This memo is a follow up to, both, our expense analysis of the Arbitrum DAO and our response to the ARB staking proposal. In this, we dissect the income side of equation for the Arbitrum DAO and link it to the staking program in a bid to find a sustainable yet appealing path to staking.
Arbitrum Income (ARDC)
The Arbitrum DAO currently has three income sources. Two sources actively earn fees (Sequencer, Orbit), while one is still in production and pending governance approval (Timeboost).
This part of the report intends to provide the Arbitrum community with a detailed breakdown of the DAO’s current income.
Sequencer
The Arbitrum sequencer is currently generating the DAO the highest percentage of its income. The sequencer generates income by collecting the delta between gas fees paid by users and the Ethereum settlement cost. This delta has grown significantly since the launch of EIP-4844, which significantly reduced L1 settlement fees.
However, the ArbOS Atlas upgrade reduced the L1 surplus fee to 0 gwei and the minimum L2 base fee to 0.01 gwei (a 10x reduction). This has lowered the gas fees users pay to improve their user experience, but it has also lowered the DAO’s net profit.
Arbitrum’s sequencer has generated $123M in revenue from transactions and ~$40M in profit after L1 settlement fees. In the 12 months leading up to EIP-4844, Arbitrum’s Sequencer generated $21.6M profit. Since EIP-4844’s arrival in March, Arbitrum’s sequencer has generated $10M, representing an annualized pace of $25M. The arrival of blobs have drastically reduced both revenue and expenses for rollups. Arbitrum’s profit margin is much improved, but its $10M profit in the first 5 months after 4844 is significantly propped up by outlier events. In the week of June 17, Arbitrum earned $3.5M profit, benefitting from an uptick in activity during the LayerZero TGE.
These outlier events are difficult to forecast, and perhaps give an overly optimistic outlook on Arbitrum Sequencer profit, but these one-off events are commonplace in crypto and will continue to occur.
Orbit Chains
Arbitrum Orbit chains are L3s. They generate income through the revenue-sharing model that Orbit chains pay if they choose not to settle on Arbitrum One or Nova. The fees are currently 10% total: 8% to the DAO and 2% to the developer’s guild.
This is a similar relationship to that of Base <> Optimism, in which Base shares 15% of profits or 2.5% of sequencer fees (whichever is greater). Base has generated more revenue and market share than Optimism itself. In theory, Arbitrum Orbit’s ecosystem can be expected to surpass Arbitrum One once it gets going.
Recently, the DAO approved the deployment of Orbit chains to settle on chains besides Ethereum or Arbitrum One/Nova. This can be an important revenue stream for the DAO because this revenue is sticky.
Once a chain is deployed, it is obligated to send 10% of revenue to the Arbitrum DAO forever. Revenue can be exponential here if the number of Orbit chains deployed continues to increase.
Base generated $51M profit in year 1, with ~$6.4M going to Optimism. If the Arbitrum Orbit ecosystem generates Base-tier profits, Arbitrum DAO would see about $3.3M annually. Base is in a league of its own and assuming any Orbit chain alone will achieve Base’s traction is naive. Arbitrum’s strategy with Orbit is geared more towards attracting a multitude of different projects to launch L3s. Zora network is a more intuitive comparable for Orbit chains early on. If Arbitrum succeeds in kickstarting a vibrant ecosystem of Orbit chains, they could potentially rival base profits in aggregate.
Timeboost
Timeboost is a transaction ordering policy proposed by the Arbitrum Foundation. It enables auctions to reward winners with transaction advantages. This is beneficial for the DAO as it effectively takes a solid percentage of the MEV that bots are generating and collects it as revenue for the DAO. These auctions can be paid in ETH or ARB. Until production, it is not viable to forecast revenue from Timeboost, as stated in the proposal.
Revenue Outlook
Arbitrum will likely be the first L2 to share real yield with stakers, and this tangible claim on future growth could offer a powerful narrative boost. Assuming 50% of profit is distributed to stakers and a 75% stake rate, staking would generate 0.93% APR.
As discussed in the expenses section, ARB has weathered its biggest unlock event but significant unlocks and DAO spending will hit the market over the next few years, doubling ARB’s circulating supply.
Arbitrum’s expenses and unlock schedule create a difficult climate for ARB holders. Roughly 6M ARB per month will hit the market through DAO expenses, and 92M ARB/month will come from team and investor unlocks. This is a total of 1.2B ARB per year, not including any additional DAO spending. This represents 36% of ARB’s 3.3B circulating supply and $700M in annual sell pressure at ARB’s current price of $0.57.
Becoming the first L2 token to share revenue with stakers will be a powerful narrative and sentiment booster, but is likely inadequate to mitigate the unlock climate. Supplementing the real yield with treasury ARB is likely necessary to act as a shield for supply dilution.
