By
Dimitar Bogdanov
July 27, 2021
4 Min Read
The EIP 1559 is an Ethereum Improvement proposal that is set to make changes to the transaction fee mechanism of the world’s second largest blockchain network in an effort to address some of the issues stemming from the current fee model. The EIP comes as part of the London upgrade, which has already been successfully launched on all three Ethereum testnets. The mainnet launch is scheduled to occur on August 4. With the upgrade being just over a week away, it is time to take a closer look at the improvement proposal and what it aims to accomplish.
The way network fees are currently being handled on Ethereum is through a ‘first-price auction’ which sees people placing bids to incentivize miners, with the highest bidder winning. This means that if a user wants to have their transaction processed faster they need to place higher bids to give miners a bigger incentive. Conversely, lower bids typically wait longer for their transactions to be included in a block.
The EIP 1559 is set to overhaul this system by scrapping the auction and introducing a base fee that will apply to all transactions on the network. On top of that users will be able to set a ‘priority fee’ as an incentive to miners. The priority fee essentially acts as a tip to encourage faster inclusion by miners.
Under the new mechanism, the base fee is adjusted automatically based on network activity. This is achieved by introducing a set ‘gas target’ for blocks and measuring how much block space is used relative to said target. So if a block is filled above the gas target, the base fee is automatically increased by 12.5%. Conversely, the base fee decreases by 12.5% if the block is filled below the gas target.
Another key point of the proposal - and one that has prompted a backlash from miners - is that the base fee is burned. This means that under the new model, miners will rely solely on priority fees for their second source of revenue.
Let’s get one thing straight right away- EIP 1559 is not aimed at lowering Ethereum gas fees. While the changes it will introduce may have such a side effect, this is not the primary focus of the proposal. Rather, EIP 1559 seeks to make transaction fees less volatile. Under the current model, transaction fee spikes can occur suddenly and without a notice. With the introduction of an adjustable base, transaction fee movement becomes much more predictable and the risk of people overpaying for transactions lessens. The new system also has the added benefit of making fees more transparent for the user and improving the user experience when using Ethereum wallets.
Another aim of the proposal is to reduce the delays users usually experience during periods of high network usage. Currently, the rigid block size means that users often have to wait several blocks for their transactions to be included. With the introduction of the gas target and the adjustable base fee, EIP 1559 essentially paves the way not only for bigger, but also adjustable block sizes on Ethereum.
Of all the changes EIP 1559 is set to bring to Ethereum, the burning of the base fee is undoubtedly the most controversial one. Naturally, the change is mainly opposed by miners who stand to lose a significant portion of their revenue under the new system. This raises the question what the fee burning is even meant to achieve?
Well, for starters, fee burning is meant to discourage attempts to cause network congestions in order to keep the base fee high. It also introduces a deflationary mechanism to Ethereum.
Unlike protocols like Bitcoin, Ethereum does not have a hard cap on ETH supply. BTC supply, for example, is capped at 21 million tokens and its issuance is controlled through scheduled events called halvings. In contrast, Ethereum relies on the fact that as long as ETH demand outpaces the token’s steady issuance rate (2 ETH per new block, currently), it acts as a natural counter to inflation. Well, in fee burning, the network will gain another, arguably more reliable, counter. However, it should be noted that the exact impact of fee burning is difficult to estimate, as it will largely depend on network usage.
Currently, the expectations are that most people will not compete on priority fees, but will rather use the base fee to get their transactions included in a block. This could help improve transaction ordering, as there will be less financial incentive for miners to prioritize transactions. For example, while it still should be expected miners to prioritize transactions with higher tips over ones with lower tips, they should sort transactions with identical priority fees by the time of receiving.
This has led some to suggest that EIP 1559 could be the solution to the MEV (miner extractable value) issue that is becoming increasingly prevalent on Ethereum thanks to the rise of DeFi applications. However, this is unlikely to be the case.
MEV refers to the income miners are able to earn by exploiting their ability to order transactions. And while the proposal removes the transaction fee incentive from the equation, it doesn’t challenge miners’ control over how transactions are ordered. This means that will be able to continue to perform tactics like front-running, back-running and sandwiching, which make up the bulk of MEV.
With Ethereum moving closer to becoming a proof-of-stake platform, validators are set to take over the ordering duties from miners. This will provide two additional revenue streams - priority fee and MEV - for validators, who currently have staking as their only income source.
