Thread by @_KtorZ_

Another hot and quite captivating topic these days is whether or not #Cardano needs a *fee market*.

I don't have myself a definitive answer for I think a large part of the answer is not software-related, but about economics.

Here's my two lovelace nonetheless... 👇👇 1/n

Firstly, why do we need fee at all on blockchains? For two reasons mainly.

(a) as a security mechanism to prevent spamming attacks against the network.

(b) as an incentive to pay those powering the network -- typically nodes, but in PoS, this also includes delegators!

On Cardano, fees can be mapped to physical quantities (e.g. bytes in storage, bytes in RAM, seconds of CPU time...) so that they make certain classes of attacks infeasible (too expensive). This is the case for tx fee, but also stake key deposits or Plutus execution costs.

Fees are typically collected by miners / minters as an incentive for including transactions.

On Cardano, they aren't directly collected by pools but they are first collected into a *reward pot* which is then redistributed to pools and delegators as rewards.

Most blockchains require transactions to have a mininum fee, but let users over-specify fee to give more priority to their transactions.

This is often done as a *first-price auction* system where, the highest fee gets the highest priority, then the second one and so forth.

On Cardano however, while it is possible to over-pay fee, they do not lead to any kind of prioritization. So far, the prioritization of transactions mostly follows a "first-come first-serve" pattern: it depends on how fast certain transactions can reach leaders.

That approach makes the system very egalitarian. No one is favored based on their wealth, and there's no incentive to add high fees to transactions.

On the other-hand, there's no way for end-users to set a different priorities on their transactions (might it be lower!)

That question has become a burning topic in times where the demand has exceeded by some factor the network capacity (e.g. congestion during NFT drops).

For some, those spikes in the network usage are screaming for a fee market. For others, they call for better prioritization.

Duncan explained well in a Github comment (github.com/input-output-h…) that before jumping to a fee market, prioritization could come from intrinsic characteristics of the network (e.g. favor less verbose peers) or the transactions (e.g. favor those transferring the most value)

So, does Cardano need a fee market? I find the egalitarian idea appealing, but the general consensus in the blockchain space seem to be: yes.

Yet, I've failed so far to find good literature about why that is. If anyone has any, please forward!

I am glad to get convinced 🙏!

But let's go with the general consensus for a minute and assume that yes, we need a fee market on Cardano.

What could it be?

First-price auctions are terrible and everyone is moving away from them for a reason. What about EIP-1559? Anything good to take from that?

The core proposition of EIP-1559 is really to separate fees in two parts: the security part and the incentive.

The first part is a function of the network usage based on the previous block(s) occupation. The second remains pure incentive for the miners, as "usual".

Separating the two components is really interesting as it allows users to pay a minimum fee if they do not care about prioritization, and let the other fight for priority should they really want to. To work however, it's important that miners can't collect the base fee directly!

On Ethereum, this was solved through burning as it was the easiest way to get this implemented, and it has the nice side-effect of increasing the token appreciation. Remember that on Cardano, fees are not collected directly by pools, so this could be implemented without burning.

About the incentive now, searching a bit through the literature led me to read up on *second-price auctions*.

The core idea is simple: an auction, but the winner pays what the second has bid. This changes a lot the game strategy and leads to much cheaper auctions!

On blockchain, this concept can be adapted as multi-unit auctions (ssrn.com/abstract=33183…) where fees end-up being the smallest fee of a handful of picked transactions. There are some rules to avoid manipulations by miners/minters, but overall, it seems interesting / doable.

Combining this with an existing base fee as there's currently on Cardano fits very nicely. Plus, since a fee market is only really needed in times of high network occupation, they could also remain very much optional and only kicks in when necessary 😎.

To conclude, as I said initially, I don't have a definitive answer myself on the topic but here are some thoughts to fuel the discussion. If anyone has papers, articles or walk-through on the economics behind fee market, that is something I'll gladly read! Thanks in advance!