Understanding Ethereum: EIP 1559 & The Merge

What Is It & Why Does It Matter?

EIP (Ethereum Improvement Proposal) 1559 is the start of a new monetary policy for Ethereum and looks to change the landscape of crypto, smart contracts, and blockchain technology. It’s up to you to decide if that change is for the better.

What is EIP 1559?

“A transaction pricing mechanism that includes fixed-per-block network fee that is burned and dynamically expands/contracts block sizes to deal with transient congestion.” – Ethereum Foundation.

            Wake back up! I realize that was boring, now let’s try and figure out what it means.

Understanding The Basics

Understanding this particular upgrade requires a simple understanding of how fees will begin to work within this new system on the Ethereum Network:

1.     Gas – This is the currency spent on the Ethereum Network. Gas is just another word for Ether (ETH), the actual currency of Ethereum. I’ll reiterate, Ethereum is the Network Protocol, Ether is the actual Currency, and Ether is referred to as Gas when involved in a transaction.

2.     Base Fee – The minimum amount charged as a Network Fee for processing the transaction. This amount can move up, or down, based on an algorithm that measures congestion and other metrics. Just know that the fee can change per block.  Originally, Miners collected this Network Fee.

3.     Priority Fee – Maximum amount willing to be paid to Miners to include the transaction in the block. Simply put, how much someone is willing to pay the miner to do the job. These miners need incentives to do this, and that is achieved through the Priority Fee.

4.     Max Fee – Add the Base Fee & Priority Fee together, that’s the max someone is willing to pay to get the job done!

What Changes?

“—network fee that is burned”. As we noted, the Network Fee is the Base Fee. The fee is paid in Ether, the native currency of Ethereum. To burn it, means to destroy it. Gone, forever. You could say it is lost in the ether…. I’m not sorry for that joke.

            This means the ETH (Ether) can only be used to pay for transactions, that’s it. The Network doesn’t hold onto the asset, it is destroyed by the protocol, immediately.

            Miners will be paid by the Priority Fee and Block Reward (Ether you get for solving the block), meaning their incentives are still strong, but miners will not be able to manipulate gas fees.

            Burning, or destroying the Base Fee, means destroying Ether. This means that for every transaction completed on the protocol, Ether is destroyed. This is Deflationary. That means that the value of Ether rises with each completed transaction, as the asset becomes more and more scarce. Now, it’s important to note that the current Block Reward (Inflation) will currently outpace the Base Fee Burn (Deflation). But it is definitely scarcer within this model and is the beginning of Ethereum moving towards Hard Money principles.

            There is still a chance that this singular move will not result in either an Inflationary or Deflationary change, as the Network demand will drive that direction. But the system allows for Deflationary change within a high network demand.

            In short, Ethereum will have begun the path to becoming a scarce asset.

Why Does It Matter?

First, inefficiency will kill any business model, and that’s what the current model is, inefficient. Rather than having a Base Fee, the Ethereum Network functions as an auction, allowing people to throw out crazy prices for Gas Fees, and of course, the Miners pick the transactions with the highest Gas Fees, resulting in stupid high fees and the transactions that cannot pay those fees are stuck waiting.

            Second, one of the biggest gripes held towards Ethereum is that it is not a scarce asset, at least, not compared to the likes of Bitcoin. The Base Fee burn allows Ethereum to take steps towards scarcity, and when speaking of currency, or a store of value, scarcity is king.

When Does It Happen?

Already has, kind of. The London Hard Fork took place on June 24th, and the expected date of adoption across the protocol is August 4th, though it could be sooner, or even possibly later.

What’s Next?

The Merge.

            Ethereum Main net or ETHpow (Ethereum Proof-of-Work) is set to merge with The Beacon Chain, which currently uses PoS (Proof-of-Stake).

            This will create a Proof-of-Stake protocol that has access to all things Ethereum, including past transaction history and Smart Contract usability.

PoS means Miners become Validators, meaning hardware is no longer needed to solve blocks to gain block rewards because there is no competition. Validators are randomly chosen and must have at least 32 ETH to be a Validator, or participate in a Staking Pool (a group that pools their ETH together to be a Validator). Proponents of this cite the environmental benefits of leaving PoW (Proof-of-Work) methods.

            Once the change is made to PoS, significantly less ETH will be issued as a Block Reward. This graphic gives you an idea of how much issuance should be expected, given certain Validator levels. For reference, ETH currently issues at 4.5% (inflation).

            Not hard to see that the amount issued should drastically drop. Add that on to the burning mechanism of the Base Fee, and ETH should enter the deflationary world of monetary policy, drastically improving its scarcity.

            The Merge is set to happen at the end of 2021, or the 1st quarter of 2022.

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