Decomposition of EIP-1559’s core features

Ethereum will usher in the biggest hard fork upgrade in recent years. The “London” upgrade will be activated at a block height of 12,965,000 (it is estimated that it will be carried out on the evening of August 5, 2021, Beijing time). This upgrade mainly includes 5 EIPs, namely EIP-1559, EIP-3198, EIP-3529, EIP-3541 and EIP-3554, the most important of which is EIP-1559.

The original EIP-155 proposed in April 2019 can be summarized in one sentence: “A transaction pricing mechanism that includes a fixed network fee per block, which is destroyed and the block size is dynamically expanded/shrinked to cope with instantaneous network congestion. “

Below we break down each part of this summary to illustrate how EIP-1559 works. 

“Transaction Pricing Mechanism”

To send transactions or interact with Ethereum decentralized applications, users need to pay a fee, which is often referred to as “Gas”. Similar to cars requiring gasoline to run, Ethereum applications require Gas to execute. 

At present, Ethereum uses the so-called first-price auction to determine the gas price, which may cause uncertainty and inefficiency. Imagine trying to call a taxi at a busy airport, but instead of waiting in line for a taxi, you blindly bid to complete the trip at the highest price you are willing to pay without knowing what other people are bidding. On the other hand, taxi drivers can see all the bids received and choose the highest bidder to maximize their profits. 

This is a simplified Ethereum current fee mechanism. Ultimately, users must strategically consider how much other people will bid, which usually results in bids that are too high or too low, and lead to high volatility in fees. For example, the figure below shows the average and median transaction fees (in GWEI) paid by block for approximately 5000 block samples on July 25, 2021. Note the large abnormal blocks, where the average (red) is much higher than the median (green). This indicates that some transaction senders pay too much, because the intermediate fee is enough to include the transaction in the block.   

f80e56784a98f1d01cd51e302060f024Source: Coin Metrics Network Data Pro

“Fixed network fee for destroying each block” 

In order to improve the predictability of the cost of the Ethereum user experience, EIP-1559 introduces a basic cost in each block. The basic fee is the necessary payment included in a block and is determined programmatically based on the previous block. This actually automates the Gas price bidding system. Under the selected parameters, the fluctuation range of the basic fee from one block to the next cannot exceed 12.5%. 

This provides something more similar to a predetermined list price that the user can reject or accept. However, users can also choose to add tips.

The basic fee will be destroyed rather than paid to the miners, which is probably the most discussed part of EIP-1559. This is good for Ethereum’s supply economics because it will permanently eliminate some ETH and reduce supply inflation. According to some basic assumptions, 75% of the expenses are destroyed. The following figure shows the historical scenario of the release of EIP-1559 ETH. Please note that during periods of severe network congestion, the daily circulation may become negative. 


Source: Coin Metrics Network data chart

“Dynamic expansion/reduction of block size” 

In order to determine how the basic cost of each block changes, the protocol needs to estimate the demand for block space. EIP-1559 accomplishes this by introducing the target block size. In short, the maximum size of an Ethereum block will double from its current limit, but the goal is 50% capacity. If the previous block is larger than the target block size (that is, more than 50% of the capacity), the basic fee will increase and continue to increase until the block size falls back to its target. This rising basic fee eventually makes transaction costs for some users too high, thereby reducing congestion and causing the block fill rate to naturally rise to 50%.

A common misunderstanding of EIP-1559 is that it aims to solve high transaction fees and reduce the average fees paid by users on the chain. But the high cost is ultimately a scalability problem, not a problem to be solved by an inefficient or unpredictable cost mechanism. Scalability is being resolved through the final upgrade of the L2 solution and planned Ethereum 2.0. However, due to better cost predictability, cost fluctuations should be reduced.

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