Value Accrual in the Modular Stack: Unpacking Where Value Might Accrue in a Modular Blockchain Future

Guest Author: Gabe, author from Shoal Research

Author Introduction:

Gabe was formerly with the listings team at Coinbase, and is an author from Shoal Research, a firm specializing in DeFi and infrastructure research.

Introduction

Modular blockchains have been all the rave, but one often overlooked aspect of them is that they fragment value. In a world where we have one monolithic blockchain, all value accrues to this blockchain’s ecosystem — but that’s not the case with modular blockchains.

This is due to their inherent design. Modularity, as it relates to core blockchain components, means that different layers specialize (i.e., do what they’re best at), and the best layers for data availability and consensus, settlement and execution are coupled into one blockchain, which when presented to the end user allows them to get a better product at a lower price. (The reasons why blockchain components such as data availability and consensus are grouped will be touched upon later in this post, as well as execution and settlement.)

Elaborating on this theme, the modular stack’s main benefit materializes with users being able to access cheaper and better blockspace (better in the sense that this specialization allows for total blockspace to expand exponentially; more on this below). As the number of blockchains proliferates, it will unlock applications that we haven’t even thought of yet — much the way broadband unlocked social media for us, as well as better security guarantees. Developers of applications also need to worry less about the “ideal” stack for them; they can just plug and play, subsequently deploying their app. So when the functions of all these core components are carried out by different blockchains, where exactly does value accrue?

But before getting to that, let’s get a little deeper into modular blockchains. One reason the modular blockchain narrative is going to be instrumental for the paradigm shift into blockchain technology and web3, in general, is that it allows us to scale bandwidth without compromising on the very reasons blockchains are so interesting — censorship resistance, vitality and credible neutrality.

Scalability With Modular Blockchains

In essence, with modular blockchains, we can try to make the best trade-offs on the blockchain trilemma (see above) by scaling in layers. Take Ethereum as an example: with modular blockchains, Ethereum can be used as a settlement layer, since it has the most (and the most geographically distributed set of) validators (as well as a lot of solo stakers and overall less cloud concentration, see here). In addition, Ethereum’s chain is arguably being secured by the best crypto money after Bitcoin — Ether. But effectively, Ethereum is well suited to be a settlement layer, making it a place to have the canonical bridge, as well as dispute resolution (such as for fraud/fault proofs).

Now, with regard to scalability, we do this on layers built on top of Ethereum, much like we do in TradFi (for example, Stripe or something like PayPal is built on top of many financial layers, and usually banks, say every week or so, settle up on the base layer using Fedwire, i.e., the Federal Reserve settlement system). Nic Carter, in this episode with Lex Fridman, breaks it down well (it’s worth noting that TradFi is at an advantage since it utilizes centralized databases to record transfers, etc., while blockchains are distributed ledgers that require cooperation of thousands of nodes to append and verify). 

This mechanism takes the form of rollups and other scaling solutions, rollups being the predominant one, which solely specialize in execution ( basically, just running code in an execution environment, which takes the form of the EVM for Ethereum and Ethereum rollups), and can hence make some trade-offs when it comes to decentralization and security (this is another post in and of itself). Rollups also need data availability and, by extension, consensus in order to function, and while this can be done by Ethereum, it can be outsourced (trade-offs here, too) to blockchains like Celestia that specialize in it. A nice example of a project that embraces modularity is Eclipse, which uses Ethereum as a settlement layer and Celestia as a DA+consensus layer, achieving execution by itself using the SVM (Solana virtual machine) as its execution environment. The SVM is creating a lot of buzz right now as one of the only multithreaded virtual machines, allowing for parallelization (basically transactions to be processed in parallel to each other), unlike the EVM, which is single-threaded. Hence, sequential transactions are the norm and parallelization isn’t possible.

Modular or Monolithic?

Let me precede all this by saying that Ethereum in and of itself is not a modular blockchain, in the sense that it can do everything (data availability, consensus, execution and settlement) by itself, but can be used by other blockchains and layers of the modular stack (for example, execution layers like rollups) for functions such as settlement, which then makes Ethereum a component of another project’s modular stack. Hence, this meme fromJon Charbonneau, who has done some amazing writing on Ethereum’s road map and Ethereum rollups. 

The way this meme can be understood is that everything is a modular blockchain, and everything is a monolithic blockchain (performing all the functions on the base layer, like Solana), depending upon how you look at it. For example, if I built a rollup on Solana, is Solana itself a monolithic blockchain, or a modular one? Likewise for Ethereum. Even Celestia can achieve execution and settlement as well, but if it’s only utilized for data availability and consensus, then it's a modular blockchain (you get the point).

