Thomas Trutschel | Photo library | Getty Images
Ethereum’s much hyped and somewhat controversial “London” hard fork has just been activated.
So far, the news of the successful upgrade coincided with a ramp-up in the price of Ether, the native token of the Ethereum blockchain. The cryptocurrency is at USD 2,620, up 3.9% in the last 24 hours.
Much of the buzz has to do with the fact that the software upgrade means some big – and necessary – changes to the code underlying the world’s second largest cryptocurrency.
It has always been a difficult path for Ethereum users. The blockchain has long had a scaling problem, and its highly unpredictable and sometimes exorbitant transaction fees can piss off even its biggest fans.
The problem has worsened in recent months thanks to increased interest in non-fungible tokens, based primarily on Ethereum’s blockchain, as well as explosive growth in the world of decentralized finance, or DeFi, which also largely uses the Ethereum blockchain.
Thursday’s changes, which have little to do with the City of London, are designed to address many of these issues by destroying or “burning” Ether coins and changing how transaction fees work so that they are more predictable.
If you think of Ethereum like a motorway, London adds a few lanes to slow traffic and standardize toll prices.
“This makes the charge logic a lot more complex, but it’s an interesting approach that could potentially stabilize the charge momentum,” said Nic Carter, general partner of Castle Island Ventures and co-founder of Coin Metrics.
Make fees more predictable
Even if the Ethereum blockchain is constantly being revised – for those who keep track, this is Hard Fork # 11 – the “London” upgrade is a game changer, according to experts.
The hard fork itself consists of five Ethereum Improvement Proposals. They are called EIPs for short, and each one brings about a number of changes to the code.
The one everyone is clinging to is EIP-1559.
Before upgrading, users would essentially participate in an open auction every block, where they would have to bid in what is known as a “first price auction” with a miner. The closed bid setting meant that users often felt in the dark when proposing transaction fees (called “gas prices”) and choosing a number that they believed would guarantee their inclusion in the next block of transactions.
Zoom In Icon Arrows pointing outwards
Some users who felt the need to prioritize their transaction would offer to pay a premium over their bid in an attempt to gain preferred status within the block itself.
“Fifteen-fifty-nine is really meant to create an ecosystem that encourages lower gas tariffs,” said Auston Bunsen, co-founder and CTO of QuikNode, which provides blockchain infrastructure to developers and businesses.
“Sometimes people are willing to pay a lot to get into a block. Fiffteen-fifty-nin is trying to fix this problem by creating a basic fee,” Bunsen continued.
Rather than blindly auctioning each block to determine the price of gas, Ethereum’s protocol algorithmically decides the transaction fee based on total demand on the network.
If the protocol decides on a single gas price, major price spikes should be avoided, although that does not necessarily mean it will be cheaper for buyers. It’s essentially a great hedge against the completely out of whack market.
However, the upgrade still allows users to skip the line by tipping.
But one major change fueled by EIP-1559 is a doubling of the block size.
While this theoretically means that double the number of transactions can take place in each block, in fact the upgrade was designed so that the protocol just wants the block to be half full. This is intended to help offset peaks in demand and keep gas charges stable.
Matt Hougan, Bitwise Asset Management’s chief investment officer, uses the metaphor of a ferry to explain the design logic.
If the ferry companies have underestimated the price of a ticket, they may need the extra seating capacity to accommodate the docked passengers who want to board at the base ticket price.
“But the price goes up very quickly and algorithmically to the point where you should hit a clearing price that will allow the block to hit its target of half full, and that certainly allows for all of the transactions to go through should, can be processed, “explained Hougan.
The dynamization of the block size to adapt to fluctuations in demand ultimately stabilizes the basic fee.
“It sounds pretty simple, but it’s a really elegant design solution to a problem that has plagued Ethereum since its inception,” he said.
The ticking time bomb
The not-so-quiet elephant in the room is the fact that the upgrade diverts some of the miner’s income to existing token holders.
The ether that would otherwise go to the miner is now “burned”, whereby part of the digital currency that would otherwise be put back into circulation is permanently destroyed.
Some have argued that the EIP-1559 upgrade will create some sort of deflationary pressure on Ethereum as lower supply can lead to a price hike. But this reasoning makes a couple of big assumptions.
“It creates deflationary pressures only on condition that the fees burned actually exceed new issues,” Carter said. “This is only the case in times of extreme fee intensity.”
Carter says burning gas prices are unlikely to become net deflationary, at least not under the current tariff regime.
But burning those fees will also mean a big shift for the miners so they really only have two sources of income.
Miners can still sell their computing power to the network and hope to be rewarded with re-minted ether should they win a block.
You can also continue to receive tips from users who want to prioritize their position within the block.
But in the short term, miners won’t make quite as much money as they did before the hard fork.
Hougan argues that since the miners are organically linked to the total value of Ethereum, the hope is that if the price of Ethereum goes up thanks to these protocol changes, the miners will ultimately be able to make up for those losses.
However, experts tell CNBC that the problem with this logic is that in the next few years, Ethereum miners will be nearing a cliff that will make them obsolete. In fact, there is a condition in Thursday’s upgrades specifically related to that mining Armageddon.
While it doesn’t receive the same amount of attention as EIP-1559, EIP-3554 is another of the EIPs included in the London Junction and its importance cannot be underestimated. This change in code paves the way for Ethereum 2.0, an upgrade and a complete overhaul of the system that has been in the works for years.
Ethereum 2.0 would switch the network from the energy-intensive “proof-of-work” mining system, in which miners solve difficult mathematical equations to create new coins, to “proof-of-stake” in which users only use their existing ones must use Ether’s cache as a means of verifying transactions and minting new tokens. This change will be huge not just for Ethereum, but for the broader cryptocurrency community as a whole.
EIP-3554 is taking an important deadline that will encourage Ethereum miners to update their software in preparation for the switch – known as the “difficulty time bomb” – and is pushing that deadline from summer 2022 to this December.
“The point of the problem bomb is forcing miners and node operators to update their software after a set period of time,” said Carter.
As Bunsen describes, the proof-of-stake transition would make Ethereum essentially undegradable once activated. In other words, in a few years, once the protocol has fully migrated to a proof-of-stake model, the entire industry surrounding Ethereum mining as it exists today will no longer be relevant.
So why London? The Ethereum community has set itself the task of naming their hard forks after cities in which the international developer conference Devcon took place. Next up on deck: Shanghai.