Taylor Monahan, CEO of MyCrypto, and Tim Beiko, Ethereum Foundation core-dev facilitator, discuss the upcoming upgrade to the Ethereum network, EIP 1559. Show highlights:
- why Tim believes EIP 1559 is necessary
- what narrative is driving EIP 1559
- what problems the network upgrade will solve
- how Ethereum transactions/fees work
- whether gas prices are correlated with ETH/USD
- the 3 main protocol changes that EIP 1559 proposes
- why Taylor, as the CEO of a wallet provider, is wary of EIP 1559
- how EIP 1559 will affect Ethereum’s block size
- what changes wallet providers are considering due to EIP 1559
- whether ‘Black Swan’ events will be more or less likely after the network upgrade
- how EIP 1559 will affect miners
- whether Tim or Taylor believes that miners could fork Ethereum to stop EIP 1559
- how EIP 1559 will change the state of miner extractable value (MEV)
- how Taylor and Tim feel about the Ethereum as sound money narrative in light of EIP 1559
- when EIP 1559 will go live
Thank you to our sponsors!
- Resources: https://hackmd.io/@timbeiko/1559-resources
- Taylor Monahan tweets
- Actual proposal: https://github.com/ethereum/EIPs/blob/master/EIPS/eip-1559.md
- Research: http://timroughgarden.org/papers/eip1559.pdf
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Today’s topic is EIP 1559. Here to discuss are Taylor Monahan, founder and CEO of MyCrypto, and Tim Beiko, Ethereum Foundation core-dev facilitator. Welcome Taylor and Tim.
So we’re here to discuss this upcoming upgrade to the Ethereum network called Ethereum Improvement Proposal 1559. It will be a pretty substantive overhaul that will affect a number of things on Ethereum, including its monetary policy, security, and user experience. Can you give an overview of what EIP 1559 does?
Sure. I can take that. EIP 1559 is, like you said, a pretty big change to Ethereum. At a high level, what it does, is it changes the way transactions are included in block — from going to a spot where all of the blocks have a fixed size and then the transaction fees need to vary a lot in order to get into the block, to allowing blocks on Ethereum to have more of a variable size so that we can get tighter bounds on the fees that people pay on Ethereum. That’s really kind of the gist of it. And in order to get that right, there’s a ton of adjacent changes that need to happen.
Maybe it’s worth taking a minute to explain kind of why we’re going about it this way. So if you look at transaction fees on Ethereum and Bitcoin, and most blockchains that don’t have something like EIP 1559, they typically use what’s called a first-price auction. So that means people will just put in a bid, which is your gas price on Ethereum, and whoever has the highest bid gets included.
The problem with that is it leads to people overbidding. It’s kind of like buying a house in like a hot market where like the house might be listed for a million dollars, but you really wanted it, so you put down $1.1M, somebody else will put the $1.2M, and then somebody else will come in, and they’ll put $1.5. They’ll pay $1.5 million, even though they could have paid $1.2M and 1 cent — they would have still been the highest bid. So that difference is kind of a loss to them. Outside of blockchains, this problem is actually solved for the most part. Typically what people do is they’ll use a second price auction.
The most popular implementation of that is stuff like Facebook and Google ads, when people bid to have an ad show up in your Google search or your ad feed, they’ll do the same thing, right? Everybody will say how much they’re willing to pay, but then they’ll only pay the second-highest price. So if I would have paid one dollar, Taylor would have paid two dollars, and you would’ve paid three dollars, your ad gets put in, but you’ll pay Taylor’s $2 bid. This is kind of like the optimal economic way to do this.
The biggest problem is the record. It requires a centralized party to look at all the bids and trustlessly say this is actually the highest and the second-highest. And because we don’t have this kind of central trusted third party on blockchains, we can’t simply switch to that model.
And that’s why we need to do something like EIP 1559, where, instead ,we just have this value in the protocol, which we call the base fee, which tells you what’s the minimum amount you need to pay to be included. And if more people want to do transactions on Ethereum, we simply raise that minimum. And if fewer people want to do transactions, we’ll lower it. So this is a bit of background on how it works and kind of why we have to use this pretty special and sometimes convoluted mechanism on Ethereum.
Taylor, do you want to add anything?
I think that was a really good explanation. I guess from my perspective, I think the biggest points of conversation right now are more about like the monetary policy aspect of it than all the other things. Because as I was doing my research from like a variety of perspectives, right? Like, I’m a wallet, I need implement this perspective, but also like I’m an Ethereum holder and I care about this stuff, perspective… I was actually really surprised to see how much the sort of, I guess the narrative behind the EIP 1559, has changed. And I don’t necessarily think that that’s the contributors to EIP 1559, the writers of EIP 1559, whatever you want to call them. I don’t think it was them so much doing it.
I guess for most of 2021, it’s been more about the monetary policy and specifically about this like idea that the inflation decreases and therefore the price of ETH goes up. Like that very FOMO-y, hyped up narrative was kind of overwhelming. That that’s where I guess some of my commentary has been coming from.
We’ll dive into all that in a moment. First we’ll just cover the basics on EIP 1559. But did either of you want to elaborate a little bit more on the other problems that EIP 1559 aims to solve? So there’s overpayment or inefficiency of payments, but was there anything else that you feel this is trying to tackle?
One of the things that we see — I think any user of Ethereum has experienced this — is the fact that you don’t actually know what to pay. Period. Like you’re trying to send a transaction and you don’t know what to pay. And part of the reason is because the wallet doesn’t actually have all the information it needs because you, as the user, are the only one that knows what priority your transaction is. Right?
Sometimes I’m sending a transaction and it’s a payroll, or it’s something like that, and I just want it to go through at some point today, and I want to be confident that it’s going to get through. Obviously there are all the DeFi farmers and the arbitragers and the traders who need that transaction now, like the next block. They’re so hardcore about it that like if it’s in three blocks, they don’t want it. Or if it’s in two blocks, they don’t want it. If it’s not in the next block, they don’t want it to go through.
And so there’s a lot of different issues where like the user, the person behind the screen, has information that the wallet doesn’t have, but the network doesn’t have. It’s just a mess to be honest. There’s so many different factors and all of those things coming together in the most elegant way is what this EIP is trying to solve. And I think it does a good job at a lot of them actually.
