but just by buying ETH, effectively you are securing the network, aren't you? That's a pretty big dream for protocol engineers, I'd imagine, because as you were saying, David, what could be more decentralized than the actual distribution of ETH is one of the most decentralized

Starting point is 01:00:13 things we actually have in this entire ecosystem? And Justin, I introduced you as a crypto-economic meme lord. When the value of the Ethereum supply chain blockchain does get ultimately funneled to just the ETH holder what would you say that this does to the legitimacy of ether the asset? Right. So it turns out there's multiple economic benefits that come from burning the EF. And, you know, we could maybe start go through them one by one. One of them is that it actually makes Ethereum run smoother.

Starting point is 01:00:46 It makes the economic efficiency of Ethereum go up. And what do I mean by this is that we have this consensus engine, which is securing Ethereum, and basically we need less fuel to run it. So right now, the way that we've designed the consensus engine is that with issuance alone, you can secure Ethereum. So anything on top of that, any additional fuel beyond issuance is wasteful. And so right now we're kind of overpaying for economic security. And so we have the opportunity with MVBurn to run this economic engine more efficiently. Another very important thing is economic bandwidth.

Starting point is 01:01:24 There is a possibility that, you know, for example, we're entering. a ball run and there's going to be lots and lots of MV, lots and lots of transaction fees. Now, what will happen in that instance, what will happen is that the rewards to becoming a validator will go up and more, more validators will come in. And that will suck all the if towards staking, towards securing the base chain. And there won't be much if that is available as economic bandwidth to be used as collateral by applications. Now, I believe that Ethereum needs very, very large amount of pristine raw eph as collateral for applications, for example, for decentralized stable coins. We want to have trillions of dollars of decentralized

Starting point is 01:02:09 table coins, and we don't want all the eph to be sucked out for staking, because that's not the most utilitarian, the most useful way of allocating ether. Another very important thing is around economic sustainability. So right now, the sustainability of the sustainability of of ether the asset hinges on one single business model, which is congestion fees. And there is a possibility that this business model will get eroded or jeopardized over time. And the reason is that congestion only happens if there's more demand than there is supply. But we live in an exponential world with technology, right? We live in a world where supply grows exponentially.

Starting point is 01:02:52 There's this equivalent of Moore's law for bandwidth, which is called Nielsen's law. Law says that every year consumer bandwidth grows by 50%. And so if we have this exponential growth of block space supply, then we might essentially have infinite supply and the congestion fees will go to zero. Whereas contention is something that's kind of always there. It's latent. It derives from these market inefficiencies that can be arbitrashed out. And so now we have these two business models.

Starting point is 01:03:24 If one of them fails, it may be okay because the other business model. comes in. That's really fascinating that business model idea, Justin, because, you know, one thing we've tried to reinforce on bank lists and people are trying to understand blockchains is what products do blockchains produce. We always say this. Blockchain sell blocks. That's the product that they actually sell, right? Blockchains sell blocks. Yeah. And we've compared it to sort of like Apple, right? So the value of an iPhone is worth more than sort of a, you know, a commodity phone. You could see that in the profit margin. So, you know, Apple sells really good phones. And so they're able to charge a premium. That's why there's a premium on Ethereum Blockspace. What's also interesting is this idea of a second

Starting point is 01:04:01 business model here. If you notice that a company like Apple, their first business models, they sell the phone, they sell the hardware, they make $1,000 a phone, that's fantastic. They also have other business models, one of which is like App Store 30% tax on everything. And that's their second model kicking in. And you're saying, you're implying something similar to Ethereum. Of course, a little bit different, not the same mechanics, but its first business model is congestion. second business model is contention, and you're kind of able to sell both of those products to the highest bidder. That is a really cool way to look at the economics of this thing that we're building to understand back to what is the fair market value of Eath, which is the market is trying to figure

Starting point is 01:04:41 out. This is primary information that goes into those valuation mechanisms. I just wanted to make that point. I think you had another comment on this as well about the benefits. Right. I mean, we can try and quantify, you know, what are the benefits of adding this second business model running in parallel with the first business model. And the way that we can quantify that is by just asking ourselves, you know, how much more burn would we have had we had MEP burn? And the answer is on the order of 250,000 if per year. And that's during the current conditions, kind of the bare market conditions. Wow. But actually, the story gets even better because remember how I was saying that by burning the MEV,

Starting point is 01:05:25 you actually have a more efficient consensus. So that means that you're issuing less. You have to issue less to pay for security because the more validators come in, the more issuance there is. And that is a roughly 200,000-if improvement over the status quo. So we have two benefits to MEV burn.

