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Here’s How EIP-1559 Changes the Economics of Ethereum

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Defiers may be a disparate, opinionated bunch but there is one thing we can all agree on — Ethereum gas prices are a real drag. 

Just look at what’s happened over the past few months. Gas prices have ping-ponged all over the place, turning off users from doing all the cool things Ethereum was designed to support, such as minting NFTs, sending money, or playing with DeFi apps and services. Volatile fees have also been a boon for other blockchain projects like Solana and Cardano, which are trying to one-up Ethereum. 

The bottom line is that gas prices — essentially, the cost of processing transactions — are preventing Ethereum from truly being Ethereum. Yet this week we may finally have a solution: It’s called EIP-1559, and it is the mother of all updates for the Ethereum blockchain so far.

The upshot: Ethereum users should get a much needed break on the costs of using their beloved network.

Dubbed London after the legendary devcon in Britain’s capital in 2015, The Ethereum Improvement Proposal is a hard fork for the most valuable cryptocurrency protocol after Bitcoin. 

It’s designed to make gas prices more predictable and less vulnerable to manipulation. The upshot: Ethereum users should get a much needed break on the costs of using their beloved network. To understand the significance of this change, you have to unpack how gas fees are currently calculated. For every transaction that’s executed on Ethereum, you pay “gas,” or a transaction fee to miners. The miner gets that fee as a block reward when they verify a block of transactions. When transactions pile up, the network gets bogged down and the gas fees creep higher. 

Quite Volatile

Over the years, transactions fees have varied a lot. The minimum fees are normally around 2 gwei (10^9 gwei = 1 ETH) but they’ve been as high as 500 gwei in the past. That correlated to a transaction fee of several hundred dollars. As a user, if you do not set a gas fee above the average, sometimes your transaction can be delayed. So that is to say, gas fees have been quite volatile, which can turn users off from making transactions on the network. 

Image source: Ycharts. 
Gas fees over the past 6 months. Source: Ycharts.

Right now, there is an auction system for determining the gas price. If the gas price is high enough, miners will bid to include the transaction to the block. So it is more likely that a miner includes a transaction in a block if the user is willing to pay more. As a result, if the network is busy — over the 15-20 transactions per second which is currently Ethereum’s limit — users must incentivize miners to accept their transaction, which leads them to add higher gas fees to their transaction. 

Image source from Metamask.com

This auction system has a lot of inefficiencies. On of the problems is that there is no simple strategy for choosing the optimal bid price. For example, let’s say you are willing to bid $0.50 for a transaction but everyone else is bidding $0.05, then it would make more sense to bid $0.08 instead. With today’s system that is not easy to do. If you want a more detailed write up on this, check out this post where it is explained.

There has also been a problem with miners artificially increasing the gas prices by including their own transactions in a block. 

Ethereum can handle 15 to 20 transactions per second, and at times this creates traffic jams and sends gas prices higher. Sometimes  transaction fees have soared to several hundred dollars to send money on the chain.

The problem with high and unpredictable gas prices

When the gas prices are that high it might force developers to move to other blockchains like Solana or Cardano. It also affects users who might have to pay as much as 30-50 USD to for example swap tokens on Uniswap or Sushiswap.

The high price of gas isn’t the only issue. Another problem is that the fees are very unpredictable. Certain times they are fairly low and sometimes they skyrocket. At as we went to press the average fee is $7.982 per transaction. Below you can see how gas fees have bounced around during the past last 50 days or so.

Image source: Ycharts

EIP-1559 looks to change all this by doing away with Ethereum’s auction system for gauging gas fees and replacing it with a base fee mechanism. This means that instead of only paying a fee to the miner you will now pay a base fee that gets burned and then you can tip the miner.

How will gas fees get decided after EIP-1559?

And instead of an auction, EIP-1559 will feature a base gas fee that changes depending on the flow of transactions on the network. The base fee will be burned, which means it doesn’t go to the miners. 

There will also be something called a “priority fee” that can be compared to tipping. So if a user wants their transaction at the head of the line, they can add a priority fee.

EIP-1559 will also increase the network capacity by changing the max gas limit per block from 12.5M to 25M gas. This means that when the network is >50% utilization, the base fee is incrementally pushed up. Inversely, when the network is <50% utilization, the base fee is lowered. As a result, the network will reach balance at 50% capacity by adjusting fees accordingly to the traffic. 

There have also been heated discussions over what will happen to miners’ revenue after EIP-1559. Obviously, the change cuts into their revenue; figures vary widely from 20% to 35%

Still, for all the hope and promise that a new, more stable era is about to dawn, the shift to EIP-1559 has brought up a lot of questions. 

For starters, will EIP-1559 lead to lower gas prices? That’s been a hot topic on Twitter, Ethereum forums and Reddit. The answer is unknown. Then there’s the not insignificant point that for all the fixation on gas prices the primary goal of EIP-1559 is to make fees more predictable and less volatile, not cheaper. 

Still, the gas prices will likely be lower for some transactions and higher for others.

Will EIP-1559 kill mining?

A lot of Defiers are predicting the value of ETH will increase after EIP-1559, citing the burn mechanism as a way to make ETH more of a deflationary asset. But again, many other factors affect the price of cryptocurrencies and so, we won’t know for sure until the change is made. 

There have also been heated discussions over what will happen to miners’ revenue after EIP-1559. Obviously, the change cuts into their revenue; figures vary widely from 20% to 35%

As such, some of the biggest pools like Flexpool and Sparkpool have made announcements saying they will not support the proposal. 

Source: Flexpool’s Medium page

However, there’s still a lot of money to be made for the miners with the priority fee mechanism.  Plus when Eth2 goes live, mining will be removed from the network altogether so it would make sense for miners to continue with EIP-1559 while mining still works. . 

One of the more far-fetched risks looming on the horizon is the possibility that dissenting miners could launch the fabled  51% attack on Ethereum, which could force another fork.

Predictability for Ethereum’s future

Stepping back and appreciating this historic moment, it’s important to realize that EIP-1559 aims to do nothing less than improve the reliability of transaction fees and lower congestion. So it’s no wonder that seasoned Defiers and newbies alike are excited about what’s coming.

If Ethereum wants to continue being the dynamo for DeFi and NFTs it needs to work on the gas fee problem. Hopefully, EIP-1559 is a step in the right direction.

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