Ethereum Development Update: London Hardfork

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The Ethereum network is set to download some upgrades via a planned hard-fork named “London” on August 4, 2021. A hard-fork changes the rules of a blockchain-based network in such a way that the changes render older versions of the client software incompatible with the new, upgraded version of the client software. Network participants who fail to download the changes will be disconnected from the other participants that are running clients that have incorporated the new rules. These participants will effectively be operating on separate chains. At this time there is no evidence of a large faction that intends to not upgrade. A notable split seems highly unlikely but is never fully out of the question.

EIPs included in the London Upgrade:

  • EIP-1559: An architecting of the fee market designed to improve the user experience which also happens to harden ETH monetary policy.
  • EIP-3559: The Difficulty Bomb has been delayed to December 2021.
  • EIP-3529: Reduction in gas refunds on operations whose benefits don’t justify the costs.
  • EIP-3541: A reformatting of smart contract byte code to help guarantee their validity.
  • EIP-3198: Addition of the Base-fee opcode which is a crucial part of the new fee architecture outlined in EIP-1559. 

EIP-1559

In a previous post, we described EIP-1559 in some detail, as it is the most radical and highly anticipated change to Ethereum within the London upgrade.

The TL/DR version of that post:

Ethereum users (wallets & advanced users) currently bid a gas price and set a gas limit for every transaction. Post-EIP-1559 users will bid a price for a Base-fee (minimum fee to get in the next block), include an Inclusion-fee (miner fee or tip), and a Cap-fee (max fee payment).

The protocol adjusts the Base-fee to bring blocks to a long-term average of half full, meaning if the previous block is less than half full the Base-fee will be decremented down in proportion to its distance away from being half full. If the block is more than half full, the Base-fee will be incremented up in proportion to its distance away from being half full. However, these changes in the Base-fee are bounded to 12.5% adjustments in either direction, which limits the range of Base-fee price hikes or price drops, making the job of fee estimation easier for wallets and users.

If a user pays the minimum Base-fee of a particular block and includes a miner tip of at least 1 gwei, they have very high assurances that their transaction will be included in that block.

If a user over-bids the Base-fee, they’ll only have to pay the lower Base-fee since they are still willing and able to pay that minimum. If they underbid the Base-fee, they still have a shot for inclusion given that their Cap-fee (max amount they’re willing to pay) is above the minimum Base-fee plus the tip they’ve included in the transaction. This setup is designed to limit the occurrence of overpayment and dropped transactions making the user experience better for everyone. 

The entire Base-fee is burned every block. The burning mechanism was instituted to discourage any manipulation of the Base-fee by miners since whatever manipulation they engage in will be burned anyway. As a side-effect of this attempt to dissuade manipulation of the Base-fee, ETH becomes less inflationary, and even deflationary, under certain circumstances. 

During times of high utilization of the Ethereum network, when base fees are greater than the sum of the tips and block subsidy, ETH monetary policy turns deflationary.

There are two common misconceptions about EIP-1559:

  1. “It will reduce transaction fees”. The proposal indeed creates a fluctuating gas limit, but this is implemented to create assurances around transaction inclusion. Increases in gas limits create more block space, but they also imply an increase in the next base fee. If Ethereum continues to have a high demand for its block space, users can expect high fees under an EIP-1559 regime. However, they should experience higher assurances around transaction inclusion while not overpaying, and a simultaneous hardening of ETH’s monetary policy
  2. “EIP-1559 makes ETH deflationary”. Hardening an asset does not automatically imply a deflationary monetary policy. EIP-1559 only guarantees ether’s inflation rate will be reduced going forward. Only under certain conditions does ETH’s monetary policy turn deflationary. The total supply of ETH will increase under EIP-1559 if Base-fees stay low enough for long enough.

Before going live on mainnet the proposal, like all others, starts on a testnet version of ethereum to test the quality of the implementation. EIP-1559 has been active on an ethereum testnet named Goerli since July 30th, which you can track here. At the time of writing ~80 ETH has been burned since the EIP’s launch on Goerli, which is nearly ~160,000 USD worth of ETH burned in 22 days. We should not expect this amount, but using this as a baseline pace of burning, we could expect roughly ~1300 ETH to be burned in a year under an EIP-1559 fee regime with the network conditions of the Goerli testnet. Given the block subsidy creates ~1300 ETH every 650 blocks or roughly every 3 hours, this would have a very small impact on ETH’s inflation rate. Nonetheless, the burning does create deflationary pressures and under certain conditions, ETH monetary policy can turn deflationary. The possibility is very real. 

Another site allows you to toggle between different parameters to visualize the impact that Ethereum staking plus EIP-1559 will have on the supply of ETH. You can see clearly how high base fees and high participation in staking hardens ETH, and that low fees and low participation keep ETH’s inflation rate closer to its max. 

EIP-3559

The concept of the difficulty bomb was developed in 2015 to act as a social forcing function on Ethereum miners. The “bomb” increases proof of work difficulty to such a degree that proof of work miners cannot produce valid blocks and thus they can’t capture revenue. This is done to motivate miners to migrate to the proof of stake implementation of Ethereum. However, with proof of stake not being production-ready, it makes no sense to motivate the miners to move to something that doesn’t exist yet, while effectively murdering the live proof of work chain that’s responsible for tens of billions of dollars worth of value. Instead of the bomb going off in August, this EIP will delay the detonation of the difficulty bomb to December 1st, 2021 where there is a better chance that the proof of stake chain will be production-ready. From our research, this will be the fifth delay of the difficulty bomb.

Coda

At genesis, ether was initially emitted at a rate of 5 ETH per block. After the Byzantium hard fork in 2017, it was reduced to 3 ETH per block. After the Constantinople hard fork in 2019, it was reduced again to 2 ETH per block. And now in 2021 after the London hardfork, a portion of the fees paid in each block will be burned. This burning mechanism produces a lower but variable inflation rate that can turn deflationary in times of very high usage. 

The critic will claim that Ethereum’s monetary policy is too easy to change, unpredictable, and thus untrustworthy, while the supporter will say that it is trustworthy precisely because each time the Ethereum community changes its monetary policy there is a reduction in inflation. This is a fascinating debate, but our focus is on giving everyone access to a diverse set of crypto-assets that reflect their preferences while also facilitating their ability to swap out of assets that no longer align with their preferences.
 
After this upgrade goes live, the Altair upgrade is next on the Ethereum roadmap. This will be the first official upgrade for the beacon chain, which serves as the backbone of Ethereum’s move to proof of stake. The upgrade will, at the very least, include parameter updates for slashing, pushing penalties higher for stakers for the sins of downtime and malicious behavior.

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