Tonight, Ethereum’s London hard fork upgrade is about to be implemented. Will deflation come?

On August 5th, Beijing time, the Ethereum mainnet will implement the London hard fork upgrade when the block height reaches 12,965,000 (around 8 pm). This is also the largest update to the Ethereum core protocol in many years.

This upgrade incorporates five major Ethereum Improvement Proposals, among which the EIP-1559 proposal has attracted widespread attention from the crypto community in recent months. It constitutes a major change to the Ethereum (ETH) economy and will have a wide-ranging impact on all aspects of the Ethereum ecosystem.

Therefore, in this article we will focus on the EIP-1559 proposal.

Ethereum's upgrade path

Ethereum is the second largest cryptocurrency by market capitalization, but it is more than just a digital currency. Since its creation in 2015, Ethereum has begun to drive a range of applications, from decentralized finance (DeFi) to stablecoins (such as USDC) to NFTs.

Unlike its predecessor Bitcoin, which is more of a pure digital currency, Ethereum is a highly flexible platform for smart contract applications. One way to think about the Ethereum network is to imagine a giant global computer consisting of thousands of computers around the world, each running a copy of the Ethereum software.

In this case, the Ethereum software is the operating system — just like the operating system on your phone or computer, it is upgraded from time to time. Some upgrades are small tweaks, while others introduce major new elements.

Unlike your phone, Ethereum is decentralized, meaning there is no central developer to send out upgrades. Instead, changing the core Ethereum software requires a “hard fork.”

As long as the majority of the Ethereum community (usually including users, miners, developers, and investors) agree to change the core rules of the management software and the underlying blockchain, the hard fork upgrade can proceed smoothly. The most core and controversial protocol change proposal for the London hard fork upgrade is EIP-1559.

So, what does EIP-1559 do?

ETH has long played a key role in the Ethereum network, with users paying for "gas" in ETH when conducting transactions. Miners who work on transaction verification and blockchain updates have also been paid in ETH.

In 2018, EIP-1559, proposed by Ethereum co-founder Vitalik Buterin and others, aims to change this system. Users will pay a simplified fee (now called a "base fee," which is usually set automatically by your wallet), as well as a "tip" that can be used to speed up transactions.

However, this base fee is not paid to the miners who validate the transaction. Instead, it is “burned” by the network — meaning it is permanently removed from circulation. Some potential impacts include:

1. In the long run, EIP-1559 will not reduce gas fees because it is not a scaling improvement, but it can help users not pay more for transactions due to a better fee estimation process. In addition, due to the variable block size, it can also smooth the gas price between blocks.

2. Burning ETH will naturally make many people excited, but this does not mean that ETH will immediately become a deflationary asset. To achieve this goal, the ETH burned must be more than the newly issued ETH rewards.

3. Under the current proof-of-work (PoW) model, the annual issuance of ETH is relatively high (about 4% of the total supply of ETH). After the implementation of EIP-1559, in order to offset the newly issued ETH through burning, we need to keep the gas price above about 150 gwei. We have encountered this situation before, but it did not last long.

4. But when Ethereum switches to the Proof of Stake (PoS) consensus mechanism, the situation will change dramatically, which will cause the ETH issuance rate to drop sharply to about 0.4% per year. In this way, the issuance of ETH will drop by 90%, which is equivalent to experiencing three halvings.

In the future PoS model, we only need to maintain a gas fee of about 20 gwei to offset the issuance of ETH.

Is there anyone in the Ethereum community who objects to this?

Of course there is, which is why the London hard fork upgrade took so long to be adopted. Miners do a lot of the heavy lifting for the network, and some are concerned that their income will drop as a result of EIP-1559 being implemented. This could lead to a contentious fork or a decrease in miner activity, or even two competing Ethereum chains (similar to what happened when ETC was created in 2016).

What happens next?

The London hard fork is just one of Ethereum’s many upgrade plans, and the next merge upgrade (expected to happen early next year) will completely move Ethereum away from PoW mining.

After Ethereum is upgraded to the PoS consensus mechanism, the issuance of ETH is equivalent to experiencing three "halvings". In this case, EIP-1559 will truly make ETH a deflationary asset.