The most difficult aspect of this exercise will be finding the optimal amount of ARB to offset ARB dilution. Dedicating treasury resources to improving the token holder climate offers concrete benefits to the DAO; it offers a more sustainable habitat for long-term holders and prevents the need to liquidate ARB to front-run unlocks. This will support ARB price and mitigate the issue of decreasing ARB price and reduced purchasing power for DAO spending.
2.9B ARB are remaining of team and investor unlocks. Theoretically, Arbitrum could dedicate almost the entirety of its 3.1B treasury ARB to offset ARB unlocks. This exaggerated example would deplete over 90% of treasury ARB resources, but it’s a helpful way to frame the optimization problem that faces the DAO. In order to improve sentiment around the ARB token, a material portion of the ARB treasury will be necessary. In addition, providing clarity around the timing and use of future DAO spend could prevent the market from lumping it in with unlocks.
Staking Program
The Arbitrum Staking program should be designed to incentivize delegation while also ensuring delegates are active, as the DAO suffers from a lack of participation amongst delegates. We believe rewarding delegates who are active in governance is the best approach. However, systems currently in place do this but have not been successful in ensuring delegates’ votes.
Users’ stake’ their ARB by delegating to themselves or a third-party delegate.
Rewards can be distributed in weekly epochs with a split of 90:10 between delegators and delegates.
If a delegate fails to vote on all of the proposals that week, they and their delegates should not receive ARB rewards for that week. This incentivizes active delegation and ensures delegators are careful whom they delegate their ARB to.
The program should be incentivized with X% of the Sequencer, Orbit fees, and Timeboost revenue.
Currently, the Timeboost proposal offers two options for the proceeds of the revenue generated:
- Collect the proceeds in ETH and send them to the DAO.
- Collect the proceeds in ARB and send them to the burn address.
We propose a third option: collect the proceeds in ARB and distribute to stakers.
Burning the ARB collected from Timeboost misaligns incentives between long-term and short-term ARB holders. Instead of reducing the ARB supply, the DAO should focus on putting ARB tokens in the hands of holders who are aligned with Arbitrum’s long-term mission. This is likely to be the holders delegating and the delegates.
The revenue generated from the sequencer and Orbit fees is not consequential enough to justify being the only sources of revenue directed to the staking program. Therefore, we believe it is in the best interest of the DAO to direct Timeboost revenue to the staking program as well.
All revenue should either be collected as ARB or ETH and swapped into ARB to distribute to stakers.
This is because distributing as a buyback will be net positive for ARB’s price performance and help reduce regulatory risks associated with distributing in-kind.
Supplementary reward approaches
Standard, flat - A standard X ARB distributed to stakers over X months approach is safe, easily digestible, and potentially effective. ARB staking rewards from the DAO partially offset ARB unlocks. ARB stakers effectively maintain a greater portion of their share of total network ownership than non-stakers and receive tangible upside in network traction through real yield. The risk with this approach is that it is not sufficiently differentiated from other models. With at least 1.2B /year hitting the market, Arbitrum may not want to dedicate a large amount of ARB to offset 25% of the unlocks for the market to just not care because the situation is still suboptimal.
Linear decay - A front-loaded strategy offers a no-nonsense approach to the current ARB price action and provides a path to sunsetting for real yield. This approach would somewhat mirror Optimism’s approach, whereby RPGF rounds are funded with OP, before tapering off in favor of sequencer fees.
For example, 20% of treasury ARB (60M) is dedicated to the program, with 35M in the first year, 15M in year 2, and 10M in year 3. ARB rewards would materially offset dilution immediately, tapering off while real yield increases.
One drawback of this approach is ARB hitting circulating supply accelerates in the short term. However, holding ARB will become much more attractive for long-term stakeholders.
Linear growth - Yet another option could involve scaling up ARB emissions as more ARB hit the market. This would allow ARB staking rewards to keep pace with an expanding circulating supply in the months to come. The issue here is that ARB staking will be resource-intensive later on when, ideally, alternative income streams are up and running. ARB staking will also be less impactful on a token-for-token basis.
Key Takeaway:
Standard flat, safe option for supplementary ARB rewards may be the best fit if the DAO is willing to dedicate a substantial portion of the treasury (25-30%) to the staking program over the next few years. If the DAO prefers to spend less on the staking program, the linear decay approach may work better in order to allow for strategy on behalf of the user to make the opportunity worthwhile. Using a front loaded 15% of treasury arb for staking rewards could give similar benefits to the prior option in the short run.
Arbitrum should seriously consider a strong investment into the supplementary staking rewards. Prior snapshot concluded 100M (3%) of the budget, more of the unlocks. Holding ARB is unattractive, and this dynamic has harmful repercussions to DAO operations and in the community. Arbitrum has a healthy supply of ARB in the treasury, and should consider deploying it while it is most effective.