What L2's Need To Know About Accounting for L1 Gas Fees

What L2's Need To Know About Accounting for L1 Gas Fees

In a recent webinar hosted by Blocknative and Bitwave, we discussed accounting for Layer 2 blockchains. Here are some key takeaways from that discussion:

Layer 2 (L2) blockchain networks like Optimism and Arbitrum are shaking up the crypto world by offering faster transactions and slashing costs compared to Ethereum mainnet. These faster transactions and lower costs, however, don't mean margins don't matter. For finance teams, understanding the nuances of gas fees and the related accounting challenges is crucial to keeping margins healthy. This post dives into the essentials of L2 gas fees from both a technical and accounting perspective, helping you make informed decisions and stay ahead in the game.

The Nitty-Gritty of L2 Gas Fees

On the Ethereum network, users pay a gas fee for every transaction. This fee is influenced by network congestion and transaction complexity. L2 networks address this by bundling multiple transactions into batches, which are then posted to the base L1 (such as Ethereum mainnet). Since these bundles are handled like a single transaction, the gas cost is spread across all transactions in the batch which results in gas savings. 

To grasp L2 gas fees, you need to understand two main types of fees:

1. The L2 Fee: This fee is paid in real-time by the end-user when they execute a transaction on the L2 network.
2. The L1 Batch Fee: This fee is paid by the L2 operator when they post the transaction batch to the Ethereum mainnet later.

Estimating the L1 batch fee is tricky because it depends on Ethereum gas prices at the exact posting time. L2s have different strategies when it comes to posting batches. Some post every minute, others once a day. Spikes in gas prices throughout the day and block to block can eat into or even wipe out the L2 operator’s profits.

To tackle this issue, Blocknative has developed advanced gas fee estimation models tailored for L2 networks, helping operators make data-driven decisions and optimize fee structures. The gas estimator does a few things:

1. Gas fee prediction up to 5 blocks in the future
2. Pricing confidence levels for inclusion in the next block

Getting a Handle on L2 Gas Fee Accounting

From an accounting viewpoint, the timing mismatch between collecting L2 fees and paying L1 batch fees presents several key considerations:

1. Revenue Recognition

One of the most critical questions for L2 operators is when to recognize revenue from the L2 fees. Should these fees be recognized immediately upon collection, or should they be deferred until the L1 batch is posted? The answer depends on the L2 operator’s terms of service and contractual obligations.

If the operator has an obligation to ensure that the transaction is eventually posted to the L1, then revenue recognition might need to be deferred until this obligation is fulfilled. This approach aligns revenue recognition practices with the underlying economic reality, offering a clearer picture of financial performance. Alternatively, if there is no such obligation, immediate recognition might be appropriate.

2. Expense Matching

Financial integrity demands recognizing costs in the same period as the associated revenue. This principle, known as the matching principle, ensures that financial statements accurately reflect the true profitability of transactions.

If L2 fees are recognized immediately, an estimate of the L1 batch posting costs must be recorded, with adjustments for actual costs later. This involves using a standard costing model to estimate the L1 costs at the time of recognizing L2 revenue. Conversely, if revenue recognition is deferred, book the actual L1 cost simultaneously with the corresponding revenue. This ensures that the true profitability of L2 transactions is accurately reflected in financial statements.

3. Margin Analysis

Continuously monitoring and analyzing the variance between estimated and actual L1 posting fees is vital. This variance, or the difference between the estimated costs and the actual costs, is a key performance indicator (KPI) for L2 finance teams aiming to optimize operations. Even minor improvements in fee estimation accuracy can significantly boost margins. Regularly reviewing and refining fee estimation models can uncover optimization opportunities and inform data-driven decisions to enhance profitability.

Technical Considerations in L2 Gas Fees

Understanding the technical intricacies of L2 gas fees is essential for optimizing costs and ensuring accurate accounting. The technical side of gas fees involves several key components:

1. Gas Price Estimation:

   • Accurate gas price estimation is crucial for minimizing costs. Blocknative offers gas estimators to help L2 operators predict gas prices. These tools consider real-time market conditions and historical trends to provide accurate estimates.

