Recycled Fees, Network Taxes, and Token Sinks

[dob]

The Livepeer protocol tokeneconomic design has always had a historical leaning towards the theoretically pure, sometimes at the expense of the practically applicable. It would assume states that would come to exist when acted upon by rational actors under efficient market conditions and high speed. Some examples of this include:

1. ETH as the payment mechanism for jobs rather than LPT because of the theoretical infinite velocity of money on the blockchain, would lead to no benefit of using LPT, while ETH was far more widely available amongst potential users of the network in the early days.

2. Ignoring the issue of paying fees to oneself on the network because there’s no actual harm in doing so. The main way to prevent this is a network level tax, and that just makes the network more expensive - a worse outcome for users.

3. Ignoring the issue of orchestrators claiming rewards when not actually doing work, because it doesn’t actually harm anyone, and is sub-optimal for those actors vs delegating towards high performing nodes that are actually sharing fees.

4. There is no LPT burn mechanism, because LPT is based on the “network ownership % as proxy for ability to earn fees” model, rather than trying to be an increasing $/LPT currency asset.

Focusing on the behaviors In cases two and three, the cost to acting this way is not rational from a profit-maximization perspective. It’s cheaper to avoid the gas fees on ticket redemptions and just perform the work without settling payments to oneself through the network. It’s more rewarding to stake towards a high performing, low reward cut, low fee share node than it is to run infra, pay for daily reward calls, and earn no fees.

I still stand by the fact that those two behaviors are not actually hurting the network as much as people think, if at all. But there are some side effects that seem to capture people’s attention, that they bind on to in forming negative sentiments about the project. I’d like to focus this post on the narrative and impacts around the recycled fees concept, in which users run gateways and send jobs to their own orchestrators. The narrative goes as follows:

• The circular fees are fake and they’re inflating network statistics and perpetuating a false usage narrative!

Why does this happen?

Some nodes have sent fees to themselves over time for different reasons. Some are testing their PM setups. Some are using their own infrastructure first when available, and then falling over to other providers when extra capacity is needed. And some are just padding their stats (and the Livepeer network stats in general) on the explorer.

Yes, from the very onset of the project, there has been nothing stopping people from setting a 100% fee cut, then sending PM tickets to themselves. I’m actually surprised this doesn’t get acted upon more, since it has always been trivial to send 1, 10, 100 ETH payments to oneself onchain without risk. Of course any node who has a fee cut set below 100% would have a tremendous cost to doing this - they immediately share a portion of their fees to their delegators - so any stake they attract would mean that for each ETH they send to themselves, the less ETH they get back.

A fee cut under 100% serves as a tax against recycling fees to oneself. And a 100% fee share means there is no tax on the fees, though it’s unlikely the nodes will attract stake. Without a tax, there is nothing to stop this behavior.

Network Observability

Observers of Livepeer want a way to evaluate the usage of and utility of the network. The accurate way to do this would be to analyze the users of the network themselves. What are they paying for transcoding or AI inference? Are they happy with the QoS? At what scale can you observe their own usage of it via the sizes of their businesses or applications?

Collecting this data is slow, offchain, and requires hard analytical work. But it’s the most telling. If the network is making users happy, then this is all that should matter, and usage should grow

However the market seeks a way to evaluate the network simply by reading data about usage onchain. The protocol design doesn’t provide any foolproof mechanism for this however. Media data doesn’t hit the blockchain for obvious reasons, the PM payment mechanism is approximated to be gas efficient, and the network is intentionally open access and non-limiting and non-intrustive to users. The best proxy for doing this is to observe fees. However, given the recycled fee scenario, this isn’t perfectly accurate either given that some fees may be self-dealt. An analyst willing to do a little more work could do a better job by observing “fees to non-100%-fee-cut node operators.” And that would probably be a pretty good solution.

Another option to prevent recycled fees

As noted above, any time there is a tax on redeeming fees, it stops people from paying fees to oneself. Any fee share already serves this need, but there is another option: instituting a network wide fee tax as a parameter on the protocol. Then, even in the case of nodes that take 100% fee cut, some percentage of the fees would immediately be taken from them upon ticket redemption.

