#6 EIP 1559, inflation, Binance and little monsters
Burning money never got anybody so excited. Today we explain why EIP 1559 is a software update people can't wait to see happen. Good boys (Circle), bad boys (Binance) and some potato shaped monsters.
EIP 1559
Can you imagine being excited about a software update? The Ethereum community is. The London hard fork is a much-awaited upgrade that finally has a release date after a lot of time and discussion. It will happen on August 4th, in block 12,965,000 (because time in the blockchain is measured in blocks).
Nobody would ever celebrate if a big international bank updates its technical capabilities, but the technology design equals the design of incentives in crypto. And incentives are what keep the community working together. Updates are big news.
The London hard fork will include the much-awaited Ethereum Improvement Plan number 1559, or EIP 1559. EIP 1559 started as a proposal to improve the user experience by avoiding excessive waiting times for transactions. However, the subsequent debates and proposals brought features to EIP 1559 that have ended up turning it into a de facto proposition for a new monetary policy within Ethereum. And that is what has the community excited.
EIP 1559 changes Ethereum's fee market mechanism. From a first-price auction system, where the highest bidder wins, to a more predictable fixed price sale (with a couple of interesting side features)
Every new block written in the Ethereum blockchain is (and will be until August 4th) preceded by an auction. The highest bidders get their operations included in the block, and miners receive the money from those bids. First-price auctions are prone to errors, inefficiencies, and a worse user experience. Users can find themselves often underestimating costs and seeing their transactions delayed or overestimating them and paying more than they should.
Consensys compares it to Uber or Lyft rides. Imagine taking a ride was auction-based. How would you even calculate how much to pay? In crypto, it's wallets that aid users by estimating reasonable fee prices. But they are just that, estimations, and this creates mistakes and friction in the system.
EIP 1559 solves this by establishing an initial fixed price, the basefee. Traveling from A to B should have a reasonably fixed price, and so should transactions. Users can still speed up their transactions by adding a tip to their transaction cost and thus incentivizing miners to pick their operation first. But the cost of having your operation processed will be fixed.
There are several relevant things to say about basefees.
First of all, the price is indeed variable and linked to demand, but the variations are defined in the protocol (they go up or down in fixed percentages) and are therefore predictable. Wallets will no longer guess and will therefore help users make the best decisions possible (and feel less dumb waiting for too long because their bid was too low, or because they paid too much because their bid was unnecessarily high).
Second, and most importantly, the basefee gets automatically burnt. Instead of reaching the hands of miners, the agreed ETH vanishes into the air like an unlucky Avenger. And this is where things get interesting.
Burning basefees was brought forth as a countermeasure to the hypothetical miner collusion to increase basefee price and extract even more value from users via fees. But the elimination of ETH via basefee burning has ended up being the most wanted feature in EIP 1559. Ethereum was missing its own version of one of bitcoin's key features: supply control. EIP 1559 is being considered by some as the most relevant manifestation of Ethereum's monetary policy, a mechanism to increase the value of the current circulating ETH and a possible boost for the currency's growth.
To sum things up:
What is EIP 1559?
A change in Ethereum's fee mechanism that will alter the incentive to miners, and that brings a burning mechanism that might contribute to making ETH deflationary.
What problem does EIP 1559 solve?
Improved UX. First of all, EIP 1559 makes fee calculation controlled. Basefees will be calculated by the protocol and will vary predictably.
And, as a welcomed consequence of the burning mechanism, monetary policy. Burning ETH will give deflationary powers to Ethereum. Peaks in Ethereum use will bring proportional decreases in ETH supply.
What problems does it not solve?
Many have pointed out that EIP 1559 was a solution to the problem of skyrocketing fees in Ethereum. EIP 1559 does not solve this, and transaction costs will still be highly dependent on demand, although, at least, less volatile.
Predictability and transparency might have the side effect of affecting user behavior: users might refrain from submitting operations if they see or foresee price increases.
What problems does it create?
The changes in the incentive structure have brought questions about the implications for miners, who might see their revenue decrease. Happy miners make blockchains secure, and unhappy miners could make the hard fork fail.
