IOSG: A Discussion on the Monetization Design of Rollups
Is Rollup a profitable business?Author: Jiawei, IOSG Ventures
Is Rollup a good investment category among many infrastructures?
The investment logic of Rollup has evolved from the early ZK/OP narrative battle, to the later competition in TPS and user experience, and then to the moat built around derivative tools like OP Stack—different stages of industry development may yield different answers to this question.
But ultimately, we need to answer whether Rollup is a profitable business. What is the economics of Rollup? This article attempts to explore the business model of Rollup and its design space for monetization.
Barry Whitehat first proposed the concept of Rollup on the Ethereum Research forum. When the concept of Rollup was in its infancy, we referred to the roles operating Rollup uniformly as Relayer or Operator. As the infrastructure developed in detail, this role was broken down into multiple entities: Sequencer is responsible for ordering transactions and writing to DA, Challenger is responsible for raising challenges, and Prover is responsible for generating proofs. When we discuss Rollup economics, we can basically start from these entities.
Source: IOSG
This article mainly discusses several aspects of Rollup monetization:
- The reasons, composition, and profit and loss situation of transaction fees;
- The form and monetization of MEV in the context of Decentralized Sequencer;
- The possibility of monetization based on Fault Proof and Validity Proof.
Transaction Fee
Similar to other chains, users need to pay transaction fees when sending transactions on Rollup.
From the perspective of Sequencer, this transaction cost mainly covers two parts of expenditure: execution costs and security costs.
Execution Cost
Source: John Adler
The execution cost of Rollup inherits from the Ethereum model. Abstractly, each Ethereum node runs a replicated state machine. As shown in the figure above, nodes download and store transaction data, execute computations, read and write memory and storage, and these operations correspond to physical resource expenditures and consumption. Gas, as a unified resource pricing unit, is used to measure the resources implied behind these operations.
Thus, extending to Rollup, operating Rollup nodes will incur certain execution costs, which is the origin of the transaction fees paid by Rollup users. Due to subtle differences in EVM equivalence and different Rollup designs, different Rollups may have slight variations in pricing execution costs (for example, zkSync Era provides native account abstraction, and some operations may require paying more Gas compared to EOA), but overall, they follow Ethereum's Gas model.
Source: Dune Analytics @springzhang
In addition to the aforementioned execution costs, congestion fees and minimum transaction fees should also be considered.
- Congestion fees. This reflects the dynamic balance between Gas prices and network traffic. For example, during the Arbitrum Odyssey, the surge in network traffic led to a significant increase in Gas prices.
- Minimum transaction fees. On blockchains with extremely low network fees, it is necessary to set a lower limit on transaction fees to avoid Spam and DoS attacks. Currently, the minimum transaction fee on Arbitrum One is 0.1 gwei, and on Arbitrum Nova, it is 0.01 gwei. The value of the minimum transaction fee depends on the design of the network (it is 0.001 gwei on Optimism).
Security Cost
Source: Celestia Forum @adeets_22
Security costs refer to the data availability (DA) costs we discuss, which guarantee the security of Rollup equivalent to Ethereum, ensuring that everyone can reconstruct the state of Rollup based on the data published on Ethereum L1 (here we discuss the situation of Ethereum L1, of course, there are other DA solutions). The DA costs contributed to Ethereum L1 account for the vast majority of Rollup's total costs. In May of this year, Arbitrum submitted approximately 3,927 MB of data to Ethereum and paid 4,856 ETH for it, with DA costs around 1.24 ETH/MB. (Based on S3 Standard at $0.023 per GB and ETH price at $1800, the DA storage cost on Ethereum is approximately 100 million times that of AWS).
Due to the high cost of on-chain DA, various Rollups have adopted data compression methods. Arbitrum and Optimism Bedrock use open-source data compression libraries Broti and zlib to compress data published to Ethereum L1, respectively. StarkNet and zkSync Era compress data by publishing State Diff (the difference between the previous state and the new state) instead of all data. (P.S.: The Optimism Bedrock upgrade also employs various methods to compress transaction costs, where we can see more data metrics).
Source: IOSG
It is promising that the high DA costs on Ethereum L1 will be significantly alleviated after the Decun Upgrade introduces EIP-4844. Additionally, the "security costs" discussed here actually imply different levels of security. Besides the DA guaranteed by Ethereum L1, solutions like DAC, Celestia, and EigenDA provide various "security-cost" trade-offs, offering multiple choices for the DA demand side. Some low-frequency, high-value DeFi applications require more security guarantees, while some high-frequency, relatively low-value applications (such as games) can consider costs more; each to their own.
