Explaining the economics of Penumbra as a network is easiest to do by describing how a user’s experience of the Penumbra chain interfaces with the UM token that represents it. The UM token stands not only for privacy principles at the core of the Penumbra protocol: privacy that starts and ends on user’s devices and private trading or transactions, but the UM token is also crucial in comprehending how the chain’s economy works. More specifically, the UM token is integral to the economic engine that supports the protocol.

Here’s how:

1. UM is a token used to pay for transactions (Gas Fees)
2. UM issuance acts as a system of deflationary reward for work done in providing consensus to the chain (Staking and Governance)
3. UM is an integral component of the Penumbra DEX stack (Trading)

For this first post on network economics, we’ll focus on the UM token’s use as a component of Penumbra’s fee payment (‘gas’) system. 

$UM as a gas token

On most crypto-economic networks and in particular those based on the Cosmos SDK a ‘gas token’ is used to pay for the execution of transactions on the network and the inclusion of these transactions in the record of blocks proposed to the chain (hence ‘block-chain’). Generally, fees that accrue in the form of this ‘gas token’ from transactions are distributed to service providers known as ‘Validators’ and their ‘Delegators’ (more in a subsequent post about Staking, coming soon) for helping execute transactions on behalf of users on a network.

Penumbra breaks from these norms first by splitting these fees into a base fee and a proposer tip, both of which are included in the actual fee a user finally sees when paying a transaction. Proposer tips are intended as a form of payment to the specific Validators who propose a block of transactions, and the base fee is a nominal fee set below the difference between the tip and the total.

Currently, both the base fee and the proposer tip are burned as a part of the transaction’s execution for ease of implementation, but both the pricing of the base fee and the burning of the proposer tip on Penumbra can be altered through on-chain governance depending on public opinion.

Alternative gas tokens

Penumbra additionally breaks from norms set by most chains in a particularly innovative way: in order to prioritize a smooth user experience for newcomers using the chain, fees can be paid by users in assets other than the UM token. What this means is that any new user of Penumbra is able to bridge assets accepted as alternative fee tokens without the requirement to trade into UM and can immediately start transacting. 

This minimizes a poor user experience trade-off seen on other chains usually requiring users to figure out how to acquire a network’s token in order to submit a transaction. It’s likely that the incentive for doing so on other chains is to encourage purchasing of the network’s token before using the aforementioned, but this doesn’t really serve users, so Penumbra did away with it.

As of this writing, Penumbra accepts three compatible ‘alternative’ fee tokens as part of its “multi-dimensional gas fee” architecture: OSMO, USDC, and ATOM, but this can be expanded at community will.

All of these mechanics, other than whether or not the protocol accepts UM as a fee token, are adjustable through governance. If the community feels there is an unfair cost to transacting on the chain, it’s just a matter of submitting a proposal to change the parameters. This allows the community to adjust both pricing and the tokens accepted for fee payment. The current alternative fee tokens were set by Proposal #1, which refined the Mainnet parameters for Penumbra. Since that proposal passed, the tokens submitted as alternatives were instantly usable for fees on the network. For any future alternative tokens, the outcome would be the same: as soon as the proposal for their use passes, the new alternative will instantly be usable to pay for transactions.

Users should note, however: fees paid in alternative tokens are always higher than those paid in UM - a multiplier, determined through governance as well, applies here. These fees are accepted at the time of transaction, swapped for UM, then burned, just like fees paid directly in UM. Because the fee in the form of the alternative token is larger, the amount of UM ultimately burned is nominally higher. This setup encourages users to eventually use UM to reduce cost, while still enabling newcomers to transact without needing UM in advance.

What this means for users

All of these choices were made at the level of network architecture with the specific intent to prioritize a good user experience when transacting, just as with the rest of the software experience of using Penumbra. 

This way, privacy doesn’t mean a trade-off, it means engaging with better UX than you’ll find anywhere else.

Stay tuned to learn more about Penumbra’s economy - the next post will be on Staking and Governance