EIP 1559 – An Evolution in Ethereum’s Monetary System

The Ethereum EIP 1559 proposal has just been accepted by core Ethereum developers, with the game-changing proposal set to introduce a monetary policy for crypto’s second-largest coin.

An Ethereuem Improvement Proposal (EIP) is a mechanism that allows changes and improvements to the Ethereum Network to be requested. These improvements can range from standard track, core, networking, interface, ERC, meta, and informational types of requests.

Initiated by Etherem CEO Vitalik Buterin in April 2019, EIP 1559 introduces two main mechanisms to Ethereum’s fee market creation of a ‘market-rate for gas and burning the base fee

Critical to delivering both improvement proposals is Ethereum’s BaseFee; the minimum price necessary for transactions to be included in blocks. The purpose behind EIP 1559is to provide UX, economic and security benefits to Ethereum.

Ethereum’s lead developer Tim Beiko told ACCOINTING.com:

“EIP-1559, is the long awaited transaction fee upgrade, deployed to the network this summer. It will introduce a market rate for gas fees and will allow base fee burning to remove ETH from circulation”

Creating a market-rate for gas

Under the present fee market set-up, users often have to wait a long time for pending transactions to be processed. This occurs because the number of transactions that can be registered on a block is limited. This occurs because the number of transactions (lower gas prices) is forced to wait until space for the transaction is made available.

According to Tim Beiko:

“With EIP 1559, Ethereumaims to create a network utilization equilibrium by adjusting the BaseFee in accordance with network use. This is achieved by increasing block capacity, so that blocks can become 200% full, thus processing more transactions; and creating a ‘going market rate by adjusting the BaseFee mechanism depending on how full a block is.”

As a result, the EIP 1559 allows the Ethereum network to process greater transactions more efficiently and faster by targeting a 50% equilibrium utilization capacity (0%, 100%,200%). Additionally, the proposed BaseFee mechanism could adjust to network utilization.

This would mean that users no longer would have to rely on their wallets to generate an individual gas price estimation. Instead, users would be able to simply send a transaction with the gas price adjusting to the transaction demand independently.

Burning the base fee

Once a user agrees to make a transaction at a given BaseFee, the user can then be refunded by the difference between the BaseFee and FeeCap, the maximum a user is willing to pay for their transaction to be included onto a block; with miners receiving a tip from the refunded transaction. During this process the BaseFee is burnt, having three major impacts:

  • Burning the base feee prohibits the possibility for validators to exploit the fee marketor use any other tender.
  • Burning the base fee is also an easy way for Ethereum to collect fees for using itsblockspace
  • Burning the base fee can be deationary

By introducing BaseFee burning, the Ethereum block space is paid for, with 100% of the fees then turned over to validators of the blockchain. Under Eth2, validators are those who stake ETH. Hence, every time transactions are made across the Ethereum network, the base fee will burn more ETH from the existing supply offering.

The more ETH burned, the tighter the supply of ETH becomes, and more revenue is generated which improves network security. As a result, burning under the EIP 1559 solves the “tragedy of the commons”, by ensuring that one’s externalities are paid for by increasing the scarcity of Ether.

Ethhub.io

As shown in the table above, it could be possible that the block rewards are less than the base fee if the network use (the number of validators) increased to large proportions. The potential drawback of base fee burning is that, as the network usage grows, control over inflationary and deflationary pressure would decrease. That being said, inflation would not be a significant problem, as the act of burning the BaseFee would force inflation to be capped at roughly 0.5 – 1.5% per annum.

OUTLOOK

The timing of the EIP 1559 proposal is yet unknown, however, it looks likely that the proposal could be implemented following the Berlin hard fork which is set to be undertaken sometime this year. Depending on when the Berlin hard fork occurs, EIP1559 could be part of Ethereum 1.0 and/or Ethereum 2.0.

“The Berlin upgrade brings a few things. First, EIP-2929 fixes a security issue that has prevented us from launching more complex features on Ethereum. It also introduces building blocks that we will be able to leverage in future upgrades, such as EIP-2718, which enables multiple transaction types on the network. Both these EIPs are prerequisites in getting EIP-1559 underway.

Tim Beiko

That being said, earlier this month GrayScale published a report titled “ValuingEthereum“, highlighting the potential impact that EIP 1559 could have. According to the report, the possible proposal could “institute a consumption mechanism that should serve as a positive feedback loop for Ether’s price.”

The crypto trust believes that the burning of the base fee could result in “an increase in the unit price for Ether.”Whatever happens, remains to be seen, but what is clear is that Ethereum has been hard at work, developing Eth2 and developing proposals such as EIP 1559. With both major developments underway, scalability, security as well as Ethereum’s monetary policy may be set for ground-breaking changes in the near future.

Related posts