The London Hard Fork and EIP 1559
Will the EIP 1559 make ETH deflationary and reduce gas prices?
EIP, or the Ethereum Improvement Proposal, is a technical document that suggests changes to the Ethereum network as well as the rationale behind them. Usually EIP is discussed among the core Ethereum development community due to it being highly technical.
The EIP should provide a concise technical specification of the feature and a rationale for the feature. The EIP author is responsible for building consensus within the community and documenting dissenting opinions.
The London hard fork brings 5 EIPs .It was deployed on the Ropsten testnet on June 24 and will be deployed at weekly intervals in the remaining ones: Goerli, Rinkeby and Kovan . The 2 major changes it brings is a change in the pricing model and delaying the difficulty time bomb.
The most hotly debated is EIP-1559 and has everyone speculating, even the traders and token holders who do not do any development work on Ethereum.
First Price Auctions: The existing model
In the current system, to execute a transaction users send a certain amount of surplus ether earmarked for gas purchase, as well as how much they’re willing to pay per unit of gas. Gas is not available externally, and can only be bought and used as part of a transaction. The bids are submitted in a pool, from where miners choose the highest bids to include in the next block. Miners are rewarded a block subsidy and the entire gas fees used for the transaction, so they are incentivised to mine those with higher gas prices.
As a result, to ensure fast confirmation of transactions, users end up trying to outbid each other, driving up gas prices. A lower bid transaction will have to wait a long amount of time to get confirmed. There is also a lot of volatility in gas prices, especially during times of network congestion.
EIP 1559 Objectives
EIP 1559 aims to reduce the volatility in gas prices, and make their movement more predictable. This will lead to lower confirmation times on average. It also changes the miner incentivising structure and introduces automatic token burns.
New Pricing Model
The new model introduces a base transaction fee per block. This fee is adjustable up to 12.5% of the base fee of the previous block. The block size earlier was limited by the maximum amount of gas that could be used in any transaction. That gas limit has been doubled from 12.5million to 25 million. The aim is to shift the volatility from the gas prices to the block size. So in times of higher network congestion, larger blocks will be mined and vice versa.
Each transaction also will include a miner’s tip, which will wholly go the miners. To prevent the miners from colluding to artificially increase base fee, it will now be burned.
Base fee for each transaction will get burned, thus the miner’s tip and the block subsidy remains the only source of income for the miners.
ETH becomes deflationary?
During times of high network congestion, more amount of ETH gets burned ( as gas ) . If the burned amount exceeds the sum of block subsidy and miner tip, then ETH does become deflationary. Critics point out that this causes loss of control over the long term monetary policy of Ethereum. Sometimes it will be inflationary, sometimes it will be deflationary. However such models are difficult to formulate and predict due to so many unknown variables.
EIP-3238 , The Difficulty Time Bomb
In built into Ethereum is a difficulty time bomb, a mechanism in which it becomes so hard to mine a new PoW block that it becomes totally unprofitable for miners to do so. The reason is to ensure that everyone transitions to the PoS chain when it goes live, instead of a hard fork like Ethereum Classic. However, the difficulty would had reached that level before the PoS consensus mechanism would be ready for deployment and thus, it has been pushed back for one final time to December of 2021.
Ethereum 2.0 is set to go live in 2022 so the effects of the London hard fork, however significant, will be temporary.
