Economic Layer

The native asset (e.g., ETH, BTC, SOL) is the foundational currency of the economic layer. It serves multiple critical functions:

• Transaction Fees (Gas): Paid to compensate validators for computation and storage.
• Staking/Security: Used as collateral in Proof-of-Stake systems to secure the network.
• Unit of Account: The primary metric for valuing network activity and assets.

This defines how network participants agree on the state of the ledger and how they are incentivized or penalized. Key models include:

• Proof-of-Work (PoW): Miners expend computational energy to propose blocks.
• Proof-of-Stake (PoS): Validators lock (stake) the native asset to propose and attest to blocks, facing slashing penalties for misbehavior.
• Delegated Proof-of-Stake (DPoS): Token holders delegate their stake to elected validators.

The mechanism that determines transaction priority and resource allocation. Users bid (via gas fees or priority fees) to have their transactions included in a block. This creates a fee market where block space is a scarce, auctioned resource. Designs like EIP-1559 introduce base fees that are burned, making the native asset deflationary during high demand.

The protocol-defined rules governing the issuance (creation of new tokens as rewards) and, in some cases, burning (permanent removal) of the native asset. This controls inflation and deflation.

• Example: Bitcoin has a fixed, halving issuance schedule capped at 21 million BTC.
• Example: Ethereum's post-merge issuance is minimal, with fee burning often making it net deflationary.

The processes for proposing, voting on, and implementing changes to the economic layer's parameters (e.g., block reward, fee structure). This can be:

• On-chain Governance: Token holders vote directly via smart contracts (e.g., Compound, Uniswap).
• Off-chain Governance: Stakeholders coordinate through social consensus and client implementations (e.g., Bitcoin Improvement Proposals (BIPs), Ethereum Improvement Proposals (EIPs)).

The economic layer's ultimate role is to provide a secure, irreversible settlement layer for transactions and smart contract states. Finality is the guarantee that a transaction cannot be reversed.

• Probabilistic Finality: Common in PoW, where reversal probability decreases with more confirmations.
• Absolute Finality: Achieved in PoS systems after a validator set agrees, often within epochs.

The economic model of a cryptocurrency, defining its supply, distribution, and utility. Key components include:

• Token Supply: Total, circulating, and emission schedules (e.g., fixed cap like Bitcoin, inflationary, or deflationary).
• Utility: Functions like governance rights, fee payment, staking collateral, or access to services.
• Distribution: Initial allocation (e.g., ICO, airdrop, mining rewards) and ongoing incentives.

Economic rewards and penalties that secure the network by aligning participant behavior. Examples:

• Proof of Work (PoW): Miners expend computational energy (hash power) to validate blocks, receiving block rewards and transaction fees.
• Proof of Stake (PoS): Validators lock (stake) tokens as collateral. Correct validation earns rewards; malicious acts trigger slashing, where a portion of the stake is destroyed.

The mechanism determining transaction priority and cost, typically through an auction system. Users bid (pay a fee) to have their transactions included in the next block.

• Base Fee + Priority Fee (EIP-1559): A base fee is burned, while a tip goes to the validator. This creates predictable costs and a deflationary pressure.
• Gas: On Ethereum Virtual Machine (EVM) chains, fees are paid in gas, a unit measuring computational work.

The protocol-enforced rules controlling the native token's supply over time. This is a core differentiator between networks.

• Disinflationary: Bitcoin has a halving event every 210,000 blocks, reducing the block subsidy by 50%.
• Algorithmic: Some chains use formulas to adjust issuance based on network conditions (e.g., targeting a specific staking yield).
• Burning Mechanisms: Permanent removal of tokens from supply (e.g., via transaction fee burning) to counteract inflation.

The process of locking tokens to participate in network consensus and earn rewards, central to Proof of Stake (PoS) economics.

• Active Validation: Running a node with a minimum stake to propose and attest to blocks.
• Delegation: Token holders can delegate their stake to a validator, sharing in the rewards (minus a commission).
• Liquid Staking: Using derivative tokens (e.g., stETH) that represent staked assets, allowing them to be used in DeFi while earning staking yields.

Protocol-controlled capital used to fund development, grants, and incentives, often governed by token holders.

