The much-anticipated Ethereum update is broken down. Important Points to Remember
- EIP-1559 will use a large amount of Ethereum's transaction fees to burn while also introducing variable block sizes to increase efficiency.
- The upgrade will hurt Ethereum miners, but it will increase the value of ETH for holders by making the asset more scarce. Gas prices will also be more consistent.
- The EIP-1559 proposal will be included in Ethereum's planned London hardfork, which is set to go live around August 4th.
EIP-1559 is being prepared by Ethereum. EIP-1559, which will be released as part of the impending London hardfork, is Ethereum's most significant improvement since the Berlin hardfork in April, when the gas pricing modifications were applied. The first-price auction fee structure will be replaced with a new base charge model with an additional miner tip as part of the upgrade.
All Ethereum users are currently placing bids to have their transactions included in new blocks. During moments of high demand, the amount consumers must pay can vary dramatically. MetaMask, an Ethereum wallet, analyzes this demand and offers a variety of pricing alternatives, with confirmation periods ranging from 12 to 24 hours. However, even a long wait does not guarantee that the transaction will be included in a block.
To avoid their transaction getting delayed in the mempool for days on end, users often have to speed up their transaction by substituting their original fee with a higher bid.
EIP-1559 tries to remove this ambiguity by computing the block's base charge in advance based on the level of congestion. The introduction of configurable block sizes with a larger gas limit of 25 million units, double the present limit of 12.5 million, is another big enhancement in EIP-1559.
EIP-1559 will impose a basic fee that is computed as the market-clearing price and is based on the gas limit and demand. Based on these variables, the protocol will dynamically set the block's gas limit and change the fees. The ETH paid in the base fee will then be burned instead of being passed on to the miner. The user will be able to leave a gratuity for the miner.
The network will aim for a 12.5 million gas limit on average, with the base cost increasing or decreasing depending on how far the network deviates from the 50 percent GAS limit (i.e. 12.5 million units). For brief time intervals, Ethereum will enable a larger gas limit than 12.5 million.
Users will be able to choose whether or not to include their transaction for the provided base cost, or to wait for a cheaper block. One significant benefit of EIP-1559 is that it should eliminate the need for users to play a guessing game in order to authenticate transactions. Meanwhile, the suggested upgrade's flexible block size will assist cushion sudden demand spikes without causing a fee increase.
Exorbitant gas taxes and long wait times have harmed Ethereum's user experience, and the network has been rendered unworkable at times for small investors. In the last three years, the average daily gas consumption has ranged from 60,000 to 80,000 units, with rare surges on select days. Gas prices, for example, jumped from about 50 gwei to over 600 gwei on Tuesday, when Mila Kunis debuted her Stoner Cats NFT collection.
It's a prevalent misperception that EIP-1559 is a long-term scalability solution. The change is expected to prove ineffectual in lowering fees, with miners receiving recommendations during periods of heavy demand.
The Impact of ETH Inflation on Miners' Earnings
While EIP-1559 benefits ordinary Ethereum users and holders, it has a detrimental impact on miners. Because it burns a percentage of the fee, it has a direct impact on miners' earnings.
Furthermore, there is a possibility that the plan may be rendered useless if miner tips exceed the base fees by a sufficient margin. The auction market for a greater tip would then mimic the current first-price auction charge process, defeating the aim of EIP-1559. This is most likely to be an issue during times when block space is in high demand, such as during big NFT declines or price collapses.
The current yearly inflation rate for Ethereum is over 4%. It's slowly reducing as the increased supply dilutes fresh block rewards. The network will burn ETH after EIP-1559 goes live, thus working against the block rewards of 2 ETH every block. The question is whether the fee burn will cause ETH to become deflationary.
The predicted rate of inflation, according to Coinmetrics, is entirely unexpected.
The annual inflation rate in the EIP-1559 module would have been below 1% during busy periods on the Ethereum network, such as March and April of this year.
Nonetheless, the upgrade is unlikely to have an immediate deflationary effect. Coinmetrics believes that the decline in inflation will be less than many have predicted if around 70% of the base fee is burned and the rest is paid to miners in tips.
Since the crypto market crashed in May, the amount collected in fees has plummeted, bringing the inflation rate estimate to around 3.5 percent—just 0.5 percent lower than the current rate.
The transaction fees earned by miners are likely to drop by 70% after EIP-1559, while block rewards will remain at 2 ETH. Overall, the net revenue loss to miners is estimated to be between 10% and 20% based on current percentage profits in fees and block rewards.
The estimate of a 10 to 20% reduction in miners' earnings is lower than previous estimates of a 30 to 50% reduction. Nonetheless, these figures hold true during moments of high demand, when transaction fees can account for up to 50% of a miner's revenue.
Preparing for Proof-of-Stake EIP-1559 also signals a departure from Ethereum's Proof-of-Work consensus mechanism, which takes care of the majority of the miners' tasks.
Along with the existing Proof-of-Work system, it will introduce Proof-of-Burn in Ethereum. Instead than distributing the value onto miners, this effectively increases value for ETH holders by making the asset more scarce.
As part of Ethereum 2.0's next phase, the network will eventually switch to Proof-of-Stake, at which point all block rewards will go to ETH investors. Beacon Chain, Ethereum's staking contract, was launched in December 2020, with over $14.5 billion in ETH now deposited.
For the fee burn to exceed the amount of ETH issued, the average base charge must be sufficiently high. The amount of ETH staked, network activity, and merge date will all have an impact on whether or not ETH can achieve deflation over the long run.
By offering predictability and the ability to absorb abrupt surges in demand, EIP-1559 marks a significant milestone in Ethereum's overall development as the basic layer for financial applications. It will also make ETH more scarce, which is why the Ethereum community has embraced it so enthusiastically. However, it may take the market two to three months to fully comprehend EIP-1559's favorable impact on Ethereum's tokenomics.
The London hardfork is expected to go live between August 3 and 5, with a block height of 12,965,000.
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