Starting point is 01:05:44 The first one is that we'd be burning on the order of 250,000 if per year. And on top of that, would be saving, you know, 200 eph that we wouldn't be printing, that we wouldn't be issuing. So it roughly speaking, it's a half a million eph per year optimization that we have as an option. So MEV burn is a half a million per year optimization? Yes. Okay, so I've got ultrasound.com money.

Starting point is 01:06:08 That website is made by Justin Drake here. So the man right in front of me. The merge happened 230 days ago. And we have burned 135,000 ether. I am famous on bank lists for being terrible at math, but I think that means we are roughly two-thirds through the year. So if I multiply 135,000 by 1.33, we get to 180,000 ether that is burned under an EIP-1559 paradigm post-merge. And so you're saying that MEV burn is going to burn an additional quarter million on top of that. Yes, the net supply will decrease by another quarter million.

Starting point is 01:06:47 And so it will roughly double the speed at which the supply would go down. That's only including the burn. But then if you include the savings from issuance, it will actually triple the speed at which the supply has gone down. And the reason is that the issuance, you know, there's a saving of roughly 200,000 eph per year. So if we had had M&V burn right now, we would have decreased the supply by roughly 400,000 if

Starting point is 01:07:14 instead of only 135,000 if. Wait, can you explain the mechanism of we actually have to issue less ether? Maybe I missed that part. Can you explain that? Right. So there's two rewards for the validators. The first one is issuance and the other one is MEV. And so the higher the MEV, the more of an incentive there is for validators to come in.

Starting point is 01:07:34 But the more validators there are, the more issuance there is because the total amount of issuance grows with the square root of the number of validators. So if we remove MEV from the equation, we only have the number of the number of a validators that is required to secure the chain, and no more. There's no wastage from an issue and standpoint. So the net effect of MEV burn will actually be a transfer of wealth from ether stakers to ether holders. And so there will be a lesser incentive to stake ether because the yields to e-staking will actually go down. But everyone knows there's a reciprocal relationship to yields and principal value. The idea is that the yields to e-staking will go down,

Starting point is 01:08:14 it will fall probably down to the rate of ether issuance, the yield from ether issuance, and therefore the supply of e-stakers will go down, but that's because we're going to burn more ether. So in theory, the reciprocal relationship of principle to interest, interest goes down, principle goes up, and what is principle other than the value of ether? That's my understanding, is that correct? So there's actually some subtle things going on. And one of the very common question that I get is, is MEV burn to the detriment of stakers, right? because we're removing one of the incentives to become a staker.

Starting point is 01:08:47 And so you'd think that maybe your APR as a staker will go down. Now, my response to that is that no, is actually not only not to the detriment, but it's to the benefit of stakers, but I need to kind of make my case. So in an efficient market, the rewards for staking will tend to the cost of money. What do I mean by that?

Starting point is 01:09:08 When you're staking, you have various costs. You know, you need to run a node, you need to pay for the bandwidth, if you need to pay for the electricity. But you also need to pay for what's called the opportunity cost of EF, right? Because you're taking this EF and you're locking it in a black box and you could be locking it in a different black box. For example, you could be putting it in defy yield somewhere and getting some percentage.

Starting point is 01:09:29 And so there's this concept of the opportunity cost of money. And by far the biggest cost when you're staking is the opportunity cost of money. Now, let's say that the opportunity cost of money is 2%. Well, what will happen is that organically, the staking use, will tend towards 2% in the competitive market, and the reason is that the margins go to zero. Now, whether or not there is MEV burn, the rewards will tend towards the cost of money over time as an equilibrium. So from a if-denominated standpoint, you get the exact same percent. So if you have a 2% cost of money, you should expect that every validator gets 2%

Starting point is 01:10:04 of 32-if, which is 0.64 if, regardless of whether there is the burn. But now let's think from a USD denominated standpoint, right? Because the burn increases the scarcity of EF, it fuels this value in the price of EF. And so the price of EF should go up. And so as a staker, you're actually making more returns from a USD denominator standpoint. Now, the other thing worth mentioning is that

Starting point is 01:10:30 for the average validator, as I mentioned, we're all kind of losers and there's a few jackpot winners. And so not only are we increasing the returns from a USD perspective, but we're also moving the median up to the average, which increases rewards for everyone. And there's this additional thing, which I mentioned, is that if you're participating in a pool, then you won't get rock pooled.

