Ethereum's London hard fork drops this week, and bundled with it is EIP-1559—an Ethereum Improvement Proposal that aims to address the network's persistent issues with transaction fees.
It's a significant change for the Ethereum network, and one that's already got the markets a-flutter. But how's the upgrade set to unfold, and what comes next for Ethereum users?
What is EIP-1559?
At its core, EIP-1559 aims to make Ethereum's transaction fees less volatile and more predictable, removing the problem of people overpaying for transactions. It also helps to reduce uncertainty for users who don't know if a transaction will be approved as a result of their gas prices being set below an accepted or expected rate.
EIP-1559 will not only help speed up wait times per transaction, but will also enable a more seamless experience for Ethereum's global community and its layers of decentralized applications (dapps).
How does it work?
The Ethereum Improvement Proposal is based around two core elements. First up is the BASEFEE—a minimum gas price required for transactions, and a new method of regulating transaction fees, which will rise when the market is busy and fall when it's quiet.
The difference between the current system and this new version is that miners won’t set the rates; the network does using an algorithm, creating more consistency across the Ethereum ecosystem. Also, miners will not receive transaction fees; instead, they will be burned, which reduces the supply of Ethereum and prevents any deliberate congestion of the network.
Less than 10,000 blocks until London 🇬🇧🕰🎉https://t.co/NzZo1a8IeO
— Tim Beiko | timbeiko.eth ☀️ (@TimBeiko) August 3, 2021
EIP-1559 also introduces the "inclusion fee", an optional tipping system that you add to the base fee so that miners can give your transaction priority over others in the network. Effectively, the inclusion fee replaces the original transaction fees as an income source for miners.
What happens next?
EIP-1559 is designed to reduce volatility with gas prices, but it doesn’t guarantee cheaper rates—because Ethereum can still only handle a limited number of transactions at a time. Under EIP-1559, fees based on the minimum standard can only increase and decrease by 1.125x each block, allowing for greater stability and predictability for Ethereum transactions.
That's important, because uncertainty over gas prices has historically limited the scaling and adoption of Ethereum’s dapps in favor of other competitive protocols. Given that Ethereum already has a significant first-mover advantage in establishing a dapp and developer ecosystem, EIP-1559 could further limit the appeal of "ETH killers" like Polkadot, Dfinity, and Solana, by undercutting their USP of lower fees and faster transaction times.
Counteracting Ethereum's increasing supply
One of Bitcoin's key strengths, according to its supporters, is its limited supply of 21 million coins. That stands in contrast to Ethereum, whose supply is technically unlimited—at least, until the London fork kicks in.
Currently, for every new block mined on Ethereum, two additional coins are issued into circulation; this dilutes Ethereum’s value as more of the asset becomes available. The current annual issuance rate on Ethereum is around 4%, while on Bitcoin it has declined to around 1.8%.
With the introduction of EIP-1559, the new aspect of burning will, through the underlying programming, automatically remove coins from circulation after new ones are issued, nullifying the increased supply of Ethereum without introducing a supply cap.
In future, during bull markets or periods of high network activity, the total amount of ETH burned via payments for the base fee could be greater than the amount of newly issued ETH through block rewards. This could lead to a gradual and consistent decline in the supply of Ethereum, resulting in the annual issuance rate dropping from 4% to zero or negative figures.
“It’s like a company that earns a profit and buys back shares,” Tim Ogilvie, CEO of Ethereum infrastructure services company Staked, told Decrypt. Burning billions of dollars in ETH could pump up the cryptocurrency's price, he said. “The net effect is that the remaining shares increase in value because the supply is smaller.”
However, critics have argued that burning and counterbalancing supply could lead to economic instability throughout the network, as it’s difficult to accurately forecast what the total amount of Ethereum created will be over time.
Bringing the ecosystem together
Although most Ethereum fees are currently paid with ETH, there's nothing stopping miners from accepting other currencies as payment. The incentive for users to pay miners in a currency other than Ethereum is to have their transaction included in the next block for a gas price of zero—basically as a backdoor or under the table approach to mitigate against spending anything more than necessary.
With EIP-1559, that changes: the network base fee must be paid in Ethereum for transactions to be processed. Although a miner could still accept an alternative currency to prioritize a user's transaction, the underlying base fee would still need to be paid in Ethereum—either by the user or the miner—to include their transaction in an Ethereum block.
This ultimately further strengthens Ethereum's utility as a vital element in approving transactions on the network. EIP-1559 is also expected to solidify Ethereum’s role as a form of payment when using computing resources and interacting with its broad ecosystem of dapps.
In essence, Ethereum is slowly closing the loops and filling the holes in its ecosystem the same way Apple created an integrated and complementary infrastructure for iOS devices—allowing for end-to-end control and efficiency.
Rewards and risks
It's not all plain sailing, though. For one thing, as with any major technical upgrade, the risk of bugs is ever-present. These bugs could also lead to malicious behavior from users looking to exploit loopholes or vulnerabilities in the system.
To counter this, several audits and reviews of EIP-1559 have been crowdfunded by the Ethereum community to flag any potential issues. In addition, the upgrade is entirely open source. With the combination of dummy tests and community support, a thorough analysis is being made to ensure there aren’t any outstanding risks upon or after the launch.
However, there's also the possibility of pushback from disgruntled miners. After the launch of EIP-1559, miners who have upgraded in advance to the latest client software will automatically begin producing blocks under the new fee structures. Others who have not upgraded will continue mining the older version of Ethereum.
These split-offs are known as “contentious hard forks”, and have occurred in the past. In 2017, the Bitcoin network split because they were divided over a scalability upgrade known as “Segwit”. Ethereum itself saw a hard fork lead to the creation of Ethereum Classic in 2016.
However, despite an initial revolt over reduced miner revenue, Slava Karpenko, the chief technology officer of Ethereum mining pool 2Miners, and other Ethereum miners have reportedly accepted the activation of EIP-1559. Resident Ethereum miner Brian Lee, who runs 11 GPUs in his garage in California, told CoinDesk in June that "All of us accepted it, I'm pretty confident that they're going to get it done. It's just a matter of time."
Into the future
One thing EIP-1559 doesn't do is change the fact that in its current form, Ethereum can only handle a limited number of transactions at a time. The network's scalability has long been a focus for Ethereum creator Vitalik Buterin, and it's something that the upcoming Ethereum 2.0 upgrade aims to address.
Ethereum 2.0 will see the network switch from a proof of work consensus mechanism (as employed by Bitcoin) to one based on proof of stake. As well as being less energy-intensive, Ethereum 2.0 will also enable the network to scale from around 30 transactions per second to up to 100,000 transactions per second, through the implementation of shard chains.
EIP-1559 will continue to have an impact after Ethereum completes the switchover to proof of stake. That’s because its biggest contribution largely affects how fees are determined on Ethereum, not the network's scalability in terms of the number of transactions it can manage.
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