Ethereum London upgrade detailed analysis of EIP-1559 new features

The "London" upgrade will be activated at block height 12,965,000 (estimated to take place on the evening of August 5, 2021, Beijing time). This upgrade mainly includes 5 EIPs, namely EIP-1559, EIP-3198, EIP-3529, EIP-3541 and EIP-3554, of which the most important is EIP-1559.

The original EIP-155 proposed in April 2019 can be summarized in one sentence: “A transaction pricing mechanism that includes a fixed network fee per block that is burned and dynamically expands/contracts the block size to cope with instantaneous network congestion.”

Below we break down each part of this overview to illustrate how EIP-1559 works.

“Transaction Pricing Mechanism”

To send transactions or interact with Ethereum decentralized applications, users need to pay a fee, commonly referred to as "Gas." Similar to how a car needs gasoline to run, Ethereum applications need Gas to execute.

Currently, Ethereum uses a so-called first-price auction to determine gas prices, which can create uncertainty and inefficiencies. Imagine trying to hail a taxi at a busy airport, but instead of waiting in line for a taxi, you blindly bid the highest price you are willing to pay to complete the trip without knowing what other people are bidding. On the other hand, taxi drivers can see all the bids received and choose the highest bidder to maximize their profits.

This is a simplified version of Ethereum's current fee mechanism. Ultimately, users must strategically consider how much others will bid, which often results in over- or under-bidding and causes fees to be highly volatile. For example, the chart below shows the average and median transaction fees paid by block (in GWEI) for a sample of about 5,000 blocks on July 25, 2021. Note the large outlier blocks where the mean (red) is much higher than the median (green). This suggests that some transaction senders are overpaying because the median fee is enough to get their transactions included in the block.

Source: Coin Metrics Network Data Pro

“Destroy fixed network fees per block”

To improve the fee predictability of the Ethereum user experience, EIP-1559 introduces a base fee per block. The base fee is a required payment to be included in a block and is determined programmatically based on the previous block. This effectively automates the gas price bidding system. Under the chosen parameters, the base fee cannot fluctuate more than 12.5% ​​up or down from one block to the next.

This provides something more like a predetermined price that users can reject or accept. However, users can also choose to add a tip.

The base fee will be burned instead of paid to miners and is probably the most discussed part of EIP-1559. This is good for Ethereum's supply economics because it will permanently eliminate some ETH and reduce supply inflation. Based on some basic assumptions, where 75% of fees are burned, the chart below shows the historical scenario of ETH release if EIP-1559 is used. Note that during periods of severe network congestion, daily issuance can become negative.

Source: Coin Metrics Network data chart

"Dynamically expand/contract block size"

In order to determine how the base fee changes with each block, the protocol needs an estimate of the demand for block space. EIP-1559 does this by introducing a target block size. In short, the maximum size of an Ethereum block will double from its current limit, but with a target of 50% capacity. If the previous block was larger than the target block size (i.e. more than 50% capacity), the base fee will increase and keep increasing until the block size falls back to its target. This rising base fee eventually makes transactions too expensive for some users, reducing congestion and causing the block fill rate to naturally rise back to 50%.

A common misconception of EIP-1559 is that it is designed to address high transaction fees and reduce the average fees users pay on-chain. But high fees are ultimately a scalability problem, not an inefficient or unpredictable fee mechanism to solve. Scalability is being addressed through L2 solutions and the planned Ethereum 2.0 final upgrade. However, fee volatility should decrease due to better fee predictability.