Miners favor 1559

Towards a smaller share of a bigger pie

I’ve seen a lot of concern from miners recently about the proposed changes to the fee market under EIP-1559 and how that seemingly impacts their bottom line. I understand the concern but ultimately think this position is regressive and I would like to explain why EIP-1559 should not harm the viability of mining as a profession. To the contrary, the upgrade strengthens ETH the asset which is a clear boon for miners. The upgrade should also bolster adoption so that even if a miner has less claim on the value flowing through the Ethereum protocol, the overall pie gets bigger for everyone — miners included.

EIP-1559 changes the mechanics of the fee market such that every transaction is broken into a BASEFEE and a TIP. The TIP works much like the fee works today: the sum of TIPs in a given block go to the miner of that block. A critical change from the status quo is that each BASEFEE paid by every transaction on-chain is burned. During normal circumstances, we expect the TIP to be nominal relative to the BASEFEE in ETH terms and this is where we see the cause for concern. If the absolute quantity of ETH flowing to miners is expected to decrease, why would a miner choose to support this upgrade?

An important aspect of EIP-1559 is that for a transaction to be included on-chain, the user must include the BASEFEE which is only payable in ETH. This change enshrines the utility of ETH as the fee token for the base layer protocol. This use case of ETH is not enforced today — even though most transaction fees are paid in ETH, there is no protocol rule ensuring users do so. Here is a recent example of a transaction that pays almost 0 ETH as a transaction fee:

https://etherscan.io/tx/0xfabaf9798a7c2e5ccb63f8a254bf8b81a1c924336fd520d6f602879fec5c5f70

Rather than being paid in ETH, the miner of this block was compensated in KP3R token. And to further demonstrate this point, here is another transaction that has exactly 0 gas price:

https://etherscan.io/tx/0x77c7d9e5427749fb1379cb02ec8e5117fa3277e743e5556c134de812605a6dde

Taken together, you should see that it is possible (and already happening) to sidestep ETH as a channel for fee payments under today’s protocol rules. This situation is bad for miners as it erodes the monetary premium of ETH, which ultimately means the ether you collect for your services transmits less value than it could otherwise. If mining is already a low margin business operation, then less valuable ETH means it becomes harder to cover your liabilities over time, even to the point of becoming unprofitable. This effect is pronounced with hobbyist miners and smaller pools who have less market power to take advantage of these “side channel” venues under the umbrella of “miner extractable value” (MEV) which harms decentralization of the network overall. EIP-1559 solves this problem by enshrining ETH as the sole protocol-wide fee token.

Not only must the BASEFEE be paid in ETH, but the BASEFEE is also burned (i.e. deleted from the total supply). To understand why, we have to recall that the BASEFEE under EIP-1559 scales up or down (just like the difficulty adjustment today) in response to demand for block space. If blocks are less full than some long-run target, BASEFEE decreases. If blocks are more full than the target average size, BASEFEE increases. Because theBASEFEEcan change in response to the contents of a block, it is critical that we do not give this value to the entity producing the block, i.e. the miner. If the BASEFEE went to the miner of a block, then a colluding cartel of miners could keep the BASEFEE arbitrarily high by filling blocks with junk transactions. This strategy would pump miner revenues but at the expense of users of the network.

So if the BASEFEE cannot go to the miner, what can we do? One option is to just “pay it forward” to the miner of the next block (who should be randomly distributed under the Poissson process of proof-of-work). I believe this option was explored in the early research around EIP-1559 but the EIP ultimately suggests a different route that burns the BASEFEE. This solution is actually pretty interesting because it introduces deflationary pressure on the ETH supply, countering the inflationary pressure of the block rewards. Having a more deflationary ETH better aligns with broad community sentiment (even outside the Ethereum ecosystem) towards what we all think is “responsible” monetary policy, i.e. not papering over tough social decisions with currency debasement. A deflationary “sink” for ETH the asset should take supply off the open market resulting in a greater valuation for ETH given the same level of demand. The fee burn then acts as a “rebate” to all ETH holders, miners included.

Burning the BASEFEE turns murky demand for an inflationary asset into clear demand for a deflationary asset. A welcome change for the unit of account miner revenues are denominated in.

Another important part of EIP-1559 is that (by design) it trades off volatility in the fee market for volatility in the block size. Variable block size means the chain can (within reason) always accommodate the batch of outstanding transactions that are willing to pay a certain BASEFEE. If you don’t want to pay BASEFEE for your transaction, you simply wait until the fee comes down. A nice analogy I heard from Tim Roughgarden (who did a thorough economic analysis of EIP-1559) was that the proposed system is more like shopping on Amazon: if I want a book at $12.99, I click buy. If I don’t think the book is worth that much, I wait for the price to drop. This process is far more orderly than what happens today where you are essentially in a perpetual arms race against all other participants to compete to get into the next block.

This orderliness translates into better predictability such that it becomes far easier to write wallet software that should make the process of using Ethereum more streamlined for all of its users. Even those of us who understand the intricacies of the calculations going on at https://www.gasnow.org have still had to play a bidding war to get transactions on-chain in times of high demand. With a smoother user experience, we have less friction to adoption so that we can retain more of the people who come to Ethereum wanting to experiment with something small (like minting a CryptoKitty) and not leaving the ecosystem upon having to deal with the headaches of surging gas markets and unconfirmed transactions. And it should be clear to miners that increased adoption means more fee revenue overall, directly padding their bottom line.

Combining all of the above, I think we can make a pretty strong argument that mining under EIP-1559 is certainly not less profitable — possibly even more so if it fosters greater adoption.

Mining is a competitive and often thankless task so we should acknowledge the work miners put into securing the network. They provide a valuable service; in exchange, users of the Ethereum protocol agree to reward this effort via the block subsidy and block fees. And I definitely agree, taking a haircut on your topline revenue is scary. But I think the overall benefits of EIP-1559 are great enough that we should embrace the change as we onboard the next wave of users coming to the protocol.

We should not forget that the degree to which we achieve success in the long run is a direct function of our ability to align our efforts towards a common cause. By reaffirming our commitment to all users of the protocol (even stakeholder groups we don’t identify with), we provide a stronger Schelling point for the coordination of our efforts. With strong alignment, we raise our chance of success as we unveil the outcome of this grand experiment. Here’s to a strong and thriving Ethereum ecosystem under EIP-1559. I hope to see you there!

ethereum r&d