EIP 1559: The Final Puzzle-Piece to Ethereum’s Monetary Policy

EIP 1559 is the final component to Ethereum’s economic system. It solves the UX surrounding gas management, but it does so much more…

EIP 1559 is a Ethereum Improvement Proposal submitted by Eric Conner (@econoar). I recommend reading this short (4-min) article from Eric about EIP 1559, as a precursor to this article.

EIP 1559 does two main things:

Establishes “the market rate” for block inclusion

Burns the majority of the ETH in the transaction fee

This change to Ethereum’s gas management has significant implications to the monetary system of Ethereum, which is explained in this article. EIP 1559 is the final piece of the puzzle in Ethereum’s monetary policy.

Burning the bulk of the ETH in transaction fee:

Provides a deflationary mechanism to Ether’s supply, which adds to the scarcity of Ether and long-term security of Ethereum.

Benefits all Ether holders equally, rather than exclusively benefiting validators.

The purpose of EIP 1559, according to Eric Conner, is to provide wallets and users a much needed improvement to the user-experience of gas management. Knowing how much to spend on gas in order to pay for one’s transaction is a UX issue that plagues Ethereum. Eric (rightfully) claims that the auction-style mechanism is highly inefficient and leads to gross-overpayment to validators. EIP 1559 and its BASEFEE mechanism was designed specifically to address this.

However, EIP 1559 is much bigger than that. The way that EIP 1559 solves the gas-management problem also improves Ethereum’s monetary management system. EIP 1559 ‘completes the circle’, ‘finishes’, or ‘syncs up’ Ethereum’s monetary policy to what it should be:

A recreation of a traditional nation-state economic system, but replacing the nation state with code.

This has always been Ethereum’s primary goal; to create an alternative economic system on the internet. Using code, we can design for the same institutions found in the traditional world (banks, credit-markets, borrowing/lending institutions, exchanges) but on Ethereum. Importantly, we can design them without the need for human involvement, removing the need for bureaucracy, management, oversight, or rent-seeking.

What EIP 1559 actually does:

Algorithmic gas estimation: ‘The Market-Rate for Gas’

Using a system that is comparable to Bitcoin’s difficulty adjustment, EIP 1559 increases or decreases a number, ‘BASEFEE’, based on the current levels of congestion on Ethereum. If Ethereum is greater than 50% utilized, BASEFEE automatically increases; if it is less than 50% utilized, BASEFEE decreases.

BASEFEE attempts to generate “the market rate” for gas prices, natively on Ethereum. While we can see the typical rates that are being paid on websites like EthGasStation.Info, or Etherscan’s Gas Price Tracker, these are 3rd party gas-market estimations. Additionally, they also do not illustrate the level of overpayment for gas fees. BASEFEE formalizes the “going market rate” for block-inclusion, removing the need for each and every wallets to generate their own individual gas estimation strategies. This will allow users to just press “Send Transaction”, and not have to be presented with ‘gas’.

When it comes to getting your transaction through quickly, users can still “jump the line” by paying a ‘tip’ to the validators. This ‘tip’ serves the purpose that gas-auction does in today’s version of Ethereum; by ordering transaction inclusion based on tip size. Those that ‘tip’ higher get served first. The Tip is what is paid to validators.

“In times of high network usage, a user can ensure that their transaction is included sooner by including a larger tip along with the BASEFEE amount. Meanwhile, users who are not in a hurry can set a maximum fee that they’re willing to pay. The protocol will then wait for the BASEFEE to drop below this number before confirming their transaction.” — Eric Conner

Burning BASEFEE Burns ETH

BASEFEE is BURNT. No-one receives BASEFEE.

Burning this is important because it prevents miners from manipulating the fee in order to extract more fees from users. It also ensures that only ETH can ever be used to pay for transactions on Ethereum, cementing the economic value of ETH within the Ethereum platform. — Eric Conner

Burning BASEFEE removes the ability for validators to manipulate the fee market for their benefit. It also ‘locks-in’ Ether as the native currency of Ethereum, as it should be. No other currency on Ethereum can be used to pay for transactions. This is comparable to a nation-state demanding that only their native currency be legal tender.

Paying Fees to ‘Ethereum’

Burning ETH in transaction fees is a simple way to pay Ethereum for its blockspace. In the Ethereum 1.x/Bitcoin model, 100% of the fees are paid to the validators of the chain. This adds to the security of the chain, as there is more revenue that make mining/validating profitable. However, if the chain is overpaying for security, then those funds were much better used elsewhere.

Two Core Values

Ethereum has two core values that play off of each-other.

Ethereum’s monetary policy is to prioritize security. Minimal viable issuance to achieve security

Ethereum prioritizes security above all else. This is why Ethereum has chosen to fund security with block-rewards rather than fee market like Bitcoin. Funding security with block-rewards means that Ethereum’s security will never be 100% reliant on transaction fees for its security; Ethereum pays for its security ahead of time.

Here’s a chart, developed by Ethhub.io, that shows how much stakers will receive, based on how much total ETH is being staked (its a dynamic number: more total ETH staked, less paid per ETH. Less total ETH staked, more paid per ETH)