The Resurgence of Solana's Economic Value

Solana's economic landscape has seen a significant transformation since late 2023, marking a resurgence that has carried through into 2024. Dan Smith from Blockworks Research joined the Lightspeed podcast to discuss the intricacies of Solana's Total Economic Value (TEV), MEV extraction on Layer 2 solutions, and the evolving validator revenue streams. The conversation shed light on the current state of Solana's ecosystem and its position relative to other blockchain networks.

The podcast began by highlighting the recent uptick in Solana's economic activity. Smith noted, "About November, 2023, and it's kind of when Solana had its DeFi resurgence. And that's really carried through into 2024." This resurgence has been closely tied to the increased activity in decentralized exchanges (DEXs) and the proliferation of meme coins within the Solana ecosystem.

Understanding Total Economic Value (TEV)

Total Economic Value is a crucial metric for assessing the health and growth of a blockchain network. For Solana, TEV comprises vote fees, transaction fees, and GITO tips. Smith explained, "We have the two year view on in the weekly and you can see that for much of this chart, you can't really see any bars." This visualization underscores the dramatic increase in economic activity on Solana since late 2023.

The concept of TEV is particularly important as it represents the top-line revenue for the blockchain. It's a measure of the value being generated by network activity and provides insights into the overall health of the ecosystem. As Smith pointed out, "About 95% of fees come from, again, tips and priority fees." This breakdown highlights the significance of user behavior in driving economic value on the network.

MEV Extraction on Layer 2 Solutions

One of the key topics discussed was the extraction of Maximal Extractable Value (MEV) on Layer 2 solutions. Smith challenged a recent statement by Justin Drake from the Ethereum Foundation, who claimed that MEV was not being extracted on L2s. Smith provided data to refute this claim, particularly focusing on the Optimism (OP) stack, which includes networks like Base, Zora, and OP Mainnet.

Smith explained, "All the chains in the super chain, which I think the four largest are again, Zora mode base and OP Mainnet. You can see on this chart here, this dark red is the L2 base fee... That accounts for roughly, let's call it 10 to 15 to 20% of the total fee revenue for these chains while the priority fee or again, that ordering fee is about 80% to get in the block."

This data reveals that a significant portion of the fee revenue on these L2 solutions comes from priority fees, which are essentially a form of MEV extraction. Smith further illustrated this point by analyzing the first transaction in each block on Base: "If you just look at the priority fees paid to be the first transaction in every block on base, the those fees make up 40% of the total transaction fee revenue for the entire chain."

The Mechanics of MEV on Layer 2s

To understand how MEV works on Layer 2 solutions, Smith provided an example: "Let's say there's a DEX on base that was selling, you know, you could buy one ETH for having checked the charts here. So let's just say, you know, ETH is at $2,000. You can buy one ETH on chain for two grand and you can turn around and sell that's a Binance for $2,010."

In this scenario, arbitrageurs are willing to pay high priority fees to ensure their transaction is processed first, allowing them to capture the price difference between on-chain and off-chain markets. This competition for block position drives up priority fees, which become a significant source of revenue for the network.

Validator Economics on Solana

The discussion then shifted to validator economics on Solana, a topic that has been the subject of much debate within the community. Smith highlighted a significant change in the distribution of economic value: "If you think back to, you know, August 2022, we, we have this interesting world where stakers were actually making no fees. And they're getting none of this total economic value. And it was just 50, 50 split between validators and then sol burn."

This historical context is crucial for understanding the evolution of Solana's economic model. Smith pointed out a unique aspect of Solana's design: "An interesting thing about Solana that I don't think is like common knowledge is transaction fees are kept by validators. There are some community validators that return a portion of that to their stakers. But this is like an out of protocol mechanism, like actually in Solana, there's just no way to take a commission on transaction fees earned by the validator and pass the rest of the stakers."

The Rise of MEV and Its Impact on Validator Revenue

The introduction of MEV, particularly through the GITO block engine, has significantly altered the revenue streams for validators and stakers. Smith explained, "With the increase in MEV activity, and some of the network congestion issues that have led people to wildly adopt the Geto block engine and using their transaction processing mechanism. That is a huge difference between staker income because again, transaction fees can't be split in protocol with stakers, but MEV tips are."

