Ethereum to Overhaul Its Transaction Pricing Mechanism with EIP-1559 Upgrade

Data & Research / 20.03.2021

Ethereum is about to reach one of its biggest milestones in recent memory with the rollout of a long-anticipated upgrade that overhauls how the network handles transaction fees.

Dubbed the Ethereum Improvement Proposal 1559 (EIP 1559), the upgrade is scheduled for inclusion into the network’s codebase this coming July. Ethereum CEO Vitalik Buterin originally proposed the EIP in 2019.

ETH users are required to pay a gas fee for each transaction they make on the blockchain. Currently, the fee is set by an auction that enables miners to manipulate the pricing system, resulting in exuberant transaction costs.

In recent months, gas fees have risen so high that many ordinary ETH users, especially in DeFi, strain to afford the network charges.

This guide examines how the ETH developers plan to reduce transaction fee volatility and fix other issues with Ethereum’s user experience via the EIP 1559 model.

EIP 1559 Model Greenlit for July

As rival blockchains such as Binance Smart Chain and Cardano with lower fees threaten to conquer Ethereum, Buterin and his team have been forced to take action.

In a March 5 “All Core Developers Call,” the ETH team announced that EIP 1559 would be packaged with the London upgrade in July 2021, regardless of discontent from miners over the update.

The upcoming proposal flips the current auction method that determines gas fees, where users submit their bid to be included in a block.

Under the new model, it won’t pay these fees to miners; they will send them to the ETH network itself, where a portion will be taken out of circulation permanently in a “burn” model called BASEFEE.

The model replaces the current bid-based system for a BASEFEE, which is essentially a standard rate across the network that will go up when the market is busy and drop when it’s quiet. The ETH network will also include a small tip for miner compensation.

The crucial difference between the current auction system and the EIP-1559 model is that the network’s gas fees are set and altered by burning ETH.

Moreover, the EIP fixes multiple fundamental parts of Ethereum, such as transaction format, block headers, and the transaction pool, while introducing substantial economic and user experience benefits to the protocol.

EIP-1559: Good for Ethereum?

The upcoming change has garnered some of the largest support to date from ETH users and App developers, as it is expected to enable them to pay a fair fee. This is because the burnt fee is determined by an algorithm, making it easier for all users to predict the correct transaction fee.

The current supply/demand auction-style system makes it impossible to estimate the fees paid for transactions reliably. Moreover, miners have the power to determine the cost of using the network, which depends on the level of demand from users and the supply of miners available to process transactions.

In times of heightened market activity, a bottleneck could occur on the network, prompting miners to charge excessive average fees of more than $20 per transaction. The overhaul of the pricing system means that miners don’t set the rates; the network does.

Furthermore, the transaction fees don’t go to miners; they’re burned. The introduction of a deflationary burn mechanism will tighten supply, possibly increasing the value of the cryptocurrency.

According to Tim Ogilvie, CEO of ETH infrastructure startup Staked, the imminent change is likely to be positive in the long term to the Ether token price. It will also offer lower and more predictable gas fees, encouraging the average user to build and use the network.

Controlling Inflation on the ETH Network

The importance and functionality of EIP-1559 in curbing inflation on the ETH ecosystem cannot be overstated. Before the overhaul of the current system, the supply of Ether was theoretically infinite.

Eric Turner, Director of Research at Messari, told Bloomberg that EIP 1559 is a huge step in actually controlling inflation on Ethereum.

The new model also promises to instill better stability and security in the long-term by removing the network security dependence on gas fees. Instead, ETH will incentivize miners with a more reliable perpetual block subsidy that offers them a more stable income.

The EIP 1559 model is a significant component of the move to Proof-of-Stake (PoS) mechanism. The Ethereum team is accelerating the move towards PoS, with developer Mikhail Kalinin recently issuing the specifications for the chain merge with ETH 2.0.

Buterin has also recently revealed that his team prioritizes the chain merge over implementing sharding, as the move would diminish the potential impacts of resistance from miners.

Ethereum Miners Revolt Over EIP 1559 model

ETH miners have announced their discontent with the EIP 1559 upgrade, claiming that it would cut into their fees. Some of the notable critics of the imminent change include Spark Pool, a mining pool that currently controls about 26% of the hash rate. Ethermine.org, a mining pool with control of 21.8% of the network’s hash rate, has also rebelled against the move.

Indeed, the new pricing model that burns fees is projected to reduce miners’ fee revenues sharply. Per data from Coin Metrics, the lucrative mining business on ETH earned miners a record $1.3 billion last month, with about $600M of the revenue coming from gas fees alone.

In a show of force against the EIP implementation on the mainnet, miners plan to direct their hashing power to the Ethermine mining pool on April 1, 2021. The coordinated action is scheduled to last 51 hours, allowing participants to concentrate more than 51% of the network’s hash rate under the guise of “educational purposes.”

One Redditor slammed the imminent showdown between miners and devs, warning that the April 1 revolt will hurt all ETH stakeholders in the near and long term.

Another ETH supporter on Reddit advocated for the network to hasten its chain merge. It provides a fallback for the community in case miners collude to nullify the positive effects of EIP 1559.

Fortunately, the ETH dev team had foreseen such a rebellion and paired EIP-1559 with a delay to the difficulty bomb to make a hard fork less likely.

Miners in the F2Pool, which controls 11.4% of the ETH hash rate, favor the fee structure overhaul.

Conclusion

The EIP 1559 model introduces a new transaction pricing mechanism that includes a fixed-per-block fee that is burned. This upgrade also expands and contracts block sizes to take care of transitory congestion on the network. Although miners will lose revenue, ETH core developers argue that the upgrade will bring in a host of benefits. For instance, the new pricing mechanism is projected to pump up ETH prices and make the network cheaper and easier to use for all stakeholders.

avatar
Wayne is a Blockchain enthusiast and expert in crypto trading. Currently, he covers trendy issues on digital currencies.