Source: Dune Analytics @optimismfnd
In summary, simply from the perspective of Sequencer: Sequencer collects transaction fees from users and pays DA fees to Ethereum. Thus, Sequencer's profit can be calculated in the manner described above. Currently, most Sequencers are operated by Rollup teams, and if we ignore the income from token issuance and inflation and other details, Rollup's revenue can also be roughly measured in this way.
Source: Token Terminal
Source: IOSG
Taking Optimism as an example, in the past 30 days, Optimism's daily profit was about $20k. According to data from Token Terminal, Optimism's total profit since its launch is approximately $10.9 million.
MEV
MEV is an important way for Rollup to establish its business model. Discussing MEV in the context of a centralized single Sequencer is not very meaningful, so we will start with Decentralized Sequencer and then explore the MEV economy of Rollup.
Decentralized Sequencer (DS)
As of now, Arbitrum ($5.87b), Optimism ($2.14B), and zkSync Era ($649M) rely on centralized Sequencer/Operator for transaction ordering, batch submission, and other operations.
Decentralization is a complex matter, and the process of introducing multiple participants needs to be carefully refined; there is no need to achieve it all at once. From the perspective of security, competitive landscape, and developer resources, it makes sense to adopt centralized Sequencer in the early stages of a project. However, centralized Sequencer has at least two obvious drawbacks (which are also common flaws of most centralized methods).
- Transaction censorship: This refers to the censorship of transactions from specific users, including extortion attacks, etc. To address this issue, Arbitrum and Optimism provide options for users to force the inclusion of their transactions; for example, all users on Arbitrum can call the forceInclusion method to force the inclusion of transactions; StarkEx has implemented an Escape Hatch mechanism to achieve partial censorship resistance.
- Uptime guarantee: Can the Sequencer remain online continuously? If a centralized service experiences a single point of failure (such as hardware failure or software configuration error), the entire network will go down. While this possibility is small, it can have widespread negative impacts if it occurs.
Source: Taiko
Currently, Sequencer actually plays the roles of both Builder and Proposer on Ethereum L1: responsible for transaction ordering and batch submission—achieving DS is somewhat like retracing the old path of Ethereum PBS.
To achieve DS, Rollup typically has several options.
- Leader Election/Rotation mechanism, plus local block building, which is the case of non-PBS on Ethereum L1. Vitalik proposed several election/rotation methods in his An Incomplete Guide to Rollups: Sequencer auctions, random selection based on PoS, DPoS voting, etc. Based on Ethereum's practice, it is clear that PBS would be a better solution.
- Leader Election/Rotation mechanism, plus an open block building market, which is the case of Enshrined PBS or Proposer using MEV-Boost on Ethereum L1.
- Some specific mechanisms, such as FCFS (First Come First Serve). FCFS ultimately leads to latency competition, similar to colocation in traditional high-frequency trading. Arbitrum currently uses FCFS and is researching variants like Time-Boost. Time-Boost introduces priority fees based on FCFS, allowing users to pay fees to speed up transactions by up to 0.5 seconds. This is a two-dimensional trade-off between latency and fees.
Rollup teams can either internally build DS using the above options or consider outsourcing Sequencing:
- Projects like Espresso/Astria have proposed their DS/SS services;
- Flashbots is building SUAVE, a cross-domain universal cryptographic memory pool;
- Justin Drake proposed Based Rollup, which directly leverages L1 consensus, allowing the Proposer of Ethereum L1 to include Rollup blocks into L1 blocks, inheriting the same level of decentralization and uptime guarantee as L1.
Choosing between internal building or outsourcing involves some trade-offs, which will be further discussed later in this article.
Rollup MEV in the Context of DS
Source: odos.xyz/arbitrage
If we have an open block building DS market, then the MEV supply chain on Ethereum will replicate on Rollup. Among them, intradomain MEV refers to MEV occurring within Rollup, which is not much different from MEV on Ethereum L1. For example, sandwich attacks in DEX, cross-DEX arbitrage, etc. Since Rollup has not yet achieved DS, the above figure uses cross-DEX arbitrage on Ethereum L1 as an example.
More interestingly, there may be cross-domain MEV. We can divide cross-domain MEV into ordinary cross-domain MEV and cross-domain MEV under Shared Sequencer (SS).
- Ordinary Cross-domain MEV
Source: odos.xyz/arbitrage
Ordinary cross-domain MEV occurs between Ethereum L1 and Rollup, and between Rollup and Rollup. In the context of DS, each domain has its own MEV pipeline, covering different roles. The above figure is an example of cross-domain arbitrage.