Starting point is 01:10:51 And so again, that will increase your APR. Okay. The supply of ether stakes is going to go down probably, right? Yes. The total amount of eph-staked is going to go down. Okay. Yields your claiming is saying the same. Over time.

Starting point is 01:11:04 The equilibrium yield is the same, yeah. So fewer validators, but the same rewards per validator? And fewer validators means less issuance, which goes back to Justin, and saying that there's also a savings on issuance on top of the MV burn that's happening. Okay, so like Raleigh intuitively, we're taking away yields from ether stakers, and we're burning it, giving it to ether holders. Yet Justin is still saying that the yields are going to stay the same. And the way that you, the mechanism that you're saying that this is happening is that

Starting point is 01:11:38 the incentive to stake is actually going to. to decrease. And so people will unstake because they're actually getting some value of the ether burn anyways by not staking, by just being an ether holder. And so then the issue is the yield that you get from staking will actually increase because this is what happens when people unstake their ether yields go up. And so you're saying that fewer people will stake, but yields will stay the same. And so maybe if we're going from like 30% of ether staked to just 20% of ether staked, yields are still going to be the same. It's a net loss to stakers as like a system, but individual stakers are still getting the same yields that they already were prior. Is that correct?

Starting point is 01:12:18 Yeah, that's correct. So as a system, there's less if that goes towards rewarding all of these stakers, but from an individual standpoint is the same. But one thing worth mentioning is that, you know, usually when you're running a staking business, you think in U.S. dollar terms. So if you're Coinbase or if you're Lido or whatever, you're going to take a fee, which is kind of USD denominated. And it's possible that the increase in EF price is going to more than compensate than the loss of ether that you're going to collect. And so even for services like Cracken and Coinbase and Lido, it is to their benefit likely from a USD denominated standpoint. And then what was that other part, Dom, that you were mentioning? That was basically the same point that fewer validators equals the same per

Starting point is 01:13:05 or validate or yield. Okay, Justin, so I want to ask you a question. You put out some numbers there. I'm trying to assess the magnitude of the impact that this could have, right? And putting on the investor cap, because every time we have Justin Drake in the podcast, this time aided by Dom, I learned something new about Ethereum and this asset that I hold. And I bet a lot of bankless folks listening will be learning something about ETH today. And we're learning that there is this new business model that is going to start burning

Starting point is 01:13:33 a new furnace, like the eth burning scheme that is going to be added with MEV smoothing and MEV burn, right, in addition to EIP 1559. And since we actually conducted the merge and we migrated to proof of stake and received the issuance reduction from proof of work to proof of stake, and the net impact of EIP and the move to proof of stake, we have burnt Ethereum's ultrasound up to a total of about 120,000 eith. And that happened, of course, last September, 2022. If we had MEV smoothing and MEV burn in place since September 2022, let's say, that mechanism was on as well, we had not only the first furnace, but the second furnace, how much do you estimate, how much eth would we have burnt? Because I heard you say something in the number of 450,000 per year.

Starting point is 01:14:25 And so I'm kind of doing the math. And that seems like it's about like 3x, the amount of issuance decrease. So this second furnace, I'm trying to gauge the order of magnitude, is maybe like a 3x increase in supply or decrease in supply. Give us that number again. So what do you think? If we're 120 since a September of this year, how much would we have been if we had the second furnace activated, do you think?

Starting point is 01:14:52 Right. So since the merge 229 days ago, according to ultrasound, money, the supply has reduced by 136,000 eph. Now, if we had had MEP burn, the supply would have decreased by roughly three times faster. So we would be right now at minus 400,000 if. And the reason is that there's two things going on. On the one hand, we would be activating this new furnace, which would burn on the order of 250,000 eph per year. But this is very volatile, because because it depends on the conditions of the market. This would be assuming kind of the last few months of conditions, which has been a bear market.

Starting point is 01:15:34 So it's kind of a conservative assessment. But then there's this other thing that kicks in, which is that we would be potentially reducing the total amount of EF stake and thereby reducing the total amount of issuance. And thereby making it also easier for the supply to go down simply because we're not printing as much. We're not issuing as much. And so that would kind of add on top of the burn. And net net, roughly speaking, we're talking about a 3x speed up in the speed at which the eF supply goes down. So let me translate that into some annualized percentage numbers. So since the merge, Justin, we have been about kind of an annualized supply reduction of 0.179%.

