What are gas fees?
Ethereum relies on validators to verify and execute transactions published by users to the chain. Existing as a validator, verifying and executing transactions all entail costs upon the providers of these services. Therefore for transactions to exist these validators as service providers must be remunerated in a similar way to how banks must charge fees to provide electronic payment systems. Because Ethereum transactions serve more purposes than just that of facilitating financial transactions a simple percentage as a fee does not properly reflect the appropriate remuneration.
Instead gas fees as they are known are conceptualised as a mechanism that attaches a market-demand price to a unit of gas that abstractly represents the costs of performing certain actions to a validator. If a transaction involved a complex program it would have a greater number of units of gas to execute than a simple transaction that simply transferred money from one user to another. Depending on the demand for and supply of validators gas fees, the costs that must be paid per each unit of gas, may increase or decrease as per natural market forces.
If validators don’t feel there are sufficient fees being paid per a unit of gas they won’t perform the necessary services. If a user doesn’t offer as much fees per a unit of gas as another user for their transaction then validators may ignore said user’s transaction. Hence, it can be seen from a simplistic perspective that a greater demand for transactions will lead to an increase in gas fees as users compete with each other. Though gas fees and validator rewards aren’t synonymous and there is more to the latter topic that needs to be understood first.
What are validator rewards?
Previously it has been investigated within other articles what validator rewards are, how they are earned and how they are withdrawn. These details will be mentioned succinctly here for the purposes of understanding the remainder of this article. Validators are rewarded for performing various duties necessary for Ethereum to function. These duties include collecting transactions to be published in blocks and attesting to the validity of the transactions within these blocks. For both actions rewards are derived from issuing new ETH, though for the former there is the possibility to receive some of the gas fees as a reward too.
Gas fees paid in a transaction are split into a base fee and a priority fee. Base fees are “burned” (removed from circulation) and the validator who collected and published that transaction as part of a block receives the priority fee. It is important to note that base fees are determined algorithmically instead of by market-demand. The reason these are burned is to offset some of the inflation from the issuance of new ETH to pay validator rewards. Therefore, validator rewards are reliant on both base and priority fees but the relationship is difficult to measure.
It can be seen though that if demand for transactions increase and by extension gas fees increase, there will be increased incentive for validators to join the network as there will be more rewards available to earn (either through direct priority fees or decreased inflation from base fees). Interestingly it can be noted that the increased availability of validators does not necessarily exert downward pressure on gas fees (though it does exert downward pressure on the validator rewards available per an individual) as the real limitation is the finite number of transactions that can be published in a single block. If gas fees decrease again, due to a decreased demand for transactions, it would be expected that the number of active validators would decrease.
Are there negatives with staking?
However, as an increase in gas fees incentivises an increase in validators the decrease in liquidity brought about by this could become more impactful. Rapidly diminishing liquidity combined with increasing costs for services can be fatal to any economic system. When considered with the observation that an increase in validators does not necessarily decrease gas fees but does decrease the rewards earned by each validator it can be visualised how such conditions could spiral. These concerns and many other worried perspectives have been put forth in recent months but as with almost any economic issue there is more to the picture.
There is a churn limit in Ethereum that limits the number of validators that can join the network in a given unit of time. Only a maximum of ~0.0002% of all ETH in circulation can be staked to add more validators to the network every 6.4 minutes (an epoch). Over an entire year this would approach ~20% assuming validators joined at the maximum rate possible and never withdrew. This gradual pace of illiquidity would dampen any runaway effects or sudden market collapses. It would also mean that gas fees would continually have to increase to such a degree as to prompt continual validator increases for such an extended time period.
If gas fees do increase drastically a deflationary effect will be experienced across the Ethereum network where more ETH is being removed from circulation than added. While deflation will increase the reward for validators (by the nature of staked tokens increasing in value naturally) it would also likely decrease demand for transactions. Users are more likely to hold onto their current supply of ETH than spend it if the value of holding it is greater than not. With decreased spending it would be expected that gas fees would likewise decrease which would incentivise validators to withdraw from the network.
It can be seen that the relationship between gas fees and validator rewards isn’t clear and that there is lots of room to hypothesise about the consequences of this relation. However, it can also be seen as evident that there are counterbalance effects that would likely ensure gas fees and the total number of active validators remain in relative stasis (relative to the needs of the wider economic system). Churn limits and deflationary effects would reduce liquidity losses and transaction demand respectively. Validators are also never in a position where they can exploit their position without sufficient demand to justify their need. Conversely as long as there is a need for transactions there is always a consistent source of income for validators to provide their services.