And maybe two things I’ll add to that, like on the user part specifically. One thing that’s kind of neat about EIP 1559 is it lets you say what’s the maximum you’re willing to pay for your transaction. But then it gives you a refund for the difference between that and basically the market price. Whereas today, if you know, I’m willing to pay 10 gwei or 20 gwei or 50 gwei, I’ll have to put that as my gas price. And that’s like the amount that will end the paying. But maybe I could have been included for 12 gwei instead of 20 gwei. 1559 by default kind of gives you that to refund. I think the other part that’s kind of somewhat related to the monetary policy that I do find quite important, is 1559 makes sure that transaction fees on Ethereum at the protocol level needs to be paid in ether.
If you start from the other way and I tell you there’s this blockchain called Ethereum, and ether is like the currency that you use to transact on it, but you don’t actually need ether. You don’t actually need ether to use it. That kind of sounds like a bug. To me, it kind of fixes this bug in the economics where now after 1559, every transaction needs to pay at these a minimum part of the fee using ether. Wallets and miners and whatnot — they’re still free to like abstract that to their users. There will be services that allow you to pay for your transactions in DAI or we’re even seeing some company allowing payments with fiat and whatnot. But behind the scenes, whoever is including your transaction in the block, actually needs to own ether to pay for that transaction. That’s like a pretty fundamental part that I think was missing in Ethereum, that 1559 brings.
When I first read about that, I thought, who’s going to use Ethereum and then try to pay the fee in something other than ETH? It just seems like that’d be the easiest way. But then when I was doing research, I actually came across this report that was like, oh, here’s an example of such a transaction. And I thought, so people are actually doing this. We’ll get more into this later, but essentially what will happen after this is adopted is that this fee is burned. And in order to have that fee be burned it can only be burned in ETH. And so even if someone were to try to circumvent, eventually the miner would have to obtain enough ETH to pay that fee and have it burned.
So let’s actually just dive into the fee issue because that’s been probably one of the biggest pain points for Ethereum users for quite a while now. But before we get into the particulars on that, I just want to make sure the whole audience kind of has the baseline. Why don’t we just kind of break down, at a simple level, how fees for transactions work on Ethereum right now?
Right now, if you want to send a transaction, most of the wallets will abstract this away in some capacity. You have the gas price, which is the call it like the multiplier, the priority, the speed — it’s how fast the transaction is, right? The higher the gas price, the more the miner will be paid, and therefore the more likely the miner is going to include it in the block sooner — the miners prioritize the transactions that pay them the most over ones that pay them less.
Then you have the gas limit, it’s basically how much computational power a transaction takes. And this is why a basic transfer of ether costs less than doing some fancy, crazy flash loan with four different DeFi protocols.
Together, combined, they create the transaction fee, and that entire fee is attached to your transaction. Whatever you’re doing in your transaction, whether you’re sending ether, doing a contract, or whatever you’re doing, that transaction fee is attached. Then that ether is moved from you to the miner who successfully mines the block. So from the miner’s perspective, they have all of these transactions flying at them, and they all are promising different amounts of money, and they choose the ones that have the most money. They include those in the block next.
If the block is full, which it is a lot these days. If the blocks are full, that’s where you get into these crazy situations where like Uniswap does an airdrop, and then everyone’s trying to claim their UNI and running around and racing. And the gas price goes from say 5 gwei all the way to 500 gwei in a matter of hours. And then me, I’m like, what’s going on? I just want to run my payroll. I just want to buy my coffee. That’s where the frustration is stemming from. And it makes sense. It makes sense from the miner’s perspective, it makes sense from the perspective of the protocol, but as a user, I’m just sitting there going like, screw this.
And Tim, did you want to add anything?,
I think that’s like a very good overview of the status quo. One thing that’s worth highlighting too, is yes, for example, when UNI makes an airdrop, more people want to use the chain, so it makes sense for the price to go up, right? Because the kind of demand for the chain is increasing and obviously the supply of block spaces is fixed. But what you start to see in those periods, is people who get included in the same block will pay wildly different prices. And this is kind of the craziest part because except for the very first few transactions in the block, which often are transactions with MEV or arbitrage opportunities or things like that. After that, the basically there’s no difference whether your transaction is like the 50th or 60th in a block.
Ideally, you’d want to pay the same price because you’re getting executed at the same time. And if you look at the data right now, we’ll sometimes see like a 5X-10X difference between the 10th percentile transaction price and the sort of mean or median. This is what 1559 will help reduce. It won’t make the price cheaper when everybody wants to use Ethereum at the same time, but it will make the range of prices that people pay kind of much tighter. And it’ll tell you, well, if you want to use Ethereum right now, this is how much you should pay. And if if the price is too high, you’re welcome to wait, and wait until the UNI airdrop is over. But at least you’re not trying to kind of outbid everybody and then end up overpaying.
I think of it a little bit like the Uber or Lyft price surging element, you know? One thing that I see confusion about sometimes online is people feel that maybe the price of ETH can be correlated with the fees. But as far as I understand, the price of ETH going up does not directly cause high fees. It’s that at that time, it’s correlated at times of high network activity, which is what causes the gas prices to go up. Is that a good explanation?
It always depends on what timescale you’re looking at, right? If you look on a very short timescale, I would say that gas fees are correlated not with the price, but with the volatility, mostly because of DeFi. So if ETH goes up 20% in a day, everybody will want to take loans, a margin loan, on ether. That obviously creates demand for the platform. Similarily, if you see ether drop 20% in a day, then people want to like fund their loans and not get liquidated and whatnot. And that creates activity. So it’s not the fact that the price is high or low, but there is some correlation between the volatility of the price and the gas fees. It is worth noting though that the gas price you pay is like independent of the ETH/USD price. Assume you have like just the price going up kind of steadily without much volatility, and the same amount of demand for the network, then the actual price of ETH would go down, right? Like the two markets to start are deccorrelated, but because you have DeFi which uses ETH/USD price as input, it obviously blurs the two together.
There’s a word for the relationship, but I can’t remember it. It might be like, oh God, it’s like reflectively or one of those words, right. Where, because this is happening over here, it’s like causing this, and so there’s this relationship between them, but they’re not actually directly correlated. The relationships are actually really interesting cause you have the ETH/USD price. With the amount of like wrapped bitcoin on Ethereum, now you also have like the ETH/BTC relationship.