• Source: Funds are typically accrued from a portion of block rewards, transaction fees, or a dedicated inflation tax.
• Governance: Token holders propose and vote on treasury allocations via on-chain governance (e.g., Compound, Uniswap).
• Purpose: Funds ecosystem growth, security audits, bug bounties, and public goods funding.

The design of a blockchain's native token supply and issuance schedule. This includes:

• Inflationary vs. Deflationary Models: Whether new tokens are continuously minted (e.g., for staking rewards) or a hard cap exists (e.g., Bitcoin's 21 million).
• Emission Schedules: Pre-programmed rates of new token creation, often decreasing over time.
• Burn Mechanisms: The permanent removal of tokens from circulation (e.g., via transaction fees or buybacks) to counteract inflation.

The economic rewards and penalties that secure the network via its consensus mechanism. In Proof-of-Stake (PoS), validators stake tokens as collateral to earn block rewards; malicious acts lead to slashing (loss of stake). In Proof-of-Work (PoW), miners expend real-world energy (electricity) for a chance to earn block rewards, making attacks prohibitively expensive.

The decentralized system that determines the cost of using the network. Users bid (via gas fees or priority fees) to have their transactions included in a block. This creates a fee market where block producers (validators/miners) are incentivized to include the highest-paying transactions, efficiently allocating scarce block space.

The process of locking tokens to participate in network consensus and earn rewards. Direct staking involves running a validator node. Delegated staking allows token holders to delegate their stake to professional validators, sharing rewards for providing network security and governance rights. This creates a yield-generating asset class from the protocol's native token.

The accumulation and management of assets controlled by the protocol itself. Funds often come from transaction fees, staking rewards, or token issuance. A DAO treasury uses these funds for grants, development, and incentives, aligning long-term growth with stakeholder interests. Protocol-Owned Liquidity (POL) is a key strategy where the protocol owns liquidity pool assets, reducing reliance on external incentives.

The principle that a blockchain's monetary policy is governed by immutable, transparent code rather than a central authority. This creates credible neutrality: the rules are the same for all participants and cannot be changed arbitrarily. The goal is to establish a sovereign money system where the asset's properties (scarcity, issuance) are guaranteed by mathematics and decentralized consensus.

A majority attack where a single entity gains control of more than 50% of a Proof-of-Work network's hashrate or a Proof-of-Stake network's staked tokens. This allows them to:

• Double-spend coins by reorganizing the blockchain.
• Censor transactions by excluding them from blocks.
• Halt block production, disrupting the network. The economic cost to execute such an attack must outweigh the potential profit, a principle known as Nakamoto Consensus.

A theoretical attack on Proof-of-Stake networks where an adversary acquires private keys from validators that staked in the distant past (e.g., years ago) at a low cost. They can then create an alternative chain history from that old point. Defenses include:

• Checkpointing: Periodically finalizing blocks to create irreversible points.
• Slashing: Penalizing validators for signing conflicting blocks.
• Subjectivity periods: Requiring new nodes to trust a recent, trusted block hash.

The risk that stake becomes concentrated among a few large entities (e.g., centralized exchanges, whale validators), undermining network decentralization and security. Consequences include:

• Increased risk of collusion and censorship.
• Governance capture, where a minority can dictate protocol changes.
• Reduced liveness guarantees if major validators go offline. Protocols combat this with mechanisms like minimum stake requirements, delegation limits, and algorithms that penalize correlated failures.

The ability to pay transaction fees in tokens other than the network's native asset (e.g., paying Ethereum gas fees in ERC-20 tokens). While improving user experience, it introduces risks:

• Erosion of native token value: Reduced demand for the base asset can weaken its security budget.
• Validator complexity: Validators must manage price oracles and multiple asset types.
• MEV extraction challenges: Front-running and arbitrage become more complex across multiple fee markets.

A game-theoretic scenario where rational validators are incentivized to act in ways that reduce overall network security or efficiency. Key examples:

• Nothing-at-Stake: In early PoS, validators could vote on multiple chain forks for free, preventing consensus. Solved by slashing penalties.
• MEV (Maximal Extractable Value) Extraction: Validators reorder transactions for profit, leading to network inefficiency and unfairness.
• Liveness vs. Safety Trade-off: Parameters that make the chain finalize quickly (liveness) may make it easier to reverse transactions (safety).

