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Will Ethereum‘s London Fork & Brand New Burning Mechanism Allow Price Appreciation To Continue?
2021-08-18, 03:17
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Key words: London Upgrade, Ethereum, EIP-1559, Gas fee
The Ethereum’s London Hard Fork update took place at an estimated block height of 12,965,000, at 12:33 (UTC) on 5 August 2021. This is the tenth hard fork upgrade since the birth of Ethereum and the five community proposals including the hot proposal EIP-1559 which aims to change the ETH 1.0 fee market, will be contained into the Ethereum network.
There are heated disputes about this upgrade earlier in the Ethereum community which, however, generally accepted the EIP-1559 after the hard fork upgrade and the Ethereum mainnet remains stable without new tokens created. As of the article writing time(9:00 AM 11th August, UTC), the London Upgrade has been achieved in 98% of Ethereum nodes.
At the same time, this upgrade is the penultimate update for Ethereum before entering the ETH2.0. And the Shanghai Upgrade, as the final step of the network transition to ETH2.0, will take place in October 2021. At that time, Ethereum mainnet will be fully shifted from POW model to POS.
EIP(Ethereum Improvement Proposals), whose term naming is inherited from BIP(Bitcoin Improvement Proposals), refers to an improvement proposal to the Ethereum network(Reference: https://eips.ethereum.org/).
London Upgrade consists of five proposals in Ethereum community:
EIP-1559：Fee market change for ETH 1.0 chain;
EIP-3198：BASEFEE opcode
EIP-3529：Reduction in refunds
EIP-3541：Reject new contract code starting with the 0xEF byte
EIP-3554：Difficulty Bomb Delay to December 2021
Among the above proposals, EIP-1559 has drawn the most attention. There will be some changes when it is implemented: as the mechanism for the original users to set the gas fee by themselves will be modified.
Other changes include that the basic rate can be calculated and determined by the system and users can choose whether to add "priority fee". With the base fee burning, the proposal may lead to a temporary decrease in miners’ revenue. With the gradual completion of the ETH2.0 upgrade, Ethereum will be on a more deflationary path.
Horror by High Gas Fee
Issue regarding gas fees on Ethereum has been around for a long time.
Users conducting transactions on Ethereum have to pay gas fees to miners who package the transaction. Miners will preferentially choose transactions with higher gas fees for packaging to increase their own profits. From the perspective of the Ethereum Virtual Machine (EVM), Gas corresponds to the number of computational steps required by the EVM to process transactions, and gas fee is the price paid for EVM processing power. The more complex and urgent the calculations required, the higher the fee should be.
The smallest unit of Ethereum Gas fee is Gwei and each Gwei is equal to 0.000000001 ETH
Gas fee = Gas fee per gas*Gas
Due to the limited transaction processing capacity of the Ethereum network (currently only 15-20 transactions per second), congestion on Ether will occur when transaction frequency is beyond its processing capacity. In this case, if users want to ensure that their transactions are processed first, they have to increase the gas fee they set before submitting, and this model is called first-price auction. Considering the fact that users are not accessible to real-time bidding situations, they tend to panic and blindly add gas fee when congestion occurs, which leads to an enormously rise in the gas fee on the whole network.
Average daily gas price(in Gwei)
Image source: statista.com
Image source: statista.com
Since 2020, ETH has soared from $300 to a maximum of over $4,500 due to the big explosion of DeFi projects. The bull market has brought frequent transactions, which in turn has led to a sharp increase in gas fees. During the “May 19th Event”, the average ETH gas fee reached a record high and an average of $59.57 per transaction was required according to the price at that time. Major exchanges had to suspend the ETH withdrawals to avoid losses from blind withdrawal by numerous investors.
More details about “May 19th Event”, please check the article:
Ether Network Fees - Traders Can't Afford It
Faced with the problem related to high network fees on Ether, Vitalik Buterin, as early as 2018, proposed the EIP-1559 changes adopted in this London Upgrade. These proposed changes altered the transaction auction model mentioned above and introduced a fixed-price sale model. After the London Upgrade, the Gas Limit (the upper limit of gas available in a transaction) in each block has been upgraded from 12.5M to 25M.
Traders do not need to set the gas fee as before, and the system will calculate the base fee automatically according to the network situation. When the gas usage in the previous block is higher than 50%, the base fee will increase; while the usage is lower than 50%, it will decrease. In addition, the base fee in each new block cannot be changed more than 1/8.