What Tim said is a hundred percent correct in terms of the volatility. All the people who are trying to make moves, that becomes like more and more urgent when there’s a high spike up or a spike down. And then you also have to keep in mind with DeFi, you have things like liquidating loans, arbitrage opportunities, or these bots that actually are reacting to certain market conditions.
And, again, if the price of ether is generally stable, your loan isn’t going to be liquidated, which means that the arbitragers aren’t going to be doing these two things at one time to try to make money. You don’t have the bots running around chasing the loans. All of those things are just not happening. So it’ll be interesting.
But another thing to keep in mind is the demand for Ethereum. Technically, when we think about markets, it usually means higher demand Ethereum means that the ETH price does go up as well. So that’s like another relationship. You just have all of these relationships intertwined. I don’t think any of them are directly correlated, but they do have this reactionary relationship to one another.
So now that we’ve kind of just set the picture of how things work right now and kind of what some of the issues are. Let’s dive into more details on how EIP 1559 changes how fees are calculated on Ethereum. We can get more granular now.
I can give like the protocol view and then I think Taylor can maybe talk through how wallets will actually show this to users. At a very basic level, 1559 does three main protocol changes. The first is that it introduces a new transaction type on Ethereum. So this is something that’s sometimes misunderstood. Legacy transactions, like transactions with gas prices, will still be possible. They’ll still burn ether behind the scene, but if you’re using your wallet or if you are a wallet and you don’t want to update, you don’t want to support 1559, it’s optional.
You don’t need to actually change the types of transactions you said. But with EIP 1559, we introduced a new type of transaction which has a few benefits. Basically that new type of transaction will not have a gas price like the legacy transactions on Ethereum.
Instead, it will have two components to the price paid. One is called the max fee or a maximum fee. The other one is called the priority fee. In the past, this was called the tip. So if you hear about the tip, they’re basically synonymous. The max fee, like I mentioned earlier, is basically the maximum amount that you’re willing to pay for your transaction. The priority fee is the maximum amount you’re willing to give a miner for your transaction. So this is all that changes on the transaction side.
On the Ethereum blocks, every block will now have what’s called a base fee, and this base fee specifies what’s the minimum gas price that a transaction needs to pay to be valid in this block. And so what this means is if you send a transaction with a maximum fee that’s lower than the base fee, that transaction is no longer valid.
And this is really interesting because, today, for example, the gas prices today are roughly 20 gwei. If I send the transaction with one gwei, it’s not actually invalid, even though it might never be included. And this causes like a lot of drag on the system, because you can’t put a clear line of, oh, this transaction is in and this transaction is out. So after 1559, we’ll have like a really clear view into the transaction pool of these transactions could actually be in the block and these could not.
The last protocol change that we make is blocks go from having your fixed size to having a variable size. So right now on Ethereum, we have a gas limit, which is the equivalent of the block limit in Bitcoin, which says this is the maximum amount of transactions that can go in.
Because of demand for the network, blocks are basically always full. So if you’re a wallet or app developer or anyone who’s kind of interacting with the network, your default assumption is like, there’s no room in the block, right? Everything is always full.
What 1559 does, is it doubles the block size on Ethereum and it aims to keep it 50% full. And when blocks are more than 50% full, and we simply raise the minimum price until it’s back to 50% full again. And if it’s less, we’ll simply lower the minimum price to kind of induce demand. So that means that when you’re sending your transaction, on average, there’s always going to be kind of extra room in the next block to include you, as long as you pay this minimum price.
And this is like a really nice property because, today, if I send a transaction say gas prices are 20 gwei, I send my transaction and it just kind of shifts a little bit on me, and it moves to 25 gwei, I might end up waiting five, ten minutes and not knowing exactly when my transaction and then I’ll speed it up on MetaMask because I actually don’t want to wait five or ten minutes. Whereas after 1559, I could just say, look, the maximum I’m willing to pay is like 50 gwei. So even if the next block was 20 gwei, but it was full. I kinda missed that one. Then maybe the minimum price in the next block is like 23-24 gwei and then I get included in that one, and I’ll get the refund from like the 50 gwei minus 24 gwei.
On a protocol level, this is basically what it changes. Last thing, as we mentioned earlier, is obviously this transaction fee, this base fee, needs to be paid with either directly from the account that is sending the transaction.
Yes, that was good. That was a lot, but that was good. Thanks.
Now, do you want to talk about it from the wallet perspective?
I love that Tim said that from a wallet’s perspective, all the blocks are full all the time. That’s our perspective. When the blocks aren’t full, we don’t have to deal with it. Like we don’t get support tickets. I can pay my payroll. Users can just go about their lives. Everyone’s happy. Also, people aren’t paying as much. That’s also like happy users, whereas when the blocks are full, not only are they paying more, but if there’s like a weird token and you’re trying to send and the gas limit estimation is off for whatever reason — there are a variety of reasons this happens — but then the transaction fails, but you still pay a certain amount for a failed transaction.
That’s like a really bad experience. Back in the ICO days, people would be like, I didn’t get into this ICO, and I still paid you. You are the devil. And I was like, no, no, it goes to the miners. I’m answering this for free, sorry. All of those reasons is why we’re so focused on these like high periods because when everything’s swimming along smoothly, like we’re happy, users are happy, everyone’s happy. And so I think that when I look at the EIP 1559, I’m looking at… I think in like normal-ish times, you know, meaning that when either the demand is stable, the base fee is stable, it’s not increasing and everything’s happy, then yeah, we’re all going to be happy.
So then the question is, okay, so what happens when things are congested? For wallets, another question that we ask ourselves is what are the edge cases?
In a world where we’re responsible for, even for noncustodial wallets, like we still have a major impact on what people pay and whether or not their transactions are, or are not, successful. It’s like always this balance between educating and showing and giving users a choice versus abstracting everything away. If we abstract everything away and then the user doesn’t send, the transaction fails, they pay too much, or they pay more than they expected. That comes back to us because they never really had a choice. And so that’s like sort of this big mashup of hard questions that we have to answer in the design process. And that’s why I think some of my criticisms of EIP have been…The writers and staff have been like 99% of the time, Taylor, it is going to be fine.
