Understanding Ethereum’s biggest upgrade in years

A beginner’s guide to EIP-1559: what it is, why it matters, and what's next

Published August 3rd, 2021

This week, Ethereum is rolling out the “London” mainnet upgrade — which is the largest update to Ethereum’s core protocol in years. 

The upgrade includes five Ethereum Improvement Proposals. One of these — EIP-1559 — has generated a lot of attention in recent months, despite its less-than-thrilling name. Why? Because it constitutes a major shift in the economics of Ether (ETH), the native cryptocurrency that powers the Ethereum network. 

EIP-1559 has the potential for wide-ranging ramifications for all parts of the Ethereum ecosystem. It’s designed to reduce the amount of ETH circulating at any time, which could potentially result in higher prices, assuming demand remains constant. And it should make transaction fees more predictable (or even reduce them) — which could benefit users who, in recent months, have often experienced fees spiking to the point where smaller or more frequent transactions can be unfeasible. 

A brief history of Ethereum

Ethereum is the second-largest cryptocurrency by market capitalization. But it’s not just a form of digital money. Since its creation in 2015, Ethereum has come to power a universe of applications ranging from decentralized finance (DeFi) to stablecoins like USDC to non-fungible tokens (NFTs)

Unlike its predecessor Bitcoin — which is more purely a form of digital money — Ethereum is a highly flexible platform for running smart-contract powered applications. One way to think about the Ethereum network is to imagine a giant, global computer made up of thousands of individual computers all around the world, each running a copy of the Ethereum software. 

The Ethereum software, in this scenario, is the operating system — and like the more familiar operating systems on your phone or computer, it also gets upgrades from time to time. Some upgrades are minor tweaks, while others introduce major new elements.  

Unlike your phone, Ethereum is decentralized — which means there’s no central developer that can just send out an upgrade. Instead, changing the core Ethereum software requires a “hard fork.” 

A hard fork happens whenever a majority of a cryptocurrency’s community (typically comprising users, miners, developers, and investors) agrees to change the core rules governing the software and underlying blockchain. Enter the London upgrade, which is set to roll out this week and contains, among other changes, EIP-1559. It’s scheduled to go live between August 4th and 5th at Ethereum block 12,965,000.

Got it. So what does EIP-1559 do?

The ETH digital currency has long played key roles in the Ethereum network. Users pay “gas” fees in ETH whenever they make a transaction. Miners, who do the work of validating transactions and updating the blockchain, have also long been paid in ETH — both in the form of gas fees paid by users and new ETH generated by the network.  

EIP-1559, which was first proposed by Ethereum co-creator Vitalik Buterin in 2018, changes this system. Users will pay a simplified fee (now called “a base fee,” which will typically be set automatically by your wallet), along with a “tip” that can be added to speed up transactions. 

The base fee, however, doesn’t go to the miner that validates the transaction. Instead, it’s “burned” by the network — which means it’s permanently removed from circulation. Some potential consequences include:

  • Gas prices should be more predictable. Pre EIP-1559, users were incentivized to spend more on gas to win a “first-price auction” — because miners, unsurprisingly, tended to validate higher-paying fees first.

  • ETH prices have the potential to rise due to reduced circulating supply. Given that a portion of ETH will be permanently removed from circulation — or “burned” — during each transaction, the supply of ETH will be reduced overall. Assuming demand remains constant, prices may rise. (There are also risks associated with the upgrade, the biggest being the possibility of disgruntled miners quitting or revolting — thus impacting security and transaction times. See the section below for more.) 

  • This reduction in supply could eventually make ETH a deflationary asset and help it evolve into a “store of wealth”-style investment similar to Bitcoin. Some analysts suggest this will aid in institutional adoption.

  • The upgrade has been successfully rolled out on the Ethereum testnet, and simulations have begun to estimate potential rates of supply deflation.

Did any parts of the Ethereum community object?

Yes, and that’s why it’s taken so long for the London upgrade to be adopted. Miners do a lot of the heavy lifting for the network, and some are concerned that their income will drop as a result of EIP-1559. 

This could potentially lead to a contentious fork and reduced miner activity, and could even result in two competing Ethereum chains (similar to what happened in 2016 when Ethereum Classic was created).

What happens next?

The London Mainnet is just one of many planned changes to Ethereum. An even bigger shift, to Ethereum 2.0 (ETH2), will move Ethereum away from mining entirely.