But what exactly is behind the upgrade, and why could Ethereum become a deflationary and potentially more valuable cryptocurrency than Bitcoin?
EIP stands for Ethereum Improvement Proposal. Since Ethereum is an open-source program, anyone can submit a suggestion for improvement via GitHub. But in order for the new code to be integrated on the ETH Mainnet, it must first go through an approval process. In addition, the Ethereum core developers who manage Ethereum’s GitHub must confirm the improvement proposal at the end of the process.
The passing of an EIP can therefore be thought of as the passing of a law by a parliament or a congress. An EIP can only be implemented once it has gone through a certain approval process. First, someone has to propose an EIP, then it has to be approved by developers, and finally, the proposal has to be tested before it is fully implemented on the mainnet.
The EIP-1559 differs from all previous EIPs from Ethereum. The upgrade not only aims to reduce the problem of high transaction costs but also to fundamentally change Ethereum’s monetary policy. The upgrade could even make Ethereum a scarcer commodity than Bitcoin. In addition, small investors in particular hope that the EIP-1559 will lower the ETH transaction costs, which have risen sharply in recent months.
The graph from Etherscan shows that the Ethereum transaction costs have leveled off at an extremely high level for some time. Whales can still afford the high transaction costs, but Ethereum is currently unsuitable for a majority of users.
For this reason, many investors are currently relying on smart contract platforms such as Cardano (ADA), Polkadot (DOT), or the Binance Smart Chain (BSC). Above all, the BSC was able to win over a considerable part of the capital and users of the Ethereum Decentralized Finance (DeFi) Space in the past few months. In the meantime, the turnover of some Decentralized Finance (DeFi) projects at the BSC even exceeds that of many large Ethereum DeFi projects.
Any of these Ethereum alternatives will result in users migrating from Ethereum. While many expect the Ethereum 2.0 upgrade to solve this problem, it is not yet clear when exactly this will be the case.
Some experts believe that it will take several more years for ETH 2.0 to be fully implemented. For this reason, the Ethereum community needs an interim solution as soon as possible, and this is exactly where the EIP-1559 is supposed to help.
So far, transactions on Ethereum have been carried out with the so-called “first-price auction mechanism.” With this mechanism, users outbid each other so that miners can add their transactions to the next block.
The competitive nature of this mechanism causes Ethereum transaction costs to rise. At the same time, it means that some often end up having to pay more unnecessarily than others, even though the transactions are in the same block. Therefore, this mechanism is far from fair or efficient.
The EIP-1559 will not solve all the problems of the Ethereum network, but it will be a start. As the EIP-1559 introduces a basic fee, the market price for transactions can be set per transaction block and adjusted block by block (depending on how full individual Ethereum transaction blocks are). So if the majority of the blocks are over 50 percent full, the transaction costs go up, and if they are less than 50 percent full, they go down.
Because of this, the base fee can fluctuate between the time a user sends a transaction and the time a miner puts it in a block. To counter this, users can post a maximum amount (fee cap) set. This corresponds to the maximum amount that a user has to pay for a transaction.
After inclusion in a transaction block, the difference between the final basic fee and the specified maximum amount is returned. Wallets can set this value by default so that you don’t have to set it manually every time. The advantage of this is that users no longer have to guess which transaction costs to choose.
These new mechanisms make ETH transactions more effective, as the built-in flexibility ensures more transaction capacities.
In addition, the EIP-1559 introduces a new option that makes it possible to tip miners. This tip is intended to motivate miners to execute transactions faster.
The EIP-1559 has had a serious impact on Ethereum’s monetary policy. The upgrade could make ETH one of the scarcest cryptocurrencies in the entire market. This is because the entire base fee, i.e. the fee that everyone has to pay for executing transactions on Ethereum, disappears permanently.
Because this fee is paid in ETH, more ETH will be burned as more transactions take place. Therefore, there is a possibility that the fee burn will massively counteract future inflation of the ETH offering.
In a new podcast episode from Uncommon Core, the three crypto experts Hasu, CryptoCobain, and Zhu Su, CEO, and founder of the investment company Three Arrows Capital, even sketch a scenario in which the EIP-1559 could help Ethereum to add Bitcoin in the next few years overtake.
The experts believe it is possible that the EIP-1559 will make Ethereum a deflationary cryptocurrency that will oppose a rapidly growing demand for ETH. The reason for this assumption is based on the fact that DeFi applications and NFT on Ethereum could grow massively in the next few years. That, in turn, would lead to an increased demand for ETH. In addition, they believe it is possible that Ethereum, due to its deflationary nature, could develop into a “safe haven asset” that Bitcoin could overtake.
If the three crypto experts have their way, then you should definitely listen to Ethereum. Even so, one should keep in mind that the EIP-1559 is not the panacea for all the problems the Ethereum network has. Although the upgrade brings enormous improvements, it is already clear that the scaling problem of Ethereum cannot be completely solved by it.
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