In T-minus 10 days, the Ethereum blockchain will undergo its 11th backward-incompatible upgrade, also called a “hard fork.” This hard fork, dubbed “London,” contains five Ethereum Improvement Proposals (EIPs), each featuring code changes aimed at optimizing and improving the world’s second-largest cryptocurrency by market capitalization.
Of these five EIPs, EIP 1559 has been the most controversial among Ethereum stakeholders due to its radical redesign of the network’s fee market. Today’s Briefing features an edited excerpt from CoinDesk Research’s latest report, "The Investment Implications of EIP 1559," that explains the risks and reward dynamics of this code change for investors.
Rewards of EIP 1559
One of the most common arguments against ether as a store of value is its unbounded coin supply.
While EIP 1559 does not introduce a bitcoin-like supply cap on ETH, it does activate a mechanism to curb total supply growth over time by taking a variable amount of ETH out of circulation each time a transaction is executed.
Simulations of EIP 1559 as of June 8 suggest the activation of EIP 1559 over the trailing 365 days would have burned a total of 2,967,937 ETH for a net reduction of 76% in ether supply growth over that period.
In addition to creating a bitcoin-like narrative of limited supply to ETH, EIP 1559 is expected to improve transaction wait times and remove fee-market uncertainty that damp developer and user adoption of dapps.
Finally, EIP 1559 is expected to solidify ether’s role as a form of payment for using Ethereum’s computing resources and interacting with the network’s broad system of dapps by requiring payments of transaction fees on the network to be exclusively paid in the network’s native cryptocurrency.
Risks of EIP 1559
Any technology upgrade comes with risk, and the most salient risk posed by EIP 1559 comes with its proposed changes to reward dynamics and payouts to miners, who face reduced earnings for their work with the activation of EIP 1559. Instead of pocketing 100% of transaction fees, miners will only receive tips from users through an optional "inclusion fee," paid electively by users seeking priority for their transactions.
Changing reward dynamics on its own won’t affect Ethereum’s ability to process blocks or computations. There is the potential, however, for disgruntled miners to leave the network, sabotage it or start a competing chain. If a large share of Ethereum miners exit or revolt, block times and network security would be negatively affected.
As for users and dapp developers, the benefits of EIP 1559 may not prove to be as efficient in practice as they are in theory. A failure to deliver promised fee-market efficiencies could result in user and developer disillusionment. If that occurs, Ethereum competitors such as Binance Smart Chain and Cardano, the two largest smart contract blockchain platforms by market capitalization after Ethereum at time of writing, will undoubtedly seize an opportunity to grab market share.
To gauge the subsequent rewards of EIP 1559 and its impact on users over the long term after activation, investors can view in real time the number of transactions styled in accordance to the EIP 1559 format as a way of tracking its usefulness in practice through privately maintained nodes or public block explorers.
Finally, the activation of EIP 1559 poses the risk of unforeseen bugs or malicious user behavior. A few have already been discovered during the process of testing EIP 1559 on public and private test networks.
At its core, EIP 1559 is designed to make transaction fees on Ethereum less volatile and more predictable. Beyond that, however, the code change poses several risks and potential rewards to Ethereum that will be important to watch for in August.