Hackernoon logoWhat the heck is EIP-1559? by@haroonbaig

What the heck is EIP-1559?

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Haroon Baig Hacker Noon profile picture

@haroonbaigHaroon Baig

👋 I write fluff-free & engaging content in crypto space, ECDSA to zk-SNARKs, Bitcoin to Polkadot, DeFi to NFTs 👨‍💻

Is it finally The Time for ETH transaction fees to go lower with EIP-1559? 🤔

Yes, but juuusst a little bit! 🤏

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EIP-1559 introduces several changes that will help you pay less fees, and settle your transactions quicker than before. But don’t get your hopes too high; I’ll explain that in a minute. 

A brief overview 👨‍💻

EIP-1559 was first proposed by Vitalik Buterin in 2018 and is the most anticipated upgrade in Ethereum’s history. Before we go into the details, here is a TLDR for what EIP-1559 is all about: 

👉 There is no ‘single fee’ anymore

Instead, there are two fees - One is called Base fee, and the second one is called Inclusion fee, or a tip for the miners. The base fee is burned, while the inclusion fee (tip) goes to the miners.

👉 Elastic block size

Block sizes are now dynamic and will increase or decrease depending on the state of the network congestion. The maximum gas limit per block will now be 25 million, which is 2x the current gas limit per block of 12.5 million.

However, the target gas limit per block will be kept at 12.5 million, but in the state of transient congestion, bigger blocks will be used to accumulate more transactions. 

That’s pretty much this improvement proposal is all about! 😀

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Now let’s perform a much deeper analysis to understand the mechanics and impact of EIP-1559.  

First Price Auction model & wrong fees estimation 🚨

Aside from the standard block reward, miners or block producers are also rewarded with transaction fees. Each transaction includes a fee, and miners incentivize themselves by prioritizing transactions with higher fees to maximize their revenue. 

If you want your transaction to process quicker, you’ll simply bid a higher fee. This is called the first price auction model, where the chances of your transaction included in the nearest block are maximized if you bid higher. 

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First price auction model is designed to prioritize high-value use cases and make sure that the blockchain isn’t filled with lower-value use cases. However, there is one single problem with first price auction mechanism, i.e., there is no way to calculate the optimal price of a single transaction. 

Let’s say you included a Tx fee of $10 because the previous higher Tx fee was $8, but if everyone else is bidding $5, you would have been better off if you included a Tx fee of $6, saving $4 straightaway! 

Guess what? The current ethereum wallet you’re using cannot accurately estimate how much Tx fee you should be paying, and almost all the time, people tend to pay higher than they should be for their transaction to go through. 

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One solution to this problem could be a uniform price auction, where the next bid is always higher than the previous bid. In this case, however, there is a serious loophole where the miners will include their own transactions in a block, thereby pumping the Tx fee artificially to maximize their revenue. 

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How does EIP-1559 solve the problem?

EIP-1559 introduces a new transaction pricing mechanism to overcome the problems that we saw in the first price auction model. It introduces two different types of fees, i.e., the base fee and inclusion fee

The Base fee will be a fixed-per-block network fee that any transaction has to include. For the geeks out there, this fee will be a function of gas used in the parent block and gas target (formerly known as gas limit) of the parent block.

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If the blocks are above the gas target limit, this base fee will increase and when they are below the gas target limit, base fee will decrease. The gas target limit is set to 12.5 million, but it can go to a maximum gas limit per block of 25 million (2x the gas target). 

When the network congestion is higher, the base fee will be higher, and when the network congestion is lower, the base fee will be lower. However, the transactions will be slightly quicker because blocks with higher gas limit would include more transactions to be processed. 

Because these base fee changes are constrained, the maximum difference in base fee from block to block is predictable. This will allow wallets to auto-set the gas fees for users in a highly reliable fashion.

Deflationary pressure on Ethereum 📉

This base fee will be burned, thereby putting deflationary pressure on Ethereum. To put this in perspective, the issuance rate of Ethereum stands at 4.5% per year and according to the estimates, the issuance rate once the proposal is implemented will be 0.5 - 1%. 

This is HUGE! 

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If EIP-1559 was live yesterday, it would have burned roughly 17,000 ETH. Annually that equates to over 6.2 million ETH! It will have more effect than halving has on Bitcoin.  

Miners’ perspective & the inclusion fee 💸

EIP-1559 is, without a doubt, bad news for the miners! 

Last month, Ethereum miners made a whopping $1.3 billion, and almost 50% of it came from transaction fees. 

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Imagine losing a big portion of your business; it sounds painful! Alongside the base fee, there is an inclusion fee that will directly go to the miners. However, people can choose not to add an inclusion fee. 

Two of the three largest Ethereum mining pools have taken a public stance on EIP-1559. Sparkpool (combined hashrate above 50% at present) is on the opposing side, while F2Pool (11% of the network's hashrate) is on the supporting side.

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Regardless, EIP-1559 gives miners more control over the block size and makes their revenue more predictable. EIP-1559 will be packaged with the London hard fork in July this year, regardless of the mining industry’s discontent with the proposal. 

Learn more about EIP-1559 📖💡

If you want to learn more about this improvement proposal, have a look at the following resources: 

Over and out! 👋

Haroon

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Haroon Baig Hacker Noon profile picture
by Haroon Baig @haroonbaig. 👋 I write fluff-free & engaging content in crypto space, ECDSA to zk-SNARKs, Bitcoin to Polkadot, DeFi to NFTs 👨‍💻Get in touch!

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