Swaps and Options on Ethereum Gas Fees: A Framework for Risk Management in DeFi

<p>The rapid expansion of blockchain-based applications and decentralized fi<span>nance (DeFi) has led to a substantial increase in demand for block space, resulting&nbsp;</span><span>in pronounced volatility in transaction costs, commonly referred to as gas fees.</span></p> <p>Such volatility introduces significant budgetary and operational risks for a wide&nbsp;<span>range of market participants, including protocol developers, arbitrageurs, mar</span><span>ket makers, and institutional users. In this paper, we develop a comprehensive</span></p> <p>theoretical and computational framework for the valuation of derivatives written<span>on Ethereum gas fees. We focus in particular on swaps based on average gas</span><span>costs and European-style options on gas fee levels. Our approach yields tractable</span></p> <p>(semi-)analytical pricing formulas for these instruments, allowing for explicit de<span>composition into hedgeable and non-hedgeable risk components. The proposed</span></p> <p>framework not only provides practical tools for managing transaction cost risk&nbsp;<span>but also lays the foundation for the development of a new class of derivatives</span></p> <p>markets centered on blockchain base fees.</p>