Centaur Library: How EIP-1559 Will Lower High Ethereum Gas Fees
Cryptocurrencies were designed to eliminate inflation — the threat of rising prices devaluing a currency that hangs over the head of central bankers like the sword of Damocles. To accomplish this, most cryptocurrencies are designed with a deflationary mechanism. Bitcoin, for example, has issued 18.8 million BTC coins of a maximum supply of 21 million coins to date. As demand grows for BTC, the increasing scarcity of supply is placing upward pressure on the price of Bitcoin.
One exception is Ethereum. Ethereum has a circulating supply of 116.9 million coins with no set limit on the maximum supply. Although Ethereum controls inflation by issuing two new coins for each block produced and a capped annual supply, its inflation rate is high at 3.8 percent versus 1.6 percent for Bitcoin.
Ethereum plans to cap its unlimited coin supply by introducing scarcity through its upcoming EIP-1559 proposal. EIP-1559 is the central upgrade of five Ethereum Improvement Proposals (EIPs) in its London hard fork taking place at block 12,965,000, around August 4th. The London hard fork is part of the migration to Ethereum 2, a series of interconnected upgrades being rolled out in phases with the ultimate goal of improving the scalability and efficiency of Ethereum.
What is EIP-1559?
The primary aim of EIP-1559 is to lower the cost of the Ethereum network while providing more predictable transaction fees paid in ETH to miners for creating new Ethereum. These goals will be accomplished by setting a base fee and burning a portion of the ETH tokens. By burning a portion of the transaction fees, EIP-1559 introduces a deflationary mechanism to the Ethereum Network. Burning creates scarcity and therefore should increase the value of ETH. The more stable supply is expected to lower price volatility and make gas fees more predictable.
ETH users often face high gas fees and long transaction confirmation times owing to an inefficient first-price auction fee mechanism. Users currently place bids to have their transactions placed in new blocks and the highest bidder wins the auction. During periods of high demand, though, the fees can soar as bids spiral higher. Ethereum block times average 13 seconds but for lower bidders can take hours and even days. To avoid long transaction delays, users raise their bids.
EIP-1559 introduces a base fee model. A base fee is calculated for every transaction on the Ethereum blockchain based on the level of congestion. Furthermore, variable block sizes with double the gas limit at 25 million units will be introduced. The base fee will determine the market-clearing price based on demand and the gas limit. The network will continue to support a 12.5 million gas limit, which will fluctuate higher for short intervals. In the face of a sudden demand surge, fees are prevented from skyrocketing.
Benefits of a Deflationary Ethereum
The base fee allows users to better control and estimate the overall cost of transactions, whereas the live auction model is blind and the fees less predictable. Fee reductions in the 20 percent range can be expected, estimates Tom Beiko of the Ethereum Foundation in an interview with The Decrypt Daily.
The base fee is algorithmically adjusted upward or downward when the block size is larger or smaller, respectively, than the target block size. The positive expected impact of variable blocks has already been demonstrated. Since Ethereum raised its gas limit to 15 million in April, allowing more transactions to be processed in each block to ease congestion, gas prices have started to decline.
In this way, the burned base fee rises and falls with demand, with the block size becoming a proxy for demand. By raising the value of ETH, Tim Roughgarden in his Economic Analysis of EIP-1559 aptly describes the process of burning fees as a “lump sum refund to ETH holders.” If transaction fees are high, burning them will decrease the inflation rate.
At the same time, the launch of scalable blockchains like Centaur, Polygon and PolkaDot are helping to ease congestion as high traffic DeFi protocols like AAVE and Pancake Swap switch over, and as a result are reporting boosts in trading volume.
How will things change under EIP-1559?
For miners, however, EIP-1559 means a threat of a loss of mining fees is hanging over their heads. Miners earn fees for running the computationally expensive hardware that processes and validates transactions. As a result of the burning of ETH, holders will benefit from an increase in value whereas miners will see a decrease in mining fees under the base fee model.
Formerly, miners split the fees based on their proportional contribution to the work. Under EIP-1559, the fee is burned. Although the user has an option of sending a tip to the miner. This raises the risk that during periods of peak demand mining tips could become higher than the base fee, essentially replicating the inefficient auction mechanism of the first-price auction.
Since Ethereum is preparing to replace its Proof-of-Work (PoW) mining model with a Proof-of-Stake (PoS) consensus mechanism, the loss of mining fees will become less and less relevant. Ethereum is preparing for a future without mining fees as it transitions to the PoS consensus mechanism. That future is here. The Beacon Chain is now live and the staking consensus mechanism active. The Mainnet Ethereum is scheduled to merge with the Beacon Chain in 2021.
The upshot of EIP-1559 is that taking coins out of circulation will create deflationary pressure. In anticipation of the London hard fork, the Ethereum price is starting to rise. Post-hard fork, as supply is reduced and demand for the currency that supports the majority of smart contracts grows, the price of ETH should continue to rise and fees stabilize
Hadar Wallet EIP-1559 Upgrade
Users of the Ethereum network, by far the most active dApp ecosystem, are anxiously awaiting the lower fees that will make smaller transactions more economically feasible. They will not have to wait long. The Hadar wallet by Centaur will be upgrading to EIP-1559 to accommodate the new base fee and tips mechanisms. Following the London upgrade, Centaur Swap users will immediately benefit from reduced Ethereum gas fees.
By combining the best elements of decentralised finance with measured regulatory control, Centaur is bridging DeFi and traditional finance. For more information, please visit our website, join our Telegram community discussion group and announcement channel.