EIP-1559 is an Ethereum improvement upgrade that updates transaction fees on Ethereum. The change makes the network more efficient by using a hybrid system to evenly incentivise miners in periods of high and low network congestion. In this article, we will explain what EIP 1559 is, the impact on the ETH price, and what happens to Ethereum miners.
What Is EIP 1559?
EIP-1559 is an Ethereum software upgrade that changed how Ethereum transactions are processed on the blockchain network. The upgrade fundamentally shifts how ETH transactions are processed and introduces a base transaction fee that is paid to the miners validating the transactions. The new system aims to evenly distribute miner block rewards during high and low network congestion periods.
What Problem Does EIP 1559 Solve?
To send a transaction on the previous Ethereum network users need to attach a ‘gas fee’ to process the transaction. As there is no base fee, individuals do not know how much gas to send with each transaction. This often results in users overpaying the gas fees for miners to prioritize their transactions with the highest gas price. The problem with the current Ethereum transaction fee model allows ETH miners to decide the gas price which can influence the overall fees on the network.
The upgrade to EIP 1559 reduces the gas fees to send transactions on the Ethereum network by establishing a floor price that is known as the ‘base fee’. An individual can prioritise transactions using a ‘priority fee’ in addition to the EIP 1559 base fee.
How Do EIP 1559 Transactions Work?
EIP-1559 aims to create a fair, efficient, and transparent system to determine the ETH transaction fees. The system comprises a combination of ETH base transaction fees and tips to prioritize transfers. The base fee price is algorithmically determined by the Ethereum network, whereas tips are chosen by the individual as an optional fee to encourage miners to process the transaction quicker.
The previous protocol of Ethereum gas fees has been replaced by a mandatory and algorithmically determined base fee with the introduction of EIP-1559. The base fee can fluctuate according to the network congestion. However, the network attempts to regulate the usage to 50%. This means each block mined will be filled with transactions to 50% of the block size.
If network usage falls below this capacity, the base fee decreases slightly and vice versa. Unlike the previous Ethereum network, where users have to estimate an appropriate gas price, the predictable pricing mechanism with EIP-1559 allows transaction costs to be set automatically. Wallets and cryptocurrency exchanges can now set the ETH transaction fees automatically.
What Are Ethereum Tips?
Ethereum transactions can be prioritized under the EIP 1559 upgrade by including an optional ‘tip’. The tip is paid in addition the base fee transaction fee. If the network usage is within the congestion thresholds when a user initiates the transaction, a small tip can be provided to guarantee the transaction is prioritised and completed quickly. Unlike the base fees which are burnt, the tips are paid to miners to incentivise them to prioritise transactions with tips.
During increased network congestion, the base fee would rise accordingly which means higher tips may be required for miners to prioritize the transaction. Once the priority transactions are cleared, the base fee would decrease for non-priority ETH transactions to be processed.
How Does EIP Affect The Price of ETH?
Under EIP-1559, transaction fees that would normally be sent to the miners will be 100% burnt that is intended to reduce the overall supply of ETH tokens. This can result in fewer tokens being released on the market that could put upward pressure on the price of Ethereum. Andrew Keys, the managing partner at DARMA Capital, suggested EIP-1559 in Q1 2022, could “easily quintuple the price of Ether” next year. The burning of ETH tokens is comparable to the Bitcoin halving events, which have caused a supply shock in the market resulting in asset price appreciation.
What Is The Impact For ETH miners?
Miners are still rewarded under the Ethereum upgrade by the additional fee “tip” for including transactions into a block. Users have paid a total of 7,141 ETH, worth around $22.4 million at the time of writing this article, in prioritising fees since the activation of the London upgrade. Though the proposal received mixed feedback in the crypto community prior to implementation, the overall consensus is that the upgrade will benefit the ETH network long term making it more useable and saleable.
Ethereum is at the core of the blockchain revolution. Multiple projects are being built on the Ethereum network, and developers face high transaction costs regularly. Our takeaway is that the key benefit of EIP-1559 is that wallets now have better gas fees estimates, referred to as base fees in EIP-1559, which makes transaction fees predictable.