Poorly designed monetary policy can lead to unsustainable inflation, disincentivize participation, or cause token price collapse. Critical failures include:

• Hyperinflationary rewards: Issuing too many new tokens to secure the network, diluting holders.
• Misaligned incentives: Rewards that encourage short-term speculation over long-term staking.
• Death spiral: A falling token price reduces security spending, making attacks cheaper, which further erodes price and security. Successful models like Ethereum's EIP-1559 burn base fees to create deflationary pressure.

Every transaction on a blockchain requires a fee, paid in the native token (e.g., gas on Ethereum). This fee serves multiple economic purposes:

• Compensates validators for computation and security.
• Prevents spam by making network abuse costly.
• Prioritizes transactions via fee markets (e.g., EIP-1559 on Ethereum, which burns a base fee, creating deflationary pressure). The fee mechanism is a core economic policy tool for regulating network demand and resource allocation.

Protocols manage their native token supply through predefined issuance schedules. For example:

• Bitcoin has a halving event every 210,000 blocks, reducing new coin issuance by 50%.
• Ethereum transitioned from a fixed block reward to a variable, minimal issuance post-Merge. This controlled inflation funds security (paying validators) but is balanced against dilution. Some chains (e.g., EIP-1559 Ethereum) can become deflationary when fee burn exceeds new issuance.

Many protocols embed a decentralized governance system where token holders vote on proposals (e.g., Uniswap, Compound). The economic layer funds this through a protocol treasury, often filled by a portion of fees or initial token allocation. Votes can decide on:

• Fee structure changes
• Treasury fund allocation (grants, development)
• Critical protocol upgrades This creates a feedback loop where token value is tied to the protocol's ability to govern itself and fund its future.

Decentralized Finance (DeFi) protocols are applications built on top of the base economic layer that create new economic systems. They exemplify its programmable nature:

• Automated Market Makers (AMMs) like Uniswap use constant product formulas (x * y = k) to set prices, funded by liquidity provider fees.
• Lending protocols like Aave create money markets with algorithmically determined interest rates based on supply/demand.
• Stablecoins like DAI are collateralized debt positions managed by smart contracts. These compose to form a complex, interconnected financial ecosystem.

The interdisciplinary study of economic protocols and incentives within decentralized systems. It combines game theory, cryptography, and computer science to design systems where rational actors are incentivized to behave honestly.

• Purpose: To secure the network without a central authority.
• Key Mechanism: Aligns individual profit motives with network health (e.g., staking rewards, slashing penalties).

The economic model governing a blockchain's native token, detailing its supply, distribution, utility, and value accrual mechanisms.

• Supply: Fixed (e.g., Bitcoin's 21M cap) vs. inflationary (e.g., Ethereum's issuance).
• Utility: Used for transaction fees (gas), staking, governance, or as a medium of exchange.
• Example: Ethereum's ETH is burned (EIP-1559) with each transaction, creating a deflationary pressure tied to network usage.

The protocol that enables network nodes to agree on the state of the ledger, directly underpinning the economic security model.

• Proof of Work (PoW): Security via computational expenditure (hash power).
• Proof of Stake (PoS): Security via financial stake (locked capital).
• Economic Security: The cost to attack the network must exceed the potential reward, a principle known as Nakamoto Consensus.

The maximum value that can be extracted from block production beyond standard block rewards and gas fees, by including, excluding, or reordering transactions.

• Sources: Arbitrage, liquidations, and frontrunning.
• Economic Impact: Represents a leakage of value from users to validators/searchers, leading to the development of MEV auctions and fair ordering protocols to democratize its capture.

The process of locking tokens to participate in a Proof-of-Stake network's consensus and earn rewards, representing a core capital allocation mechanism.

• Direct Staking: Running a validator node with a minimum stake (e.g., 32 ETH).
• Liquid Staking: Using a derivative token (e.g., stETH) to maintain liquidity while staking.
• Slashing: The penalty (loss of stake) for malicious or faulty validator behavior, a key economic disincentive.

The mechanisms that determine how users bid for block space and how fees are processed, critically impacting token supply and user experience.

• First-Price Auction: Traditional model where users overbid (pre-EIP-1559 Ethereum).
• EIP-1559 Model: Introduces a base fee (burned, reducing supply) and a priority fee (tip to validator). This creates predictable fees and a deflationary pressure on the native token.