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EIP1559: Ethereum Becomes a Deflationary Asset

EIP1559 is coming to Ethereum with the London Upgrade. Learn what this means and more in the article below:

DeFi Slate 📈

Jul 12, 2021

DeFi Slate Fam:

You’ve heard us preach Ethereum as one of the most robust developer communities across Fintech.

The talent, skill, and cooperation amongst contributors has led to a global financial revolution we know as DeFi. Although ETH and its applications are already considered members of the financial upper echelon, there are two major upgrades pushing Ethereum to the next level: EIP1559 and ETH2.0.

EIP1559 stands for Ethereum Improvement Protocol #1559. The system is getting faster, cheaper, and more secure. Today we dive into the impact of 1559 and the ramifications of a major upgrade to the network.

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EIP

For those unaware, An EIP is known as an Ethereum Improvement Proposal. Anyone can make an improvement proposal, but it is up to the core developers of Ethereum to ultimately determine whether it gets passed.

EIP 1559 was actually a proposal put forward in part by Vitalik himself in 2019 as a “fee market overhaul”.

Most proposals don’t get much attention outside of the core developers, but since 1559 has such large ramifications it has ended up being widely discussed.

EIP 1559 is now expected to be implemented on August 4th of this year.

EIP-1559

EIP-1559 is the first real attempt on the main layer to do something about Ethereum's problematic gas fees. It does not necessarily aim to lower them, but to make them less volatile in times of high and low network congestion.

How EIP-1559 works is that it finds an equilibrium for gas prices by automatically increasing prices when blocks are more than 50% full, and decreasing them when they are less than 50% full. What this does is it balances out blocks so miners are disincentivized to go back and re-mine the rewards out of old blocks that had massive fees and do the current ones instead, because all blocks are much closer to equal.

What makes this feasible is that part of the proposal is to double the blockspace for each block, but aim to have each block at only 50% of capacity. So over time there will be the same amount of blockspace, but how each block gets balanced is very different.

MEV (Miner Extractable Value)

If balancing out the fees from each block doesn’t incentivize miners to operate efficiently, getting rid of the fees altogether surely will. That’s right, the most discussed topic of EIP-1559 is the fact that it will burn the ETH that previously went to miners as fees, making ETH a deflationary asset.

The goal of this is the same as what we previously mentioned, to stop miners from operating anyway other than what is most efficient for the network as a whole.

Previously, a big part of the problem was that arbitrage bots running on the Ethereum network would pay huge fees in order to get the miners to process their transaction in the often short time window that the arbitrage opportunity existed.

Why this does not “solve” gas fees however is that with the introduction of EIP-1559 comes the ability to “tip” miners in exchange for a faster transaction. So in times of high congestion it may still be expensive to get a quick transaction, but as we mentioned the main difference between “fees” and “tips” is that it stops miners from wanting to go back and purposelessly re-mine old blocks.

It is easy to imagine that a huge part of the controversy that surrounds EIP-1559 is based on resistance from miners, who are set to lose a significant part of their income, as the tips will likely not replace the total amount they were making in fees.

However, a large part of the leverage miners would have under usual circumstances is muted because of Ethereum’s near transition to proof of stake, meaning that if miners hold out in protest, they are giving up a significant portion of the remaining time they have to get a return on valuable equipment they have purchased.

ETH as a Deflationary Asset

For the broader market who is not necessarily engaged with the Ethereum network on a daily basis, the big story in all this is surely ETH becoming a deflationary asset, meaning the total supply only goes down over time as the fees that previously went to miners are now burned forever.

This means that when looked at through the lens of simple supply and demand, ETH becomes more valuable because if demand stays constant but supply decreases, that will lead to an increase in price.

With EIP-1559, the excess value that the network generates is now captured by ETH instead of the miners.

Improvement in User Experience

By making these changes to how gas fees operate, it has the potential to make Ethereum transactions that much more user friendly by removing the need to set gas fees manually.

It would work because the differences in gas fees would be predictable enough that wallet providers like metamask could remove the gas selection interface altogether.

Upon reflection it makes sense for this to happen, it is difficult to see Ethereum being a mainstream infrastructure and yet not being able to just click “send” like any other type of mainstream technology. Obviously once you are an experienced user of Ethereum it’s not a huge deal, but it is one of many confusing road blocks for new users.

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⚠️ DISCLAIMER: Investing into cryptocurrency and DeFi platforms comes with inherent risk including technical risk, human error, platform failure and more. At certain points throughout this post, we might get commission for promoting certain projects, if this is the case we will always make sure it is clear. We are strictly an educational content platform, nothing we offer is financial advice. We are not professionals or licensed advisors.

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