Thread by @sanjaypshah

1/ ELI5: The argument for why Solana will eventually become a rollup on Ethereum (or other base layer). 🧵 👇

2/ Let's first start with a basic fact. The market cap of any L1 token MUST go up for that network to be secure in the long term. The more it goes up, the more secure the network is.

3/ This is because the security of a PoS chain is directly tied to the market cap of its token.

Example: It's much more expensive to accumulate enough SOL to attack the network if its market cap is $1T than if its market cap is $1B.

4/ There are only two ways an L1 token can increase its market cap in the long term:
1. Value accrual via profitable economics
2. Monetary premium

(Marketing / speculation can help increase market cap in the short term, but not long term)

Let's explore both of these below.

5/ Value accrual via Profitable Economics -

Having profitable economics means that the revenue generated in transaction fees is greater than the amount paid to validators to secure the network.

These profits are then burned which ultimately accrues value to the network.

6/ Currently SOL's economics are quite unprofitable.

The protocol is spending $4.6M per day to secure the network via issuance, but generating only $0.04M per day in fee revenue.

7/ SOL not being profitable today is actually okay, as long as there's a path to future profitability. Think of a startup that doesn't make money today, but eventually will.

8/ So what options does SOL have to increase fee revenue and achieve profitable economics in the future?

9/ Firstly, it could allow for more transactions (i.e. bigger blocks), which would generate more cumulative fee revenue.

But this would lead to further centralization (due to higher node requirements) of an already centralized network, so it's not really a viable path.

10/ Secondly, it could keep its current block space fixed, and wait for transaction fees to increase as demand for SOL blockspace grows.

However, cheap fees are one of the main value propositions of Solana, so high fees would likely lead to people moving off the network.

11/ Finally, it could copy ETH and become a settlement layer for rollups. This would allow high fees on Solana, with cheaper fees on Solana L2s.

However, this would sacrifice SOL's key value prop, composability, since projects across SOL rollups wouldn't be composable.

12/ Additionally, it's unclear why rollups would choose to use Solana as a security / settlement layer, when they have the choice to use Ethereum or other base layers that are more decentralized and secure.

13/ We've now looked at the 3 different options SOL has to generate more fee revenue and increase network profitability, but they come with tradeoffs that don't make them viable.

Hence it's unlikely that SOL achieve's profitable economics.

14/ Remember a protocol must increase market cap for long term security, and there are only two ways to do that:

1. Value accrual via profitable economics
2. Monetary premium

Since value accrual via profitable economics is unlikely, let's now look at monetary premium.

15/ Monetary Premium -

Monetary premium is accrued by tokens that act like money, and is the value above and beyond any intrinsic value.

16/ Monetary premium accrues to the networks that maximize decentralization and security, as people are most likely to store value in protocols with these characteristics.

That is why BTC and ETH have the most monetary premium in crypto.

17/ However, Solana is still relatively centralized. The charts below show insider allocation % and validator hardware requirements relative to ETH.

18/ Additionally, SOL doesn't have a clear path to decentralize.

- A better token distribution will take many years.
- Reducing node requirements means sacrificing on their high TPS / low fee value prop. This is the scalability trilemma that most monolithic blockchains are in.

19/ So we've learned that monetary premium accrues to the most decentralized and secure protocols.

SOL is relatively centralized and without a clear path to becoming decentralized (due to scalability trilemma).

Therefore, it's unlikely that SOL accrues monetary premium

20/ Without a path to profitable economics or monetary premium, SOL doesn't have a path to long term security.

Remember, you need profitable economics or monetary premium to grow market cap, and you need to grow market cap for security (more costly to attack $1T vs $1B network)

21/ Of course, there is an easy way out: just become a rollup on ETH or other base layer (e.g. @CelestiaOrg). As a rollup, you don't have to worry about long term security, since you are outsourcing that to the L1.

22/ But what about composability?? Solana would retain all of its composability by becoming a rollup, so there is no tension between composability and becoming a rollup.

https://twitter.com/epolynya/status/1493815859453652995

23/ This is why I believe the most likely outcome is for Solana to ultimately end up as a rollup on another base layer.

24/ All that said, not all hope is lost for Solana to stay a monolithic chain. There is one option they have that I haven't yet mentioned.

This was outlined by @VitalikButerin in his excellent post titled "Endgame": vitalik.ca/general/2021/1…

25/ In a nutshell, SOL could separate the function of block building and block validation.

The block producers could be centralized to allow for high throughput big blocks, while the block validators could be highly decentralized with low resource requirements.

26/ This would allow SOL to generate more fee revenue due to bigger blocks, and have a path towards profitable economics.

This would also open the door to accruing monetary premium because the network would become much more decentralized (due to decentralized block validation).

27/ However, until we see some movement in this direction of separating block production and validation, a rollup is still imo the most likely outcome for Solana.

28/ In reality, this thread is a framework for understanding why most monolithic blockchains are likely to end up transitioning to rollups.

I've just used Solana as a specific example to demonstrate a more general concept.

29/ Hope you learned something. Shout out to @epolynya, @TrustlessState, and @RyanSAdams who first introduced me to the advantages of rollups.

Follow me for more threads about modular blockchains and rollups. ✌️