Ethereum: The EIP- 1559 Narrative

Ever heard of “gas wars”? It is what users experience on the Ethereum network when performing transactions in high network congestion. Due to the popularity of Ethereum which has caused price appreciation in ETH in the past few months, users have had to deal with high gas fees when performing different operations.

Refer to Gas and Fees in Ethereum’s Docs to first understand what gas fees are.

A particular solution was offered for tweaking Ethereum’s current gas fee model: EIP 1559, which recently has been activated on 5th of August, 2021.

So, we're currently undergoing major changes.

Gas fees have gone beyond 200 Gwei since the beginning of this year, which is extremely inefficient to users. ETHERSCAN.IO

This proposal was first brought up by Ethereum co-founder Vitalik Buterin in 2018 to replace Ethereum’s old price-auction model, which suffers from a lot of pitfalls.

The old price-auction model (Pre - EIP 1559):

All pending transactions from the Ethereum network land in the Mempool, a place where miners pick them up to verify and include them in the next Ethereum block. Since there is a maximum gas limit per block (number of transactions to be included per block) which is capped to 12.5 million gas, miners are incentivized to verify and include the most profitable ones, which has given the power to the richer users and has allowed for the existence of unfairness: “front running” in decentralized exchanges. Users who don’t overpay suffer from delays, and most of the time, their transactions could fail. Yet, regardless of whether transactions fail or succeed, users still pay for the computation: miners must still validate and execute your transaction (compute) even if it fails. All of these mentioned cases have no social benefit to users, which creates pure deadweight loss.

So, how will EIP - 1559 fix these issues?

The new transaction pricing mechanism will include a fixed-per-block base fee and “tips'' to incentivize miners. In more depth, the base fee is fully burned – miners will not be rewarded. This fee contracts/expands according to an algorithmic formula which is the function of gas used in the parent block (most recent previous block) and gas target of the parent block. The per-block fixed gas usage (12.5m) is relaxed in this proposal and is rather utilized as a median; the base fee adjusts whenever the size of the latest parent block is bigger/smaller than this average block size. Block size can at most increase by 2x, which according to the proposal, will approximately increase the base fee by 1.125x; this should mitigate the risk of “over-stressing nodes and miners” during periods of high network congestion. Moreover, the creator of the transaction specifies a certain amount for the “tip” to be paid with the base fee, which directly goes to the miner in charge. Just as in the price auction model, the larger the tip, the faster a user’s transaction will be verified. Users also specify the maximum gas fees (tip + base fee) they are willing to pay in their transactions.

Accordingly, the proposal should definitely enhance users’ experiences on the Ethereum network. It doesn’t aim to reduce gas fees but rather places caps to mitigate fee spikes. Users' fee estimation will be very straightforward and will not be based on other people’s behaviors since base fee changes are algorithmically set. Moreover, base fee changes are restricted, which makes it even more measurable for users. The likelihood of miners including dummy transactions might eventually decrease since they’ll be obliged to pay the base fees (which they wont be rewarded with and will get burned).

Yet, on the other hand, there might be some pitfalls and some people have raised their concerns.

First, ETH will be deflationary which should cause price appreciation for ETH holders if more is burned on the base fee than is generated in mining rewards – the tips. Developers aren’t certain whether ETH will end up being inflationary or deflationary since it’s entirely dependent on user demand for block space. By burning the base fee, the supply of ETH will not be constant over time, which could create some economic instability in the long run - the argument that inflation is ‘healthy’ could be brought up. Secondly, of course, miners are the most negatively affected by those new changes. Popular pools like Ethermine, Sparkpool, and Flexpool have shown their discontent. Over 60 percent of the hash power is against the proposal; even though this means that a 51 percent attack is probable, it’s deemed to be unlikely as there are more financial incentives not to attack the network. Overall, it is estimated that miner revenue will be reduced by 20% to 35% at most. Lastly, in Laura Shin’s Unchain Podcast, both Kain Warwick, co-founder of Synthetix, and Kyle Samani, managing partner at Multicoin Capital, pinpointed that there’ll be an undistributed wealth effect: a unit bias that’ll allow people to feel that they don’t own a decent stake of the network, which could disincentivize investors to lock in their ETH. They further iterate that simply, due to the burning of base fees, the price appreciation of ETH will make the Ethereum network more expensive to use, which counterfeits what the proposal aims to do.