On the Searcher side, cross-domain MEV involves complex execution risks, as different domains have different confirmation times and finality, making it uncertain whether transactions will be included as expected. To address this, Primev is building a communication network where Searchers can submit bids to multiple Builders across multiple domains to obtain pre-confirmation guarantees for their Bundles. This way, Searchers can quantify and manage their execution risks.
Cross-domain MEV has a tendency towards centralization. As Flashbots pointed out, Builders who build blocks across multiple chains have a greater advantage in cross-domain MEV compared to those who only build blocks on one chain, which can easily lead to centralization. Under the Rollup-centric Roadmap, this is a topic that needs to be addressed in the coming years.
- MEV under SS
If multiple Rollups use the same SS, the situation is different.
Source: IOSG
One of the characteristics of SS is that it can achieve cross-Rollup atomic arbitrage. Originally, when Searchers submitted transaction 1 and transaction 2 separately, they were uncertain whether these two transactions would be included as expected (for example, included in the next block). With SS, Searchers can submit a Bundle like the one shown above, which will only be executed if both transaction 1 and transaction 2 can be satisfied simultaneously; otherwise, neither transaction will be executed (of course, it needs to be ensured that the transactions are not invalid transactions). This implementation reduces the execution risk for Searchers.
Ideally, SS will achieve "the whole is greater than the sum of its parts." For example, the information covered by a single transaction may not have value on a single Rollup, but in the case of shared ordering across multiple Rollups, it can be combined with transactions from other Rollups, thus fully utilizing some "invalid information" and achieving a positive-sum game.
Despite the numerous benefits, Sequencing involves complex business issues, so I believe that SS will not be adopted by leading Rollups in the short term, but may be implemented and validated first in long-tail App-specific Rollups, or offered as an optional feature for developers in Rollup-as-a-Service projects.
Rollup Economics Around MEV
Source: IOSG
After DS is implemented, the question returns to how to build economic models and value capture mechanisms around MEV.
In the previous discussion, we talked about the costs of Rollup. The source of these costs is the DA resources and the physical resources of operating Rollup itself. These limited resources constitute the scarcity of block space. MEV reflects the dominion over the scarcity of block space. Rollup can price that dominion.
Fuel Network believes that an optimized token model should reasonably capture the value of block space. Users pay transaction fees using Rollup tokens, which is one way of value capture (i.e., granting the token utility). However, this also introduces additional friction on the user side. Fuel's idea is also to tokenize the scarcity of block space, but what is tokenized is the "right to charge fees within block space." This is from the perspective of block producers and MEV, and does not affect end users.
Corresponding to the aforementioned DS options, I believe there may be the following design spaces:
- MEV Auction (MEVA). Sequencer participates in auctions to determine the transaction ordering rights for specific blocks or blocks within a specific time frame. The bids in the auction serve as revenue for Rollup.
- PoS. Stake Rollup tokens to randomly select Sequencer; the more tokens staked, the greater the probability of becoming a Sequencer. Note that Rollup is still secured by Validity/Fault Proof and Ethereum, and does not need to rely on the economic security provided by PoS. PoS is only a method for selecting leaders. Staking tokens provides value capture for Rollup, and this lock-up essentially reflects the scarcity of block space.
- SS. Compared to the above two points, SS is an interesting new topic, and there is currently no conclusion. Suppose Rollup chooses to outsource Sequencing to SS, which also means relinquishing its right to capture intradomain MEV—although the benefit of doing so is that network effects will arise between multiple domains, forming a positive-sum. But from another perspective, Rollup can fully choose to keep its MEV within its own ecosystem, capturing it itself or tokenizing intradomain MEV.
Therefore, I believe that SS should redistribute the MEV captured across its various domains in some way. In the case where multiple SS compete for their Rollup clients, this redistribution incentive becomes particularly important. In this scenario, the redistributed MEV can serve as revenue for Rollup.
Fault Proof
(The community proposed renaming Fraud Proof to Fault Proof, as even honest parties may submit incorrect state transitions due to software configuration errors and other reasons. The term "fraud" actually implies malicious intent, making it an inaccurate description.)
The general design of fraud proofs is that during the challenge period, individuals (called challengers) can question state transitions; once the challenge is verified as correct, the malicious party will be penalized, and the challenger receives part of the penalized funds as a reward. The remaining penalized funds may be destroyed; if the penalized funds are Rollup's tokens, this is seen as compensation for all token holders (rather than for the victims of the attack). Arbitrum and Optimism Cannon currently adopt interactive fraud proofs.
In Arbitrum, the party observing the state transition and raising challenges is called the Validator, while the party observing the state transition is called the Watchtower Validators. The main difference between the two is that the former can raise challenges, while the latter can raise alerts in any manner (e.g., through community or social media). Becoming a Validator requires whitelisting permissions. Watchtower Validators do not require permission.
