All views are my own. This is not financial advice.
The Problem
If you have used Ethereum the last few months chances are you’ve seen how high the gas fees are. It’s not uncommon to be hit with a $200 gas fee when buying an NFT on Opensea, or a $175 gas fee when swapping on a decentralized exchange like Uniswap.
This is not scalable and is a huge deterrent for new users coming into the Ethereum ecosystem.
What are gas fees?
Gas fees are essentially transaction fees paid by the users of the Ethereum blockchain. In the physical world, when you go to CVS and buy a tube of toothpaste, Visa and other credit card providers charge a small credit card swiping fee to merchants that are absorbed either by the merchant or passed on to purchaser. The fee is so low that it’s relatively painless for merchants and allows them to do business with credit card providers without providers weighing down their business.
This is essentially what gas fees are. As a user, if you want to transact on the blockchain, you must pay a gas fee (transaction fee).
The difference between what Visa is doing and what Ethereum is doing is multifold but on a high level Visa can process transactions cheaper and faster. Both speed and cost will need to be dramatically improved for Ethereum to have mainstream adoption.
Where do gas fees go?
Gas fees go to the Ethereum miners. In the CVS example given prior, a company like Mastercard or Visa take the credit card swiping fee. This is their business. On the Ethereum network this fee goes to miners. Miners are people who are lending out their computer processing power to the network to process transactions. This is what Visa does but they get all the value. In the Ethereum ecosystem anyone can be a miner. You can be a miner. I can be a miner. You essentially just need to download software on your computer and set up your computer to be a “node” that helps run the network. This is extremely processor intensive so miners will typically buy a bunch of processors and dedicate them solely to mining. It’s passive income for these people. It takes a lot of energy so it makes more sense for people who live in areas where electric is cheap. It’s highly scalable if you are in a region that is profitable so many decide to scale up their operations by buying lots of processors and dedicating garages or warehouses to just mining.
Note that Ethereum is looking to move away from this model as it uses a lot of electricity and is not very environmentally friendly. This change will most likely take a few years to take place so it’s not immediate but this isn’t necessarily a business that will be longterm sustainable. Getting in early years ago yielded the best rewards.
What Ethereum has done is take Visa’s business and make it an opportunity for individuals. Instead of a centralized entity like Visa getting the swiping fees, now individuals can earn those fees by lending out their processing power to the blockchain.
Why are gas fees high?
Ethereum was originally created as an experiment. Vitalik Buterin and the other co-founders of Ethereum saw what Bitcoin was doing and had a new idea to push the concept further. Bitcoin is a token that can be exchanged and has a finite amount that will ever be created. Ethereum takes that a step further and allows developers to program on top of it.
These programs are called “smart contracts”. The name is slightly misleading because smart contracts are computer programs that run on Ethereum. For example, a developer can write a smart contract in code that says, “if my wallet has not been touched for 5 years, pay balance to Todd”. In a sense this is a Will. If Brian wants to give Todd the balance of his wallet after he dies he can write this code and the money will transfer on its own as long as there is no interaction with Brian’s virtual wallet for 5 years.
Doing this will not go through a centralized entity like Paypal or Chase Bank. If you try to send a friend $100,000 through Paypal you will get flagged. Using the Ethereum network is permissionless. You can send money to anyone without any intermediary. Sending money via the Ethereum network is simple and allows users to interact directly with one another, instead of having middlemen acting as arbiters as to what can and cannot be done. If Brian wants to send Todd $100,000 it will appear in Todd’s wallet in less than 5 minutes, ready to use.
There are endless concepts that can be explored using this technology. It can eliminate middle men on so many levels.
Right now unfortunately gas fees are extremely high. Gas fees were created to incentivize miners to process transactions and prevent spam on the network. Gas fees are calculated based on supply and demand. They have nothing to do with the value of what you purchase or the value of your transaction. Gas fees are based on the complexity of your transaction. If you are buying a $10 NFT and gas fees are high (a lot of network demand) you could end up spending $100 in gas just to get a $10 NFT. Not all interactions with the blockchain are for purposes of value transfer between users. For example, to upload a smart contract on the blockchain, it costs gas. Because of this it would not make sense to tie the value of gas to transaction value. This is a pressing issue and developers are desperately trying to find a solution.