Starting point is 01:16:20 With MEV burn would be like 3x, that number? something along those lines? Right. So roughly minus 0.5% annualized. Okay. So this is another burn mechanism, which is going to make ETH more deflationary. So I look at that with kind of my investor hat. One question I have for you, though, is it bad for ETH to get too deflationary? Like, are you guys a little bit worried as kind of IRS agents and kind of the protocol researchers here that what if we make ETH2 ultrasound? What if it becomes too deflationary? Is that a concern at all? Right. So I guess there's two answers here. One is that the deflation eventually ends.

Starting point is 01:17:00 So what happens is that there is this equilibrium where eventually the supply is constant. So for Bitcoin, right, there's this equilibrium on the upside. The Bitcoin supply will grow roughly for the next century, but the BTC supply will inflate and then eventually it will reach 21 million. For ether, it will be the opposite. For the next century, it will go down and then eventually it will reach. an equilibrium. What this final equilibrium is depends on economic activity and also as to whether or not we enable the MEV burn. But it's going to be something between 50 million and 100 million

Starting point is 01:17:38 EF. So the total supply of ether, roughly speaking, ballpark figure should decrease by a factor of two over the next century and then eventually we reach this equilibrium. But the other thing worth mentioning, I guess, is what does it mean to be money and what are the various uses of money? And the way that I think about it is that there's basically two types of money. And maybe we should be using different words because it's confusing to be using the same word. So on the one hand, we have currency. Currency is this money that flows in a system. It comes from the word current. And it's used as a medium of exchange. And you know, you want your currency to be non-volatile, to be stable and to be very easy to move around.

Starting point is 01:18:22 And the way that I think we will build currency on Ethereum is through decentralized stable coins. So you're going to put Eiff as collateral and you're going to stabilize EF, kind of create this synthetic asset, this debt. And so on the one hand, we have this currency, which is a debt asset. And it's kind of good if this debt asset goes down in value over time. because if you have a loan, for example, on your house, if the value of the asset keeps up and up and up,

Starting point is 01:18:53 it makes it more and more difficult to repay your loan and you might default on your house. So you kind of want these debt assets, these currencies to kind of go down in value, and that lubricates the economy. On the other hand, you have a different type of money. You have collateral assets, things like gold, for example, or things like property.

Starting point is 01:19:11 These are used as collateral against which you can take a loan against which you can draw currency. And here is the opposite mechanism. You want the value of your collateral assets to go up over time. And the reason is that this reduces the risk of default. So if you go on Maker, you deposit if, you draw some dye, and the value of your if goes down, then you're at the risk of being liquidated. But if the value of your if as a trend goes up and up over time,

Starting point is 01:19:41 then that makes it the perfect collateral asset. And my thesis is that ether is the collateral asset, the collateral money for the incentive value. And it has two main use cases. On the one hand, it's a collateral asset for staking and it secures Ethereum as a settlement layer as a platform. But the other very important use case is that it's economic bandwidth. It's collateral. It's money that is used by application that is consumed to create things like decentralized stable coins that will be the currency for this internet of value that we're creating.

Starting point is 01:20:17 I would like to add a little illustration to that. With the idea that your property is collateral value, like say you take a loan against your property, against your house, and if you want the loan to be inflationary and easier to repay over time, because that allows you to, for example, improve your property and increase the value of your property to unlock more bandwidth to let you take a bigger loan and keep improving. it. It's like a feedback loop. And it's very simplified, but the same thing should happen with

Starting point is 01:20:49 defy and Ethereum as collateral. So let's say you take a stable coin loan with your ether as collateral, and then your stable coin loan lets you go in defy and do arbitrage or do all sorts of things. And that gives you value. And also that's increased economic activity on Ethereum, on the broad Ethereum economy, which generates M.AV, because whatever you do, the more economic activity, more MBV there is, which burns more ETH due to MavV burn, which increase the value for collateral. So there's the same feedback loop happening where it's very lucrative to just hold ease as collateral. And the lesser the incentive to stake, we don't have to go through a liquid staking that has additional risk, both for yourself and the broader system, if everything relies on one liquid

