## Protocol economics: the Ethereum protocol's perspective
### What are some protocol economics questions that matter?
* What are the incentives facing users?
* What are the incentives facing consensus actors (miners / validators)?
* What is the (i) average-case, and (ii) extreme-case behavior of the chain, and how does that affect incentives at the application layer?
* How do applications affect any of the above?
### What are some risks to watch for?
* Complex user incentives → wallet centralization
* Economies of scale for consensus actors → consensus centralization
* Incentives to participate in censorship or reorg attacks
* Apps that work fine during average protocol behavior breaking in extreme cases
* Incentive to have low latency → geographic concentration → jurisdiction risk
### Rise of defi
<img src="https://i.imgur.com/T7JWzpf.png" style="width: 42%" />
<img src="https://i.imgur.com/6Eqvn6a.png" style="width: 50%" />
* Burst MEV existed before (eg. 2017 ICOs), but not enough to justify developing infrastructure to try to capture it; since 2020 it's permanent
* Creates economies of scale for consensus actors
### EIP 1559
* Greatly reduced waiting times for users
* Much less incentive to use complex gas price strategies → lower barriers to entry for wallets
### The merge
* Completely changes the class of participants maintaining consensus (miners -> ETH stakers)
* Makes reorg attacks vastly harder (see https://www.paradigm.xyz/2021/07/ethereum-reorgs-after-the-merge)
* Very different incentive landscape re centralization and pooling
### Upcoming changes
* Withdrawals enabled
* Single secret leader elections
* Different types of in-protocol PBS
* Single slot finality
* People can withdraw, so some will withdraw → less ETH staked
* But... people can withdraw, so people become more confident they can get their money back if they stake → more ETH staked
* Only the proposer will know that they are the proposer before the block is produced
* Though they could voluntarily reveal this info
* Intended effect: reduce DoS risk against proposers
* Are there unintended effects? Particularly, might there be incentives for proposers to pre-reveal their identity to anyone?
### Single slot finality
* Even more reorg security (see https://www.paradigm.xyz/2021/07/ethereum-reorgs-after-the-merge)
* More bridge-friendly
* Though with layer 2 pre-confirmations, maybe not de-facto single-slot...
### Layer 2 and protocol economics
* Sequencing style: "based rollups" vs L2-controlled sequencing
* What percent of L1 defi will move to L2s?
* Fraud proof windows and censorship
* On the whole, will the L2 shift make L1 economics "more boring" or "less boring"?
<img src="https://i.imgur.com/Y5Cz5NR.png" style="width: 60%" />
With PBS, total anarchy ("based rollups") is much more viable! But what would the consequences be?
### Could layer 2s absorb "complex" layer 1 MEV?
* If rollups are based, no
* If a large part of L1 defi stays on L1, no
* If rapid L1 tx inclusion helps L2 arbitrage in other ways, no
* Otherwise.... maybe?
### Fraud and censorship
* If you can censor a chain for a week, AND that chain doesn't socially reorg you, then you can steal from optimistic rollups
* However, much shorter-term censorship attacks on defi exist too
Even if have single-slot finality on L1, we still have pre-confirmations on L2.
* Arguably, this is a point _in favor_ of SSF: it means that we could compromise on slot times (eg. to 32s) to make SSF easier on L1, and it would not hit users much
* But still, we have two tiers of confirmation
* This is fundamental: L1 is not willing to centralize as much as L2, and so L2 confs will always be faster
* Note: preconfirmations are incompatible with based rollups
### Will L1 be more boring or less boring?
* My hope: more boring. But this is not guaranteed!
* All depends on to what extent L2 absorbs functionality and risk, as opposed to creating new and more complicated interaction effects with their own risks
* Need more analysis of a fully post-L2 world!