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Cardano may have tiered pricing in the future

Published 10.5.2023

One of Cardano's advantages over other chains is the predictable fees for on-chain services. Cardano processes transactions on a first-come, first-served basis. Unlike most blockchains, the transaction fee size does not increase when the network is under pressure. However, this approach is not ideal. Block space is a scarce resource that can be in high demand. As demand increases, the value of block space should also increase. Most networks use a so-called fee-market mechanism that allows block producers to choose transactions based on the size of the fee. If the network is clogged for an extended period of time, people fight over block space and fees skyrocket. It may be fair, but it's not inclusive. They say that in this case, only the rich can use the blockchain. Come see what tiered pricing will bring.

TLDR

Tiered pricing allows users to set the fee according to how urgent their transaction is. If they pay a higher fee, the transaction will be processed quickly. Transactions that are less urgent will be cheaper. Cardano will thus remain, at least partly, inclusive.

The fee market makes blockchain exclusive

The fee market is used by Bitcoin and also used by Ethereum in a modified form (EIP-1559). It is sometimes called an auction system. Block producers use it when they are selecting transactions that are to be inserted into a new block. Transactions are selected based on the size of the transaction fees. The higher the fee, the more likely the producer is to include the transaction in a new block. The incentive, of course, is the financial reward that goes directly to the producer.

Fee-market has one significant disadvantage. Once the network is congested for a longer period of time, older transactions with a lower fee may not make it onto the block. They may be in the mem pool for long periods of time while the node is constantly accepting new transactions with a higher fee. The mem pool has limited space. So as soon as transactions don't fit in it the mem pool the node will start discarding some of them. Transactions with the lowest fee will be discarded first. This cycle may repeat itself. This mechanism increases the minimum fees that users are forced to pay to have a chance to get into the block. If they set a low fee, they can't be sure.

The minimum fee can be tens of dollars in a short while. In the future, networks will be more adopted, so fees may be hundreds of dollars. Although it is not at all certain that users will be willing to pay such high fees, and more likely not, one thing we know for sure. People in developing countries will not be able to access on-chain services because fees in the tens of dollars will not be affordable.

If opening (or closing) a channel on a second layer requires an on-chain transaction, all second layers will also be economically inaccessible to most people. They will be forced to use centralized services where fees may be lower and services faster. But the fee paid to a centralized service is a missed economic opportunity for blockchain networks. From the perspective of the long-term economic sustainability of all blockchain networks, it is desirable that they are as profitable as possible, i.e. that most of the fees that are associated with cryptocurrencies are earned by the first layers.

The fee market is a fair approach from an economic point of view, as the value of block space is according to the current demand. The problem is that it discriminates against poor people and makes access to the blockchain an exclusive service.

Of course, a large number of users cannot get transactions to the blockchain at the same time, so it will always be a somewhat exclusive service. On the other hand, we need to look for ways to give access to as many people as possible at a reasonable market value. Tiered pricing can help with this.

How to get smart on fees?

Tiered pricing is based on the assumption that users have different expectations for each transaction in terms of the size of the fee and the delay in including into the block. Some are happy to pay more to get their transaction into the block as quickly as possible, while others prefer to pay less and are willing to wait longer. The same applies to applications. Some need the transaction to be settled as quickly as possible, for example, DEXs. In other applications, like the NFT marketplaces, transactions are not as urgent.

Tiered pricing will use traffic diversity to make Cardano more inclusive. At the same time, it allows users and applications to assign priority to transactions.

Note that the fee market mechanism is driven only by the size of the fee and is unable to distinguish between lower and higher-priority transactions. Users may not be able to correctly set the fee size to correlate with the delay when they want the transaction to be settled.

The tiered pricing paper proposes splitting block space into tiers. Each tier will have a different settlement delay and fee. The number of tiers, along with delays and fees in each tier, will be adjusted automatically depending on current demand.

You can think of the mechanism as a multi-lane highway. Each lane will have different speeds and different gas charges. The right lane will be slow and gas will be cheap while the left lane will be fast but expensive. There may be multiple lanes between the left and right lanes. Users can decide which lane to take based on how fast they need to get to their destination and how much they are willing to pay.

If the highway is not under pressure, a single right lane may be used for all. Once that lane starts to clog up, the next lane will be used, which will be faster but more expensive.

Different policies can be applied regarding how much space in the block will be reserved for transactions with a different urgency. For example, it will be possible to define what percentage of the block space will be reserved for transactions with the lowest priority, i.e. with a low fee. This mechanism will ensure that some block space remains inclusive while wealthier people can pay extra for faster services.

While modeling tiered pricing behavior, the team also looked at EIP-1559. It was found that Ethereum is not inclusive and fees surge horizontally during periods of congestion. Tiered pricing allows for achieving stable prices that can be kept low for low-urgency transactions, resulting in a diverse set of transaction types entering the blockchain. What was a surprise, the mechanism does not necessarily sacrifice revenue. The lowering of the prices for low-urgency transactions can be covered from high-urgency ones due to the fee discrimination ability of the mechanism. The average revenue with the tiered pricing mechanism can be higher than with EIP-1559, despite about 75% of users paying a significantly lower fee.

Let us add that the conclusions of the tiered pricing paper are general and can be used for different blockchains. It is unknown at this time how specifically tiered pricing will be implemented in Cardano.

In addition, the paper shows that it is difficult to make strong generalizations about the long-term performance of the two mechanisms described. Tiered pricing is based on the logical assumption that people and applications have different settlement and fee expectations from transactions. It is therefore smart to try to accommodate these expectations.

One of Cardano's competitive advantages is fee predictability and determinism. If Cardano were to retain this feature, it will be difficult for the IOG team to combine this with the dynamic adjustment of fees and delays. If anything is to be dynamically modified in a distributed network, it is necessary that all nodes are synchronized. The resulting solution can be relatively complex.

If tiered pricing could be delivered, Cardano would be able to better manage network congestion, which would be beneficial, especially for users. They will need to understand this mechanism in order to use it well. Wallets and apps can help them do this (even in the case of a fee market, wallets can recommend a fee).

In our view, tiered pricing is fairer than the fee market, as it allows the protocol to distinguish between urgent transactions and those that may have longer delays. Cardano thus remains inclusive, but it is necessary to add that if there is high demand for the cheapest transactions, for example, some will be discarded anyway. Users will have to resubmit them.

Conclusion

Tiered pricing can be seen as an attempt to solve the problems with clogged blockchains. This is a problem we are currently experiencing due to the mania around meme coins, but with higher adoption, it may be a common condition. Expensive on-chain fees can only be reliably solved by one thing, and that is higher scalability. If blockchain is only available to the rich, it will essentially lose any meaning to its existence. Using cryptocurrencies through centralized services makes almost no fundamental sense for humanity, as the benefits of openness for everyone, resistance to censorship, transparency, fairness, etc. are lost. Cardano may have tiered pricing in the future, but if it was more scalable, it is possible that this feature would only be used occasionally. That would be the ideal state.

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