Arbitrum may decentralize the role of Validator (i.e., Challenger) in the future. However, in reality, the Challenger only requires a 1 of N trust assumption; one honest Challenger is sufficient for the network. Therefore, I believe that decentralizing Challengers merely meets the requirements of decentralization; aside from the aforementioned Challenger receiving part of the penalized funds, there is not much design space in economics, and it may be more about design redundancy considerations.
Prover Network/Market
Source: Figment Capital
Figment Capital distinguishes between Prover Network and Prover Market in its article: Prover Network is a collection of Provers that serve only a single application (e.g., Scroll). Prover Market is an open market where multiple applications (e.g., Scroll, Succinct) can submit proof requests to this market. This article has summarized various aspects of Decentralized Prover, so I will not repeat too much here.
Prover Network
Scroll proposed the idea of decentralized Prover two years ago.
Source: Scroll
Provers (Scroll calls them Rollers) need to stake tokens to gain initial reputation, which is directly proportional to the staked tokens. When the network needs to generate proofs, Sequencer randomly selects multiple Provers based on their reputation and requires them to generate proofs within time T—if the proof is invalid, they will be fined; if the proof is valid but late, their reputation will be reduced; if the proof is valid and within time T, they have a chance to receive a reward.
The design of introducing a limited time T, rather than simply measuring by "the fastest," is to avoid a winner-takes-all situation for the fastest Prover, because as long as they can complete within time T, the fastest Prover and slightly slower Prover have the same probability of receiving rewards. This mechanism encourages the fastest Prover to generate proofs for other blocks in parallel to maximize profits.
Prover Market
Source: =nil;
=nil; provides generalized services for building circuits and proof markets. Developers building circuits and Provers generating proofs each receive a portion of the income.
As an open market, =nil; is similar to a spot market, with two roles: proof requesters and proof producers. The former can post buy orders, while the latter can post sell orders. The parameters of the posted orders include Statement (such as state proof circuits for Mina or Solana), cost, order timeout, and proof generation time.
=nil; also adopts a similar reputation system, where Provers who fail to generate proofs on time or generate incorrect proofs will have their ratings lowered or even penalized.
Both Scroll and =nil; adopt designs based on Staking-slashing and reputation systems, with the difference being the target user groups. The former serves the ZKRollup itself, while the latter serves multiple ZK applications. These two examples correspond to two forms of internally built Prover and outsourced Prover.
Closing Thoughts
In summary of the above discussions, I propose several points:
- Transaction fees are a simple and effective business model, and one of the main selling points of Rollup for scaling Ethereum is low fees, so they will not make too much fuss over transaction fees. With the adoption of EIP-4844 and the maturity of various DA solutions (Celestia, EigenDA, etc.), Rollup transaction fees will be further reduced. This is a good thing for users.
- Regarding Rollup, I believe that mainstream Rollups will gradually move towards DS in the next two to three years, while some long-tail Rollups may take the lead. MEV, as a more subtle business model, will become the main growth point of Rollup revenue. Among them, if DS is built internally, it relates to token economics design; if DS & SS are chosen, how to reasonably allocate the MEV within them is a point that both Rollup and DS & SS projects need to consider. The importance of MEV on Rollup is currently severely underestimated.
- Decentralization is often a gradual process, and there are different degrees of decentralization. Whether it is a decentralized Sequencer or Prover, there are mainly two options: internal building by the team or outsourcing. The former has a broader design space, mainly based on Staking-slashing cryptoeconomic primitives, and there are already some mature mechanism designs available for reference. I speculate that the latter may rely on a paid model similar to DA.
- DS may be more complex in mechanism design, while Prover is relatively intuitive. Because it is difficult to say whether the transaction sequence returned by Sequencer is correct or incorrect, while mathematical proofs are deterministic and can be quantitatively measured, such as time, cost, and other parameters. DS considers more from the perspective of MEV economics.
- How Rollup chooses between the above two methods varies depending on the stage of the project, and at least factors such as capital efficiency and developer resources need to be considered. For early Rollups, including some App-specific Rollups, outsourcing this decentralization work for rapid bootstrap may be the optimal solution (through DS & SS or EigenLayer). More mature Rollups, on the other hand, have more sufficient developer resources and funding, and will consider token value capture and resource connection more, thereby building moats and flywheel effects.
Reference
- https://joncharbonneau.substack.com/p/rollups-arent-real
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- https://figmentcapital.medium.com/decentralized-proving-proof-markets-and-zk-infrastructure-f4cce2c58596
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