This shift has led to a more equitable distribution of economic value within the Solana ecosystem. According to Smith, "Last week we earned the network earned $8 million in total economic value between tips and transaction fees. And that was split between stakers, validators, the soul burn in Geto labs in a so 30% went to stakers, 37% went to validators, 30% was burned. And then the Geto labs takes a cut on the top line of tips moving through their system."

The Profitability of Solana Validators

One of the most striking revelations from the discussion was the current profitability of Solana validators. Smith provided some eye-opening figures: "In the forecast for 2024, which is just taking the current data through September 5th and just linearly projecting that forward. So they're on pace to make about $1.2 billion and it only takes $70 million to run the set."

This substantial profit margin raises questions about the long-term sustainability and fairness of the current economic model. Smith suggested that validator profit margins might trend towards more typical business margins of 5-10% in the long run, as the ecosystem matures and competition increases.

The Role of Stakers in Solana's Economy

The podcast also delved into the role of stakers in Solana's economic model. Smith posed a philosophical question: "I don't necessarily see why stakers are entitled to a large share of the TV on Solana. Because the validators are performing the service. They're the ones doing bringing network to consensus, building the blockchain, stakers to go back to the economy example. It's like the validators go build the bodega across the street. The stakers are just throwing $10 into the hat to help them with inventories."

This perspective challenges the notion that stakers should receive a significant portion of the network's economic value, given their relatively passive role in the ecosystem. However, Smith also acknowledged that market forces might push for higher rewards for stakers as validators compete for stake.

The Future of Solana's Economic Model

Looking ahead, Smith speculated on potential changes to Solana's economic model: "That's kind of like my my hot take is I think there will be some economic changes coming to Solana in 2025, I would say. I'm not going to say near near future, but like I feel this changing in the wind where, you know, burning less than 5% of the daily emissions or weekly emissions, it doesn't feel necessary to be emitting that much."

This prediction suggests that Solana might be moving towards a more balanced approach to its economic design, potentially reducing inflation and adjusting the distribution of economic value among network participants.

Comparing Solana to Ethereum

Throughout the discussion, Smith drew comparisons between Solana and Ethereum, particularly in terms of total economic value and token issuance. He noted, "Ethereum was always light years ahead of Solana in total economic value. And I'm picking a couple of random weeks here. It's like, you know, 10 to 20 to 30 X to 90 X the differences in Ethereum being the larger value there. We fast forward to today. The two are kind of on top of each other."

This convergence in economic value generation is a significant milestone for Solana, indicating its growing competitiveness in the blockchain space. However, Smith also pointed out a potential imbalance in token issuance: "Solana issues. On some days, almost double the amount of value that Ethereum is to its validator set." This observation suggests that there might be room for Solana to optimize its issuance model in the future.

The State of NFTs on Solana

The podcast also touched on the current state of Non-Fungible Tokens (NFTs) within the Solana ecosystem. While NFTs have seen a decline in popularity since their peak in 2021, Solana has maintained a strong position in this market segment. Smith noted, "Solana really has taken a meaningful lead in terms of NFT volume and users and all these things."

However, Smith was quick to caution against using certain metrics to compare NFT activity across chains: "Active addresses are not users. They are not comparable across chains. It costs two tenths of a cent to be an active address on Ethereum or sorry, on Solana and it costs a couple bucks to be an active address on Ethereum. Therefore, there is no use in comparing it to because they are not comparable."

Instead, Smith emphasized the importance of looking at revenue generated from NFT transactions. He pointed out, "Chain revenue the past seven days. Solana is at 30% Bitcoin, 29% ETH, 27%. The lead is actually driven by like transaction fees driven by NFTs." This data suggests that despite the overall cooling of the NFT market, Solana continues to be a significant player in this space.

The Evolution of NFTs and New Use Cases

The conversation also explored the potential future of NFTs beyond the speculative PFP (profile picture) trading that characterized the 2021 boom. Smith expressed skepticism about a return to that model: "I think the last cycle of PFP trading gamified nonsense is dead and it never never coming back and that's for the better."

