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EIP-1559: What it is, what it means

EIP-1559: What it is, what it means

On August 5th, Ethereum went through a much awaited software update: the London hard fork brought 5 Ethereum Improvement Plans, with all eyes set on one of them: EIP-1559.

EIP-1559 started as a proposal to improve the user experience by avoiding excessive waiting times for transactions. However, the subsequent debates and suggestions brought features to EIP-1559 that have ended up turning it into a de facto proposition for a new monetary policy within Ethereum. And that is what had the community excited.

EIP-1559 changes Ethereum's fee market mechanism. From a first-price auction system, where the highest bidder wins, to a more predictable fixed price sale (with a couple of interesting side features)

Every new block written in the Ethereum blockchain was (up until until London) preceded by an auction. The highest bidders got their operations included in the block, and miners received the money from those bids. First-price auctions are prone to errors, inefficiencies, and a worse user experience. Users founds themselves often underestimating costs and seeing their transactions delayed; or overestimating them and paying more than they should.

Consensys compared it to Uber or Lyft rides. Imagine taking a ride was auction-based. How would you even calculate how much to pay? In crypto, it was wallets who aided users by estimating reasonable fee prices. But they were just that, estimations, and this created mistakes and friction in the system.

EIP-1559 solved this by establishing an initial fixed price, the base fee. Traveling from A to B should have a reasonably fixed price, and so should transactions. After EIP-1559 users can still speed up their transactions by adding a tip to their transaction cost and thus incentivizing miners to pick their operation first. But the cost of having your operation processed is now fixed.

There are several relevant things to say about base fees.

First of all, the price is indeed variable and linked to demand, but the variations are defined in the protocol (they go up or down in fixed percentages) and are therefore predictable. Wallets no longer had to guess and therefore now help users make the best decisions possible (and feel less dumb waiting for too long because their bid was too low, or because they paid too much because their bid was unnecessarily high).

Second, and most importantly, the base fee gets automatically burnt. Instead of reaching the hands of miners, the agreed ETH vanishes into the air like an unlucky Avenger. And this is where things got interesting.

Burning base fees was brought forth as a countermeasure to the hypothetical miner collusion to increase base fee price and extract even more value from users via fees. But the elimination of ETH via basefee burning ended up being the most wanted feature in EIP-1559. Ethereum was missing its own version of one of bitcoin's key features: supply control. EIP-1559 was considered by some as the most relevant manifestation of Ethereum's monetary policy, a mechanism to increase the value of the current circulating ETH and a possible boost for the currency's growth.

To sum things up:

What is EIP-1559?

A change in Ethereum's fee mechanism that will altered the incentive to miners, and that brought a burning mechanism that will probably contribute to making ETH deflationary.

What problem does EIP-1559 solve?

Improved UX. First of all, EIP-1559 makes fee calculation controlled. Base fees will be calculated by the protocol and will vary predictably.

And, as a welcomed consequence of the burning mechanism, monetary policy. Burning ETH will give deflationary powers to Ethereum. Peaks in Ethereum use will bring proportional decreases in ETH supply.

What problems does it not solve?

Many have pointed out that EIP-1559 was a solution to the problem of skyrocketing fees in Ethereum. EIP-1559 does not solve this, and transaction costs will still be highly dependent on demand, although, at least, less volatile.

Predictability and transparency might have the side effect of affecting user behavior: users might refrain from submitting operations if they see or foresee price increases.

What problems did it create?

The changes in the incentive structure brought questions about the implications for miners, who might see their revenue decrease. Happy miners make blockchains secure, and unhappy miners could make the hard fork fail.

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This outcome, nevertheless, is improbable for a bunch of reasons. To name just three of them:

  • Those users who are currently bidding higher for their transactions in the first-auction system will probably still be interested in getting their operations validated first. Tips are likely to become a relevant source of income, even if they are optional.
  • EIP-1559 might increase ETH's price. Miner revenue, calculated in dollars, can become higher thanks to EIP-1559.
  • ETH 2.0 is getting closer and closer. Ethereum has a very relevant upgrade coming up that will bring, among other revolutions, the change from Proof of Work to Proof of Stake. Are miners willing to make the system tremble when they are months away from a crucial improvement in Ethereum's history?