Stablefees and the Decentralized Reserve System
Exploring a new mechanism to help make fees fair, stable, and more predictable over time
10 June 2021 7 mins read
Facilitating transactions in cryptocurrency platforms stumbles on the dual utility of the platform’s underlying asset. On the one hand, users can hold and trade it as part of their investment portfolios. On the other hand, it supplies the necessary “fuel” for processing transactions. This duality suggests that the system should have a mechanism for adjusting transaction costs, so they remain competitive and reasonable. Also, the bounded throughput of decentralized platforms per unit of time introduces another hurdle: the system should also allow the users to discover the correct price for timely transaction processing, depending on their individual needs.
Why not drop transaction fees altogether? Three reasons: One, transaction processing incurs costs on the system’s side (in terms of computation and storage). It is reasonable to allow transaction processors (stake pool operators, in the case of Cardano) to offset their costs. Two, even with a theoretically infinite capacity, it is important to prevent transaction issuers from saturating the network with worthless transactions. Three, it is appropriate to incentivize transaction processors to provide quality of service. A surge in demand should influence their payoffs accordingly.
Adding a fee to each transaction can address the above considerations.
Bitcoin and beyond
Bitcoin set out the first mechanism for pricing transactions in distributed ledger platforms. This mechanism resembles a first-price auction: transactions bid for a place in a block naming a specific reward, and block producers select the transactions that they prefer to include. Block producers also get rewarded with the right to mint new coins, i.e., their operation is subsidized by the whole community via inflation of the total coin supply. Inflation drops geometrically over time, and transaction fees become increasingly dominant in the rewards. This mechanism, while enabling Bitcoin to run for well over a decade, has been criticized for its inefficiency. Transaction costs have also risen over time.
In this blog post, we explore a new mechanism that builds on Cardano's approach to ledger rules and system assets, and complements the Babel fees concept. The objective is making fees fair, stable, and predictable over time. We describe the mechanism in the context of Cardano. However, it can be adapted to any other cryptocurrency with similar characteristics.
The core idea behind Stablefees is to have a base price for transactions through pegging to a basket of commodities or currencies. Stablefees includes a native "decentralized reserve" contract that issues and manages a stablecoin pegged to the basket. A comparison in the fiat world might be the International Monetary Fund’s SDR, (established in 1969) and valued based on a basket of five currencies—the U.S. dollar, the euro, the Chinese renminbi, the Japanese yen, and the British pound sterling. The stablecoin --- let’s call it "Basket Equivalent Coin" (BEC) --- is the currency used for paying transaction fees (and all other real world pricing needs of the platform, e.g., SPO costs).
In this system, ada will play a dual role: Reserve asset of the decentralized reserve, and reward currency for staking. It will also be the fall-back currency in extreme scenarios where the reserve contract is in a liquidity crunch. Before a transaction, the issuer will have to obtain BECs, either via other third parties or directly by sending ada to the decentralized reserve contract. On what basis will the reserve issue BECs? The reserve contract will also issue equity shares -we will call them decentralized equity coins (DECs)-, in exchange of ada. Leveraging the value of DECs, the decentralized reserve will often adjust the value of BEC so it is pegged on the underlying basket of commodities. In other words, DECs will absorb the fluctuations of ada vs. the basket to ensure that the real-world value of BECs remains stable (cf. the AgeUSD stablecoin design that has been already deployed and used on Ergo).
This trinity of coinage, issued natively by the system, will attract different cohorts. BECs' stability and liquidity might be attractive to risk-averse, transaction-intensive holders. DECs will offer the highest rewards if ada goes up, but also take the most significant hit when ada goes down. Long-term holders may find DECs more attractive. Also, since decentralized reserve prices these coins in ada, both BECs and DECs can facilitate participation in staking and governance. Returns can be issued at different rates, reflecting the different nature of each coin. Ultimately, rewards will always be denominated and payable in ada, which will remain the most versatile of all three coins.
The centerpiece of this mechanism is an on-chain oracle that determines the price of the basket in ada. SPOs can implement this oracle in a decentralized manner. The reserve can offer extra rewards to all oracle contributors from the fees collected during BEC/DEC issuances. This will ensure two things: thousands of geographically-diverse contributors, and ledger rules calculating a synthesized exchange rate in some canonical way (through a weighted median across all price submissions in an epoch, for example). If oracle contributors manipulate their contributions, they can be held accountable by tracking their reputation and performance on-chain.
The pricing mechanism
How would one price transactions and reward block producers? Using the current approach in Cardano, each transaction will be deterministically mapped to a precise value denominated in BECs, using a formula determined by the ledger rules. The formula will take into account both transaction size and its computational requirements, and may also incorporate runtime metrics (such as the average system load). The resulting value will be the base fee guaranteeing that the transaction will be processed by the system. Given the base fee, end users will be able to apply a multiplier if they wish (which will be a value at least 1, e.g., 1.5x, 3x, etc.) to increase the fee and accelerate processing. This will become relevant at times of surging demand.
This approach has one advantage when compared with the first-price auction model: the pricing mechanism is continuously stabilized to a reasonable default value. Users perform price discovery in one direction only to accelerate processing, if required. Also, transaction issuers can store BECs to secure their future transaction-issuing ability without being affected by ada price volatility.
Stablefees and Babel fees
The Stablefees mechanism can be considered a natural extension of Babel fees ---spot conversion of BECs into ada by the decentralized reserve. Both mechanisms complement (and are compatible with) each other. Babel fees can be deployed together with Stablefees with just one change: Using BECs to cover Babel fee liabilities, instead of ada. This also means that fees will always be payable in ada (via a Babel fee liability convertible in ada on the spot). Hence, the whole mechanism is backwards compatible: it won’t affect occasional users who just hold ada and do not wish to obtain BECs.
A final point about diversity. While the above narrative identifies a unique and global BEC, the same mechanism can be used to issue regional BECs pegged to different baskets of commodities, which could possibly be weighted differently. Such “regional” BECs will be able to increase system inclusivity, while enabling SPOs to have more fine-grained policies in terms of transaction inclusion.
The above mechanism requires a decentralized reserve contract and the issuance of BECs and DECs by the contract to buyers. A “lite” version avoids the reserve contract and directly adjusts the fee formula by pegging it onto the agreed basket of commodities through the price oracle. The resulting system denominates transaction fees nominally in BECs and immediately converts them into ada. The payable amount fluctuates, depending on the value of BEC. The mechanism is otherwise identical, also facilitating unidirectional price discovery through the multiplier. The only disadvantage is that a prospective transaction issuer has no access to a native token that enables transaction processing predictably; transaction issuers must pay fees in ada. Still, the fees will continuously adjust and remain stable via the pegging mechanism with respect to the basket. As a result, a transaction issuer will be able to organize their off-chain asset portfolio to meet their transaction needs effectively.
The road ahead
Our team is currently researching the granular details of the Stablefees mechanism. Once this research is complete, Stablefees can be integrated into Cardano to offer fair and predictable transaction pricing. Moreover, the price oracle and the global BEC (and regional variants, if included) will undoubtedly find uses beyond paying transaction fees, expanding the capabilities of decentralized applications in the Cardano ecosystem.