This outcome, nevertheless, is improbable for a bunch of reasons. To name just three of them:
Those users who are currently bidding higher for their transactions in the first-auction system will probably still be interested in getting their operations validated first. Tips are likely to become a relevant source of income, even if they are optional.
EIP 1559 might increase ETH's price. Miner revenue, calculated in dollars, can become higher thanks to EIP 1559.
ETH 2.0 is getting closer and closer. Ethereum has a very relevant upgrade coming up that will bring, among other revolutions, the change from Proof of Work to Proof of Stake. Are miners willing to make the system tremble when they are months away from a crucial improvement in Ethereum's history?
Oh, and another important reason to be optimistic. If users win, we all win, don't we? For all of us who are in this for the long run, user adoption is the real MVP.
โฌกย Six Angles
We select six topics to illustrate the very different angles crypto can be approached from. We could choose dozens, but six is the atomic number of carbonโฆ and otherwise we'd be writing for ages.
1. Macroeconomy | Inflation
During the last weeks, the European Central Bank changed from a vague "below but close to 2%" to a more straightforward "2%" as the EU's inflation target. The decision follows the need to speak to the markets in clearer terms, but it is also the confirmation of the consequences of the post-pandemic stimulus packages.
Meanwhile, inflation climbed more than predicted in the US, as the price index rose 5.4%, an increase unseen since 2008.
The data seems inconclusive, so there is a lot of room for opinions about what the future holds in terms of inflation. Everything depends on how big one believes the impact of the pandemic was.
Inflation is also highly concentrated in a subset of goods associated with global disruptions of the coronavirus pandemic and the surge of demand that has followed reopening in the United States. Inflation is rampant. Is it time to buy bitcoin? (Yahoo Finance)
Bitcoin has been long regarded as a hedge against inflation. It has a hard-coded monetary policy that often points at it as a safe place:
It has a predicted limited supply. Only 21 million bitcoin be ever mined. We are currently above the 18,7M line. And although it seems like we are getting very close to the end, the protocol has a mechanism to slow down the issuance of new bitcoin, the halving, that will extend the supply of new coins until 2140. But the supply growth is totally predictable and guarantees a scarcity that explains the interest it generates as a store of value.
Bitcoin is disconnected from any country's currency or economy. While this is also one of the most used arguments used by critics to bash Bitcoin, it is also a reason it is perceived as a haven. Bitcoin is less affected by the ups and downs of financial policy.
2. Regulation | Chasing Binance
Last Wednesday, Binance turned four. Founded in 2017 and headquartered... somewhere, Binance is the largest crypto exchange by daily trading volume. In our last newsletter, we already discussed the UK's Financial Conduct Authority "sort of" ban over Binance's activity in the country. Ever since the FCA delivered its warning, news has kept pouring in. First, it was Barclays, then Santander, stopping payments from UK accounts to Binance. Then the Italian financial authority followed the UK's steps and issued a similar warning to its citizens. Lithuania, Hong Kong...Not the happiest birthday.
Binance has always been comfortable playing Tom and Jerry. The company's history is full of plane tickets, ever since they exited China in a rush back in 2017. Japan, Malta, and the Cayman Islands were some of the destinations. And, over the years, subsidiary companies (like Binance US or Binance SG) blossomed to help Binance stay on the dark side of the moon.
Some companies, like Coinbase or Circle, have made playing safe a part of their value proposition. Binance belongs to that other group of companies that decided not to wait for regulators to clearly understand what was going on before growing aggressively. The latest events are probably the consequence.
"Compliance is a journey,โ said Changpeng Zhao, CEO of Binance. And in the last months, Zhao has gathered a fellowship of high-profile compliance experts, hired directly from the same regulators Binance is dancing with.
Binance has grown very quickly and we haven't always got everything exactly right, but we are learning and improving every day. A Letter from Our CEO: Reflecting on Progress and the Road Ahead
Binance is a very attractive target for regulators. An industry leader living on the edge. There's probably no other solution for both parts than meeting somewhere in the middle.