However, he did acknowledge emerging trends in NFT utility, citing projects like Zora, Drip, and Blackbird. These projects are exploring ways to integrate NFTs into more practical applications, such as digital identity, content creation, and real-world experiences. Smith remarked, "I think like the the zores and the drips of the world, like, yeah, I think there's probably something there. I don't particularly love it. Like as a consumer, like it's just not my thing, but that doesn't mean it like I think it's a bad thing."

The Importance of Community in NFTs vs. Meme Coins

An interesting point of comparison emerged between NFTs and meme coins in terms of community building. The podcast host suggested that NFTs might have an advantage in this area: "I feel like, I mean, so obviously meme coins are maybe more liquid, more tradable than a crypto punk. But like, I don't know, the idea of community never really took off with meme coins because people just want to turn a quick bunk, turn a quick buck and dump on you. But NFTs do have these sort of long term holders that, I don't know, I feel like it, it is more conducive to creating real community."

This observation highlights a potential long-term value proposition for NFTs beyond their speculative nature, suggesting that they might play a role in fostering digital communities and engagement in ways that more fungible tokens cannot.

Sanctum's LST Partnerships and Their Implications

The podcast also covered recent developments in Solana's liquid staking landscape, particularly Sanctum's partnerships with major centralized exchanges. Smith commented on the strategic value of these partnerships: "From the sanctum angle, I think it's the right method to go. I don't know what their business model is. Like, okay, this is great. You have these awesome partners and centralized exchanges to your point of phenomenal distribution. All the users are on their platform. Makes sense to go after that as a target customer."

These partnerships, particularly with Binance, have the potential to significantly increase the adoption of liquid staking within the Solana ecosystem. The ease of access provided by these integrations could lead to a larger portion of Solana tokens being staked, potentially impacting the overall tokenomics of the network.

The Changing Landscape of Liquid Staking on Solana

Smith provided insights into the shifting market shares within Solana's liquid staking sector: "Marinade when Geto launched roughly marinade was about 80% of total stake. And if you fast forward to today marinade is let's see, M soul is roughly about 20. And so sanctum and its crew of LST is plus Geto. I've just absolutely eaten into that that market share."

This redistribution of market share indicates a maturing and diversifying liquid staking ecosystem on Solana. It also highlights the competitive nature of this sector, with new entrants like Sanctum and established players like GETO gaining ground.

Potential Challenges and Considerations

While discussing the various developments in Solana's ecosystem, Smith also pointed out potential challenges and considerations. For instance, he mentioned the potential negative externalities of Marinade's stake auction marketplace: "If I was like a malicious sandwich attacker, you know, I can basically control a validator that runs one of these dark undercover mempools where it like, finds user transactions, or receives user transactions, and then allows people to sandwich them."

This scenario illustrates the complex interplay between different protocols and mechanisms within the Solana ecosystem, and the need for careful consideration of potential unintended consequences as new features are introduced.

The Future of Solana's Economic Design

As the podcast drew to a close, Smith offered his perspective on the future of Solana's economic design. He suggested that changes might be on the horizon: "I think there will be some economic changes coming to Solana in 2025. I would say, I'm not gonna say near near future, but like I feel this changing in the wind where, you know, burning less than 5% of the daily emissions or weekly emissions is just not, it doesn't feel necessary to be emitting that much."

This prediction points to a potential shift in Solana's approach to tokenomics, possibly moving towards a model that reduces inflation and optimizes the distribution of economic value within the network. Such changes could have significant implications for validators, stakers, and other participants in the Solana ecosystem.

Conclusion: Solana's Evolving Economic Landscape

The discussion with Dan Smith provided a comprehensive overview of Solana's current economic landscape and potential future developments. From the intricacies of MEV extraction on Layer 2 solutions to the changing dynamics of validator economics and the evolving role of NFTs, the podcast highlighted the complex and rapidly changing nature of the Solana ecosystem.

