The Risks & Rewards of the London hard fork
In just over a week from today, the Ethereum blockchain will launch its 11th upgrade, also known as a ‘hard fork’. This one is called London. It contains five Ethereum Improvement Proposals (EIPs) and each of these contains code that is aimed at optimizing and improving the Ethereum blockchain.
One of these EIPS, namely EIP 1559, has been somewhat controversial with Ethereum stakeholders due to the way in which its radically redesigns the network’s fees.
EIP 1559 Rewards
One of the arguments against investing in Ethereum has been the fact that it has an unlimited supply of coins, compared with Bitcoin’s finite supply. For many this means it cannot be a ‘store of value’ in the same way as Bitcoin.
EIP 1559 is an answer to this. Whilst EIP 1559 does not introduce a bitcoin-like supply cap on ETH, it does activate a mechanism to curb total supply growth over time by taking a variable amount of ETH out of circulation each time a transaction is executed.
A simulated model of the effects of EIP 1559 showed that if the EIP was in operation for 365 days, it would have burned a total of 2,967,937 ETH, giving a net reduction of 76% in ETH supply growth over that period.
Furthermore, EIP 1559 is expected to improve transaction wait times and remove the kind of fee-market uncertainty that dampens developer and user adoption of dapps. You’ll probably remember the many discussions earlier this year around Ethereum fees.
EIP 1559 also serves another purpose: it is expected to boost and solidify ETH’s role as a form of payment for using Ethereum’s computing resources and interacting with the network’s broad system of dapps by requiring payments of transaction fees on the network to be exclusively paid in the network’s native cryptocurrency.
Upgrades always carry risks, and the most prominent one with EIP 1559 is its proposed changes to reward dynamics and payouts to miners, who face reduced earnings for their work with the activation of EIP 1559. Instead miners will only receive tips from users through an optional “inclusion fee,” paid electively by users seeking priority for their transactions.
This may cause miners to leave the network, and if there is a major miners’ exodus then block times and network security would be negatively affected. It is also the case that the activation of EIP 1559 poses the risk of unforeseen bugs or malicious user behaviour.
For a full explanation of the implications of EIP 1559 for investors, read The Investment Implications of EIP 1559 published by Coindesk Research.