And I’m like, yes, but we already are fine during those times too. I’m worried about these other times. I think the outside perspective, like people on Twitter watching us are going… I don’t understand why you’re arguing, what’s going on?
So that’s a little background on like how wallets look at stuff. I think that how we’re going to handle it in general, like from a very high level, right, is currently most wallets, give you a look at the USD estimate of the transaction fee and they abstract away both the gas limit and the gas price. Then there’s various levels of advanced mode if the user does want to give input on how much they’re willing to pay. So if they want it to be faster or slower. That’s going to change because of the biggest thing is, I think for me personally, the biggest mind shift is moving from speed to priority, which we already have sort of done.
It’s like a brain split right now. Sometimes we’re thinking about how fast the transaction is going to be mined versus what priority it is in the block. But specifically with EIP 1559, we’re thinking a lot more about the priority of the transaction. It’s interesting that that has also come along with this EIP with everything else.
And actually giving the user that information or framing it in a way for the user so that they can also have that mindset. So that, again, they’re going to have that education or that information to make the informed decision with the information that only they have. I think that the UI specifically is probably going to remain — it’s going to be like slightly different, obviously, but I think that in general, the user’s going to be presented with some sort of selector or slider or choice and the transaction fee is going to be displayed in USD. And it’s going to be a slight estimate.
I think that now we’re probably going to have a range rather than rate. For now, MetaMask and our UI both show a single value. You’re going to pay about $5.83 for this transaction. It’s probably going to change so that we show, you’re going to pay between $5.83 and $10.79.
That’s a whole another question for me, especially. As a user, I can definitely make a choice. I am willing to pay $5.83. Saying I’m willing to pay between $5.83 and $10.32 is like a different choice. So we’ve been going back and forth on whether we want to give them just the highest one? But then does that actually set them up for failure if they always get like half of that back?
So if I send a transaction every single day for a year, and I say I’m willing to pay $10, and then I get $5 back. I only ended up paying $5. Then one day I’m like, yeah, I’m willing to pay $20 because I’m actually willing to pay $10, but the network is congested. So I actually paid $20, but I wasn’t actually willing to pay $20. Those are the UX issues. It’s a lot. And yes, it’s going to be for the times of high congestion where things are like rapidly scaling up, but they’re hard problems to solve.
We’re going to get into this more in a moment, because there’s something that I was wondering about when I was researching this, which is about… there’s this flexible block size. We have these periods where there can be congestion kind of for a while. And so it was like, well, if you’re trying to target this 15 million gas, like what’s to stop it from always maxing out at the 30? And then how do you get back down to the 15? Because maybe you’re just gonna have miners that are mining empty blocks for awhile? Anyway, let’s talk about that right after this word from our sponsors who make the show possible.
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Back to my conversation with Taylor and Tim. So I kind of asked the question right before the break. Can you just talk about this flexible block size? I just had the founder of Polygon on my show and he was saying, oh, even when Ethereum 2.0 is adopted, we imagine it’ll get full very quickly. And so there will still be a need for Polygon. And that’s probably true. So how are you going to keep this average?
I think here, it’s helpful that I differentiate between the long-term average and the short-term spikes. To answer your question, it’s like why won’t blocks just be full forever? The short answer there is it’s the speed at which the base fee increases.
So right now the base fee increases if you have a full block — it goes up by 12.5% in the next block. That takes roughly five minutes to 10x and it’s exponential after that. So it means in 10 minutes, the gas prices are up a 100x, and in 15 minutes of full blocks, gas prices are up a 1000x. Just to put this in context, in like the entire history of Ethereum, we’ve seen roughly a 1000x variance in gas prices from the very start to now, and that’s kind of an upper range.
So that means that in practice, it would be like extremely rare to see like something like 15 minutes of full blocks because at some price, people are just not willing to pay. So what happens is prices is 20 gwei and then it goes up to like 50, 100, 250, 500 gwei. At 500 gwei, nobody’s willing to pay the base fee or less people than fit half the block are. So then the gas prices start coming back slowly again and it reaches kind of this equilibrium at the price where there’s about 15 million gas worth of demand.
One thing that’s nice about that does, it means this kind of spike in usage is processed twice as quick as it would be today because for like the short period of time where there’s a bunch of people willing to pay super-high fees, we have blocks that are twice the size as they are. But if you look over kind of a long-term average, you’re not going to have… you might have a lot of these small spikes, but you won’t just see like some major spike forever. I think I calculated, but to fill something like 100 or 200 blocks, you’re burning like a 100,000 ETH, in terms of transaction fee. So it’s just the speed at which the space increases limits how long these spikes can last.
So basically at a certain point, it’ll only be whales who will be transacting.
Well, at some point the whales will finish their transactions and then it’s back to everybody else.
By the way, we see this currently, right? I mean the UNI airdrop is one example, but the also on March 12th, when the whole world collapsed and Maker collapsed, and there was this chain reaction of all these things that happened from the real world to the crypto world, to the Bitcoin world, to the ether world, to the oracle, world, like everyone was impacted. We saw such high gas prices because there was an insane amount of volatility, but also an insane amount of money to be made both if you were like going to liquidate something — you could make money — but also if you wanted to prevent yourself from being liquidated. Everyone was in this boat of like, I need this transaction on network now. However, everyone else was like I’m just going to sit here and not do that.
And this is exactly like Uber surge pricing, like you were mentioning earlier. It’s like getting an Uber on New Year’s Eve, basically.
Even that period of time, we’re not talking about months, we’re not even talking about weeks, we’re talking about days, in terms of that high pricing. So it’ll be interesting to see how the base fee reacts both upwards and downwards. Because we do talk a lot about how the base fee moves up, but we don’t talk about what the conditions are to make the base fee go back down. Because currently, like you get up to 500 gwei and then Black Thursday or whatever happens, and you’re at a 1000 gwei and you’re dying. Then it comes back down naturally. Now that’s actually at a protocol level as well. I don’t know you guys. The devs and the researchers, they’re very confident in this, so I have faith in them, but I don’t personally understand it.
So I guess, just to touch on that. Regarding the base fee, basically the way it goes up or down is if a block is empty, it’s down 12.5%. If a block is full, it’s up 12.5%, and it’s a linear curve. If you are very math savvy, you will realize that that means it comes down a bit slower than it goes up because of how fractions work. That’s like a small edge case where we’ll probably change in a future iteration of 1559. But it doesn’t change like the fundamental design, where imagine you get to a spot where like you’ve processed these 1000 gwei transactions. Then the next block might be 25% full, rather than 50% with like 800 gwei transactions. And so these transactions will get into that next block and then the fee will lower again.