What would the network do with these fees? There are a lot of options - routing them to the treasury for public goods funding, redistributing them across all stake, or, maybe most interestingly in service of creating an LPT sink to address theoretical mechanism #4 listed above: it could implement a buy-back-and-burn mechanic to impact reducing the circulating LPT supply. Any fees taken in tax could immediately purchase LPT at market on DEX pools and burn the acquired LPT.

Why not do this? It theoretically makes the network more expensive for users….which is a pretty big reason. Node operators relying on fees to cover their operating cost, would now have to raise their prices to cover the same operating cost. UNLESS, the perceived increase in LPT value from their reward cut achieved via the buy-back-and-burn mechanism, more than offset the value of the fee tax.

It’s a long way to go before a tax on the fee value would represent more value on the network than the inflationary LPT issued in reward cuts. However as inflation has been steadily decreasing and continues on a downward trajectory, as it approaches single digits within a couple years, and fees begin to rise, there is an opportunity for an eventual equilibrium where fees outpace inflation and LPT supply begins to reduce.

On the way, would we see higher reward cuts and flat pricing? Is that ok for node operators and worse for delegators? Is that ok considering the node operators are doing the majority of the heavy lifting on the network? Or do the delegators also value the perceived LPT benefits that come with a mechanism to eventually reduce supply?

Do we actually care about the network being perfectly legible from simple onchain observability, or do we only care if users find it useful via the pricing and QoS that they receive?

Simplified option to consider

To simplify: The Livepeer community could consider introducing a network parameter “feeTax” that gets debited from onchain ticket redemptions. The tax could be used to buy-back-and-burn LPT to reduce the circulating supply.

The arguments for this include:

• Make the network fees more “trustworthy” and legible to the market.

• Reduce LPT supply.

The arguments against this include:

• Tax makes the network more expensive (either for users, or delegators), hurting adoption.

• Onchain legibility doesn’t matter, as it doesn’t increase the utility to end users.

This isn’t a solution to every challenge faced by the Livepeer network. I bias towards the theoretically pure - and stand by the fact that neither of these issues actually hurts the QoS of the network and utility to end users. But I do recognize that this is one simple mechanism that could solve two issues that often get brought up by practical actors in the ecosystem. I definitely welcome people’s feedback and community debate! What do you think?

[Karolak]

Ye that was my initial idea long time ago, users would have to pay for using the NETWORK and that tax should then go to the treasury instead of relying on stupidest idea ever to fund treasury with inflationary LPT, which is volatile and does not answer the question how network development would be fundned if inflation eventually ends on 0 or lpt drops to 0. I also proposed to spend experimental treasury LPT and swap it into stables with yield. At that time lpt was around 20$ and 5% yield from stables would be more than entire Fees from transcoding and spe expenses. You would have runway for a few more years for free. Just by converting LPT to stakedUSDC. Show me the DAO which have 100% of its treasury funds in their own token xDDDDDDDDDDD. But there is also another bigger issue. First of all you have to have a network which solve some of the problems so ppl migh want to use it and pay that fee. Currently livepeer as a network is useless and does not solve any problem at all. Base have x402 so even using livepeer micropayments is not an option for any project. It is too late now, LPT is dumping, no revenue from the apps on the horizon so the network tax wont be enough to continue treasury funding. We are dead my friend. Now you have invlationart LPT being used as a treasury > useless projects are funded > LPT is dumped instantly > lpt price drops and no revenue coming off these SPES > you need even more LPT to funds another stupid SPE > rinse and repeat. People were raising these arguments before treasury LIP, you just ignored that and pushed for this vivious circle. Network stalled for 5 years, livepeer inc were not developing livepeer as a network rather pivoted for startup which was trying to use that network (which only added problems and proved the business model a failure). Livepeer inc took position as a main user of the network instead of tinkering how to make the network attrative for actual users. Then u abandoned the responsibility and assembled olsen gang named livepeer foundation hehe

[kilout]

Thanks for opening up this debate.