As Solana continues to grow and mature, it faces both opportunities and challenges. The network's ability to generate significant economic value and compete with established players like Ethereum is a testament to its technological capabilities and growing adoption. However, questions about the long-term sustainability of current validator profits, the optimal distribution of economic value among network participants, and the future of NFTs within the ecosystem remain open for debate.

The coming years will likely see further evolution in Solana's economic model, potentially including adjustments to token issuance, changes in the distribution of transaction fees and MEV rewards, and new innovations in areas like liquid staking and NFT utility. As these changes unfold, they will shape the future of Solana as a blockchain platform and its position within the broader cryptocurrency ecosystem.

Facts + Figures

• In November 2023, Solana experienced a DeFi resurgence that has carried through into 2024.
• About 95% of fees on Solana come from tips and priority fees.
• On Base (an L2 solution), 40% of total transaction fee revenue comes from priority fees paid to be the first transaction in every block.
• In August 2022, Solana stakers were making no fees, with a 50/50 split between validators and SOL burn.
• Currently, 30% of Solana's total economic value goes to stakers, 37% to validators, 30% is burned, and 2% goes to GETO labs.
• Solana validators are forecast to make about $1.2 billion in 2024, while it only costs about $70 million to run the entire validator set.
• It costs about $50,000 a year to run a Solana validator.
• Solana is issuing, on some days, almost double the amount of value that Ethereum is to its validator set.
• Solana controls 32% of the NFT chain user share compared to 19% for Ethereum.
• In terms of chain revenue from NFTs in the past seven days, Solana is at 30%, Bitcoin at 29%, and Ethereum at 27%.
• Marinade's share of liquid staking on Solana has decreased from about 80% to roughly 20% with the entry of new players like Sanctum and GETO.
• The average commission for Solana validators is around 20%, but this is skewed higher by some 100% commission validators.
• GETO labs makes about a few million dollars a quarter from their 5% fee on tips.
• Solana's liquid staking penetration is currently about 5-6% of total stake.

Questions Answered

What is Total Economic Value (TEV) in the context of Solana?

Total Economic Value (TEV) is the top-line metric for Solana's blockchain activity. It comprises vote fees, transaction fees, and GITO tips. TEV represents the overall economic activity and value generation on the Solana network, providing insights into the health and growth of the ecosystem. About 95% of Solana's TEV comes from tips and priority fees, indicating the significant role of user behavior in driving economic value on the network.

How does MEV extraction work on Layer 2 solutions?

MEV extraction on Layer 2 solutions, particularly those using the Optimism (OP) stack, occurs primarily through priority fees. Arbitrageurs pay high priority fees to ensure their transactions are processed first, allowing them to capture price differences between on-chain and off-chain markets. On Base, for example, 40% of total transaction fee revenue comes from priority fees paid to be the first transaction in each block. This competition for block position drives up priority fees, becoming a significant source of revenue for the network.

How has Solana's validator economics changed since 2022?

Solana's validator economics has undergone significant changes since 2022. In August 2022, stakers were making no fees, with economic value split 50/50 between validators and SOL burn. Currently, 30% of total economic value goes to stakers, 37% to validators, 30% is burned, and 2% goes to GETO labs. This shift is largely due to the introduction of MEV activity and the adoption of the GETO block engine, which has created new revenue streams for both validators and stakers.

What is the current state of NFTs on Solana?

Solana has maintained a strong position in the NFT market despite the overall cooling of NFT popularity since 2021. Solana controls 32% of the NFT chain user share compared to 19% for Ethereum. In terms of chain revenue from NFTs in the past seven days, Solana is at 30%, outperforming both Bitcoin and Ethereum. However, experts caution against using active address metrics for cross-chain comparisons and emphasize the importance of looking at revenue generated from NFT transactions.

What changes might be coming to Solana's economic model in the near future?

Dan Smith predicts that Solana may see economic changes in 2025. These changes could include reducing the rate of token issuance, as currently, Solana is burning less than 5% of daily emissions, which Smith suggests may be unnecessarily high. There may also be adjustments to the distribution of economic value among network participants, potentially optimizing the balance between validator profits, staker rewards, and token burn rates. These potential changes aim to create a more sustainable and efficient economic model for the Solana ecosystem.