- >Everything You Need to Know About Ethereum’s Controversial EIP-1559
Everything You Need to Know About Ethereum’s Controversial EIP-1559
Ethereum is implementing a new transaction pricing mechanism that stands to change Ethereum considerably. EIP 1559 (Ethereum Improvement Proposal) aims to remove much of the guessing games that go on when calculating Ethereum gas fees. However this comes with a cost; burning ETH with every transaction.
This stands to reduce Ethereum supply and speculators predict that ETH may climb in value as circulating supply is “burned” by the new algorithm. But what does this mean for ETH? How does it work? And how are crypto fans from every avenue reacting?
Michael Brown | Mar 18, 2021
EIP 1559 stands to change the Ethereum blockchain by altering its “gas fees” system. Currently, Ethereum uses a simple auction system to determine transaction (gas) fees, however this system has grown inefficient and pricey. One transaction can easily cost you over $100 USD in ETH gas.
Ideally, you want these fees to be low and not high. Unless of course you’re the one collecting said fees, in which case you want them high and not low. EIP 1559 stands to change this by shifting from the current auction system to a system that settles averages based on user and market inputs. In short, this reduces the uncertainty around the gas fees.
There is speculation about the change to ETH on both sides. Theoretically, if ETH supplies begin to drop because of the new ETH burning algorithm, then it stands to reason that the price may go up. That’s simple supply and demand, however EIP 1559 is more complex than that.
A part of the new algorithm pushes miners out of the equation in the new algorithm. Gas prices are now set by traders and have no influence from miners, like things currently work. As a result of this, ETH miners are threatening to redirect their hash rates away from ETH for 51 hours. This could drop Ethereum’s value in the short term by an estimated 15% according to some.
How Does EIP 1559 Work?
EIP 1559’s algorithm works by providing an initial base fee in the gas fee equation. This base fee can go up or down depending on a formula which is a function of gas used in the parent block. Gas prices go up when a block is completed above the gas target and the price goes down when the block is completed below the gas target. This base fee is then burned.
Transactions specify the maximum gas fee they are willing to pay to miners to create an incentive to include their transaction. These transactions also specify the total amount of fees per gas they are willing to pay for, called a max fee. A max fee covers both the miner’s incentivization fee and the base fee.
So that’s all really confusing. What’s that mean? First of all to be clear, all of this is adjusted and calculated by the network. None of this is manually input and manual inputs should be fairly rare. It means that ETH’s value is going to be a lot more predictable, because the network will have a concrete base fee estimate to work with, and then apply decreases or increases in fee value when the network is in a period of low or high congestion, respectively. There are minimums and maximums to these fees as well, so that aids the algorithm in creating more reliable and more accurate predictions while the network is in extremes.
Remember the miners from earlier? Well they’re not a fan of this because this confines their mining fees to a set minimum or maximum. They’re pigeonholed in a specific amount of ETH determined not by a sale between two users, which is negotiable, but by the protocol. Which is not as negotiable.
The Good and The Bad
Depending on how the miner’s actions go, ETH could increase in value if they go poorly or just aren’t as damaging as anticipated. This loss in value is estimated to be a short term loss, as the new algorithm should be reducing supply of ETH thus increasing all of it’s value. Vitalik Buterin, co-founder of Ethereum states that theoretically, “…If demand to use Ethereum is high enough, then there would actually be more ETH being destroyed than created…” Vitalik later jokes about this creating a theoretically “ultrasound” money in a vein similar to Bitcoin, which has a fixed supply.
On the flip side of this, none of that could happen at all. Instead of going up, ETH could drop, and by quite a bit. The miners withdrawing their hash rates could crash ETH’s value which has been climbing since January of this year. Technical forecasts predict that ETH could be due for a dip based on historic trends. This forecast projects a potential drop upwards of 51%.
A bear market might not be all bad for ETH, all things considered. It is entirely possible that demand barriers could cushion the fall and ETH could be fine. Alternatively, ETH could bounce back after a crash of an undetermined size, but bounce back in a bull run once users adjust to the update.
It seems to me that once the initial hiccups are felt after EIP 1559, the market will adapt to the new standard and adjust itself, regardless of short term highs or lows. What remains speculative at such a point is, if the market drops, how much will it drop by? Forecasts range between 15 and 51%. I can’t say for certain, but there is definitely more to EIP 1559 than simple supply and demand economics.