​Implementing a fee tax doesn’t have to be heavy or disruptive. A modest 1% tax on ticket redemptions would be a perfect starting point !

Here is why:

​It naturally sanitizes network stats because even at 1% pumping fake volume through a 100% fee cut node becomes an instant continuous cash drain. It completely breaks the economic.

​It preserves our Web2 competitive edge: A 1% fee tax is completely invisible to end users and developers. Livepeer remains massively cheaper than AWS or GCP…

​It’s highly acceptable for operators: From an Orchestrator’s perspective 1% fee on collected work is negligible especially when compared to current gas.

​If this 1% tax is routed entirely to a buy back and burn mechanism the perceived value returned to LPT holders and operators via deflationary mechanics would easily offset the tiny fee. Shifting the LPT narrative towards an active token sink while instantly cleaning up our on-chain legibility is a win-win, especially as we scale into the AI era.

​Curious to hear what other operators think about a light 1% tax!

[adex-labs.eth]

I’d gladly put, lets say, 10% of the fees towards increasing the value of LPT.

[speedybird]

I think the fee tax / buyback-and-burn idea is interesting but low priority given where we stand today.

The recycled fees issue mostly seems like a stats legibility problem. It can make the explorer harder to interpret, and maybe it creates some bad market narratives, but I don’t think it’s obvious that it materially impacts Livepeer’s ability to build real revenue.

As far as the “active operator” question, an orchestrator claiming rewards while not actually doing any work feels like a more direct mismatch between what inflation is supposed to subsidize and what the network is actually getting in return. I don’t think “work” should only mean serving compute, since some orchestrators contribute through development, tooling, integrations, reliability work, or other product-level contributions that are hard to identify onchain. But the general distinction still matters: there is a difference between operators helping increase the long-term value and usefulness of the network, and operators who are mostly just collecting rewards.

This is also why I previously proposed a boost system, where delegators who are mostly yield-focused could more clearly distinguish between passive and active participants, and active orchestrators could receive a higher share of a round’s rewards. Obviously, that distinction would need to be measured objectively.

I understand the argument that this is suboptimal behavior and that delegators should eventually move toward operators that are actually earning fees. That lines up with the practical vs theoretical positioning. In practice however, giving delegators better visibility into how they are supporting the long-term viability of the network and thus their investment seems valuable as a distinction. That also seems consistent with the basic role of delegators: beyond yield, they are choosing which orchestrators they believe are doing useful and honest work for the network.

So my bias would be to improve the visibility around (and potentially boost rewards for) active operators before introducing a fee tax. Gross onchain fees are an imperfect demand proxy, but whether operators are actually doing work seems much more central to the protocol and ecosystem health.

All in all, I don’t see either as a pressing need at the moment. The attention on increasing revenue, and perhaps then tying that into the tokenomics, seems like the highest priorities.

[nhis]

I strongly support using the fee tax to buy back and burn LPT.

The revenue of the network should have some correlation with the LPT price Like JUP and HYPE even it is not that big amount.
The crypto market has matured a lot. There are few people who are willing to buy tokens that don’t have any correlation with actual revenue.

In my country’s crypto community, the followings are used as clear criteria for buying a token.

1. the network generate real fees?
2. fees connected to the token?
3. Is there an economic reason to hold the token?

[b3nnn]

I support this direction but think it should be framed a bit differently.

“We need a fee tax to stop recycled fees” may be a useful side effect, but I think the stronger framing is the positive one: Livepeer needs a clearer mechanism for network value to accrue to LPT holders.

If the network generates real revenue, some part of that revenue should connect back to the token. Otherwise we are asking the market to believe in usage without giving LPT a direct relationship to it. I think @nhis framing is right here. People increasingly ask simple questions before buying or holding a token, and our answers are a bit weak.

I’m supportive of a small protocol fee that clearly benefits token holders and that’s what I’d call it. Protocol fee is what other protocols call it and I don’t see capturing fees from protocol use as a tax.

