The Negative Effects of EIP-1559
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This post is based on correspondence between the author and Virgil Griffith. To learn how to correspond with Virgil go to his website: https://virgil.gr
EIP-1559 was a change to the fee market in the Ethereum (ETH) network in part to bring some “fairness” to transaction fees, and in part to prepare the network for the proof of stake monetary policy, which is perpetual and has no caps as in Bitcoin (BTC) or Ethereum Classic (ETC).
To provide “fairness” or certainty to the gas fee market, EIP-1559 introduced a transaction pricing mechanism that includes a fixed-per-block network fee that is burned, and also a dynamic system that expands or contracts block sizes to deal with transient congestion.
It is our opinion that this modification to the protocol did not bring any positive changes to the Ethereum fee market or monetary policy.
Indeed, EIP-1559 will have some negative effects that we will explain in the following sections.
The key is that the change needs to be seen from its whole economic impact.
Does it Bring More Certainty to Gas Fees?
EIP-1559 divided the fee payment to miners into a base fee that is burned, and a “tip” that is earned by miners when users decide to add an incentive for their transactions to be included sooner in a block.
This feature brings certainty only to the base fee portion which is algorithmic, but does not solve the total fee cost uncertainty because people still have to compensate stakers with the “tip” that is discretionary.
This tip has to be as large and uncertain as the fees were before because it will be the only way to get a transaction into the block.
Indeed, one of the main complaints in Ethereum before and after it migrated to proof of stake was that the fees didn’t change, even with EIP-1559!
EIP-1559 creates the illusion of certainty because it works like Uber. When there is a lot of congestion it increases the fees according to a specific function, therefore wallets and users can anticipate how much the base fee will be. But, that does not bring any certainty when it comes to competing to include a transaction in the next block.
The feature of expanding the block size when there is congestion also doesn’t make things much better because block size expansion must be limited to reduce bloat in the network and, when there is excess demand, the uncertainty in the tip fee still persists.
The gas fee model was perfect and simple as it was before. There is no such thing as certainty, or certainty can’t be recreated scientifically in a market that is still volatile, because volatility is a definition of uncertainty!
Certainty will only be possible when these technologies stabilize, are widely used, and the flow of transactions becomes more predictable.
For all these reasons, ETC has remained with the original gas fee model. It is correct, fair, and let’s users and miners agree on gas fees in the free market.
Does it Burn Part of the Stock?
Yes, EIP-1559 burns all the base fees, therefore implicitly changed the monetary policy of Ethereum.
This means that as stakers constantly receive newly minted coins, coins are burned and eliminated through the usage of the blockchain.
This burn feature was praised because it would increase the value of each ETH coin as it made it “ultra-sound money” as the number of coins would be diminishing over time.
However, EIP-1559 only inflates the value of the remaining stock artificially, but it does not necessarily create any new value in the system.
In other words, the market cap or overall value of the network may be the same, while the coin may be going up in value not because the system is more valuable but because the stock is diminishing.
This is an old criticism in the stock market. CEOs, in order to earn higher compensations, inflate the share values of their companies by using the corporations’ cash flows to buy back stock, reducing the supply, thus increasing the share value per unit, but not creating any new value for the companies!
Monetary policies such as BTC’s and ETC’s are truly value creating models because they issue the coins only when miners perform enormous amounts of work, and then the coins remain in the market in perpetuity, traded between free individuals according to human action.
Just as printing money out of thin air has negative effects, also burning money for no reason has negative effects.
Does it Bring a Fair Ethereum Economy for the World?
EIP-1559 has negative effects because it makes the rich get richer, it creates elites that control the system, and impoverishes people in the broader economy.
With EIP-1559 the rich ETH holders, who are stakers, and other investors just keep their holdings in ETH and receive staking rewards while the general public who uses ETH to buy and sell in the normal economy are seeing their stock diminish.
This is a Cantillon effect but in reverse. It is created not because money is being printed and inflated, but because the money is being burned and diminished artificially.
EIP-1559 creates a massive transfer of wealth from active users to large ETH holders and stakers; it inflates the value of the coin artificially, exacerbating the problem; and does not make ETH “ultra-sound money” but “ultra-perverse money” because it is a mechanism to enrich the elites that control the system, making it ever more centralized.
Networks such as BTC and ETC have simple and straightforward monetary policies that bring true fairness to the economy and create true value because they neither transfer wealth by printing excess coins nor by burning coins.
BTC and ETC will just issue 21 M and 210 M coins respectively and then the market will decide how those are allocated or what value is assigned to them.
There is no complex system to fabricate an upward trend in the price of the cryptocurrency, and complexity in itself is an enemy of certainty and decentralization.
Thank you for reading this article!
To learn more about ETC please go to: https://ethereumclassic.org