Starting point is 01:21:39 speaking operation. So I guess in the answer to the question of like can ETH be too deflationary, your answer to that, Dom and Justin is, no, it really can. I mean, the more deflationary it is, it makes it a worse currency, but a better store value, a better money, if you will, a better, richer source of economic bandwidth. It actually expands the economic bandwidth. So I think maybe that question is almost wrong. It comes out the question from the wrong perspective of what ETH is trying to do. It's not trying to be a currency, a general currency. It's trying to be a store of value monetary instrument for the entire crypto ecosystem and the entire internet. It's an important distinction. I think it's also important to zoom out and view the Ethereum economy from a system's

Starting point is 01:22:25 perspective. Justin here likes to say that perhaps the killer app of Ethereum block space is stablecoins. And so we are seeing a very intrinsic relationship between Ethereum and stable coins. and fiat inflationary units of account. So this is the idea that we have this yin and yang, this deflation and inflation, and the deflationary asset will naturally be chosen by economic agents to be the collateral to be borrowed against by inflationary assets. And the whole idea that Justin incepted in my brain way back when,

Starting point is 01:22:59 I think in the ultrasound money episode itself, the idea of sci-fi economics, where we have these financial positions, in aggregate, degen's will get liquidated. They'll put ether into AVE. They'll pull too many stable coins out. They'll get liquidated. But in aggregate, ether will be the collateral. The stable coins will be the borrowing unit of account. And the economic zone of Ethereum will have tailwinds that no other economic zone in the world will have because of the deflation of ether in contrast, juxtaposed by the inflation of everyone's unit of account. And so just the economic investment,

Starting point is 01:23:38 the downstream wealth effects that that creates around defy and the rest of the Ethereum economy are going to produce some sort of motor on the Ethereum economy that no other economy has. And so that's just the very bullish vision I have for the Ethereum economy, Justin, any reflections on that. I agree. And there are some very strong network effects around this idea of monetary premium. So how do we achieve monetary premium? We achieve it by creating shutting points. We achieve it by somehow convincing society that one specific asset is special, right? Society has successfully deemed gold to be a special asset, and that has given it monetary premium on top of its raw utilitarian value. Now, why do I talk about monetary premium? I talk about it because it is

Starting point is 01:24:26 absolutely necessary to get to this point where we have trillions of dollars of decentralized stable coins. Right now, we have centralized table coins. Right now, we have centralized stable coins, and they're on the order of $100 billion. And my thesis is that centralized table coins, I'm not going to scale very well to trillions of dollars. And the reason is that if you have a centralized stable coin, you're going to need to spread out those trillions of dollars over multiple banking partners.

Starting point is 01:24:54 And you just need one banking partner to fall through. And then that leads to a haircut, and that leads to a loss of confidence in your system. So yes, Tever was able to scale to roughly $100 billion. Will it scale to a trillion dollars? I don't know. On the other hand, decentralized stable coins are meant to be rock solid. And if we can find a way to scale them to trillions of dollars, that will really help Ethereum reach its ultimate vision. But how do we get trillions of dollars of decentralized table coins? Well, we're going to need trillions of dollars of pristine collateral. And the only way

Starting point is 01:25:30 that we get there is if we somehow create the shathing point that ether is money for the internet. net. And there's various things that are important shunning points in the context of money. One which is absolutely critical is economic security. Like how many billions of dollars are currently securing your blockchain? What is the cost of attack to do a censorship attack or to revert a finalized checkpoint, etc? And already today, Ethereum is the most secure blockchain by that metric by a factor of four. The other very important thing is, is this idea again of economic bandwidth. And as Dom said, we have this positive feedback loop going on,

Starting point is 01:26:14 because the more economic bandwidth we have, the more decentralized stable coins we have, the more economic activity we have, the stronger the shatling points become of scarcity and security. And so, yeah, there is this very strong ball case that there is going to be, in my opinion, one asset that's going to win the beauty contest, basically, of being the most attractive asset, and right now, EFERD asset, is the number one contender to winning

Starting point is 01:26:42 this beauty contest. Bitcoiners look out. Watch out for that one. I think we've long moved past Bitcoin, but I guess we still have to move past in market cap. Dom, I want to throw this quick question to you just to make sure we check this box. 4844, how does MEV burn and 4844 interact? How do these things relate to each other?

