What is EIP-1559: Explaining Ethereum’s fee burning proposal

Key points

EIP-1559 will consume a large part of the transaction fee on Ethereum, while introducing variable block size to improve efficiency.

The upgrade will have a negative impact on Ethereum miners, but will add value to ETH holders by making assets more scarce. Natural gas costs will also be more predictable.

Ethereum’s upcoming London hard fork (expected to go live around August 4th) will include the EIP-1559 proposal.

EIP-1559 is planned to be upgraded at block 12,965,000. 

Ethereum is preparing for EIP-1559 . As part of the upcoming London hard fork, EIP-1559 is the biggest update of Ethereum since the April Berlin hard fork implemented gas cost changes. This upgrade will change the first-price auction fee mechanism to a new basic fee model with additional miner tips. 

Currently, all Ethereum users are bidding to include their transactions in the new block. During periods of high demand, the amount users need to pay may fluctuate significantly. Ethereum wallet providers such as MetaMask will analyze this demand and provide different fee options, and the confirmation time is sometimes as long as 12 hours or more. However, even a long wait cannot guarantee that the transaction will be contained in a block. 

Users usually have to speed up their transactions by substituting higher bids for their original fees to prevent their transactions from getting stuck in the memory pool for several days. 

EIP-1559 aims to eliminate this uncertainty by pre-calculating the basic cost of the block based on the degree of congestion. Another significant improvement of EIP-1559 is the introduction of a variable block size, and a higher gas limit of 25 million units, which is twice the current limit of 12.5 million. 

EIP-1559 will implement the basic cost based on gas restrictions and demand, and calculate it as the market clearing price. The protocol will dynamically set the gas limit of the block based on these variables and adjust the fee accordingly. Then, instead of transferring the fee to the miner, the ETH paid for the basic fee will be burned. Users can choose to send tips to miners.

What is EIP-1559: Explaining Ethereum's fee burning proposal

Ethereum fee mechanism around IP-1559

On average, the network’s goal is 12.5 million gas limits, and the base fee will increase or decrease as it deviates from the 50% GAS limit mark (ie 12.5 million units). Ethereum will only support a gas limit higher than 12.5 million in a short period of time.

Users can choose to include their transactions at a given basic fee or wait for cheaper blocks. A big advantage of EIP-1559 is that it allows users to confirm transactions without having to participate in guessing games. At the same time, the variable block size proposed in the upgrade will help buffer sudden surges in demand without sudden increase in costs. 

High gas fees and long waiting times have a negative impact on the user experience of Ethereum. Sometimes, for retail investors with small funds, the network cannot be used. In the past three years, the total daily gas consumption has ranged from 60,000 to 80,000 units per day, sometimes with peaks. For example, as Mila Kunis launched her Stoner Cats NFT series, gas bills soared from less than 50 gwei to 600 gwei on Tuesday. 

A common misconception of EIP-1559 is that updates are a long-term scalability solution. This update is expected to be ineffective in reducing fees, and miners may receive tips during periods of high demand. 

Impact on ETH inflation and miner income

Although EIP-1559 has advantages for daily Ethereum users and ETH holders, it has a negative impact on miners. This is because it directly affects the income of miners by burning part of the cost. 

In addition, if the miner’s tip is significantly greater than the basic fee, the proposal is at risk of invalidation. In this case, the auction market with larger prompts will be similar to the current first-price auction fee mechanism; this will defeat the purpose of EIP-1559. This is likely to be a problem during periods of high demand for block space, such as during periods of sharp NFT drops or price collapses. 

Ethereum’s current annual inflation rate is above 4%. As the increase in supply dilutes the new block reward, it is declining at a slow rate. After EIP-1559 is launched, the network will destroy ETH, which is essentially the opposite of the block reward of 2 ETH per block. The question remains whether cost burning will deflate ETH. 

According to a report by Coinmetrics , the expected inflation rate is largely unpredictable . During the busy hours of the Ethereum network-as in March and April this year, the annual inflation rate in the EIP-1559 module will drop below 1%. 

Nevertheless, the update may not have an immediate deflationary effect. If about 70% of the basic fee is burned and the rest is paid to miners as tips, Coinmetrics estimates that the decline in inflation will be lower than many people’s predictions. 

Since the collapse of the crypto market in May, fee income has fallen sharply, raising the estimated inflation rate to about 3.5%-only 0.5% lower than current interest rates. 

What is EIP-1559: Explaining Ethereum's fee burning proposal

Source: CoinMetrics

After EIP-1559, the transaction fee income of miners is expected to decrease by 70% , while the block reward will remain at 2 ETH. In general, based on the current fee and percentage of block reward revenue, miners’ net income loss is expected to be between 10% and 20%. 

The 10% to 20% estimate is lower than the previous forecast of a 30% to 50% reduction in miners’ income. Nonetheless, these values ​​are still applicable during peak demand periods, when miners’ transaction fees accounted for 50% of their income. 

Ready to open the proof of equity

EIP-1559 also marks a shift from Ethereum’s proof-of-work consensus mechanism, as it handles most of the miners’ responsibilities.

It will introduce proof-of-burn and existing proof-of-work mechanisms in Ethereum. By making assets more scarce rather than passing them on to miners, this essentially creates value for ETH holders. 

As part of the next phase of Ethereum 2.0, the network will eventually move to proof of stake, when all block rewards will flow to ETH stakeholders. Ethereum’s Beacon Chain was deployed in December 2020, and there are currently more than 14.5 billion U.S. dollars in ETH deposited into the staking contract. 

The average base fee needs to be high enough so that the cost consumption can exceed the amount of ETH issued. The amount of pledged ETH, the level of activity on the network, and the merger date will all affect whether ETH will experience deflation in the long run. 

EIP-1559 marks an important milestone in the full development of Ethereum as the foundation layer of financial applications by introducing predictability and the ability to absorb sudden surges in demand. It will also make ETH more scarce, which explains why it is so popular in the Ethereum community. Nevertheless, it may take a while for the market-two to three months-to understand the positive impact of EIP-1559 on the Ethereum token economy. 

The London hard fork is scheduled to go online at a block height of 12,965,000 and is expected to arrive between August 3 and 5.

The information provided in this article is for general guidance and information purposes only. The content of this article should not be considered investment, business, legal or tax advice under any circumstances. We do not take any responsibility for personal decisions made based on this article, and we strongly recommend that you conduct your own research before taking any action. Although every effort has been made to ensure that all information provided here is accurate and up-to-date, omissions or errors may occur.

Original Author: Chris Williams 

 

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/what-is-eip-1559-explaining-ethereums-fee-burning-proposal/
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