The idea for EIP-1559 came about in 2017/2018, however this was rather dismissed with not a lot of developers working on it. ” The community just kind of sat on it for a year, a few people recognised its importance.” said Vitalik Buterin, co-founder of Ethereum. We have now seen a huge rally towards this new Ethereum Improvement Proposal (EIP) being implemented, forever changing the current transaction fee models.
Before going over this new hard fork, let’s look at the current model.
Prior to EIP-1559, Ethereum used an auction based model to decide on the price of transaction fees. This means that the more you’re willing to pay in gas fees, the quicker the transaction will be approved. Miners prioritise transactions with the highest bidders when deciding which transaction to include in the next block, thus effecting transaction execution. At the time of writing, the average gas price is 42 Gwei as you can see above. We can also see the confirmation time (secs) correlated to the gas price as well as estimated costs of interactions with DeFi protocols such as Uniswap.
One of the biggest problems with this model, is the unpredictability of gas fees. Users can’t plan for large fluctuations in the gas price, essentially guessing what miners will accept into the next block. Unless of course, you are staying up to date with every single NFT release/auction and have knowledge of the current bidding behaviour amongst users of the network.
Extensions like GasNow as well as browser wallets such as Metamask will provide rough estimates of the gas price, however not accounting for said bidding behaviour. If you use too little gas, your transaction may fail as well as if you bid too high, you may be overpaying for the transaction, in which case, the excess gas is not refunded. This can be frustrating, providing a bad UX and it is a lot of guess work for the everyday user.
It is also important to note that there is no value accrual to Ethereum’s network, all the fees go to miners. EIP-1559 aims to solve these issues along with a few other improvements. With this implemented, a transaction requires three key pieces of information:
- Base Fee amount
- Priority Fee amount
- Max Fee amount
The base fee is set by the network and is the minimum fee to get included into a block. This fee is always burnt.
The priority fee is also known as the miner tip. This is set by the user and paid directly to miners to incentivise faster processing.
The max fee is the most a user is willing to spend on a single transaction. Overbidding is no longer a problem as transactions can be guaranteed.
Max fee – (Base fee + Priority fee) = refunded to the user.
WILL ETH BECOME DEFLATIONARY?
It depends … Under the current Proof of Work, base fees of roughly 100-150 Gwei would need to be sustained to offset the supply issuance. Once we have the merge and transition to Proof of Stake, base fees of roughly 20 Gwei would need to be sustained to offset supply issuance. In our opinion, it is not likely we sustain these gas prices during PoW with the exception of NFT drops where gas can jump as high as 1500.
Above, we have the EIP-1559 London burn as well as the ETA for the merge & removal of PoW. Using the gas fee of 42 Gwei mentioned earlier, we can see that once Proof of Stake is implemented, ETH will in fact become deflationary. At an average gas price of 42 Gwei, the network will burn 4,200 ETH/Day.
Let’s assume the network is congested & gas fees are around 150 gwei as displayed below. The curve begins to flatten aggressively lowering supply, thus increasing scarcity. Once the merge is implemented (date TBA), this is when ETH truly becomes deflationary.
Another improvement is the adaptive block size which could help with scalability. Prior to EIP-1559, block sizes stayed the same and in the event that there is a sudden increase in demand, gas prices increase. After EIP-1559, the gas fees for that block are already determined, and should demand increase, the block size can expand and vice versa. This helps smooth out gas price volatility.
TL;DR : In summary, the benefits of EIP-1559 are:
- The ETH network benefits from higher transaction volumes as these base fees are burnt, making Ethereum deflationary.
- Adaptive block sizes can account for unexpected high demand across individual blocks.
- Better UX as users can estimate gas costs & are refunded on overbidding gas prices.
- Network security is advanced and helps prevent spam attacks against the network.
- Potentially lower gas fees.
EIP-1559 will be implemented tomorrow on the 5th of August 2021 12:50 UTC. The activation of EIP-1559 is a major milestone for the Ethereum ecosystem and could be the beginning of “Ultra Sound Money” as we see more ETH being destroyed than created.
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