And then maybe you’re doing like 600 gwei transactions. It’s kind of clearing the backlog that way, until you’re back to like this the kind of normal equilibrium of whatever the gas price was before that surge. I’ve been like roughly tracking them. This is not like super data driven, but it feels to me like about once a quarter, we have like these… you can’t really call them Black Swan because they’re so frequent. But like these events where everybody needs to transact on-chain right now. That seems to be roughly the frequency.
In the absolute worst case, it’s also worth noting that when everybody’s trying to out-compete each other to get their transaction in in these crazy periods, that’s basically the system we have today, right? Where today, all the time, in every block, people are trying to out-compete each other to get included in this limited block size. The part where I sympathize a lot with wallets is they need to keep supporting both forever, because like you said, Taylor, like this 1% is really important. But from the end user’s perspective, it’s like the average case today, becomes kind of their worst case 1% of the time. And then whenever that’s not the case, the system is much simpler and has better guarantees around inclusion.
I think that one one thing to point out from me, a wallet’s perspective, is that initially I was sort of looking at it like, okay, we need to build a system that gives the user this transaction fee range that’s going to be accurate in all conditions, all the time. And you have periods where its stable. Periods going up, you have periods going down. How do we create this system and stuff like that?
But one thing that I guess I’ve sort of changed is we need to really drill into the user’s needs, right? Letting the user say what priority that they want their transaction to be included at and giving them some semblance of an approximate price probably denominated in USD, so that they understand how much they’re going to be paying for this so they can make that informed decision.
Then we, or the network, have the information of how congested the network is. What the current base fee is. We can look at the priority, the tips. We can look at those as well and see what they’ve been, either over a period of blocks, like the last 50 blocks, the last 5,000 blocks, or the last one block — however we want to calculate it.
Right now, it’s all the same, right? So right now, we look and however people are estimating the gas price, they’re looking at the past and they’re guesstimating what the the inclusion will be for the next block all the time. And so there’s basically just this one scenario.
What we’re looking at now is, okay, there’s not one scenario anymore, and there’s not a one size fits all. We only should give them this very high price range, right? The $5 to $10 or the $50-$100 in those periods of uncertainty. We don’t have to give it to them all the time. And that’s one of the things that I think a lot of people, if they have experience on the wallet side, or even if they’re like an exchange — if there’s any transaction on other people’s behalf, that’s a huge mind shift. Like it really is a huge mind shift.
I guess the range of information that you’re giving the user is tighter. It’s actually directly correlated or should be directly correlated with volatility of the base fee, the priority fees, or the network, however you want to look at it. If everything’s generally okay with the network, everything’s generally stable, we can potentially give them a “about $5 fee” and that will be like the 99% of the time. And then just catching those edge cases and the 1%. I mean if it was me, right, I would be like, hey, think twice before you do this, because like stuff’s blowing up and you might pay $50 or you might pay a $100, we don’t really know… good luck! Especially for that first Black Swan event.
That would be hilarious. One thing I wanted to ask about was earlier I mentioned the transition to Ethereum 2.0, which obviously is an actual scaling solution and is meant to address the congestion issue. Between the two: when we have 1559 first, and then we’ll move to Ethereum 2.0. Between the two, this kind of like greater efficiency and fees, and then improved scalability… do you think that maybe that will reduce the number of these kinds of times when there’s just like high congestion — these quasi Black Swans? What will look like when the two are both adopted?
I think the Black Swans are going to continue on — or the frequency of the Black Swans is going to change not because of ETH 2.0 or because of this EIP 1559 or anything. It’s going to change just in general, over time, as Ethereum as a network matures. ETH 2.0 obviously part of that. It’s more about the maturity of the network. We’ve seen this a bit with Bitcoin.
When people talk about like the need for stablecoins and the fact that Bitcoin is worthless because it’s volatile and you can never buy coffee with it and those types of arguments. I think that over time, it starts off very volatile. And then over time, we’re going to see that curve sort of flatten. That’s probably going to be, in my opinion, the biggest change — with both the frequency and whether we’re talking about a 1000x volatility or a 100x volatility. Time and maturity.
Wait, I’m sorry. So you’re saying that because you think the price of ether will go up, then we’ll face other kinds of criticism. Is that what you’re saying?
ETH 2.0 isn’t gonna probably directly impact the frequency of Black Swans. It’s just the fact that Ethereum, as it becomes more mature, it becomes less volatile. So then there will be less frequent Black Swans. And when a Black Swan does happen, it’s less hurtful. In my opinion, we’re probably never going to see another March 12th again. Now that I say it, it’s going to happen tomorrow.
Famous last words.
I’m very interested to see how ETH 2.0 does impact over the long-term. Over like the year time period rather than the minute time period. Because I think that with this, both this EIP and ETH 2.0, in the short term, everything will be happy for a short period of time. There will be enough room in the blocks. That’s how these things typically work. We saw it a little bit when we increased the max block size — everything was happy for like a week.
And Tim, I cut you off early. What were you going to say?
I suspect we’ll probably have more and more like localized Black Swan’s, if that makes sense. So the the main way that we’re actually scaling computation in the next one to three years is like through roll-ups. We’re already seeing some go live. You’ve seen also the side chain — solutions like Polygon.
What I suspect is going to happen is that as more and more activity moves to stuff like roll-ups and Polygon, you might see these Black Swans on specific roll-ups. Like maybe something happens on Polygon. There might be some cases where like, it happens across the entire ecosystem. Like you saw like on March 12th where there’s just a crash across everything. So that’ll be like a mega one.
I wouldn’t be surprised if you just see these kind of micro Black Swans or something happen on different roll-ups at different times just because the arbitrage opportunities or different stuff like that. That kind of leaves the main chain to operate a bit more smoothly. So that would be my prediction. I still suspect though, that we’re nowhere near to like smooth sailing. At least for the next couple of years, like there will be some other stuff, like there will be things that happen that just create huge volatility in crypto. That’s kind of part of the space we work in.