Gas fees can’t just be removed because it will change the dynamics of the network. Some miners may stop mining, then supply will drop. New ideas are also voted on in the form of proposals so it’s not one persons decision to make this change. The problem gets complicated relatively quickly. There doesn’t seem to be any obvious simple solution.
Eth 2.0
Vitalik and the Ethereum team announced years ago that Eth 2.0 is coming. Eth 2.0 was originally supposed to come in 2019. It’s 2021 and it’s still not here. Some have the expectation that gas fees will be affordable when Eth 2.0 finally arrives. This is not necessarily true and noone is sure when it will actually come. It’s more commonly understood that it will roll out in phases as opposed to a single event. This is important because many investors are incorrectly under the impression that it will arrive all at once, this has led to a lot of uncertainty around Eth 2.0 among retail investors.
Vitalik recently stated “We thought it would take one year to do the proof-of-stake, but it actually takes six years.”
This is him referring to the new Eth 2.0 upgrade. Expecting it to come in the next year is extremely optimistic. When it does come and the rollout is complete, Vitalik has said that gas fees would be reduced but they won’t be as affordable as using Visa.
Vitalik has urged Ethereum users and developers to adopt Layer 2 scaling solutions to properly scale up Ethereum affordably and cheaply.
What are Layer 2 scaling solutions?
Layer 2 scaling solutions are technologies that run on top of Ethereum and help process transactions. They take advantage of many of the security and decentralization features Ethereum has to offer as well as the large user base already using Ethereum. Think of Layer 2’s like an expansion pack for a video game. They help augment Ethereum’s abilities.
In practice Layer 2’s use different tactics to bundle transactions and process them more affordably and efficiently. Layer 2’s give Ethereum the ability to get much closer in transaction speed and price to major incumbents like Visa. They solve a huge pain point for the network and are essential to Ethereum’s success.
There is currently a rush of new companies in the space looking to build the best Layer 2 solutions. Here are a few.
Polygon (link: https://coinmarketcap.com/currencies/polygon/)
Immutable X (https://coinmarketcap.com/currencies/immutable-x/)
What’s the takeaway?
If you are looking for an opportunity with greater risk/reward and you believe in the Ethereum ecosystem, consider Layer 2 solutions.
One year ago the Polygon token was $0.01, today it is $2.34. As of today it’s in the top 20 biggest tokens list.
Hopefully that rise in prominence illustrates the importance of Layer 2 solutions and their contribution to the Ethereum ecosystem.
Immutable X
Immutable X just released their token at the beginning of November. The current marketcap is just under $1 billion. Compare that to Polygon, which has a marketcap of $16 billion. It’s not out of the question for Immutable X to go on a nice run over the next year. I have big expectations for the Immutable X team.
I recently bought a few NFTs on Immutable X. The process was seamless. Gas fees were $0, fast, and overall it was a great buying experience. I can’t say the same about Polygon. When i’ve used Polygon in the past the process of using Ethereum on the Polygon network was a pain and not intuitive. You have to swap Ethereum into the Polygon native token and then spend the Polygon token. I have had multiple friends get confused by Polygon’s poor user experience and lose money (hundreds of dollars). Immutable X doesn’t have this problem. They’re more seamless and easy to use.
Immutable X has had some bumps in the road over the last few months. There have been multiple NFT launches on Immutable X that have crashed their servers. This is a hiccup, but I don’t see it being indicative of a longterm issue. Most new blockchain products have to be used by real users at scale in order to be properly stress tested. In my opinion it’s equally as important as to how the founding team responds to a system failure and manages public perception. It often turns negative after a major issue. Immutable X has maintained optimism in the community and worked with projects to rectify issues caused by these server crashes. I am confident Immutable X will figure out these issues moving forward and ultimately be a great L2.
I just bought some Immutable X in the recent dip. If you are looking to pick some up, as of December 9th, it is now available on Coinbase Pro.
Opensea announced in March that they will be integrating Immutable X in their marketplace soon. I think this is very bullish for Immutable X.
I will be holding this crypto for at least 1 year. I think they solve a real pain point in the ecosystem.
STRONG
impressive