I don’t think this solves the bigger problems we have though and which @speedybird touches on. Rewards don’t really flow to the orchestrators and delegators that are actually here and creating long-term value for the network, and people still extract. I see this as one piece of a broader token design:

• a modest protocol fee allocation that connects network revenue to LPT value
• better reward logic so emissions flow toward useful network activity
• clearer treatment of reward cuts, because high reward cuts can mean emissions are flowing to operators without enough connection to shared network value
• better visibility into how fees, work, GPUs, reward cuts and how rewards really flow through the network

The protocol fee can’t make Livepeer economically coherent on its own, but a 1-10% version is a reasonable place to test the mechanism and create a clearer path from network revenue back to LPT holders.

[b3nnn]

Continuing here as it seems there is agreement directionally even if urgency is still debatable. Given some of the points raised in the treasury cut conversation I thought I’d start in here a discussion around the possible mechanisms and choices for a protocol fee here.

I think there are 2 parts to this - fee collection and fee distribution.

The collection part is (relatively!) straightforward as we would take a small protocol fee in ETH when tickets get redeemed as that’s where fees settle. The rate can be set and controlled through governance and should be a flat fee. At 1% we would put in place the rails, clean up the recycled fees problem and have negligible impact on real paying users.

The harder question is where that fee goes because that in a way determines what we think LPT really is.

- Buy back and burn. Scarcity is a clean narrative, but it orients LPT towards a currency asset. I think the protocol was designed not to be that. Based on our current emissions a burn is more signal than any real supply reduction.

- Pay it to stakers as yield. This would make LPT a productive asset earning real revenue from use. This is a very good reason to hold LPT, but fairly weak at stopping recycled fees since the money flows back to bonded stake and the games continue in a new form.

- Put it into protocol owned liquidity. This would deepen the market for LPT but is the least obvious “value accrual” story

- Send it to the treasury. There are a few extra steps before value gets back to holders.

Perhaps the best starting mechanism is to have the answer to “where the fee goes” just be something governance can adjust later. I wonder whether we would be comfortable shipping something small and adjustable rather than trying to nail the perfect mechanism first up.

Keen to hear how others are thinking about this.

[j0sh]

Very sensible proposal and well thought through, thanks for putting this together Doug. I’m overall supportive of the buyback and-burn concept.

Some notes:

Timing: Agreed that it’s not an urgent priority. However, if we were to do this, I’d encourage doing it sooner rather than later, so orchestrators can adjust their operating models to account for the reduced fees. If we wait until after fees have increased substantially, then imposing this tax would mean a larger bite out of their margins, with a more uncertain outcome.

Recycling fees: Agreed that the (perceived) issues with recycling fees have more to do with narrative than actual concrete harm. Also, recycling fees isn’t a perfect pass-through either: gas still costs (~0.15% per PM ticket as of this writing) so there is still an erosion of value the more that fees are recycled.

Additionally, burning buy-backs may help counter some negative perception around token inflation and LPT being “dumpy” with more structural incentives to sell but (currently) few to buy.

Naming: “network tax” vs @b3nnn “protocol fee”. Slight preference for “tax” just because it’s a distinct term from the “fees” that we have been using to refer to network revenue. Perhaps “network cut” since we already have “treasury reward cut”. I also like “fee cut” although that’s already used to refer to the orchestrator’s take.

Non-performing orchestrators: Going a bit OT, but since non-performing orchestrators were mentioned… Agreed these aren’t necessarily causing any harm right now. However, as demand for the network grows - hopefully along with the value of LPT - the barrier to becoming an orchestrator is likely to increase. Existing orchestrators do a great job of sourcing GPUs, but we also want to make the network accessible for new entrants with additional hardware. Otherwise, we risk harming the network’s ability to scale at the moments when we need it the most. There are of course various levers to manage this which are out of the scope of buyback-and-burn, but only highlighting that the concern around non-performing orchestrators are not totally unfounded.

Misc: Presumably there are a couple of moving parts for this proposal to take effect aside from implementing the tax itself - eg a team to handle DEX liquidity and manage the buy-backs? Lots of details to hash out there but I’m supportive of this overall. Looking forward to learning more about it.