An article to understand Ethereum's Gas fee and EIP-1559 proposal
Ethereum adoption has grown at an unprecedented rate in recent months. Decentralized finance (DeFi) continues to grow rapidly, stablecoins are adopted globally, and NFTs are also a hot topic.
The widespread use of Ethereum is a good sign for its long-term prospects. But in the short term, Ethereum is going through growing pains, with transaction fees surging to new highs in early 2021.
CoinMetrics’ latest report analyzes Ethereum’s fee mechanism, the factors that lead to high fees, and the changes that the EIP-1559 proposal will bring. The key points are as follows:
Data comparison
During the 2017-2018 bull market, the average transaction fee on Ethereum hit a peak of $5.7. In this round of bull market, the data has undergone earth-shaking changes: since January 18, 2021, the average transaction fee of Ethereum has remained above $5.7, and the highest value has even exceeded $35.
Part of the reason for the increase in transaction fees is the sharp rise in the price of ethereum, and as ETH has become more expensive, so have transaction fees in dollar terms. But it is more because of the congestion of the Ethereum network that has caused the gas fee to rise sharply.
Gas costs soar
The gas fee under the current mechanism is floating and mainly depends on the user's demand for block space. In the summer of 2020, gas costs soared due to the rise of DeFi. The growth of decentralized exchanges, on-chain arbitrage, liquidity mining, and new token issuance has all led to a dramatic increase in competition for transaction priority, causing gas prices to rise.
On September 17, 2020, after the UNI airdrop on Uniswap, the average gas fee was as high as 500 GWEI. In 2021, as DeFi continues to heat up, the average gas cost will soar again, and the sharp rise in ETH prices will also attract a new batch of traders and speculators.
Block full load
Under the PoW mechanism, the Ethereum gas fee is ultimately paid to the Ethereum miners, and the miners earn income through a combination of transaction fees and block rewards (that is, newly issued ETH). With ethereum fees skyrocketing, transaction fee revenue now accounts for 50% of miners’ revenue.
When a new block is mined, miners are required to determine which transactions to include. Due to block capacity limitations, each block can only contain a certain number of transfers. Therefore, miners will naturally give priority to the transaction request with the highest gas price in order to earn more profits.
Although transactions with higher gas fees are more likely to be packaged by miners first, there is still no guarantee that transactions will be completed quickly. If a certain number of users are willing to pay a higher gas fee, the transaction needs to be queued for confirmation.
This mechanism creates more problems when blocks are constantly full. Gas fees will continue to be driven up as transaction senders compete for scarce space. Ethereum block load has remained above 95% since summer 2020. In March 2021, the block load has been as high as 97%-98%.
UNI Airdrop Causes Gas Fees to Soar
The on-chain trading mechanism of DEX (decentralized trading platform) such as Uniswap has many advantages, but it also has a disadvantage-increasing gas costs. On DEXs, faster execution of transactions often has immediate economic benefits, so many DEX users are willing to pay high gas fees.
The graph above shows block gas costs before and after the UNI airdrop. Each dot represents the average gas fee (GWEI) for a single block. The dot color represents the average transaction fee per block, in USD. Transaction fees briefly topped $12 as gas fees skyrocketed. After receiving the UNI airdrop, users rushed to start transactions on Uniswap, and the competition for Ethereum block space resources led to a sharp increase in gas costs.
If you send a transaction with a gas fee of 200 GWEI on September 16, 2020, you need to wait a day and a night until the demand for transfers weakens, and the gas will eventually fall before it can be packaged by miners.
EIP-1559 Proposal
After much debate, ethereum improvement proposal EIP-1559 has been approved for implementation in the London hard fork released this summer. EIP-1559 will fundamentally change Ethereum's gas mechanism. Gas fees will be changed from user settings to basic fees with algorithmic calculations. In addition, EIP-1559 will also introduce a new block target capacity mechanism to prevent blocks from continuously approaching the maximum capacity.
target block capacity
Instead of the current fixed maximum block size, EIP-1559 will introduce a target block size mechanism designed to keep blocks at 50% capacity. In EIP-1559, the maximum block size will increase from 12.5M gas to 25M gas. But the target block capacity will remain at 12.5M gas. The block capacity mechanism is designed to keep blocks at 50% capacity by adjusting the base fee.
basic cost
EIP-1559 will introduce an algorithmically calculated price called a base fee. The sender of the transaction needs to pay the basic fee to have the transaction included in the block.
The base fee is calculated based on the previous block and will increase or decrease depending on the load of the block. If the previous block is larger than the target block capacity (i.e. more than 50%), the base fee increases. If the base fee continues to rise, certain fee-sensitive users will reduce or suspend transactions, thereby reducing congestion and causing the block load to drop back to 50%. Conversely, if the block load is below 50%, the base fee is reduced, making transaction fees cheaper.
The base fee will effectively automate the gas fee setting system. The base fee will be calculated by the protocol itself, rather than relying on suggested prices based on current gas cost estimates.
Additionally, the base fee is not paid to miners, but is permanently burned (removed from the supply), effectively reducing the overall supply of ETH. This will be beneficial to Ethereum’s supply economic model as it will effectively reduce ETH’s supply inflation. If the total amount of fees is high enough, it is even possible to send ETH into deflation.
The graph above shows the current supply of ETH (red line) compared to the supply when transaction fees are burned (green line). This is a simplified model prediction after the implementation of EIP-1559 (the actual situation will be more complicated). Overall, supply inflation will moderate after the launch of EIP-1559.
However, this proposal has also been opposed by some miners because it will reduce the overall income of miners in the short term. After some intense debate, most major mining pools have (reluctantly) accepted the fact of the transition to EIP-1559.
tip
tip
In addition to the base fee, transaction senders can also choose to provide additional tips. Tips are paid directly to miners, similar to current transaction fees. If blocks are close to full, paying a high tip will incentivize miners to prioritize transactions.
When sending transactions, users can set a fee cap. A fee cap is the most the sender is willing to pay, including base fees and tips. If the fee cap is lower than the base fee, the transaction will not be included in the block. If the fee cap is higher than the base fee, the difference is sent to the miner as a tip.
If the block remains full, it may be similar to the current gas mechanism, where miners are rewarded with high gas incentives. However, EIP-1559's target block size mechanism will hopefully keep blocks from reaching maximum capacity for a longer period of time.
| Can EIP-1559 reduce gas costs?
Can EIP-1559 effectively solve the current problem of high gas costs and make Ethereum transaction fees very cheap? the answer is negative.
Fundamentally, high transaction fees are a scalability problem. If Ethereum can only process an average of a few hundred transactions per block, then as long as dapp usage continues to increase, transaction fees will continue to drive up. As long as there is intense competition for block space, gas fees will continue to remain high.
While EIP-1559 may not solve the problem of high fees, it could help improve the user experience on Ethereum by making fees more predictable. EIP-1559 helps reduce variance in gas fees and gives users more clarity on what they actually need to pay.
To really reduce transaction costs requires the support of layer2 solutions and the final realization of ETH2.0. By all means, scalability solutions will increase the number of transactions that can be processed per block, which will help alleviate high fees caused by congestion.
Summarize
Summarize
Ethereum transaction fees have reached their highest level ever. The rise of DeFi and fierce competition for Ethereum block space lead to full block load and congestion, which pushes up gas prices. EIP-1559 will help improve the transaction fee user experience on Ethereum, but may not end up solving the problem of high gas fees. However, Ethereum scalability solutions are on the way, which will be the real long-term solution to lowering transaction fees.