Starting point is 01:27:00 It gets a bit tricky at this point, but the way. for it's going to work is by splitting the two markets market for execution and the market for data and execution is going to be the same so there's still going to be MV happening at layer one as these whales and large institutions have to settle value in exchange on the excess on layer one because currently it's still the most secure layer and in my opinion it's going to stay the most secure layer

Starting point is 01:27:24 even if there's layer two are going to become more decentralized and more secure over time you're still going to want this fallback to layer one execution, which for many reasons it's going to keep being congested and unscalable. So there's still going to be a lot of activity and congestion fees on layer one, while a lot of stuff happens at layer two, which uses data, which with 4844 and dank sharding, it's going to be much, much cheaper. So this is the idea that data is very easy to scale at layer one.

Starting point is 01:27:56 And it's going to bring down the congestion pricing relating to data. But the way it works with MEV and layer two is like depends on how the layer two is set up. Because one of them, like optimism can capture congestion and MEV by having like one sequencer or many sequencers each taking turn at that batching data to layer one. And they can capture that MEV at layer two. But the way it can work possibly is by having what Justin coined as based rollups where the sequencing is completely permissionless at. layer one where so there's still going to be some competition between many layer one builders to create the best layer two block to post on layer one so that's going to not only bring more lifeness to the layer two roll up but it's also going to bring back the mv to layer one all the

Starting point is 01:28:48 economic activity happening at layer two is going to generate layer one miv which with miv burn is going to end up being burned just and at the very beginning of this podcast you were using the metaphor of just regular old gasoline that powers cars, but then you have highly refined jet fuel that powers jets. I want to throw a version of this metaphor into the hat and see if you like it. So we have the Ethereum economic engine. 99% of the thrust gets powered by the combustion engine and regular old gasoline, but that 1% of the contention slot, the contention side of this engine is actually a supercharger. And the way that a supercharger works is that it's a fan, that's connected to the combustion engine.

Starting point is 01:29:33 So the combustion engine's crankshaft is connected to a fan belt, which spins a compression fan that compresses oxygen and then throws that into the combustion engine. And that allows for a more efficient burning of gas. And so you've got the normal Honda Civic that's got the combustion engine,

Starting point is 01:29:51 but then you've got the supercharger on top of it, which just makes sure that the gasoline is juiced up to the max. I'm throwing that metaphor your way, see if you like it. Yeah, I love it. So basically you're taking this really high octane, high density fuel, and you're combining it with this oxygen, which is compressed. And then you're pushing the two together.

Starting point is 01:30:11 And you're running this extremely sophisticated engine, which is performance critical, mission critical, ultra low latency. You know, M.V game is kind of a game where every millisecond counts. And you have the armies of PhDs and very sophisticated players coming in. Now, one of the things to continue on this metaphor that you bring up is the exhaust. In Ethereum, we have basically cell pressure, which is taxes. So in Bitcoin land, the cell pressure comes from having to buy electricity and buy mining rig, but in context of taking, it's taxes.

Starting point is 01:30:48 And you kind of think of that as kind of pollution or like a negative externality that you want to try and minimize. And it turns out that MEV burn, in addition to being this roughly half-emission, million each per year optimization is also a tax optimization, which dramatically reduces the cell pressure of Ethereum. We're talking about nation state taxes here, Dustin. We're talking about normal taxes now. Exactly. Yes. And maybe the best analogy is with stocks. So there's this one weird trick with stocks, which is that if a company has a billion dollars, let's say your Apple, you have two options to redistribute this value to the shareholders. Option one, you can issue dividends.

Starting point is 01:31:33 So you give a billion dollars of dividends across all the shareholders. But what happens is that these dividends are treated as income tax. Now, in many jurisdictions, income tax is, let's say, 50%, just as a ballpark figure. And so you have sell pressure of half a billion dollars. But there's this other thing that you can do, which is you can do a share buyback. If you do a share buyback, this $1 billion basically translates in the total supply of the

Starting point is 01:32:02 shares going down and the price of each share going up by a commensurate amount. And now you're taxed in capital gains tax. And in many jurisdictions, capital gains tax is significantly lower than income tax. So, for example, in the UK, capital gains tax is roughly 20%, and income tax is roughly 50%. And so we have this roughly speaking, 2.5x tax optimization, which will decrease the cell pressure, the forced cell pressure that the stakeholders have when they're participating in the system. So if we have 250,000 eph per year of MEV today, well, roughly half of that is going to be cell pressure. So 125,000 eF is going to be sold. But if we instead kind of funnel everything in capital gains tax, then there's only going to be 20%.