2. Batching Transactions:

   • L2 networks bundle multiple transactions into batches before posting them to the Ethereum mainnet. This batching process spreads the gas cost among all transactions in a batch, reducing the average cost per transaction. Understanding the mechanics of batching and optimizing the batch size can lead to significant cost savings.

3. Blobs and Call Data:

   • Recent upgrades to the Ethereum network, such as the Denon hard fork, introduced blobs as a new mechanism for posting transaction data. Blobs are significantly cheaper than traditional call data but come with their own set of complexities. L2 operators must understand when to use blobs versus call data and how to navigate the associated constraints.

Strategic Implications for L2 Networks

A key strategic aspect is the ability to predict and adapt to changing network conditions. For instance, an efficient gas fee estimation model can mean the difference between maintaining profitability and incurring losses during high congestion. This ability to adapt and optimize in real-time provides a competitive edge to attract more network users.

Staying Competitive in the L2 Ecosystem

The L2 landscape is continuously changing, requiring a proactive approach to gas fee management and a commitment to constant improvement. By embracing the strategies and insights outlined here, L2 finance professionals can lead in this dynamic industry, ready to seize the opportunities ahead.

Staying competitive also involves continuous innovation. For example, the introduction of blobs and other new technologies presents opportunities and challenges. L2 operators need to stay informed about these developments and be ready to integrate new solutions that enhance efficiency and reduce costs.

Partnering with Experts

Navigating the L2 gas fees and accounting landscape requires a deep understanding of technical intricacies and the evolving regulatory environment.

Partnering with experts like Bitwave for accounting and Blocknative for gas estimation solutions. A combination of Bitwave's accounting solutions and Blocknative's gas estimation API's can help L2 finance teams overcome major challenges and focus on core business objectives.

By leveraging the expertise of specialized partners, L2 operators can gain access to cutting-edge tools and insights that drive efficiency and profitability. These partnerships can provide the technical support needed to implement advanced gas fee estimation models and optimize transaction batching processes.

The Role of Predictive Analytics

Predictive analytics plays a crucial role in managing L2 gas fees effectively. By analyzing historical data and current market trends, L2 operators can forecast future gas prices and adjust their strategies accordingly. This proactive approach helps in minimizing costs and maximizing margins.

For example, if predictive models indicate a likely increase in gas prices, L2 operators can choose to expedite batch postings to avoid higher fees. Conversely, if a decrease is predicted, they can delay postings to benefit from lower costs. This strategic use of predictive analytics ensures that L2 networks remain cost-effective and competitive.

Conclusion

Understanding and optimizing gas fees isn’t just about technical know-how—it’s a strategic imperative for finance teams aiming to maximize margins and drive long-term success. By diving deep into the intricacies of L2 gas fees, implementing best practices for revenue recognition and expense matching, and collaborating with trusted partners like Blocknative, L2 operators can confidently navigate this complex ecosystem.

By staying informed and adaptable, L2 networks can turn gas fee management from a challenge into a competitive advantage, ensuring they thrive in the rapidly evolving world of blockchain technology.

Mastering these elements is not just beneficial for operational efficiency but is crucial for long-term strategic positioning. The future of blockchain technology is bright, and those who can skillfully navigate the complexities of gas fees and gas prediction will be the ones to lead the charge.

Gas Estimation to Support Leading L2s

The Blocknative Gas Platform harnesses real-time global mempool data infrastructure to accurately and consistently predict Ethereum transaction fees. This provides L2s writing to the Ethereum L1 with real-time decision-making tools to help them optimize their COGS. 

This API provides both type-2 base fee and type-3 blob base fee prediction using Blocknative’s Gas Platform. Predictions are made for the next 5 blocks at a 99% confidence level (highest inclusion guarantee at the expense of some overpayment) and 50% confidence level (likely inclusion with reduced overpayment).

Check out the Blocknative Ethereum Base Fee Estimation Documentation to integrate the gas estimation API into your L2 today and optimize your costs.