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EIP-1559
Learning concepts in Web3 through writing - this week focuses on the EIP-1559 proposal and what it meant for the Ethereum blockchain.
P Z
April 01, 2023
In an effort to understand some concepts in the web3 world better, I’ve decided to try and write them out.
Below is the first article I’m writing at the request of one of my friends.
EIP-1559
EIP-1559 is a proposal to improve the ETH blockchain’s transaction fee mechanism.
The goal is to make transaction fees more predictable and reduce overall costs.
To understand EIP-1559, you need to understand what gas is in the context of blockchain, what ETH gas is like prior to EIP-1559, and what gas is like after implementing EIP-1559.
WHAT IS GAS?
In the context of blockchain, gas refers to a unit of measure for the amount of computational effort required to execute a transaction or contract on a blockchain network.
It’s typically denominated as a small fraction of a blockchain’s native currency, such as ETH in the Ethereum network.
When submitting a transaction to the network, they need to specify a gas price that they were willing to pay to execute the transaction, and this price will go to ETH miners as a reward for them validating the transactions on the network.
Gas plays an important role in determining the cost and speed of transactions on a blockchain network, and ensures that the network is used efficiently and fairly. If a user sets their gas price too low, the transaction may run out of gas and fail, resulting in a wasted fee. If it is set too high, the user may end up paying more than necessary for the transaction. This is one reason why wallets like Metamask are so popular because their gas estimation tool (see image below) deals with the issue of potentially not putting enough gas in for a transaction.
GAS BEFORE
ETH used a first-price auction mechanism for determining transaction fees.
A first-price auction mechanism means that users submit bids for how much they are willing to pay to have their transaction included in the next block, and the highest bidders would have their transactions processed first. See below image “Transaction Fee” options for an example.
What’s the problem with this? first-price auctions often lead to high and unpredictable transactions fees, and it is extremely problematic when there is high congestion. During the bull-run, it was not surprising to see $100+ transaction fee costs.
GAS AFTER
EIP-1559 removes first-auction pricing and changes the transaction fee mechanism in several ways.
1. A base fee will now exist and this fee is burned when a transaction is executed. The fee is set algorithmically based on network demand.
The goal for this algorithm is to achieve an equilibrium when the network is at more than 50% utilization, the base fee is incremented, and when it is lower than 50% utilization, it is decremented.
This means that the base fee increases when there is a higher volume of transactions on the blockchain, and decreases when there is less demand.
THE BENEFIT
Introducing a base fee makes transaction fees on the ETH network more predictable, transparent, and stable. This system replaces the first-price auction mechanism which inherently favors people with more money; in times of high market activity, these are the people that will be able to afford spending $100 to send through a transaction.
Additionally, having the base fee burned adds deflationary pressure to ETH’s price action. Simple supply and demand, if the base fee is being burned, then the supply is lowered and the price remains constant
2. Optional tips now exist, users can now tip miners on a transaction to incentivize them to prioritize their transaction.
THE BENEFIT
Optional tips provide users with greater control over the fees they pay for when executing a transaction.
In a congested network, user’s who aren’t in a rush to get their transaction through, wont have to pay a tip. In the alternative, those who are willing to pay more can add a tip to incentivize miners to prioritise their transaction.
3. Gas limit per block is reduced to ensure that blocks are not too large for miners. In the context of EIP, the block size effectively doubles.
THE BENEFIT
This allows for more transactions to be included in each block, which helps reduce network congestion and improves transaction throughput.
Reducing the gas limit per block can also prevent users from overpaying for transactions by ensuring that the network is not congested with unnecessary transactions.
SUMMARY OF BENEFITS OF EIP-1559
Transaction fees are more predictable and transparent.
Reducing delays in transaction confirmation
A positive feedback loop between the ETH network and the ETH supply.
Reduces the likelihood of auction failures by automating the fee bidding system, and ultimately providing a better user experience in doing so.
Reduces the overall supply of ETH by burning the base fee (potentially making ETH more valuable over time)