DeFi Gas Inflation On Ethereum Creates Opportunities And Problems

With the ascent of DeFi (decentralized finance), ethereum has steadily risen in terms of activity and market capitalization again, with prices for ethereum increasing from 2020 lows. While there has been a lot of positive effects of on-chain activity and off-chain buzz, the gas price inflation present largely because of the activity of DeFi has helped create new opportunities as well as problems in the space.

Gas is the unit of activity on ethereum and the transactional cost for expending the computational resources required to run decentralized apps or smart contracts. In order to initiate any activity, including sending ethereum to others, you need to pay a gas fee denominated in a unit called gwei.

While you decide how much gas you want to pay per transaction, in a proof-of-work system, miners decide which transactions to process, so a lower gas fee may mean that your transaction doesn’t come through at a good time — if at all. Gas fees are expected to continue to persist even in a proof-of-stake and ethereum 2.0 launch as the network’s way of compensating people for their computational costs.

Ethereum gas fees have hit all-time highs with the advent of decentralized finance applications that are largely built on ethereum. Investors that are looking to make large amounts of return on passive capital are willing to pay prohibitively high gas costs in order to make sure their transactions go through. Ethereum gas prices have risen more than 20x this year as a result. This has led to situations where a user might have paid $1 for one action and then a few months later needed to pay $50 to do that exact same thing.

You have to go back to CryptoKitties and the ICO boom in 2017-2018 to get all the way back to the price activity and on-chain activity level we see now and the gas price inflation. While this creates opportunities for entrepreneurs in the space and gathers some technical talent around ethereum, it also makes it more burdensome for users who are on the platform not to try to accumulate tons of return on a restive pot of capital, but to try to take advantage of other decentralized applications.

This has already led to the shutter or disruption of businesses that rely on gas fees that aren’t DeFi models. UniLogin had to shut down because gas fees meant that at some points, it was paying $130 to onboard new users. Publish0x, a platform that pays out writers in ethereum tokens, had to delay payments for a week and switch to a monthly system of payment, instead of weekly, in order to avoid high gas fees.

Many different decentralized organizations and applications simply can’t survive if each transaction or action on the network costs multiple dollars to effectuate. Think, for example, of a gaming use case — the need to pay multiple dollars to advance certain actions makes it difficult to ever build anything meaningful without it being prohibitively expensive for users to onboard and to enjoy.

In many ways, this gas price increase has “priced out experimentation” and jammed decentralized exchanges responsible for the interflow of volume between different tokens.

Yet it has also created the need for new solutions right as ethereum is transitioning into a new 2.0 architecture. Some are relying on what are called layer 2 solutions and sidechains in order to avoid these high gas fees and rollups that help layer the scalability of layer 2 with the trust and security of ethereum’s main layer.

Yet this challenge is also going to be something that the main layer will have respond to eventually — a constraint that invites innovators to think about how to achieve the scale and trust required to build a variety of different decentralized apps rather than a concentration of a few.