Gas Fees on the Ethereum Blockchain: From Foundations to Derivatives Valuations

TL;DR

This paper provides a comprehensive analysis of Ethereum gas fees, modeling their dynamics and introducing derivatives to hedge against cost volatility, combining protocol-based analysis with financial modeling.

Contribution

It introduces a detailed protocol-based analysis of gas fees and proposes derivatives for hedging against gas cost fluctuations, integrating blockchain mechanics with financial tools.

Findings

Gas fees are modeled using a fractional Ornstein-Uhlenbeck process.

Derivatives can effectively hedge against gas cost volatility.

The analysis enhances understanding of transaction cost stability on Ethereum.

Abstract

The gas fee, paid for inclusion in the blockchain, is analyzed in two parts. First, we consider how effort in terms of resources required to process and store a transaction turns into a gas limit, which, through a fee, comprised of the base and priority fee in the current version of Ethereum, is converted into the cost paid by the user. We adhere closely to the Ethereum protocol to simplify the analysis and to constrain the design choices when considering multidimensional gas. Second, we assume that the gas price is given deus ex machina by a fractional Ornstein-Uhlenbeck process and evaluate various derivatives. These contracts can, for example, mitigate gas cost volatility. The ability to price and trade forwards besides the existing spot inclusion into the blockchain could enable users to hedge against future cost fluctuations. Overall, this paper offers a comprehensive analysis of gas fee dynamics on the Ethereum blockchain, integrating supply-side constraints with demand-side modelling to enhance the predictability and stability of transaction costs.