3. Wall Street | Circle IPO
Hesitant investors have yet another chance to dip their feet in crypto while keeping some distance. After Coinbase's IPO in April, another crypto-native company is about to cross the road and make it into Wall Street, opening the doors to those who want to try crypto without leaving their comfort zones.
Circle was founded in 2013, making it truly venerable by crypto standards. But the company spent many years wandering the desert in search of a defining purpose: it has at various times dabbled with Bitcoin, with non-crypto payments, and with crypto exchanges. Starting in 2018, Circle seems to have truly found its calling with the USDC stablecoin. What investors need to know about Circleโs listing (Coindesk)
USDC is a stablecoin: a type of cryptocurrency whose value is pegged to another asset class in order to stabilize its price. Stablecoins offer the user experience of cryptocurrencies like bitcoin or ether, without the volatility.
Circle manages the second most important stablecoin by market cap, albeit far from the leader, USDT (USD Tether). But Circle, just like Coinbase, and unlike USDT, is the kind of company that Wall Street is ready to welcome, with its clean reputation and compliance effort.
4. NFTs | Axie finds the winning formula
There are bulls, there are bears, and there are crabs. Some companies in the industry are thriving regardless of the current uncertain times for crypto. Gaming is hosting some projects that are moving โin mysterious ways.โ
With the ink of the latest obituaries still drying ("NFT boom is over, for nowโ Quartz), some metrics from the NFT space are showing that the industry is in excellent shape. Open Sea, the leading NFT market, had its best month yet. Axie Infinity (a sort of crypto Pokemon, for the uninitiated) earned a record $12.2 million in revenue in June and a rise from 38.000 to 252.000 daily active users in two months.
The recent story of Axie is one of good market fit paired with a share of right decisions. Axie Infinity is a fun game with solid token logic that brings home the promise of play-to-earn philosophy: Axies are NFT creatures that users can breed and fight and get tokens in reward. It recently migrated its infrastructure to Ronin, a blockchain of their own, where they were able to avoid the high transaction fees of the Ethereum blockchain.
Axie is on its way to becoming the flagship or the industry of crypto-gaming. A combination of two worlds with outstanding potential.
5. Open Source | GETH
Hiring engineers is hard. There is a global shortage of tech talent. The problem Pรฉter mentions is shared by many.
But Pรฉter is an engineer in Ethereum, and he leads GETH (Go Ethereum), one of the three original implementations (along with C++ and Python) of the Ethereum protocol. Hiring engineers is hard. But when your software builds the foundations on which billion-dollar initiatives run, having problems hiring or retaining talent is plain weird.
Like the whole internet in general, crypto is maintained by anonymous heroes who work on open source projects that create building blocks for others to use. And they do so in an almost altruistic manner.
The silver lining is that the community, in general, knows this. Following Pรฉter's tweets, projects like Uniswap or Year were quick to offer ways to contribute to the issue's solution.
6. Mining | Bitcoin's difficulty drop
The consequences of the miner's diaspora in China can be seen in the on-chain metrics of the protocol. At the beginning of July, Bitcoin network underwent the biggest difficulty drop ever (-28%).
What does "difficulty" mean in Bitcoin?
Mining is the process by which new blocks are added to the blockchain. Check out our last newsletter for an extended explanation.
It is the decentralized equivalent to your bank updating your balance if you make or receive a transaction. On a blockchain, all the possible transactions enter a queue called mempool, where they wait for miners to grab them, group them in bundles and propose them as candidates to become the next block in the chain. Every single miner and there are hundreds of thousands of them, proposes a new block to the community. The block that finally makes it into the blockchain is chosen by a process, the famous Proof of Work, where miners need to solve a mathematical puzzle. The difficulty of the mathematical puzzle gets adjusted constantly depending on the competition. More miners push the difficulty up to make the competition harder and fairer.
What we have recently seen is the technical manifestation of China's anti-mining policy. As Chinese miners sell their gear or hop on trucks to find a better place to work (Kazakhstan seems to be a favorite place to land), the Bitcoin network has adjusted to the decrease in activity.
If you have any questions or there is any topic you want us to address, write us at team@carbono.com, or reach out toย @carbono_com,ย @raulmarcoslย orย @mrubioย on Twitter.
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