AL #54: The Basis for Base's Base Fee Hedge

Base wants to hedge L1 costs but who would take the short side?

NOTE: This post is part of a multi-essay effort to understand Ethena from first principles. Many people have asked me to write a take on Ethena but truth be told I don't know how it works. Each week I will cover a concept that will help me get closer to breaking down the synthetic dollar protocol. This post is focused on Futures.

Thanks to Victor Xu for elucidating two-sided market dynamics.

Futures are an often ignored part of crypto as they don't lend well to onchain liquidity (due to fragmentation of expiries) and don't have institutional hedging demand (DAOs are still institutionalizing with the help of protocols like Aera).

Apart from CME Bitcoin futures which was a way of creating Bitcoin exposure.

So I was intrigued when Jesse Pollak brought back the idea of gas futures.

Base looking to hedge L1 DA costs?

If I'm speculating on the motivation, Base spent nearly $4M on L1 settlement costs in March. They have also been thinking about long-term bottlenecks that lead to high transaction fees for users of which Base Fee volatility is definitely one.

Rollups and other bridges are natural candidates for hedging L1 gas costs, so are other smart contract developers and even power users/traders.

No counter party in sight

However, the problem is the lack of a natural short side.

Miners are in the business of producing blockspace so it is harder to argue that they should be hedging revenue denominated in their competency.

But even if they wanted to, being short gas futures would come with issues.

Base fee volatility is high. Since the short side can have unlimited losses in futures, this would hurt

Gas futures are lacking a delivery mechanism that could lead to a stable arbitrage price. You used to be able to create GasTokens that could efficiently store gas but EIP-3529 taxes them. Even without the tax priority fees get in the way of reliable delivery

And it’s not really clear to me what we should be pricing?

Base fee is manipulatable and even a TWAP version of it is arguably a weaker price discovery mechanism for block space spot than what we had before.

Base + priority fee is not an exact replacement either.

Is there a solution?

One starting point would be to improve delivery by adding a GASLOAD, GASSTORE opcode set.

Then one would have to work backwards from shorting miner exposure and creating a synthetic instrument that could be more reliably priced and had lower volatility by design.

Perhaps something more stabilizing like a clearing price on auctions in PBS markets?

Admittedly I have 0 tradfi trading experience so this is a LARP.

But would love to hear ideas & thoughts on this.