One article understands why EIP-1559 gives ETH a more solid value support

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EIP-1559 is an important proposal of Ethereum, which will have a significant impact on the value capture, user experience, security and other aspects of ETH in the future. In the short to medium term, the price impact of the EIP-1559 proposal on ETH may be second only to ETH’s PoS. In the long run, it may have a more lasting impact.

What is EIP-1559?

EIP-1559 is essentially a solution to the Ethereum network transaction pricing mechanism. It includes a fixed part of the base fee of each block network fee (that is, the basic fee, which will be destroyed, and the miner will not receive this fee). There is a dynamic and scalable block size design to cope with instantaneous network congestion.

Although the basic cost of each block is fixed, it will adjust the basic cost of each block according to the network congestion. It has a formula to adjust the increase or decrease of the basic cost. It will be adjusted according to the gas used in the previous block and the target gas (gas target, which is the previous gas limit).

When the block is higher than the target gas price, the basic cost increases, and when the block is lower than the target gas price, the basic cost decreases. In addition to the basic fee, there can also be tipping fees (tips). During congestion, the small fee encourages miners to pack user transactions into blocks. The transaction can specify the upper limit of the base fee and tip. This proposal also includes a transitional plan. At the beginning, half of the blocks retained the original bidding mechanism, half adopted the new fee mechanism, and gradually transitioned to the new scheme.

Here are a few key points: * Cost structure

Basic fee + tip

*Fee flow

The basic fee will be destroyed and the miner will not be able to obtain it; the miner’s income is mainly the new block reward + tip

*Flexible block

Scalable blocks are used to deal with network congestion, and the basic fee is also adjusted according to the congestion situation.

Why engage in EIP-1559?

For transactions that occur on Ethereum, the current charging scheme is an auction mechanism. The user bids, and the miner selects the transaction with the highest bid and packs it into the block. This approach seems simple and efficient, but there are problems:

* Inefficient bidding

The minimum bid on Ethereum may vary greatly. This leads to inefficient bidding. The user chooses the upper limit of the bid fee when sending the transaction, and the miner chooses the transaction with the highest bid. For users, it is difficult to predict how appropriate the bid is. Even if there is a complicated cost estimation algorithm, it is impossible to make a good estimate, and there are often cases of excessive payment.

* Cause delays

Due to the gas limit per block and natural fluctuations in transaction volume, this may cause transactions to wait for several blocks before they can be packaged in. For users, it may cause delays. EIP-1559 proposes a flexible block mechanism, which allows one block to become larger and the next block to be smaller, achieving a longer-term average block size limit, allowing a certain size difference between different blocks. This solves the current situation that some blocks are over-full and some blocks are under-used.

*safety

With the reduction of block rewards (such as Bitcoin and Zcash), future transaction fees will become the main source of rewards for miners. Therefore, it is necessary to have sufficient transaction scale to support the security of the network. At the same time, it may also cause problems such as selfish mining by miners, and generate some unstable factors.

In order to solve the above problems, EIP-1559 changes the payment structure and payment flow: the transaction cost is divided into basic fees + tips. At the same time, the basic fees are destroyed, and the miners cannot get them. Block rewards to reduce miners’ incentives to manipulate transaction fees and give various participants including miners a chance to benefit.

In addition, in the design of EIP-1559, when the network exceeds the target gas usage per block, the basic cost will increase in the following blocks, and when the capacity is lower than the target gas usage, it will decrease. Therefore, the gas cost changes are adjusted according to the demand situation, and the cost difference between the blocks is predictable.

This will improve the user experience. Before the implementation of EIP-1559, Ethereum used a first price auction mechanism similar to Bitcoin (First Price Auctions). One of its disadvantages was the need for cost estimation. And EIP-1559 implements the same fee rate as much as possible for all transactions. What the user needs to decide is whether to pay the fee, without too much consideration of how much to bid. The wallet can help users predict the basic fee and automatically set a little reward fee, reducing the manual adjustment of gas fees by most users. Of course, if the user manually sets the upper limit of transaction fees, the user can limit the maximum cost by setting the upper limit manually.

In addition to improving the user experience, it can also improve the security of Ethereum and solve problems such as economic abstraction. Since miners only capture reward fees in transaction fees, and the basic fees are destroyed by the agreement, this can eliminate the incentive for miners to obtain more fees. More importantly, it changes the value capture mechanism of ETH. The previous ETH represented more value circulation and value storage on Ethereum, and did not capture the cost value itself. The basic fee changed this situation. The capture of basic fees means that ETH starts to capture the transaction fees of the Ethereum network, and the amount of transaction fees depends on the scale of transactions on Ethereum. As the scale of Ethereum transactions increases, the more fees ETH can capture.

At the same time, in the Ethereum transaction fee payment before the implementation of EIP-1559, it is not necessary to use ETH to pay. After the implementation, the basic fee is paid in ETH, which also solves the problem of “economic abstraction” discussed earlier. The so-called “economic abstraction” means that users can use stablecoins or other tokens to pay fees. This will not only threaten the position of the native token ETH in the network, but also detrimental to network security.

EIP-1559 requires a certain amount of ETH to be consumed, which will increase the difficulty of economic abstraction. If the scale of transactions on Ethereum is large enough, it can capture a large amount of basic fees. These basic fees paid in ETH will be destroyed, which will reduce the inflation rate of ETH, and may even be deflationary (assuming additional issuance is lower than destruction) . This is conducive to the value support of ETH.

From the perspective of security, in Bitcoin’s incentives, when the block subsidy is completed, it mainly relies on transaction fees to maintain its security. How this model can be sustainable is still controversial. Ethereum, on the other hand, will continue to operate by destroying transaction fees and encouraging miners through block rewards. This is a more flexible mechanism. As the transaction fee is destroyed and the value is transferred to ETH, Ethereum uses ETH block rewards to subsidize miners, which provides the foundation for the long-term sustainability of Ethereum’s security.

EIP-1559’s support for the value of ETH

Through the practice of the past period of time, we can see that there are big problems with the value support of mining tokens alone. Some mining reward tokens, or so-called “governance tokens”, have a lot of selling pressure, but the value support is not enough, which eventually leads to a decline in currency prices, a decline in incentives, and even a lot of death spiral tokens. Some top DEXs have good trading volume and good liquidity. The annualized fees of the agreement are also very high. The fundamentals are good, but they cannot support the value either. Because they are also facing the situation of “digging, selling and raising”. The token itself is just a “governance token” and does not capture the value of the agreement.

In the current agreement fees, most of the proceeds are still not integrated into the tokens, but directly distributed to the LP. This means that the value growth of tokens and agreements has not reached a high degree of integration. This is why their value cannot be supported under the current circumstances. Of course, this situation may change with the deepening of governance in the future, because governance itself can change this situation. The current governance tokens more represent future possibilities.

The impact of EIP-1559 on ETH is similar. The ETH before the implementation of EIP-1559 did not capture the value of the Ethereum network fees, which caused ETH to completely fail to realize the value support when the bubble burst, from the highest of nearly $1,500 at the time of the bubble to more than $100 at the bottom. The ETH before EIP-1559 will capture the cost value of the Ethereum network. As of the writing of the Blue Fox Notes, the annual network cost of Ethereum has exceeded 1.3 billion US dollars, which is not a small fee.

This means that in addition to serving as a store of value and a value medium, ETH can truly capture large-scale value in the future. In terms of the scale of its current value capture, it is currently the strongest among all public chains.