Crypto Investing
25 Nov 2021

EIP-1559 Explained? & Its Effect On Ethereum Price

Deepan Datta

EIP-1559 makes Ethereum transaction gas fees more predictable and makes Ether a less inflationary crypto coin. The protocol is aimed to improve the transaction speed and also to improve the overall user experience. 

How EIP-1559 does it, let’s understand. 

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What is EIP-1559

EIP-1559 is also known as London Hard Fork. It was a planned hard-fork to change Ethereum’s transaction fee market mechanism to make it more predictable for users.

For those with little knowledge of the working of Ethereum, EIP full form is Ethereum Improvement Protocol. From time to time, Ethereum developers come up with various protocol updates to improve the network’s security architecture. The updates are given a name, i.e., Ethereum Improvement Protocol or EIP, followed by a unique serial number. 

The EIP-1559 is the most important protocol update for the Ethereum blockchain. To understand what Ethereum EIP-1559 is, you first need to understand the problems that plagued the Ethereum blockchain. 

Why There was a Need for EIP-1559 Fee Mechanism?

EIP-1559 was the need of the hour for the future sustainability of the Ethereum blockchain. The problem started long back when the Ethereum core team reduced block rewards to miners from 5 ETH to 2 ETH. 

This resulted in a reduction in the earnings of miners. Therefore, to compensate for the decrease in earnings, miners started prioritising transactions with high gas fees to maximise profits.

It resulted in a congested network, where users had to wait longer for their transactions to get processed. 

You must be wondering, how does the network get congested?

Earlier, there was no mechanism to know the transaction gas fee on the network beforehand. This created three major problems. First, there was always uncertainty, whether your transaction would get validated in a timely fashion or not. Second, as there was no clarity on gas fees, people tended to overpay or bid too high to make sure their transactions were added to the blockchain in the shortest time possible. And, third, high transaction cost. 

For those who didn’t bid or pay lower transaction fees, their transactions took a considerable time to get validated, which always resulted in a massive backlog of unvalidated transactions on the network. 

And, for a huge network like Ethereum, it was damaging its reputation. It affected the larger adoption of the Ethereum ecosystem. Developers started looking for alternative blockchain networks that provided similar smart contract functionality. 

Working of EIP-1559 in Ethereum Fee Market Mechanism 

Through EIP-1559, Ethereum has made some significant fundamental changes to the fee market mechanism and how transactions will be added to the chain. 

Before the EIP-1559 was implemented, the miner’s reward would consist of the block reward and the transaction fee. 

After EIP-1559 is implemented, the transaction fees or the Gas fees paid in Ether is burned permanently instead of distributed to miners. So, the miners now only receive block rewards for mining each block and validating transactions. The block reward is adjusted slightly from time to time depending on the congestion level on the Ethereum network.

This fee market mechanism eliminates the financial incentives for miners to prioritise any transaction for validation. Miners now need to select transactions as it is sequenced in the queue. 

It gives users much-needed relief. Now, they know how much time their transaction will be added to the chain or validated. And, secondly, they don’t need to bid higher for the transaction fee, resulting in reduced transaction cost. 

How does the EIP-1559 System work?

Before EIP-1559 was implemented, miners used to determine how they would validate transactions and users needed to figure out how much transaction fee they should pay. This was a highly inefficient process. 

After EIP-1559 is implemented, the transaction base fees are now determined algorithmically by the protocol. Also, for miners, it established the standard operating procedure of how network congestion will be managed, which was earlier non-existent. 

To reduce network congestion, EIP-1559 does it by reducing the network usage rate by 50%, which means each confirmed block will be 50% full only under normal circumstances. If there is a buildup of transactions, miners can add additional transactions to the block, going past the 50% block usage threshold to reduce congestion. 

In such cases, when the block usage rate goes above 50%, the base gas fee will increase automatically and vice versa. 

Now, for those users, who want their transactions to get validated quickly, EIP-1559 has a provision. It allows users to add a tip on top of the base gas fee. As the blocks are seldom full, the transactions with tips are allocated to the remaining 50% available space in the blocks.

Here the tip goes directly to the miner, and the base fee collected in Ether is burned permanently. 

From now on, EIP-1559 aims to reduce the Ethereum transaction time to less than a minute, making the network useful for all types of users. 

EIP 1559

Effect of EIP-1559 on Ethereum Price? 

Since the base transaction fee collected from users is getting burned instead of distributed to miners, it will reduce the supply of Ether in the market. Still, it will not make it a deflationary asset class. 

Deflationary means when your asset over a while gives you greater purchasing power. 

According to watchtheburn.com, a website that tracks ETH burn rate, the reduction is lower than the net supply of new Ether in the market with the current burn rate. Thus, the impact on Ethereum prices due to the implementation of EIP-1559 will not be as significant as earlier thought.

EIP-1559 and Mining

The implementation of EIP-1559 is a small part of the larger plan to move from mining to staking by addressing the system’s bottlenecks that were making it slow. 

Both EIP-1559 and the proof-of-staking consensus mechanism will benefit Ethereum. Once Ethereum moves to the proof-of-stake protocol, a significant part of the ETH supply will get locked in staking wallets. This will reduce the supply of Ether in the market, resulting in a significant increase in prices as demand grows. 

Benefits of EIP -1559

  • Reduced transaction confirmation time
  • Lower transaction costs and better transaction fees estimation
  • Reduced supply of Ether in the market, thus making its tokenomics attractive
  • Higher block space, thus able to manage the surge in transactions on network efficiently

Wrapping it up…

Like Bitcoin is the benchmark in P2P transactions, Ethereum is the benchmark for many smart contracts platforms, and the implementation of EIP-1559 further strengthens its position in the market.

And, together with the PoS consensus mechanism, Ethereum will have a major impact on the cryptocurrency market, attracting investors and developers to the project. 

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Common EIP-1559  FAQs 

What will EIP 1559 do to Ethereum price? 

The real impact of EIP-1559 will be felt only after Ethereum’s complete transition to the proof-of-stake consensus mechanism. 

Post-migration to the PoS system, when a significant part of ETH will be locked in staking wallet and due to coin burn because of EIP-1559, the price of Ether will witness massive growth due to scarcity. 

Is cryptocurrency legal in India? 

Buying, selling, trading and holding cryptocurrency is completely legal in India. 

What does EIP 1559 solve?

EIP-1559 solves network congestion that led to higher transaction confirmation time and higher transaction costs. 

How will EIP 1559 affect gas?

Post-EIP-1559 implementation, the gas fees are determined algorithmically by the system depending on the network congestion level. It enables better transaction fees estimation and reduced transaction costs for users.

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Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.

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Deepan Datta

Content Writer

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