in Ethereum (ETH)
The Ethereum London hard fork is coming up on August 4th, and will make a couple of key changes to the Ethereum protocol. These upgrades are going to make the blockchain easier to use, and they’ll also affect Ethereum’s monetary policy.
In fact, Ethereum community members are saying that the London hard fork could be the most important update on the network for years.
Find out why in our Ethereum 2021 progress report.
The Ethereum London hard fork
Since London is a hard fork the miners and nodes will have to upgrade their software to keep interacting with Ethereum. If a subset of miners and nodes didn’t support the upgrade they would fork Ethereum and start mining on a different chain. This is how Ethereum Classic was created.
EIP 1559 (Ethereum Improvement Proposal) is by far the most significant change to the network that the London hard fork is introducing. But what is EIP 1559?
- EIP 1559 changes how gas fees on Ethereum are calculated. The way Ethereum works now, users have to guess how much of a fee they need to pay to get their transaction included in the next block. The problem is that gas fees can quickly change and there’s no way to know the perfect amount of gas to use. Volatile gas fees create two problems:
- Users overpay for their transactions.
- Users underpay and their transactions get stuck, potentially for days or weeks.
EIP 1559 is going to change the way gas fees are calculated. It will introduce a system of “base fees” and “tips”. Users will know the base fee in advance, which means that they’ll know how much to pay to get their transaction included in the next block. Most Ethereum users will only ever need to pay the base fee, however, advanced users can pay a “tip” to get their transaction processed in a specific order.
- A mechanism to burn gas fees. Once EIP 1559 is implemented the Ethereum protocol will burn the base fee. The miners will only receive the tip portion of the transaction fee.
This second feature of EIP 1559, the burning of the base fee, is where we get the idea that Ethereum could become a deflationary currency (ultrasound money). If the base fee is a large percentage of every block, and it gets burned, Ethereum could potentially destroy more ETH than is produced every block.
Whether or not Ethereum is deflationary will depend on the percentage of transaction fees that come from the base fee versus the tip. For example, if 70% of transaction fees are base fees and only 30% are tips, then 70% of all transaction fees will be burned. That’s a lot! However, we don’t know if this will be the case. Although the Ethereum developers can make predictions, it’s only with real-world usage that we’ll discover the base fee to tip ratio.
Another key point is that the issuance of new ETH will decrease once the network transitions to staking. The Ethereum protocol has to issue more ETH to pay miners than it will have to issue to pay stakers once Proof of Stake goes live.
To summarize, when Ethereum bulls argue that the cryptocurrency could become deflationary they’re hoping for a combination of two factors:
- Base fees (which get burned) will make up a majority of all transaction fees
- The Ethereum protocol will issue less ETH once Proof of Stake goes live
It’s still an open question whether EIP 1559 will make Ethereum a deflationary currency, however, we can say a few things for sure:
- Even if it doesn’t make Ethereum a deflationary currency, EIP 1559 will significantly reduce the issuance of ETH which is likely to drive prices higher
- Interacting with Ethereum will be much easier since users will know the correct gas fee to get their transaction included in the next block
- There are other non-economic benefits to EIP 1559, primarily relating to how smart contracts and wallets interact with Ethereum. See this Twitter thread.
More information about EIP 1559 is available here.
The Ethereum ecosystem in 2021
The Ethereum ecosystem is rapidly expanding in 2021, driven mainly by the growth of DeFi protocols. Even though the total value locked (TLV) in DeFi peaked at $87 billion in May of 2021, DeFi still has a TLV of about $50 billion. That’s more than 3x the $16 billion TLV at the beginning of the year.
In May of 2021 Ethereum cleared $665 billion worth of transactions, a new record that’s far more than anything we’ve seen before. Then, for the first time in history, Ethereum’s address activity was above Bitcoin’s:
All of Ethereum’s key metrics are showing continued growth. That’s bullish for ETH holders and the cryptocurrency ecosystem at large.
A Few Key Terms
Ropsten - Ropsten is one of Ethereum’s primary testnets. Testnets are important since they let developers test their code in an environment similar to Ethereum, but without risking any real ETH. Most importantly, testnets allow developers to fix vulnerabilities in their code before going live on the Ethereum mainnet.
EIP 3238 - Another Ethereum improvement proposal that will go live with the London hard fork. EIP 3238 delays the difficulty bomb that makes mining Ethereum increasingly difficult. The difficulty bomb won’t go live until Q2 of 2022.
EIP 3074 - EIP 3074 will introduce a change to the Ethereum network that allows smart contracts to pay the gas fee on behalf of the user. For example, a wallet or a dapp could pay for the gas fee of its user. This is a crucial upgrade (hopefully coming with the next hard fork in 2021) since it will help beginners to use the Ethereum network.
If applications can pay gas fees for users, someone could get onboarded into crypto without even realizing that they’re using blockchain payment rails.
The state of Ethereum outside the London hard fork
An inability to scale is the number one factor that’s holding Ethereum back from mass adoption. That’s changing quickly though as new scaling solutions are coming online. Polygon is already live with more than 350 applications and approximately 7 million transactions a day.
The optimistic rollup protocol Arbitrum is a promising technology and it’s going to help further scale the Ethereum network. Arbitrum and Polygon should both help to reduce gas fees and speed up Ethereum transactions.
Apart from Arbitrum and Polygon, flash bots are also reducing gas fees on Ethereum. In fact, gas fees as of early July 2021 are the lowest they’ve been in months, if not years:
Concerning scaling, one final point is that EIP 1559 does not directly affect Ethereum scaling. EIP 1559 burns ETH and makes gas fees predictable, however, it doesn’t increase the number of transactions that Ethereum can process.
Is ETH 2.0 being delivered?
Yes, Ethereum 2.0 is coming. Nobody can guarantee when staking will go live, however, most people agree that it will happen sometime in Q1 of 2022. Staking will completely replace the miners, making Ethereum a pure PoS chain.
Already there are nearly 6 million ETH staked on the Beacon chain and the staking mechanism is performing as expected. Up-to-date stats about the Beacon chain are available here.
And with the Ethereum London Hard Fork also close to going live, the network continues to go from strength to strength in 2021.
This content is for informational purposes only and is not investment advice. You should consult a qualified licensed advisor before engaging in any transaction.