Fee Burning Comes to Ethereum, Tightening Supply of the No. 2 Cryptocurrency

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Ethereum is surging as the world’s No. 2 cryptocurrency takes the first step in a series of major upgrades.

At 8:33 a.m. ET today, the London hard fork took effect at block number 12,965,000. The transition, which began testing in June, implements five changes. The most important, EIP-1559, covers “fee burning.”

Under the old system, Ethereum users bid to have transactions processed. This blind process often produced spikes in “gas fees,” making the system less predictable and less efficient. The new system automatically calculates a “base fee” according to the network’s overall demand. Developers believe this will make Ethereum more reliable and increase adoption. The new model still keeps some degree of supply/demand forces by letting users pay extra to have transactions processed more quickly. (This is called “tipping.”)

Another potential benefit of the new system is that Ethereum now “burns” excess fees by sending them to an inactive address. This could increase its scarcity value by removing coins from circulation. Some analysts estimate that fee burning could eliminate more than half of Etheruem’s new supply.

The London hard fork will also let smart contracts enjoy the same benefits of fee burning. This was included under EIP-3198, or “Ethereum Improvement Protocol” 3198. Smart contracts are programs running on Ethereum, helping to automate transactions. They’re one of the major reasons why Ethereum has grown so quickly.

Ethereum’s Difficulty Bomb

EIP-3529 was another incremental change that discourages users from deliberately clogging up the network with pointless contracts and then getting paid to remove them. The old system issued rewards for “cleaning up” the network, but some people were gaming the system. By eliminating those payments, EIP-3529 looks to end the practice altogether.

Ethereum, daily chart, courtesy of TradingView.

EIP-3541 makes a small technical change by limiting the syntax of future smart contracts. It will facilitate further upgrades.

Speaking of upgrades, EIP-3554 gives more time for the next major upgrade to “proof of work.” (It delays a so-called “difficulty bomb” that would have made mining harder.) Developers now have breathing room to change Ethereum’s validation method from “proof of work” (p-o-w) to “proof of stake” (p-o-s).

Ethereum’s visionary founder, Vitalik Buterin, has wanted this change for years. His blockchain has used the “mining” approach established by Bitcoin, with computers competing to solve complex mathematical problems. (That’s the “work” in p-o-w.) While secure, the system is slow and energy-intensive. P-o-s will instead assign work to node operators based on the coins they hold, or “stake.”

Aside from making the network faster, p-o-s will reduce the creation of new coins. Combined with “fee burning,” it could further reduce supply. Because it will also make the network faster, it could have the double benefit of a more efficient system and scarcer asset.

Many analysts view the coming change to p-o-s as the really important one, so have named it “Ethereum 2.0.” It could take place as early as next year.

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