EIP-1559: What’s The Hype Behind BASEFEE?
EIP-1559 is the most hyped Ethereum upgrade ever. It’s like a godsend for ether holders, who can’t wait for it to come
EIP-1559 is currently one of the most argued topic throughout the cryptosphere.
This is an Ethereum Improvement Proposal (EIP) that has been thrilling a lot the Ethereum community since its inception.
This EIP was originally named “Fee market change for ETH 1.0 chain”, but is more commonly known as “BASEFEE”.
It was designed to improve the Ethereum fee system, in order to make it more efficient.
This upgrade would allow a wallet to automatically set the transaction fee, without requiring the user to decide for that. Currently users usually rely on third-party services that give only an approximate evaluation of the optimal fee, often leading users to overpay.
The direct purpose of BASEFEE is to innovate the Ethereum fee system.
However, although indirectly, this change would also affect the ether supply to the extent that it could generate a deflationary effect for the native token of the Ethereum blockchain.
Ethereum fees
Now the Ethereum fee system is nothing more than an auction mechanism.
When you want to send a transaction you will have to offer a reward to miners for your transaction to get included in a block. This reward is expressed as “gas price”, so that miners prioritize transactions that pay an above-average price.
This dynamic is particularly significant in times of network congestion: if the miner receives more transactions than the block capacity he will pick those that offer a higher reward, that is a higher gas price.
If the network is clogged, users who can’t get their transaction included in a block because of low gas price, can only queue and wait for the network to clear. If they are not willing to wait, they will have no choice but to repeat the transaction with a higher gas price to try skipping the queue.
Anyway, what is the Ethereum block size?
The “block size” is the maximum amount of gas that can be consumed in any single block. Therefore, the number of transactions that can be placed in a block depends on how complex they are in terms of instructions.
This “gas limit” (currently 12.5 million) can be increased or decreased by 1/1024 compared to the previous block through the vote expressed by the miner in each block.
Through the current fee model, when your transaction is included in a block you will pay all the fee you have bid (gas price * gas consumed). This is entirely collected by the miner.
This fee system, which is based on an auction mechanism, is particularly inefficient.
Miners normally pick transactions that offer the highest fees. This often lead users to overpay.
If users knew what others are bidding, they could avoid bidding much higher than necessary. In many cases there is a high divergence between fees paid by different users within the same block.
BASEFEE: a new fee system
The new protocol provides for an automatic fee (called “BASEFEE”), which can move up or down within the limit of 1/8 in each block.
The current gas limit, based on the miner’s vote, is changed with a hard coded gas limit of 25 million, though the target average block size over time is 50% or 12.5 million.
The value of BASEFEE is set by the protocol, in order to achieve an average gas usage of 12.5 million. This value will increase if the use is greater than the target of 12.5 million, while it will decrease if it is lower.
Miners no longer directly adjust gas limit in response to changes in network usage intensity. The protocol itself adapts the BASEFEE to generate economic pressure leading to the goal of 12.5 million gas limit:
- When network usage is > 12.5 million gas target, BASEFEE will increase slightly
- When network usage is < 12.5 million gas target, BASEFEE will decrease slightly
When the user sends a transaction he will have to enter two values:
- Gas premium: this ia a “tip” that is paid to the miner and is added to the BASEFEE to calculate the price of the gas. The gas premium can be set to a low value (eg 1 gwei), just to compensate miners for the risk of “uncle blocks”, otherwise a high value can be selected to compete during sudden surges in the volume of activity on the network
- Fee cap: this represents the maximum fee (BASEFEE + gas premium) that the sender of the transaction is willing to pay to include the transaction in a block
Let’s clarify this. In times of high network usage:
- If the user is in a hurry, he can set a higher gas premium to ensure him that the transaction will be included sooner
- If the user can wait without problems, he will set the maximum fee (fee cap) that he is willing to pay. The protocol then waits for the BASEFEE to drop below this threshold before confirming the transaction
Thanks to this innovative system most users will not have to manually adjust fees, even in periods of intense activity on the network.
Since changes to BASEFEE are bounded (1/8 in each block), the maximum difference in the value of BASEFEE from block to block is easily predictable. This would allow wallets to automatically set fees in a highly reliable manner.
Anyway, the most interesting thing of this new system is that BASEFEE is burnt, while the miner gets the gas premium only.
BASEFEE and Ethereum supply
BASEFEE was designed to make the fee system more efficient and to facilitate the management of gas by wallets. Neverthless, as a side effect BASEFEE would also affect the Ethereum monetary system.
This new fee model could trigger a deflationary effect on ether’s supply. It would be the reason for the scarcity of ether and the increased long-term security of the Ethereum blockchain.
Through the current system, miners get 100% of fees paid by users.
This is surely positive for the security of the blockchain as miners, who are attracted by the block subsidy and fees, are incentivized to mine and to keep the network safe.
However, with regard to Ethereum, the blockchain probably overpays for the purpose of ensuring the network security.
To make a comparison, Bitcoin monetary model is based on the so-called “halving”. This means that every 210,000 blocks (approximately every four years) the block subsidy is halved, until new bitcoins are no longer issued.
This is a model where fees are essential, since we will not be able to dispense with fees in the future to keep the network safe. This is because when miners no longer get the block subsidy, they will be incentivized to keep mining only if there are fees to be collected.
The monetary policy adopted by Ethereum is quite different. We usually talk about MVI, or “minimal viable issuance”.
The Ethereum protocol does not provide for a cap on the supply of ether. Even when the transition to Proof of Stake (PoS) is completed, new ether will always be issued, albeit to a minimal extent.
The policy adopted by the Ethereum blockchain provides for continuity of issuance, though only that strictly necessary to keep the network safe.
This means that the greed of miners (or validators, when moving to the PoS protocol) is already satisfied by issuing new ether, thus making fees unnecessary.
Anything that is not needed to keep the network safe does not have to be paid to anyone. This is the reasoning behind the decision to burn the BASEFEE.
Although indirectly, BASEFEE benefits ether holders.
We can consider that even holders are “rewarded” as the burning of BASEFEE could contribute to make ether scarcer, so that it may maintain a higher market price.
This dynamic is similar to how MKR holders indirectly benefit from the stability fee in the MakerDAO protocol.
The stability fee burns MKR when users who generated Dai from the protocol decide to return it. MKR holders benefit from this token’s tendency to get scarcer over time.
With BASEFEE, even smart contracts that do not use ether as an underlying reserve asset may contribute to the deflation of ether.
For instance, think of the version of Tether on the Ethereum blockchain. This is one of the smart contracts that generates the largest number of daily transactions: the more transactions the greater the number of ether burnt.
Especially in a PoS model, not only validators but also holders contribute to the security of the blockchain.
This is because when ether is out of the market there is less selling pressure, which is good for its market price. Holders can keep ether out of the market in several ways: by stake it on Ethereum, by locking it in a DeFi app or by simply holding it in a wallet.
Through the PoS consensus protocol, the higher the price of ether the more secure the network is, as this raises the cost of obtaining the required ethers to attack the network.
The interesting thing of BASEFEE is that it’s a proposal designed to make the Ethereum gas system more efficient. Nevertheless the end result may also affect the Ethereum monetary system.
BASEFEE would also ensure ether holders get value from the increased use of Ethereum. That’s the reason why this the most hyped Ethereum upgrade ever.
Eip-1559 is going to be implemented through the “London upgrade”, which is expected on August 4th. Only after this date we will be able to analyze the real effects of this innovative fee system.
