What is Ethereum’s EIP 1559?
The London hard fork changes how fees work on the original Proof of Work based Ethereum chain. The core of this update is EIP 1559 (Ethereum Improvement Proposal 1559), which will be a radical change to the network. Traditionally, transactions have included a gas fee paid to miners as a charge for processing transactions. In this new Ethereum Improvement Proposal (EIP), the gas costs will be burned, with a tip to miners possible instead. This tip is expected to be predictably low outside of times of surges in demand. This is intended to make payments on the network fairer and improve the user experience.
Ethereum’s use-cases today
With the upcoming launch of Ethereum 2.0, Ethereum is ushering in a seismic shift in the way the industry operates. Traditionally we have seen all the major blockchains run on a Proof of Work basis, yet Ethereum’s transition to Proof of Stake brings an unprecedented level of attention to this new paradigm, underscored by the growing concerns around energy consumption.
Being one of the largest blockchain ecosystems with the majority of Decentralized Finance (DeFi) innovation happening on-chain through oracles, lending, and stablecoins, it is a testing ground for really all DeFi protocols and has mushroomed into a very comprehensive ecosystem. By leveraging the composable properties of smart contracts, stablecoins (a fiat onramp work around and much more), trading, lending, derivatives, and liquid staking to financial infrastructure such as The Graph and Chainlink, the DeFi ecosystem has been rigorously tested and refined through major market events.
What problem does EIP 1559 solve?
Ethereum has a majority of the industry’s on-chain liquidity and given the beacon chain upgrade timeline (upgrade to ETH2 PoS), the network congestion problem still needs to be addressed in the near-term, even with EIP 1559 (dynamic base fee). What is in process now are the creation of bridges and EVM compatible protocols, so that DeFi protocols can easily migrate to other blockchain ecosystems such as Polkadot, Binance Smart Chain, Solana etc for a higher transaction throughput and lower gas fee, meaning they will bring liquidity to other L1 blockchains. Even though we may see some liquidity being drawn away by other chains, Ethereum is still the largest L1 that powers the most comprehensive and battle tested suite of DeFi protocols.
This sea change in the way Ethereum operates brings new opportunities to generate yield for institutional and retail investors by staking their ether. This will turn passive holders of the token into active participants in Ethereum’s consensus. The fact that Ethereum is an institutionally accepted asset (one which can be bought on popular platforms such as Venmo, PayPal, Robinhood etc.) allows big and small users alike (such as Goldman Sachs planning to offer ETH Options to investors) the chance to generate a yield on an easy-to-access asset which outperforms current interest rates for savings accounts. The result will be the largest on-ramp of customers into DeFi the industry has seen to date.
How does EIP 1559 work?
The London hardfork is significant because EIP 1559 fundamentally changes Ethereum’s financial incentives. Rather than users incentivizing miners to process their transactions faster through paying higher gas fees in priority auction style, the network will now dynamically establish a base fee which customers must pay to get their transactions processed. This upgrade is relevant to improve the cost and performance issues Ethereum faces, along with other scalability efforts in sharding, zk rollups and sidechains. It also gives miners a preview of the lower revenue they will face with the dawn of Ethereum 2.0, once validators replace them for block production. This loss of revenue ushered in by EIP 1559 removes transaction fees and replaces it with an inclusion fee and a miner tip. This tip will be an additional fee users must pay on top of the dynamically established base fee to be burned, decided by the network. Overall, the path Ethereum is taking with this update is a necessary and relevant one.
What does the London hardfork development mean for members of the blockchain industry?
The implications of the London hardfork will be different for different people in the Ethereum and blockchain ecosystem. Traders on Decentralized Exchanges (DEXs), for example, have always valued speed and reliable transaction inclusion when executing transactions – to have their trades jump the queue so-to-speak. This was made possible through Ethereum’s gas model, where traders could pay to prioritize trades and profit from arbitrage opportunities. The trading mechanics will fundamentally change on Ethereum hosted DEXs after the London upgrade. We may also see some miners leaving the Ethereum ecosystem from EIP 1559’s fee-burn mechanism and start to mine on alternative networks with higher returns. As a result, the London hardfork is crucial to Ethereum’s POW to POS transition and network security in general as the governance needed to make sure miner incentives are addressed.
From developers’ perspectives, much of the motivation behind EIP 1559 is to smooth out the experience for their dApps’ end users during times of high volatility in price. EIP 1559 is intended to simplify the process of predicting transaction costs for both end users and dApps. By varying the block size rather than dealing with volatile gas prices during surge times, developers may benefit from better market efficiencies when customers use their product. For the market as a whole, there will be a marginally lower supply of Ether in circulation, which could potentially drive up Ether price and how different agents in the ecosystem would behave (i.e. holding instead of spending).
What does EIP 1559 mean for everyday users?
There will be a significant impact on users as they can continue to still enjoy using their favorite Ethereum based applications without experiencing transactions getting ‘stuck’ when the gas price spikes just after they broadcast their transaction. Post EIP 1559, all users will be paying a base fee which is algorithmically set by the Ethereum network. As this is calculated by the network rather than in an auction style setting, there should be less risk of transactions failing to make it onto the chain. EIP 1559 represents an evolutionary step in Ethereum’s development which results in a more cost-efficient, fairer platform.