So as we mentioned before, EIP 1559 will also change Ethereum’s monetary policy because since those base fees will be burned, that leaves the potential for ether to become deflationary. If people are familiar with Bitcoin, this should lead to the price going up as adoption increases. So one thing that I’ve kind of heard about a little bit is that there are rumblings that miners aren’t super excited about this because that will at least reduce kind of in absolute terms, the amount that they’ll take home in ether. I just wondered, I don’t know if there’ve been any studies done on this, but given that the dollar value may rise in conjunction, how do you expect that this will actually impact miner revenue? We’ll say in dollars.
I can take that one. I’ve spent a lot of time talking with miners. So miners have a lot of variability in their business model outside of 1559. The first one you just mentioned is the ETH/USD price. Like if they mine two ETH worth $4,000 versus worth $2000 versus worth a $1000 — their expenses are like electricity and machines that they pay with fiat. So that has a big impact.
The second big factor is hash rate. So how many other miners are there? They can maintain all of their costs at a fixed price. The price of ETH can stay fixed, but if more people mine, then it becomes more competitive, and their odds of getting a block drops. So their revenue is also effectively lowered.
The third part that is variable in their income is transaction fees. And you can think about like two classes of transaction fees. There’s just like the general fees that everybody pays. Then there’s fees for arbitrage opportunities. People call this MEV, miner extractable value. So this is the fee that people are willing to pay for the top arbitrage opportunities on Ethereum.
After 1559, obviously, we’re not going to change anything with regards to the hash rates. So that variable is kind of out of our control. The ETH/USD price, I think is very hard to speculate on. Even though a lot of people make the argument that like 1559 reduces the supply with every transaction. And so if you have a smaller supply, the price should go up. Yes, that’s true, but that’s true if you consider no other factors affect the price of ether.
That’s just like not true in practice. There’s so many things that have a much greater impact. I’m not saying like 1559 will be negative for the price or positive. 1559, over the long run burns part of the supply. But in two months, or on any short timeframe, there’s a thousand things that could happen that impact the ETH price to a much greater extent.
Lastly, one thing that’s worth mentioning is miners are paid to secure the network, right? Like that’s kind of the whole point. They should not necessarily get more or less money based on how many people want the transact, because the security needs of the network do not change based on that. In practice, they change a bit, and they will, even after 1559 gets slightly more money when more people want to transact.
There’s no reason for them to get all of that surplus. With all that being said, it’s kind of hard to estimate exactly how much 1559 will impact my revenue. Because first of all, transaction fees off the network are very volatile. Like if we would have had this podcast three months ago, gas prices were like 500 gwei. At that point, transaction fees were actually higher on average to block rewards for the miners. So miners were upset because they were like, “you are taking away half our revenue.” Today, gas prices are like 20 gwei. Transaction fees are back to like a small subset of the block value. It’s worth noting, it’s not all of the transaction fees that’ll be burnt, because people who still want to have arbitrage opportunities, so who are competing for like a specific slot in the block, they’ll still want to pay the miner a lot of money to get that slot.
The burn-in 1559 doesn’t change that. So there’s been different estimates. They vary from 25% of transaction fees burned to 75%. It’s extremely hard to to tell you that this is how much exactly we’ll see burned. It is like a pretty volatile industry to be mining.
One final comment is it’s worth noting also for miners, if there’s some listening, mining will also be ending on Ethereum pretty soon, right? We are moving to proof of stake. The most optimistic people that are targeting the end of the year. Maybe more realistic is like early next year. Worst case is probably I don’t know, mid next year, if kind of everything goes wrong and we need to fix a bunch of things. There’s not really a world where there is proof of work for more than a year in the most optimistic case on. This also factors a lot in miner’s decisions to buy equipment.
I’ve heard like some rumblings that miners might try to keep EIP 1559 from being adopted, but does that look like a likely scenario to you at all?
So I haven’t seen any kind of proposal to like fork Ethereum when the London upgrade happens. If miners or part of the community wants to do that, it’s their right. That’s kind of what’s nice about blockchains. I think one part here that’s really important, though, is that the power that all of the Ethereum community has to coordinate around what they want to call Ethereum. Basically any project that’s relies on anything off-chain needs to target a specific fork when that happens. The most obvious example is stuff like a fiat collateralized stable coins, right? If there’s a fork on Ethereum, your USDC in a bank, the dollars don’t double. So they need to say, this is where it’s valid.
Any project that uses just an ETH/USD as the price from an Oracle also needs to say, what’s the price that we’re looking at? Even things like the Beacon Chain deposit contract, right? Like the Beacon Chain follows one chain to credit that ether back onto the Beacon Chain. And so they also need to decide which fork it follows. And so I think this is something where core developers are obviously putting this upgrade out. As I see it, there’s like tremendous support of the community. And it seems like all those projects will rally around that fork. If miners or another group wants to start their own competing fork, they’re free to. At that point, it becomes all of these actors that need to coordinate about what they want to support. To be careful, I’m not aware of such a fork being planted.
It’s not as easy as it used to be. I hate to say it like that, but it is. I guess one of the things that looking back at the DAO hard fork that I realized now, that I didn’t at the time, was it was relatively easy… The coordination is one aspect of it. But like telling everyone that they’re going to double their money. You’re going to have two chains, or even 1.5 their money, or even maybe 1.2x money. That’s a pretty promising premise for a lot of people, especially exchanges and stuff. With this, the risk is much higher because if you happen to be on the other side of the fork, the DeFi stuff, the stablecoins, the interactions between one thing and another — and even if we remove all of that, you still have everyone right now battling for liquidity on one chain.
Like you have all of these incentives, you have subsidized rewarding, you just have all of these different things. And if there was a hard fork, you would now have all of that, times two. The amount of complexity and the amount risk to actually lose money because you’re not gonna 2x money. You’re not going to 1.2x money. You might lose your money because this might happen or that might happen. Or this thing that’s interacting with USDC here, but USDC is on the other chain. There are so many unknowns. I honestly, at this point, think that Ethereum… it’s not unforkable, but I don’t think there’s a scenario where you can have a true light chain split like we did in 2016. I really don’t think so.
Especially because of composability and DeFi, like so many things would break on that side.