Starting point is 01:32:56 So there's only going to be 50,000 if of forced cell pressure. Another hidden benefit, another byproduct of this. Justin Don, this has been super helpful for the bankless community. Just a few lightning round questions for us. Okay, so we're talking about futures here. And as we know, it took a very long time before we started talking about EIP 1559 before to actually ship into production. When is this coming roundabout? know there's not a fork where it's like, well, it's then the next hard fork, but just rough

Starting point is 01:33:25 range. Are we talking like, is this like two years out? Is it three years out sooner than that? What do you think, Justin and Tom? I would say it's under three to four, kind of maybe five-year time frame. And one of the meta points that I want to bring up here is why does it take so long for us to do these things? And I guess one of the answer here is around the policy that we have as a community, this implicit policy, right? So Bitcoiners as a policy have this idea of maximum ossification. And I think for Ethereum, we have this idea of continuous innovation and improvement. And that's kind of expressed in this minimum viable issuance policy, which could be restated as maximum viable scarcity. So when Ethereum launched, the best that we knew how to

Starting point is 01:34:10 do in terms of securing the chain was to issue five-eaf per block. And then we realized that five-eaf block is way too much. can reduce it to two if per block or three if for block. And then we realized we could reduce it even further to two if per block. And then we realized we could do this really fancy optimization called proof of stake. And now it's only a quarter of an if per block. And then we realize that there's this other thing that we can do, which is EAP-1559, which so far has burned 3.1 million if since EAP155 of 9 was launched, which is a massive optimization. And now we're talking about yet another thing that we've unlocked. If you had asked me a year ago, is there any further

Starting point is 01:34:47 improvements to Ethereum, I said, I'm not sure. But actually, you know, we kind of discovered this new thing just through research and innovation. And it makes sense to integrate it in our roadmap because it's part of this maximum viable scarcity policy that the community has adopted. And if you were to ask me, okay, is there something else maybe in the pipeline? I would say, yes, there is something else maybe even beyond MEVBurn. And it's this idea of capping the active validator set. So right now, in theory, what could happen is that almost all if could come and become stakers, and that would lead to on the order of 2 million eif per year of issuance. But if we cap the total amount of active validators, for example, to 33 million if,

Starting point is 01:35:36 then we would also de facto be capping the total amount of issuance to roughly 1 million if per year. So that is kind of a further potential improvement. going down this road of minimum viable issuance and maximum viable scarcity. Yeah, that's right. I mean, that has been the social contract of Ethereum all along, is what is the monetary policy? It's minimum viable issuance.

Starting point is 01:35:59 And so all of these improvements contribute towards that. Well, thanks for giving that kind of like timeline estimates. We're talking about this is a more distant improvement. You know, PBS and other protocol changes have to happen. This might come into play three to five years down the road. I remember when I started learning about EIP 1559, and that was in, I believe, 2019. It took about two and a half years for that idea to actually get executed and deployed.

Starting point is 01:36:24 This might take that end a little bit longer to get out there, but it's super exciting. Nonetheless, I learned a lot. What do birds and oil and digital money all have in common? I hope you learned that in the episode as well. Dom and Justin, thank you so much. It's been great to have you. Thank you, guys. Bankless Nation, of course, we just had two big brain protocol researchers on the episode

Starting point is 01:36:45 today. So you might have some questions about some of the terms that we bandied about MEV. What is that exactly? Fortunately, Bankless has done an in-depth series on MEV. We will include a link to the episode you need to go look at in the show notes here. Also, if you were thrown off by the question from David to Dom about EIP 4844, and you're like, what does that mean? We have episodes about that too. So catch that in the show notes. Of course, got to also refer you to the classic Ultrasound Money Chronicles. This is a series of episodes. Justin came on for, I think this was, you know, 2021 or so. And we will include a link to that when we were first talking about this concept of ethos ultrasound money. This episode, it feels like, was just an extension of that episode that we recorded two years ago. My How Time Flies. Also, need to remind you, none of this, of course, has been financial advice. We have no idea what the future price of eth is. All crypto is risky. But we are headed west. This is the frontier. It's not for everyone. But we're glad. you're with us on the bankless journey. Thanks a lot.

Bankless - 170 - Burning MEV with Justin Drake and Dom

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