By embracing modular blockchains, different blockchains can specialize in what they do to fulfill the requirements to have an “optimized” blockchain, as I’ve elucidated above. But that begs the question: Which one of these layers (data availability/DA for short, consensus, settlement or execution) will capture the most amount of value (have the most value accrual)? This post was inspired after discovering the following Tweet:

To formalize my thinking more concisely: 1) For a DA layer to work, you need some kind of ordering on that layer (hence, DA layers come with their own consensus, i.e., ordering protocols), so in this modular stack, consensus and DA aren’t two separate things. Just imagine using data available on one chain in order to create proofs, but this data (because it's on a blockchain) is ordered in some other way by another chain. It’s just a mess. 2) Execution layers like Arbitrum have pricing (discrimination) power, while DA layers like Celestia do not. This is because Celestia provides a homogeneous service (data availability), while Arbitrum (and other rollups like Optimism; I’m just taking Arbitrum as a main example) provides an execution environment for some of the best crypto apps not found elsewhere. This in itself is one reason why Arbitrum makes a significant amount of revenue (some hundreds of thousands of dollars per day), while Celestia makes negligible fees (less than $100 per day at the time of writing, as seen below, though this is also a function of Celestia’s nascency). 

Arbitrum is also closer to the end user, due to their monopoly on sequencing (the foundation runs the only sequencer). While this will change in the future — for example, with the adoption of shared sequencing — the Arbitrum protocol (sequencer, builder, searcher) will still be the only one to receive user fees, and most importantly, MEV and some part of the fees will trickle down to the DA layer as the rollup/execution environment will still write the data to Celestia, etc.! And remember, if DA layers captured most of the value, then rollups today would be charging lower fees to users than the cost to post/write data to the DA layer (i.e., operating at a loss, which is not the case today). Anatoly Yakovenko (the founder of Solana) explains this phenomenon in depth on the Lightspeed podcast.

3) Settlement layers are more valuable than DA+consensus layers (and I’d argue execution layers) simply because of the fact that the settlement layer will be secured by the most money/money-like crypto asset, as in the case of the most credibly neutral settlement layer today, Ethereum, which is secured by ETH. A DA+consensus layer will inevitably have more activity/volume flowing through it, relative to the settlement layer (which will only be used for bridging and dispute resolution, so occasionally, block headers will be posted to it from the DA+consensus layer). But the settlement layer’s asset will still be more valuable, albeit the settlement layer is “doing less.” Just look at TRX vs. ETH; the former’s blockchain handles more volume and burns more of its native token than Ethereum’s, and yet it’s valuated at magnitudes less than ETH. 

What gives? Exactly: Monetary premiums.

Simply put, the monetary premium is the multiple at which an asset trades relative to its fundamentals/fundamental utility (due to its “moneyness”). Gold is a good example: it's not used so much in the economy for production processes — and yes, it also looks good — but most of its value comes from its hard money trait. Case in point. 

H/T to polynya for this point, who puts it better than I do:

So where does that leave us?

This is what I think: the most valuable part of the stack is settlement, then execution, and then DA+consensus, for all the reasons mentioned above (this is why I’m not delineating between DA and consensus).

My argument can be summed up as follows: The settlement layer is the most valuable because of monetary premiums, and execution is much more valuable than DA+consensus because the latter provides a homogenous service where competition is fierce, and costs (and hence revenue for the DA+consensus layer) will trend to 0 (slightly unrelated, but this talk by Peter Thiel is great and talks about why these sorts of businesses don’t make sense to pursue). Meanwhile, the former (execution) layers can build network effects at a much greater rate and solidify them with mass liquidity! (They’re also much closer to the users, and they don’t compete on fees!) Let me explain this point a little more. Right now, rollups such as Optimism and Arbitrum pay more than 90% of their costs (which are actually paid by users) for DA (this Bell Curve episode expands on what I’m saying), something they want to minimize. Therefore, they might switch to Celestia for DA (and hence consensus), thus lowering their cost (and therefore their revenue) drastically (right now, data on Celestia costs pennies for rollups; if Arbitrum wrote as much data as it did today to Ethereum to Celestia, it would only pay a few thousand dollars — Dan Smith has done good research on this). But users don’t care about small fee increments between rollups! I don’t care if I’m paying $0.01 for a swap on Rollup A when I could be paying $0.007 for a swap on Rollup B, simply because I don’t swap that much, and bridging my assets is a hurdle and entails security risks. But for a rollup —which is, after all, a business posting thousands of megabytes of data to the DA layer — these “increments” in cost matter a lot because they add up. Basically, rollups are price-elastic (very price elastic). But rollup users aren’t, to a large degree.

Conclusion

From fat protocols to fat applications, modeling value accrual in the blockchain landscape isn’t a new endeavor. The advent of modularity introduces new components to the public blockchain landscape, as well as new economic and value dynamics. Modular blockchains represent a paradigm shift in the blockchain stack — from building a complete integrated network that can serve all four blockchain functions on the base layer, to building networks which use specialized layers for fulfilling these functions optimally.

To reiterate, I believe that the settlement layer is the most valuable component of the stack, underpinned by the monetary premiums associated with the underlying asset. Execution layers follow closely behind. In contrast, DA+consensus layers, despite providing essential functions, face growing competition and diminishing revenue potential due to their semblance to commodities.

In short, the order of value accrual in the modular stack is as follows:

Settlement > Execution > DA+Consensus

#Bybit #TheCryptoArk