Understand EIP-1559’s changes to Ethereum’s economic model in three minutes

While you quietly appreciate this historic moment, please understand: The EIP-1559 upgrade is designed to improve the reliability of assessing Ethereum transaction fees and reduce transaction congestion.

For a deeper understanding of EIP-1559 and its potential impact, please read "Understanding Ethereum EIP-1559 Proposal, Why is it Controversial?"

Written by: Marcus Sandstrom, The Defiant Author Translated by: Perry Wang

DeFi media platform The Defiant community may be a diverse and opinionated bunch, but there is one thing we all agree on - Gas prices are a real drag on the Ethereum economy.

Look at what’s happened over the past few months: Gas prices are surging, making it impossible for users to do all the cool things Ethereum is designed to support, like minting NFTs, sending remittances, or playing with DeFi apps and services. The volatility of Ethereum gas fees is also a boon for other blockchain projects like Solana and Cardano that are trying to compete with Ethereum.

Worst of all, gas prices — which are essentially the cost of processing a transaction — are preventing Ethereum from truly being Ethereum. But this week we may finally have a solution: It’s called , and it’s a compilation of all the updates to the Ethereum blockchain to date.

Target Outcome: Ethereum users should no longer have to face cost barriers when using their favorite network.

This upgrade proposal was put forward at the Ethereum Developer Conference held in London, the capital of the United Kingdom in 2015, so it is called the "London" upgrade. It will be the most valuable cryptocurrency protocol hard fork after Bitcoin.

It aims to make gas prices more predictable and less susceptible to manipulation. What the London upgrade hopes to achieve: Ethereum users should no longer have to face cost barriers when using their beloved network.

To understand the significance of this change, you have to understand how “gas” fees are currently calculated: For every transaction executed on Ethereum, you need to pay “gas” or “transaction fees” to miners. Miners receive this fee as a block reward when they verify a block of transactions. When more transactions pile up, the network becomes congested and gas fees rise.

Gas prices are extremely volatile

Gas transaction fees have varied greatly over the past few years: the lowest fee is about 2 gwei (10^9 gwei = 1 ETH), but it has been as high as 500 gwei. This means that transaction fees are as high as hundreds of dollars.

As a user, if you don’t set a higher-than-average gas fee for your transaction, sometimes your transaction will be delayed. That is, gas fees fluctuate wildly and can prevent users from transacting on the network.

Image source: Ycharts

Gas fee changes over the past 6 months, source: Ycharts

There is currently an auction mechanism to determine the Gas price. If the Gas price is high enough, miners will bid to include the transaction in the block. Therefore, if the user is willing to pay more, the miner is more likely to include the relevant transaction in a block. This means that if the network is busy - more than 15-20 transactions per second, which is the current peak limit of Ethereum - users must incentivize miners to accept their transactions, which will cause users to add higher Gas fees to their transactions.

Image from Metamask.com

There are a lot of inefficiencies in this auction mechanism. One of the problems is that there is no simple strategy for choosing the best bid. For example, let's say you are willing to bid $0.50 for a transaction, but everyone else is bidding $0.05. It would make more sense for you to bid $0.08. This is not easy to do in today's bidding system. If you want a more detailed understanding of this problem, check out this post by Vitalik, which explains it in detail.

Miners may also artificially increase the gas price by including their own transactions in a block, which is also a real problem.

Ethereum can process 15 to 20 transactions per second, which sometimes causes transaction congestion and drives up gas prices. Sometimes, transaction fees for on-chain transfers alone have soared to hundreds of dollars.

Problems caused by high and unpredictable gas prices

When gas prices are this high, it could force developers to switch to other blockchains like Solana or Cardano. If users may have to pay up to $30-50 to swap tokens on Uniswap or Sushiswap, they are naturally also negatively affected.

High gas prices aren’t the only problem, another problem is that fees are very unpredictable. Some days they’re pretty low, other days they skyrocket. As of press time, the average fee per transaction is $7.982.

You can see in the chart below how gas fees have bounced around over the past 50 days or so.

Image source: Ycharts

The EIP-1559 proposal hopes to change this by removing Ethereum’s gas fee auction system and replacing it with a base fee mechanism. This means that instead of just paying fees to miners, you now also need to pay a base fee (which is burned), and then you can tip the miners.

How will the gas fee level be determined after the EIP-1559 upgrade?

Instead of auctions, EIP-1559 will introduce a base gas fee that will vary based on network transaction traffic. The base fee will be destroyed, meaning it will not flow to miners.

There is also something called a “priority fee”, which can be used as an analogy for tips. So if a user wants their transaction to be at the front of the queue, they can add a priority fee.

EIP-1559 also increases network capacity by changing the maximum Gas limit per block from 12.5M to 25M. This means that when network utilization is > 50%, the base fee will be gradually pushed up. Conversely, when network utilization is <50%, the base fee will be reduced. Therefore, the Ethereum network will adjust the fee according to the traffic to achieve a balance at the 50% capacity level.

There has also been a lot of discussion about what will happen to miners’ income after the EIP-1559 upgrade. Apparently, the trend is towards reducing their income; the numbers range from 20% to 35%.

Still, for all the anticipation and promise of a new, more stable era to come, the EIP-1559 upgrade shift has raised many questions.

First, will EIP-1559 lead to lower gas prices? This is a hot topic on Twitter, Ethereum forums, and Reddit. The answer is unknown.

It is also important to note that the primary goal of EIP-1559 with regard to gas price fixing is to make fees more predictable and less volatile, not to make them cheaper.

Nonetheless, some transactions may have lower gas prices, while other transactions may have higher gas prices.

Will EIP-1559 become the grave of the mining industry?

Many people in The Defiant community predict that the value of ETH will go higher after the EIP-1559 upgrade, arguing that the destruction mechanism is a way to make ETH a deflationary asset. But again, many other factors can affect the price of cryptocurrencies, so we can't be sure until the change occurs.

There has also been a lot of discussion about what will happen to miners’ income after the EIP-1559 upgrade. Clearly, the trend is toward reducing their income; the number of forecasts for the reduction in income ranges from 20% to 35%.

As a result, some of the largest mining pools such as Flexpool and SparkPool have issued announcements saying that they will not support the proposal.

Source: Spark Pool’s Medium page

But given the existence of the priority fee mechanism, miners still have a lot of money to make. In addition, when Eth2.0 goes live, mining will be completely removed from the network, so it makes sense for miners to embrace EIP-1559 while the mining mechanism still exists.

A more imminent risk is that dissenting miners could launch a fabled 51% attack on Ethereum, which could lead to another fork.

Predictability of Ethereum’s Future

As we quietly appreciate this historic moment, it’s important to realize that the EIP-1559 upgrade is designed to improve the reliability of transaction fees and reduce transaction congestion. So it’s no surprise that both veterans and newcomers in The Defiant community are excited about what’s to come.

If Ethereum wants to continue to be the driving force behind DeFi and NFTs, it needs to solve the gas fee problem. Hopefully, EIP-1559 is a step in the right direction.

Source link: thedefiant.io