I have a controversial opinion on this. I think that’s a good thing. Like if you are going to support a fork of Ethereum, I don’t think it should be easy to just fork the network because you see that it has a high potential for scams. We see this with Bitcoin now more than Ethereum. Funny enough, in 2017 it was kind of the opposite criticism. It’s very easy to fork Bitcoin because it’s just a set of UTXO’s. So you have Bitcoin Gold, Bitcoin Silver, and whatnot, and people can just fork that to infinity. They can like profit off newcomers to the space saying that this is the real Bitcoin or the better Bitcoin or the green Bitcoin and then retail gets dumped on by those projects.
If you want to fork Ethereum because you have like a legit disagreement, I think that’s fine. But being able to support sort of a DeFi collapse or having a migration path for it… to me seems like one of the many problems you will need to deal with in like the next five to 10 years of supporting your your fork. If you can’t even handle that, I don’t see how like your fork is going to be like long-term legitimate. Obviously, there is like a much higher bar for forking, but I think it’s because the stakes are much higher and that sort of protects newcomers in this space to some extent where like, there’s not like a different fork of Ethereum every day.
Yeah, yeah, really good comments.
So another issue that muddies this aspect of what it is that miners will earn is what’s called miner extractable value (MEV). And this is value that miners can earn, but they do it by reordering or censoring transactions on the blockchain. So how do you expect MEV to affect miner behavior once EIP 1559 is adopted?
As a little bit of background, the reason that MEV is a thing, and specifically a thing on Ethereum and not so much on other networks, is because the miners can actually get, well, the people that are using Ethereum and using these DeFi protocols and using these tokens, there’s this additional layer of value. The risk and the value, both of them are very, very high when you have these layers of interoperability in DeFi and just all of the different pieces working together. What MEV is, is basically someone kind of side-channeling or back-channeling a payment to the miner that isn’t necessarily attached to their transaction in the traditional way. The reason that everyone sort of gains from this relationship is because a lot of the positions that people are entering into or getting out of, or arbitraging, or whatever they’re doing, they have scenarios where they like only want this thing to be mined under this condition.
They only want it mined in this next block, but if it’s not in the next block, they don’t want it to be mined. Things like that. Because there’s this whole new world with DeFi, they can actually give a higher payment to the miner in return for sort of these additional assurances, which increases their revenue because they can actually make these things happen, but also it decreases their risk. If you look at arbitrage as a business, you do want to reduce your risk. And having a transaction fail when gas prices or transaction fees in general are super high, that’s a risk, and that reduces your revenue, and reduces your profits, and so on. So EIP 1559 does affect this. Tim, do you have an insight on how it might affect it?
I think I MEV could be a whole topic for a whole show. I won’t dive into that too much. The main intersection with 1559 is how much should you pay miners to include non MEV transactions? Way in the beginning, we talked about how you have your maximum fee and your priority fee or your tip that goes to the miner. The obvious reason for the priority fee is that if you burnt a hundred percent of the transaction fees, miners would just might empty blocks forever, right? Why would they even bother to try and process your transaction to run a node? They could just mine empty blocks. They’re making more money and reduce their costs. In times when there’s not huge congestion, you want the priority fee that goes to the miner to be just high enough to pay for one, like their operational costs of actually maintaining the transaction pool, but two, the risk of their block being uncled.
On Ethereum, because times are shorter than Bitcoin, it happens fairly frequently that two blocks are mined pretty close in time. And then, the chain forks for a short amount of time, and then when the next block hits, it will decide kind of which of those two blocks was the right one. And the one that isn’t in the canonical chain is what we call uncled. Those transactions don’t get executed, and the miners get a much, much smaller reward. Because of that, miners want to push their blocks as quickly as possible on the network, right? Because once you have a new block, you want to give it to everybody so that they mine on top of you and you don’t get uncled. The size of the block matters here. Pushing a bigger block is harder than pushing a smaller block on the network.
The more transactions you’re going to fit into a block, the more for the miner. They need to be paid a lot for that, because they risk losing it all if the block is too big. Where this intersects with MEV, as Taylor was saying, a lot of these MEV transactions are time-sensitive and very high value. People will be willing to pay the miner a lot of money, but only if this transaction happens now and it’s included in the canonical chain. So that means that MEV changes that uncle risk for miners, like how bad is it for your block to not be on-chain? Because without MEV, it was just a function of the block reward, right? You get a smaller block reward if you’re not included in the main chain and it’s very easy to calculate how frequent are uncles based on the size. What’s the block reward for uncles and and so what should the minimum tip be to kind of offset that risk?
Because MEV is variable, sometimes there’s just more opportunities for arbitrage and sometimes not. It gets a bit trickier to figure out what’s the minimum tip that you should give. Someone at the Ethereum Foundation has come up with a fancy algorithm that looks at like, okay, what’s the average MEV in a block? What’s the 90th percentile MEV in the block. And based on that, and based on how big blocks are, what’s the right default priority fee that you should put in your transaction? And it’s kind of a long way of saying that over time, we’re probably going to have to adjust what’s the minimum or the default priority fee, based on the amount of MEV that miners are able to extract. Once you have the formula for how to do it, it’s not hard to just plug kind of the numbers, but it was a bit of work to actually kind of derive what’s the right amount that we should compensate minors so that when they have MEV transactions in the block, they don’t just ignore everything else.
And this goes to what we were saying earlier about how we don’t really how much this will affect what miners can earn because we’re not sure exactly how much will be burned at the base fee. So last topic, and by the way, this also could be its own show. And for those of you who listen to a lot of crypto podcasts, I’m sure you all know that it is often its own show, but we will just touch on it very briefly. A lot of people are talking about how EIP 1559 and Ethereum 2.0 could turn ether into what they’re calling sound money. And what’s interesting is, as I’m sure you’re all well aware for pretty much all of its history, Ethereum’s issuance has always been higher than Bitcoin’s. And it looks like that might change after EIP 1559. Can both of you talk a little bit about how you think this will change the perception of ether as money?
I’ll go first. I think the most interesting thing about this ether as money or ether the sound money or ultrasound money or whatever — that narrative. I think the most interesting thing about it is that, historically, you have Bitcoin. Bitcoin has sort of looked down on ether as not sound money whatsoever because not only has the issuance, but it’s been kind of unknown, right? We could always hard fork and change it whenever we want. Et cetera, et cetera — that’s been the perception.
