Everything you Need to Know About the Ethereum London Hard Fork (EIP-1559)
Heading towards July 2021, Ethereum is on course to have one of the most significant and contentious upgrades, dubbed London Hard Fork, that is expected to solve the problem of high network transaction fees. The London Hard fork will implement the Ethereum Improvement Proposal (EIP) 1559, regardless of its controversy and disagreement within the mining industry.
EIP-1559 titled the “Fee Market Change for ETH 1.0 blockchain” was initially proposed in 2019 by Vitalik Buterin himself. Although the London Hard Fork is expected to implement five other EIPs this coming July, however, EIP-1559 has the biggest impact among them. This article will discuss the EIP-1559 proposal and how it will impact the users and miners.
What is EIP-1559?
Put simply, there are two main changes suggested in the EIP-1559 proposal:
Ethereum calculates the fees based on the “first-price auction” mechanism that is inefficient and unpredictable. In order to optimize their fee auction mechanism, Ethereum aims to introduce two fees associated with every transaction, a base fee, and an inclusion fee.
The base fee is a dynamic amount that adjusts with the network congestion. Since the base fee is expected to be dynamic, wallets can automatically set the gas fees for their users based on the network congestion instead of following the “first-price auction model”. Users can also manually set a max base fee they’re willing to pay to bound their total costs.
Now here is the interesting part: the inclusion fees, or priority fees, will be set aside for the miners while the base fees will be burned to ensure the economic value of ETH. The fee burn will counterbalance Ethereum’s inflation and still remain a rewarding asset for miners on the platform.
The upcoming update will introduce dynamic blocks that will adjust to the current state of network congestion. With the maximum gas limit per block set at 25 million, which is twice the current 12.5 million gas limit per block, the network will be able to facilitate a higher number of transactions while keeping the fees lower.
The Elephant in the Room
Ethereum sets its transaction fees using a simple auction mechanism called the “first-price auction model”, where users on the network send transactions with bids, or ‘gas prices,’ and miners on the network prioritized those transactions with the highest bids.
However, this auction mechanism was the source of many inefficiencies and problems on the Ethereum network. This is because if you wanted your transaction to process faster, you’d have to bid a higher fee to increase the chance of your transaction being included in the most recent block.
Source: Etherscan.io (rising transaction fees on Ethereum)
Some of the most significant problems in the first-price auction model are:
Needless network congestions and delays for users
Inefficient auction mechanism that results in wrong gas fee estimates
Potential for selfish mining attack vectors
Extremely volatile network fee levels
The first price auction model was introduced to prioritize high-value use cases to filter out lower-value use cases on the blockchain. However, this method didn’t allow the network to predict or compute the optimal price of a single transaction.
Moreover, the current Ethereum wallets that people commonly use often fail to accurately estimate the network fees you should be paying. Users often had to overpay to get their transactions included into the block.
Ethereum was planning to introduce a “uniform-price auction” model, where the latest bid had to be higher than the prior bids; however, there was a serious loophole where miners could potentially manipulate the transaction fees by including their dummy transaction in a block to increase the transaction fees.
Source: ethresear.ch (fee manipulation in the uniform price auction model)
EIP-1559 to the Rescue
EIP-1559 plans to introduce a new transaction type from the EIP-2718. The pricing mechanism aims to overcome the problems inherent in the first-price auction model. It is expected to introduce two different types of fees, the base fees, and the priority fees.
The base fee is introduced as a fixed-per-block network fee that every transaction on the network has to include. The base fee will depend on the gas used in the previous block and the gas target of the parent block.
If the blocks go above the computed gas target limit, the base fee will increase. If the blocks go under the computed gas target limit, the base fee will decrease. The novel base fee will be able to adjust itself to the state of the network allowing Ethereum wallets to accurately estimate the latest network fees.
Moreover, EIP-1559 also plans to burn the base fees, thereby countering Ethereum’s inflation. The current 4.5% annual issuance rate is expected to drop to between 0.5% and 1% once the proposal is introduced in the upcoming hard fork.
What About the Miners?
EIP-1559 is not that great for miners. It’s evident that about 50% of miner revenue comes from transaction fees. Last Month, Etheruem miners made a staggering $2.35 billion, with $1.03 billion coming from network transaction fees alone.
Source: The Block Research
The EIP-1559 is a huge hit to the mining industry. The new transaction type introduced in the EIP-1559 introduced two fees: Base Fees and Priority Fees. The priority fee serves as a tip for the miners. Users can choose not to tip the miners, which is why the new protocol is going to be detrimental for the mining industry. However, it’s not all bad for the miners. With the introduction of dynamic block sizes, EIP-1559 empowers miners to control the block size and adjust their revenue.
The EIP-1559 is scheduled to bring a lot of changes to the platform. Considering the deflationary effect it introduces, the problem it solves, and the way it optimizes the transaction fee estimation model, Ethereum is expected to gain a lot of momentum in the coming months
As Ethereum emerges in the market, ETH is bound to become more valuable over the years due to its deflationary characteristics after EIP-1559 is implemented. The platform also announced that it is going to transition to a Proof-of-Stake system within a few months.
Etheruem has been outperforming its rival, Bitcoin, ever since the start of the year. With the London Hard Fork scheduled for mid-July, it could certainly rival BTC as a store of value in the long term.
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