There is never a dull moment in crypto.

On any given day, there is a scam or a hack. On others, there is a controversy. The latest kerfuffle in cryptoland involves an NFT sale (what else?) and highlights two persistent problems: high transaction fees and regulatory uncertainty.

The Otherdeed Mint: A Troubled Sale

It started when Yuga Labs – the company behind the Bored Ape Yacht Club (BAYC) – minted land deed NFTs for Otherside, a metaverse land parcel, earlier this week. Holders of the deed could lay claim to a parcel of land in Otherside. The sale of deeds was a success and the Florida-based startup is reported to have raised $561 million in less than 24 hours.

But the frenzy of activity on Ethereum’s blockchain during that period also ended up clogging its network, resulting in skyrocketing transaction fees.

Ethereum is already infamous for its high transaction fees. Yuga Labs’ Otherdeed sale multiplied those already high fees: some users are reported to have paid as much as ten times the cost of their NFT in transaction fees. Purchasing the deed is only half the job done for owners. Owners will have to adhere to restrictions in order to resell the deed in a secondary market.    

Ethereum’s Gas Fee Problem

The total fee for a transaction on Ethereum is the sum of gas units required to record it on the blockchain, a base fee, and miner tips. At first glance, the formula seems simple enough. But it is actually a function of several moving parts.

For example, the base fee is a function of demand. The greater the demand for a particular product or service and its token, the higher the base fee. The gas unit value varies based on the type of transaction. What’s more, the gas unit of blocks (which collect transactions for confirmation on Ethereum’s blockchain) changes over time and is reported to depend on “a number of factors.” In simple words, this means that the number of transactions that can be fit into a given block changes constantly.

Finally, there’s the tip amount. It is an incentive for miners to confirm transactions. A high tip amount is reward for miners to confirm transactions as quickly as possible. But it also skews the blockchain’s workings in favor of users with big tips and may lead to losses for users whose transactions fail or remain unconfirmed. (Yuga Labs claims to have refunded gas fees for failed transactions related to its Otherdeed sale).        

An Ethereum Improvement Proposal (EIP) designed to reduce the amount of ether available as Ethereum moves from the energy-intensive Proof of Work (PoW) to Proof of Stake (PoS) has further complicated the transaction fee structure. EIP 1559 burns or removes $30 million of worth of ether daily from circulation by routing them to a defunct wallet. Yuga Labs’ Otherdeed sale burned $157 million worth of ether in a single day.

How did it manage to do that?

By creating demand for its tokens. Network congestion ensued. Ostensibly, the base fee for tokens shot up. Transactions with higher tip amounts were confirmed even as many others failed or were stuck in queue.

Is There A Solution?

The script of a clogged network and high prices is one that has been written several times before in the crypto ecosystem. It raises the same question each time: Can cryptocurrency blockchains scale to meet demand on their network?

BAYC put up 55,000 Otherdeeds for sale during its NFT sale. Based on estimates of Ethereum’s ability to handle 30 transactions per second, the NFT sale should have taken less than an hour.

But it took more than that time and was a messy process to boot. Blockchains that confirm transactions on the side and commit to Ethereum’s blockchain are being touted as possible solutions to the scaling problem but they have fewer systems to validate transactions, leading to the risk of centralization. What’s more, their connections are also vulnerable to hacks.

There was another interesting fee-related development in the Otherdeed sale. Even as gas fees rose for those waiting to purchase Otherdeed tokens, some users of OpenSea – the world’s biggest NFT platform – experienced no such bump in their transaction costs. High fees in the former case may have been a function of demand. That then begs the question whether it is economic for popular products and services to use Ethereum’s blockchain or move to a sidechain or design their own blockchain for business. The latter defeats the purpose of a decentralized system.

The Regulatory Problem

Online publication The Block reports that the Otherdeed purchase agreement forbids the resale of its NFTs to a US sanctioned individual or one who is situated in a sanctioned country. A resale also needs a buyer signature. OpenSea, the world’s biggest NFT marketplace, does not have KYC. This means that participants on the site have no idea about the party they are transacting with on the other side. In fact, most NFT marketplaces function without KYC restrictions, effectively making it difficult for Otherdeed holders to resell their deeds. The only other possibility is that of a direct sale – one that is not intermediated by an NFT marketplace. But such a sale carries counterparty risk without much legal recourse.