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EIP-1559 and the Future of Ethereum with Justin Drake

source-logo  cryptobriefing.com 04 August 2021 11:44, UTC

Justin Drake talks ahead of Ethereum’s EIP-1559 update, shipping as part of the London hardfork. 

A Landmark Year for Ethereum 

Ethereum is going through big changes. The price of ETH has risen 600% in the last year, briefly surging above $4,000 during the crypto market’s biggest rally to date. The asset has started to gain mainstream recognition, with institutional players like Goldman Sachs now offering ETH products. 

But market moves aside, the smart contract blockchain is also in the midst of several major developments on its roadmap. In December 2020, the Beacon Chain was deployed, initiating the process for its Ethereum 2.0 upgrade, otherwise known as Serenity. Ethereum is expected to dock to the Beacon Chain as part of a move to Proof-of-Stake sometime in the next year; over 6.6 million ETH has been deposited to the staking contract ahead of the merge. Several promising Layer 2 solutions are preparing to launch this summer, which should make DeFi applications like Uniswap and Synthetix more affordable for retail users. 

Ethereum is also approaching block 12,965,000, which has significance because that’s the block number at which the London hardfork will ship. On current estimates, it’s expected to arrive on Aug. 5. London will introduce several protocol improvements—known as Ethereum Improvement Proposals—though there’s one that will have a particularly profound impact on the network. EIP-1559, best described as Ethereum’s fee burning proposal, was confirmed earlier this year, though it’s been discussed within the community since 2018 (Vitalik Buterin also shared ideas hinting at the update on the Ethereum blog as early as 2016). One of EIP-1559’s most important evangelists has been Justin Drake, who works as a cryptography researcher at the Ethereum Foundation. Drake created ETH’s “ultrasound money” meme based on the idea that the asset could become deflationary over time, and his insights into the topic have helped drive ETH’s scarcity engine narrative across the Ethereum community. 

if capped-supply BTC is sound money 📢

decreasing-supply ETH is ultrasound money 🦇 pic.twitter.com/anu6QiZRcO

— Justin Ðrake 🦇🔊 (@drakefjustin) January 22, 2021

Crypto Briefing spoke to Drake ahead of the London hardfork, and he spoke at length about why EIP-1559 would have a big impact on Ethereum’s future. EIP-1559 packs a lot. It has wide-ranging implications to UX, security, and economics despite the relatively minimal consensuslevel change,” he says. “Only over time did I realize how powerful EIP-1559 is. It’s amazing, it seems to have no significant tradeoff. It’s pure improvement.”

The Benefits of EIP-1559 

EIP-1559 introduces a base fee for transactions to be included in a block and allows for the block size to double to a limit of 25 million when the network is congested. The base fee can change depending on network congestion, and the majority of it gets burned on each transaction. This has advantages in three areas. First, there’s the user experience side. Anyone sending a transaction will know the fee in advance; users currently have to submit a bid to miners, which can lead to overpaying or long wait times if the fee is too low. Meanwhile, the block size increase means the queue to get in will be faster during peak congestion. 

EIP-1559 also has some more subtle security benefits. It has the potential to reduce Maximal Extractable Value—a value known as MEV that can be lost from miners manipulating the order of transactions through frontrunning and bidding wars—because it can help oracles process gas refunds on the Layer 2 solution Optimism. “To avoid being subject to gas price manipulation for gas refunds, smart contracts need access to a decent trustless gas price oracle. That’s another thing EIP-1559 solves, Drake explains. 

“This has never happened before in crypto or finance more broadly. In that sense it’s hugely exciting,

But the most significant aspect of the three might be the monetary policy. When ETH gets burned, it becomes more scarce, which benefits all holders. With enough activity on the network, the amount of ETH burned through transactions could surpass the amount issued to validators through Proof-of-Stake. This would make ETH deflationary, or as Drake puts it, “ultrasound.” “This has never happened before in crypto or finance more broadly. In that sense it’s hugely exciting, Drake says. 

Just how much ETH will get burned depends on the fee volumes. Ethereum has faced criticism for its sometimes exorbitant gas fees, which can make the network unusable for many during peak periods of congestion. Nonetheless, activities like yield farming in DeFi have become more affordable in recent months, thanks in part to the MEV-fighting Flashbots. The recent drop in gas fees has led some to speculate that EIP-1559 won’t make a big dent on the ETH supply, but Drake says Flashbots won’t impact the fee burn mechanism. “There are two components to the transaction fee: the part which pays for transaction inclusion in a block, and the part which pays for transaction ordering within a block,” he explains. “The fee burn is exclusive to transaction inclusion whereas Flashbots is focused on transaction ordering.”

Flashbots work by removing a portion of the MEV from the native fee market to prevent extraction. Drake says the amount of the fee burned through EIP-1559 should be high because Flashbots helps isolate the MEV. “It’s hard to say how high it will be. I’m expecting around 70% but it could be as high as 80 to 90%,” he says. 

Ethereum’s Path to Ultra Scalability 

While MEV has become a major issue in recent months, Ethereum’s biggest challenge remains its scalability problem. Ethereum can be clunky and expensive, which explains why platforms like Binance Smart Chain and Polygon exploded earlier this year. Still, solutions are coming. The most promising ones include Layer 2 projects like Optimism and Arbitrum, which leverage Optimistic Rollups to execute transactions off from the base chain. Ethereum will also add 64 shard chains when Serenity completes. While such solutions aim to reduce transaction costs, Drake thinks a more scalable Ethereum will lead to a higher fee burn rate. Somewhat counter-intuitively I expect total fee burn to grow as we scale,” he said. “The total fee burn is how much each transaction burns, so the average base fee times the total number of transactions. Scaling increases the total number of transactions and reduces the fee burn per transaction.”