The fact that this narrative has taken off makes total sense in that regard, because when you’re constantly being attacked for a personality trait, let’s call it, if you can change it, it’s a really valid arguments, it’s a really valid like slap back.
Couple that with the fact that we might actually do it better than Bitcoin, it makes sense why the narrative is especially fun on Twitter and is taking off.
All that said, I think that when people lose sight of a bit is the fact that like these Twitter wars or Twitter drama, of like Ethereum versus Bitcoin or whatever, that’s still gonna exist. You know, that’s how arguments on the internet work. It doesn’t matter if we have a valid response to the Bitcoin maxis, they’re still going to find something wrong with it. That’s how it works. I guess what I’m watching carefully is how I’m more interested in how the Bitcoin maximalist argument evolves in response to this. Because for me personally, I’m more interested in the narrative and the people and the interactions then whether or not any of this is actually money. I think both bitcoin and ether have a chance to be money in the future. They both are well on their way. We are not there yet — as much as we want to be, we’re not there yet.
That’s interesting. I actually think they both are money in the sense that people accept them and they have value. But anyway, all right, Tim, what about you?
Maybe I can think a minute to talk about the numbers behind why people say or why ultrasound money needs to exists. The idea is like now the block reward on Ethereum is 2 ether per block. I think if you look at the number of blocks per day, it is something around 13,000, 14,000 ETH per day. It changes a bit based on the rewards. But call it like say 15,000, if you wanted to high round number. Obviously a very high issuance rate, higher than Bitcoin. As of today, it’s basically only inflation, right? We have no deflationary mechanism in Ethereum. So 1559, like we’ve talked about at length, will burn the base fee part of the transaction fee.
To clarify, that doesn’t burn the whole fee. The part that goes to the miners is not burned. So if depending on the breakdown there, that obviously changes the models that locked. As part of the transaction fees get burned, it does add like a deflationary pressure that offsets this issuance that we have. On proof of work, I calculated these numbers a couple of weeks ago. It might not be a hundred percent right, but roughly.
I think a base fee of roughly 150 gwei for a 15 million gas block would offset basically the two ETH issuance in that block. So that means that if we saw consistently that the base fee was 150 gwei and we kept the same issuance on proof of work, then on average, it would be deflationary.
In practice, maybe this is variable. Like maybe there’s a block where it goes up higher and like that block is deflationary and you can choose whatever time periods you want to do that analysis. But that’s based on the fact that the issuance is quite high because of proof of work. When we move to proof of stake. And on the Beacon Chain today, issuance is drastically reduced. I forget the numbers exactly again, but they’re roughly somewhere between one eighth and one tenth, even if you assume that there’s way more people that stake after the merge. That means that instead of needing a base fee of 150 gwei to be deflationary, you’re probably looking at like needing a base fee of closer to like 15 gwei to be deflationary. When people kind of say like this ultrasound money narrative, this is kind of what they mean. On one hand, we’re going to reduce the issuance a lot by shutting down proof of work. Then on the other hand, we’re going to have this deflationary pressure that comes from EIP 1559.
That’s kind of a narrative and like people like to use it to in kind oft he conversations against Bitcoiners, as Taylor mentioned. I think it’s just worth looking at the numbers. It’s worth mentioning, 1559 does not make ether deflationary just by snapping its fingers. Like you need some certain level of demand. Personally, I think what is really valuable is that over the long term, if more people want to use Ethereum, then yes, it does create kind of this pressure on the supply. Again, if you think about like how Ethereum should work, like if you knew nothing about Ethereum, like it would make sense to think like as more people want to use the Ethereum, there should be some way for like the network to capture that value.
That’s kind of what 1559 gives. It doesn’t capture a hundred percent of it, a lot of it will still go to miners, the validators, and whatnot. But it captures some portion that means that over the term, it’s kind of healthy that the network can capture it.
One final comment here. It’s worth noting, people talk a lot about the ETH price and whatnot. And one way to think about the ETH price is also… the network value of Ethereum is kind of the economic bandwidth we have on the network. And because ether is used as collateral and the fun stuff, the higher the network value, it means more USD valued ether can be used to open loans on DeFi and to fund projects and stuff like that. I think beyond like just the fact that obviously the price appreciation is nice for holders, it’s worth noting that as the total value of Ethereum goes up, we can just support more things on the network. And that’s a really valuable property.
I agree with all of that, and I find the fact that you kind of reverted to more like facts — I find that somehow very Ethereum Foundation-ish. I’m sure you’re well aware in that for a long time, and I’m not sure how it is now, but for a long time, there were edicts against talking about price too much. So when will EIP 1559 be adopted?
We are June 23rd as we’re recording this. 1559 will go live on Ropsten today. By the time people hear this podcast, it will already be live on Ropsten. Then it will go live on Gorli, which is the proof of authority multi-client test net for Ethereum, on June 30th. And then it will go live on Rinkeby, which is our third test net, on July 7th. Because this is such a big change, we want to wait and see how it goes on test nets before we schedule a date for main net. If I had to guess right now, I suspect late July to mid August is kind of the range we’re looking at for deployment on main net. I don’t see a case where it’s earlier than late July, if we found issues and whatnot, it might be delayed a few weeks by the time that we fix it. Late July, August is when we’re looking at it.
All right. Well, thank you both so much for discussing this issue. I know it’s been a hot topic around Crypto Twitter and elsewhere. Where can people learn more about each of you and EIP 1559?
You can find me on Twitter. I’m @tayvano_, because I need to change that. Or at mycrypto.com. I love Twitter, so definitely find me on Twitter. Tim’s going to give you a bunch of resources, but I will say the best EIP-1559 resource of all the resources is actually, this one called the “EIP 1559 Resources List,” which then has all of the other resources linked to it. Maybe we can link it in the show notes or something.
That’s a great idea.
Yeah, I’m on Twitter as well, @timbeiko. If you have any questions or concerns about 1559, you can reach me there. I do have a document which is a list of different 1559 resources. So just some intro materials, if people want to learn about it. There’s sections about miners, about UX, about econ, whatever kind of part you’re interested in — there should be something there for you. We can definitely add that to the show notes.
Perfect. Well, it’s been so great having you both on Unchained.
So much for joining us today. To learn more about Taylor, Tim and EIP 1559, check out the show notes for this episode, Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Daniel Nuss, Mark Murdock. Thanks for listening.