Ethereum's Dencun Upgrade

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Executive Summary

  • The Dencun Upgrade on Ethereum introduces new data storage capacities, aimed at reducing fee costs of its Layer-2 scaling solutions.
  • The upgrade also implements a fixed limit for entering validators to manage the growth of the validator set and maintain efficient node communication.
  • This change could influence Ethereum's monetary policy by reducing the rate of new Ethereum issuance. This could potentially lead to a decrease in the Ethereum supply.

Reducing Costs for Scaling Solutions

On Wednesday, March 13, Ethereum underwent another major update. The Cancun-Deneb (Dencun) upgrade, which introduced significant changes to Ethereum's rollup infrastructure. The upgrade also implements several modifications to Ethereum's staking pool to improve node communication, and network stability.

Over the recent years, various solutions have emerged to help the Ethereum network process more transactions in aggregate. Roll-ups are a blockchain which executes transactions externally to the Ethereum blockchain, utilizing a separate execution environment. They aggregate batches of transactions occurring on the roll-up, and anchor them into a single transaction, which is then submitted to, and verified by the Ethereum blockchain.

Roll-up solutions have gained popularity over the last 2 years, with the two major scaling solutions, Arbitrum and Optimism, seeing usage increase by up to 150k, and 100k daily active addresses, respectively. Meanwhile, Ethereum's mainnet still has the largest activity count, with more than 400k active addresses per day.

The major feature of the Dencun upgrade is to create additional data storage capacity on the Ethereum network. It introduces a new type of transaction capable of carrying large data packets which are referred to as blobs.

Blobs are temporarily stored on the consensus layer instead of the execution layer, which leads to decreased fee costs for both the Ethereum network, and the roll-ups themselves. As displayed in the table below, transaction costs have decreased significantly after the upgrade, with Optimism and StarkNet even recording fees below 1 cent.

Normalizing into USD allows us to understand how roll-up fees behave differently relative to mainnet fees. Since their inception, roll-ups have offered cheaper and less volatile fees, ranging between $0.10 to $0.30 per transaction for both Arbitrum and Optimism. In contrast, Ethereum mainchain fees range from $2 to $7 over the same period.

During high-activity events where there is an influx of demand for Ethereum blockspace, fees can escalate to over $30. Prior to Dencun, fees on roll-ups were somewhat dependant on mainchain fees, and have seen their fees increase up to a maximum of $2.50 during similar situations.

The co-dependence of roll-up fees on the high volatility of the Ethereum fee market tends to result in more expensive and challenging user experience overall. These layer-2 solutions also impacted the Ethereum fee market by adding a new source of demand for blockspace. According to a report by Fidelity, the transaction fees that the various Layer-2 chains paid, typically account for around 10% of all total fees paid on Ethereum's mainnet.

Source: Fidelity Digital Assets

With the Dencun upgrade, the separation of Layer-2 anchoring transactions into blobs is largely in line with improving user experience, reducing fees, and aligned with the rollup-centric roadmap of the Ethereum Foundation. The hope is that lower transaction fees will encourage more users to move onto roll-ups, thereby increasing the aggregate Ethereum based transaction throughput. This strategy aims at improving scalability without compromising the decentralization and security of the mainchain.

Shortly after the introduction of the first set of scaling solutions for Ethereum, we observed an increase in average transaction throughput in mid-2021 was 105 Transactions per Second (TPS). Of this, roll-ups accounted for around 46 TPS, or 44% of the total.

This provided an initial indication of success for the roll-up centric roadmap, and similar Layer-2 scaling solutions. However, when compared to Ethereum's biggest competitor, Solana, which averages around 2.6k TPS, there's remains a significant difference, largely a function of the design architectures of Modular (e.g. Ethereum) vs Monolithic (e.g. Solana).

Adjustments to The Staking Pool

The Dencun upgrade also introduces new technical changes which impact stakers on Ethereum, largely aimed at improving user experience:

  • Perpetually valid signed exits enhance the user experience for delegated staking participants (such as liquid staking pools). At present, the signing-key required to authorize exit of a user's stake from a staking pool resides with the validator operator. This arrangement makes the stake owner reliant on the goodwill of the validator operator when they want to exit their position. After the Dencun upgrade, validator operators can pre-sign voluntary exits, allowing the stake owner to unilaterally exit their stake.
  • Increasing the attestation window extends the time validators have to vote on a block's correctness from 6.4 minutes to 12.8 minutes. This allows for more attestations to be gathered, which can accelerate the block confirmation process. The attestation count currently stands at approximately 759k attestations per day.

A fixed limit for new validators has also been added, seeking to slow down the growth of validator set. At the moment, the churn limit regulates how many new validators can enter of exit the staking pool each day. This limit increases by one step at defined increments of total active validators.

After the Shanghai upgrade, the number of active validators saw a large increase, averaging +1347 new validators per day. However, as the number of validators increased, it was noticed that a side-effect was a slowing down of node communication.

The Dencun upgrade has now introduced a limit of 8 new validators per ~6.4min epoch in place of the churn limit function.

A slowed growth in the validator set and effective staking balance has a secondary effect on Ethereum's monetary policy. The current rate of ETH issuance is based on the number of active validators, and as fewer can now enter the staking pool, it may slow down the rate of new ETH issuance.

Since the Shanghai Upgrade, the issuance increased from ETH 1183/day to ETH 2554/day as the validator set grew. Whilst early, we have seen issuance rates decrease for the third time shortly after the Dencun upgrade.

A potentially slower issuance may also act as a net decrease for the Ethereum supply, as more ETH is burnt via transaction fees than the amount of new ETH issued. Since the Merge, we have observed a net reduction in the total circulating supply of -410k ETH.

The combined impact of the Dencun upgrade on the ETH supply remains to be seen as there are now a few changes which impact each other:

  • Layer-2 anchoring transactions have now moved into the blob data structure, removing around 10% of the fee congestion pressure. This may result in a slight reduction in ETH burned.
  • The reduced fees on Layer-2s may entice more usage of both the Ethereum mainchain and the scaling solutions, which could add to fee pressure.
  • The rate of issuance growth is likely to reduce as fewer new validators are able to enter the staking pool.

Throughout its history, Ethereum has undergone six major updates, not all of which have directly targeted a change to the ETH supply. However, it's apparent from the last four upgrades that the growth of the ETH supply has slowed. After the Merge, it has even turned slightly negative. The chart below shows these different upgrade events alongside the relative change in the circulating supply of ETH.

Summary and Conclusion

The Dencun Upgrade introduces significant enhancements to the Ethereum network, by creating additional data storage capacity via blob transactions. This upgrade effectively reducess fee costs for its various scaling solutions, which improves user experience, and potentially increases aggregate transaction throughput by encouraging the use of roll-ups.

The upgrade could also impact Ethereum's monetary policy by capping new validator entry, which acts to slow the growth of the validator set and, consequently, the rate of new ETH issuance. While reduced issuance suggests a potential decrease in supply, the new blob structure may also lead to fewer transactions on the execution layer, reducing ETH burned, and possibly mitigating the effect of reduced issuance.

All in all, this development continues Ethereum's trend toward slowing the growth of its supply, and executing on the roll-up-centric roadmap. It can be seen that the last four upgrades resulted in a deceleration and even a slight reduction in the ETH supply since the Merge.

Disclaimer: This report does not provide any investment advice. All data is provided for information and educational purposes only. No investment decision shall be based on the information provided here and you are solely responsible for your own investment decisions.

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