Although gas fees will be lower on a more scalable network, and in turn, the fees burned will be lower, Drake says the notion of induced demand shows that the network is likely to start processing more transactions, which would lead to a greater ETH supply burn. Explaining the theory, he says: 

“Think of it like road traffic. You have a road full of traffic, and you say “Oh, we’ll make the roads wider.” You make the roads wider but a few months later they are full of traffic again. You haven’t solved the traffic problem because increasing supply also increases demand. There’s so-called latent or induced demand.

In other words, once scaling makes using Ethereum cheaper, it should attract more users. That will incentivize more apps to build on the network, similar to how supermarkets may choose to build on a road with more traffic. Scalability bumps generally cause shortterm dips to total fee burn because of the supply shocks,” he says. “As the added supply gets eaten up, the historical trend is for fee volume to significantly surpass the initial fee volume. If this historical trend continues, which I expect it will, that will be extremely bullish. The potential transactional utility for Ethereum is so high that I don’t see how scalability improvements could satisfy demand any time soon.”

Factoring in Ethereum’s various upcoming improvements, Drake has developed his own thesis on the blockchain’s future: that of “ultra scalability.” He says that while Layer 2, sharding, and gas optimizations across protocols will be crucial to expanding the network, one of the most important factors is Nielsen’s Law—the observation that Internet bandwidth increases at a rate of about 50% annually.  

When scaling decentralized computation there are four fundamental bottlenecks to look at,” he says. “There’s raw CPU computation, there’s storage, there’s disk I/O, and there’s bandwidth. We have advanced techniques such as SNARKs and statelessness to deal with the first three but bandwidth is a fundamental bottleneck. Luckily, bandwidth is the one resource that just keeps growing by 50% every year.

Fiber optic technology, Drake says, could help Ethereum achieve 10 million transactions per second because it has the capacity to increase computational bandwidth. A single strand of fiber processes about 1Gb/s today, but that same strand could transmit up to 100Tb/s once the technology evolves. 

Is ETH Money? 

Drake’s vision for an ultra-scalable Ethereum is likely at least a decade or two away, which may be the length of time it takes for EIP-1559 to make a big dent on Ethereum’s circulating supply. Though the numbers are hard to predict, estimates suggest that Ethereum could burn roughly 1 million ETH a year, which would mean the supply could hit 100 million in 20 years. That’s a reduction of about 15% on today’s supply. 

“15% is not that much when you have an asset that can go up 1,000% in a year, but it is incredibly powerful from a narrative standpoint,” Drake argues. “It makes ETH stand out and reinforces its natural Schelling point as the money for the Internet of value. Bitcoin will inflate for the next century, so ETH’s supply will peak 100 years ahead of Bitcoin. Another fun narrative is that ETH has no supply floor.“

Bitcoin’s supply is capped at 21 million, which is why it’s often referred to as digital gold. With Bitcoin as it is today, miners earn block rewards and transaction fees in BTC for adding new blocks to the chain. Eventually, however, issuance will stop, and Bitcoin the blockchain will be secured by transaction fees alone. Drake says this was one of Satoshi’s mistakes: they “understandably didn’t have the foresight” to see that Bitcoin could face security issues several decades into the future. 

“With ETH, we can have our cake and eat it too.”

While Bitcoin the blockchain may face issues in the future, the asset has succeeded in becoming a store of value. Like gold, you can think of Bitcoin as money because it’s divisible, durable, fungible, transmittable, and has its own monetary premium. Ethereum, meanwhile, tries to embrace what Drake calls “sci-fi economics.” EIP-1559 is a big part of that because it could make ETH the first deflationary cryptocurrency. 

He adds that ETH can be thought of as money because it’s the collateral asset for DeFi. But it’s also used as a currency: if you want to buy an NFT or pay for gas, you need ETH first. “The transactional utility of Bitcoin is payments but I don’t see Bitcoin getting much traction in that area, as a currency. But with ETH, we can have our cake and eat it too,” he says. “We can have both the non-transactional utility of ETH as a collateral asset in line with the Bitcoin [store of value] philosophy, and at the same time, we can have all the transactional utility plus a way to capture some of the transactional value via fee burn.” 

Blockchains like Ethereum are valuable because of the technology underpinning them. That’s what gives you decentralization, trustlessness, permissionlessness, and all the sci-fi stuff Drake talks about.

The other crucial layerLayer 0, if you willis the community. Like Bitcoin, Ethereum has a powerful community of believers—to date, no crypto project has come close to competing with the two leading platforms in adoption and cultural significance. Drake has been getting into the Layer 0 memes and narratives that have helped Ethereum thrive over the last few months, but he notes that they’re only a part of the story alongside the technology layer. He explains:

“I think people underestimate what’s coming for Ethereum in terms of utility. People have this mental model that Ethereum is an expensive toy that scales poorly. That may be true today but is completely false in 10 to 20 years. I guess Ethereum’s scaling story will be similar to the Internet’s history from ultra-slow dial-up modems to ultra-fast fiber, 5G, and Starlink.” 

The Internet officially launched in 1983, and the world around us changed forever as it gave rise to the World Wide Web, e-commerce, torrenting, video streaming, social media, smartphones, and the first form of Internet money. If Drake is right, Ethereum could have a similarly wild few decades ahead. 

Disclosure: At the time of writing, the author of this feature owned ETH, ETH2X-FLI, SNX, MATIC, and several other cryptocurrencies. They also had exposure to UNI in a cryptocurrency index. 

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