Why Bitcoin and Ethereum Differ in Transaction Fees: A Theory of Blockchain Fee Policies

Abdoulaye Ndiaye

No 18890, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: This paper develops a theoretical framework to explain why transaction fee policies differ between major blockchain platforms like Bitcoin and Ethereum and proposes optimal designs for these policies. We model a blockchain as a network where user demand for transaction processing is uncertain, and a validator with temporary monopoly power and uncertain operational costs decides which transactions to include. We characterize the optimal choice between price-setting (as in Ethereum) and block space-setting (as in Bitcoin) fee policies. Specifically, when validators have high bargaining power and demand uncertainty is significant with low marginal cost-demand correlation, price-setting mechanisms are more effective; this aligns with Ethereum's adoption of price-setting along with its transition to proof-of-stake. Conversely, when validators have low bargaining power and costs are positively correlated with demand, as in Bitcoin's proof-of-work system, quantity-setting is preferable. Applying our model to Ethereum's fee policies, we find that the current rate of fee adjustment exceeds the optimal rate, and we characterize the optimal monopolist's block size target, highlighting potential vulnerabilities to maximal extractable value (MEV) exploitation. Our findings provide insights for designing efficient blockchain fee policies.

Keywords: Blockchain; Transaction costs; Fee policies; Bitcoin; Ethereum; Demand fluctuations; Price elasticity (search for similar items in EconPapers)
JEL-codes: C70 G00 (search for similar items in EconPapers)
Date: 2024-03
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