Ethereum users have faced extreme transaction fees over recent weeks and months. At one point, there were users paying $10-20 just to send ETH and ERC-20 tokens from address to address as the cost of gas spiked to 1,000 Gwei and beyond temporarily.
Many have seen high Ethereum transaction fees as something decisively bad for the network. It restricts more cost-sensitive users from transacting, as it is illogical for someone holding a few hundred dollars worth of crypto to pay $50 to use DeFi, for instance. It also limits the use cases of DeFi, as congestion means trades can’t fairly match, oracles can’t accurately provide data, etc.
But there is a way that high transaction fees can actually provide a benefit to Ethereum users: Ethereum Improvement Proposal 1559 (EIP-1559).
What is EIP-1559?
EIP-1559 is a technical improvement that suggests that the current transaction model of the blockchain is currently “inefficient and needlessly costly to users.” Ethereum currently uses a two-sided market, where users bid a certain gas price in Gwei to get to the front of the line, similar to Bitcoin. As block times are 13 seconds, this gas price is constantly changing, and wallet providers have trouble keeping up.
To solve the inefficiencies caused by this system, the authors of EIP-1559 propose a flat rate for all Ethereum transactions:
“The purpose of EIP 1559, according to Eric Conner, is to provide wallets and users a much needed improvement to the user-experience of gas management. The way that EIP 1559 solves the gas-management problem also improves Ethereum’s monetary management system.”
EIP-1559 also has the crucial ability to burn a small amount of ETH after every transaction is sent. That’s to say, the more transactions are sent, the more ETH is destroyed forever.
Analysts see this technical upgrade as critical to Ethereum’s long-term success:
As crypto research firm Delphi Digital wrote in its “The State of Ethereum 2020” report published in the summer:
“Tying things together, EIP 1559 and staking [create a] symbiotic relationship where not only does increase usage drive value but the introduction of cash flows to a wider group of participants for securing the network creates a more effective long term value proposition [for ETH].”
What EIP-1559 would have accomplished if it had been implemented
The effects of EIP-1559 should not be unstated in the slightest.
Head of DTC Capital Spencer Noon recently shared an analysis indicating that “If EIP-1559 had been implemented, over the last 365 days, an estimated 970k $ETH ($360M) would have been burnt.”
That’s to say, just under one percent of all ETH would have been burnt in the past year if EIP-1559 was implemented. This would mean that Ethereum’s inflation rate over the past year was closer to three percent, nearing that of BTC’s.
If EIP-1559 had been implemented, over the last 365 days, an estimated 970k $ETH ($360M) would have been burnt.
h/t @PhABCD @DuneAnalytics pic.twitter.com/F0ANa0y2Rx
— Spencer Noon (@spencernoon) October 15, 2020
Some have argued that this analysis isn’t entirely correct, postulating that the true EIP-1559 burn amount might be 33-50 percent less due to some nuance in the calculations. Whatever the case, EIP-1559 would cause a strong shift in Ethereum’s supply-demand dynamics.