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MEMO W25 JUN 2024

Try to get the big things right. - xh3b4sd

One topic I wanted to discuss for some time now is MEV and the varying philosophies pursued on Solana and Ethereum respectively. First of all, a sentence or two about what MEV actually is. MEV originates from the concept of Miner Extractable Value. Back in the day, Ethereum was running the Proof of Work consensus mechanism, just like Bitcoin still does today. And because Ethereum is fundamentally a platform for programmable money, there was always value to be extracted by miners. This extractable value became infamously known as MEV. Today, Ethereum is running the Proof of Stake consensus mechanism. And since there are no miners anymore, MEV became known as Maximal Extractable Value. The rise of MEV research gave birth to a completely new economical problem domain. It turns out we can frame any system as adversarial environment and analyse its mechanism design based on the objective to extract as much value as possible from said system. It turns out there is MEV everywhere, in sports, in politics, and onchain. The value being extracted onchain may come from a myriad of strategies. Most notably liquidations, arbitrage and sandwiching. For our purpose here we want to differentiate between toxic and non toxic MEV. Non toxic MEV may occur if some desirable service is provided for a small amount of value that can be described as a service fee from a user point of view. Toxic MEV on the other hand is any value taken away from the user, that turns out to be below the objectively optimal value, that said user should have received, if the given transaction would have been executed in the most optimal way possible. In other words, toxic MEV is the delta between what a user should have received, and what a user did in fact receive. We assume here that society always tries to minimize toxic MEV. Intentionally, I am not saying "prevent", but "minimize", because MEV can fundamentally not be prevented. We can think of MEV in terms of the energy conservation law. MEV does always exist. MEV cannot be destroyed. MEV can only be converted by mechanism design. Now, Ethereum's philosophy has always been to minimize the toxic effects of MEV. On a protocol level, MEV is even planned to be burned in the future. On an application level MEV is tried to be given back to the user. I think burning MEV on the protocol level and reimbursing MEV on the application level can effectively be seen as the north star for a desirable MEV endgame on Ethereum. On the other hand, Solana's philosophy on MEV is literally marketed publicly as selling point for additional staking rewards. During the past couple of weeks we have heard that Solana generated more revenue than Ethereum, because Solana's share of MEV related staking rewards was so big. Let that sink in for a second. In the spirit of Solana, more money is being made by validators, because more money is taken away from its users, and the advertisement is, that that is a good thing. All the while monumental research efforts are conducted for years and years on end to make sure Ethereum remains a bastion against centralization risks and user robbery onchain. I am of the opinion that blockchain networks have a rather short half life, if their business models depend on providing users with a worse execution price. MEV shouldn't be a selling point if its toxic effects redirect value from users to validators. We have to mention that Ethereum validators earn more rewards from MEV as well today. The difference here is that I have never heard how great this is for the ecosystem, because it isn't. On a fair note, the Solana Foundation has recently undelegated large amounts of stake from many validators that have mainly engaged in toxic MEV. While this is commendable, it says something else about centralization risks and credible neutrality.

Another analogy occurred to me for framing the potential size of Ethereum and Solana relative to one another. Solana's only selling point over Ethereum is execution speed. In particular this refers to Solana's short block times, where each slot is set to 400 milliseconds. Now imagine you try to compete against Google by delivering search results faster. Google is known to have the best answers for virtually everything and most users value quality and breadth over split second improvements. Solana is effectively saying that it is better at everything by being faster at something. Being very specialized may has its merits, but solving a niche problem in a broader problem domain is frankly not how you conquer the majority of the market. As discussed in the last Powerlaw memo, Solana and Ethereum each cater to their respective use cases. Though my understanding of the matter is that Solana goes after a smaller pie. That is not to say that this particular pie will be small in itself. It simply means that the spectrum of qualities that each individual ecosystem can capture should be considerably different in size. The target ballpark ratio in smart contract blockchain market share between Solana and Ethereum is in my mind in the order of 1:10 for the reasons explained above. Now, I might be wrong here in two different ways. First, Solana may cure cancer and takes over the world. In that instance I would be proven wrong entirely. Second, I may got the direction right, but got the magnitude wrong. It may turn out that the market share ratio between Solana and Ethereum is rather 1:100. This "failure" scenario would still be ok for somebody who is not long Solana while waiting for the directional trade to play out. I am in that camp today and am happy to be wrong like that eventually. To be fair, I do not expect a two orders of magnitude difference in relative ratio. It feels too much of a difference for what Solana has to offer. I would be curious to hear how you, dear reader, frame this problem and what market share ratio either ecosystem should obtain long term. Feel free to reach out and let me know about your thought process!

One interesting data point I saw recently from Tokenterminal was about the average trade size on CoWSwap and Uniswap respectively. Without taking 24 hour volumes into account here, the average trade size on CowSwap is around 60,000 USD while it is about 1,000 USD on Uniswap. That is a 60x difference. I am not sure right now what to make of it, but I found the stark difference to be fascinating. And some more numbers come from VanEck this week. Their model for evaluating Ethereum expresses a bear case, a base case and a bull case for the price of ETH in the year 2030. The predicted ETH prices for each case are 360 USD, 22,000 USD and 154,000 USD respectively. The VanEck model has all kinds of inputs and makes all kinds of assumptions. Let's face it. All models are wrong. Some may be useful, but they are still wrong. But first, a good word. It is great to see financial institutions put in the work in order to sell their exchange traded products. VanEck tries to frame Ethereum's financials in traditional ways so that their clients can understand this new asset class. What I find rather less helpful is the width of the predicted outcomes. We are basically saying that ETH may trade between zero and infinity in 2030. I would not know what to do with that if I were a VanEck client. In any event, I think VanEck's base case of 22,000 USD per ETH in 2030 is around the right ballpark based on my current understanding of liquidity cycles and growth trajectories ahead. Somebody's gotta say it. Higher for longer!

At last, I would like to invite anyone of my readers to reach out, if there are any questions or ideas for collaboration. I want to write about your startup, strategic execution and elegant mental models. My brand archetypes are sage, outlaw, magician and creator. If you would like me on your cap table as an angel investor, then feel free to send your pitch my way. If you would like my feedback or engage in an interesting conversation, then I am happy to chat or have a nice dinner over some sweet red wine. If you are a writer yourself, then I would love to talk about the art of writing and maybe get your feedback on my writings here. If you think we should work on something cool together, then please reach out and let's be friends.

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