In this transaction model, traders can give additional “tips”(dubbed as priority fee) to miners for faster transactions. The experience is just like when taking a taxi. The price per kilometer in taxi taking is specified by the system, but users can pay additional tips to the driver.
In this situation, Gas fee = (Gas fee per gas + Priority fee per gas) * Gas
The gas fee in congested networks will still rise slowly and moderately. However, the gas fee rate is transparent to users under the new transaction fee model, which can avoid users’ blind fees adding in the first-price auction to a certain extent. Therefore, EIP-1559 reduces the volatility of gas fees.
For users, EIP-1559 allows them to predict the network fees they need to pay more accurately, and makes it unnecessary to set the fees by themselves. This is undoubtedly much better than the original mechanism that fluctuates unpredictably, but not the case for miners, another important member in the Ethereum ecosystem.
A Fight over Gas Fee in Ethereum Community
When analyzing this issue from the perspective of miners, it is necessary to understand the composition of miners' revenues, which are mainly composed of two parts: mining block rewards and on-chain gas fee.
(Technically speaking, MEV, or Miner Extractable Value is also included. MEV will be introduced in detail in the follow-up blog posts on Gate.io, so stay tuned.) Since June 2020, the share of on-chain gas fees in miners' revenues has been rising from 18.19% to 43.83%.
EIP-1559 standing for burning base fee has undoubtedly affected profits of major mining companies and aroused their opposition. In the first quarter of this year, 12 mining pools including Sparkpool and Ethermine all declared their resistance to EIP-1559. The total computing power of these mining pools has reached 62.88%, and if these 12 mining pools join forces, they can perform 51% attack on blockchain.
In the blockchain ecosystem, miners play important roles in providing computing power and maintaining the security and stability of the blockchain network. This upgrade makes the miners feel that they have been ignored or even abandoned by the community. Fortunately, with controversy gradually petering out, the London Upgrade was implemented smoothly while the Ethereum community was not completely divided as a result.
In the short run, base fee burning may temporarily reduce revenues of miners who then have to grab more profits in MEV and other aspects for income increasing. But in the long run, the burning mechanism can reduce the supply of ETH circulating in the market, benefiting all ETH holders, including miners.
Burning ETH into Deflationary Era
Since the London Upgrade, according to the on-chain data, as of 2:00 AM(UTC) on August 11, a total of 25,000 ETH was burned and an average of 0.705 ETH has been burned per block. At present, the output rate of ETH is about 4%, but the rate will drop to 0.5% with the transition to the PoS consensus mechanism next year. It is temporarily difficult to estimate the specific percentage of ETH burned each year, however, it is foreseeable that Ethereum will gradually become deflationary. ETH holders will benefit from this situation.
The market's response on the London Upgrade has been very positive. After the upgrade, ETH price dropped in a short term and then climbed sharply. From August 1 to 11, the price rose from $2,458 to $3,120, an increase of 26.9%, much higher than the 11.1% increase of Bitcoin. The recent soaring trend is bound up with the London hard fork.
But in the long run, deflation cannot ensure the growing price of ETH whose value is up to the growth of the entire Ethereum ecosystem. EIP-1559, a stopgap measure to stabilize transaction fees by changing the fee mechanism, but it does not fundamentally improve insufficient performance on the Ethereum network. When it comes to truly improving network processing capabilities, reducing transaction fees and benefiting users, miners as well as other community members, the upcoming rollup, layer 2 and other new technologies and mechanisms should be adopted.
The London Upgrade is just a start to the Ethereum evolution, while the ETH2.0 merge at the end of this year will be the climax in this evolution journey. By then, how will Ethereum lead the crypto coin revolution and change the industry? Let’s look forward to it.
Further Reading:
Ethereum Layer 2: An Upgrade of Scalability
Dogecoin: Why is Vitalik Buterin Against it? Will Scaling Increase its Popularity?
From Bitcoin to Ethereum: Why Ethereum is Blockchain 2.0
Ethereum Transforms to PoS -- The Environmental Trend of Cryptocurrencies?
Gate.io Cryptopedia: ETH 2.0 Staking
Author: Gate.io Researcher: Edward. H
*This article represents only the views of the researcher and does not constitute any investment suggestions.
*Gate.io reserves all rights to this article. Reposting of the article will be permitted provided Gate.io is referenced. In all other cases, legal action will be taken due to copyright infringement.
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