What Is the London Hard Fork and What Does it Mean for Ethereum?

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What Is the London Hard Fork and What Does it Mean for Ethereum?

3 days ago



Ethereum is upgrading soon, and this is one of the most anticipated events in the crypto space this year.

And for a valid reason.

Expected to take place at block height 12,965,000 on August 5 11:55 (UTC), the Ethereum London hard fork will drastically change how transaction fees are paid in the smart contract blockchain’s network.

At the same time, the upgrade will introduce a deflationary mechanism to combat ETH’s inflation and make the cryptocurrency more attractive to investors.

In addition to the above, some minor yet important changes will be implemented with the London upgrade.

In this article, we will explore what the London hard fork is, why Ethereum needs it, and how it will impact the smart contract blockchain’s network and participants.

Let’s dive in!

Why Does Ethereum Need the London Upgrade?

Before we take a closer look at the actual changes the London upgrade is expected to introduce, it’s important to discuss why the smart contract blockchain needs to upgrade in the first place.

As you may know, Ethereum is the leading smart contract platform in the cryptocurrency space that has been serving as the ultimate hub for decentralized applications (dApps), decentralized finance (DeFi) solutions, and the non-fungible token (NFT) boom.

For that reason, it’s among the most active blockchains out there. However, increased popularity also comes with certain downsides. The massive user activity on the platform has placed quite some stress on the network, which has been infamous for its limited scalability.

As a result, network congestions have become the standard way to operate for Ethereum, leading to excessively high gas fees and slower processing times. While the London hard fork won’t fix this issue – as it doesn’t focus on improving the network’s capacity –, it offers a way for individuals and enterprises to estimate the costs of their transactions more precisely.

It’s safe to say that the Ethereum fee market has been rather chaotic lately. The current auction-style process to determine transaction costs requires users to set bids for their transfers, in which miners pick up the ones with the highest prices to include in a block. If the cost is too low, it can lead to senders waiting several hours (or even days) to get their transactions processed by validators.

The current upgrade seeks to fix this by eliminating this fee market uncertainty, which helps facilitate developer, end-user, and enterprise adoption of applications within the ecosystem.

And this is an important area for Ethereum to focus on. Unlike Bitcoin that is favored by institutionals due to its excellent store of value qualities, ETH is mainly utilized to deploy, run, and use decentralized applications and other solutions on top of the blockchain. Due to its massive ecosystem and extensive network functionality, Ethereum has experienced quite some adoption from enterprises and governments to date.

For example, while the Canadian government has been running a pilot on top of the smart contract blockchain to increase the transparency of research grants and funding information, the European Investment Bank (EIB) issued digital bonds on Ethereum. At the same time, the central banks of Israel and Thailand have both utilized the chain to test their central bank digital currencies (CBDCs).

In addition to its blockchain network and dApps, it seems like Ethereum is trying to make its cryptocurrency more attractive to investors by aiming to fix its inflationary nature.

Unlike Bitcoin that features a maximum cap of 21 million BTC, ETH’s supply growth is basically unlimited. As new coins are mined with each block, the lack of a decent mechanism to control the supply’s extension leads to inflation and a depreciation of purchasing power.

The inflationary nature of ETH has been long criticized by members of the crypto community, and that’s why developers are rolling out a deflationary mechanism to attract investors by facilitating a price appreciation for the cryptocurrency in the long term.

In addition to the above, Ethereum developers have discovered a network function that users have abused. Besides fixing that, the project is also rolling out some changes in the London hard fork to get the smart contract blockchain ready for its transition to Ethereum 2.0.

It’s a long-waited upgrade that will introduce sharding and a shift from the current, energy-intensive Proof-of-Work (PoW) consensus algorithm to Proof-of-Stake (PoS) to enhance the network’s scalability and throughput.

What Is the Ethereum London Hard Fork About?

The Ethereum London upgrade is a hard fork – a network change incompatible with previous versions of the software – that includes five different Ethereum Improvement Proposals (EIPs).

In the following sections, we will take a look at each of the EIPs and the related changes they introduce to Ethereum and its users.

EIP-1559

EIP-1559 is the most crucial, controversial, and anticipated upgrade of the London hard fork. And this shouldn’t come as a surprise.

EIP-1559 is the proposal that seeks to drastically change how the smart contract blockchain’s fee market works. At the same time, it will have a significant influence on ETH’s price dynamics and supply.

So, let’s see what all this buzz is about.

Base Fee

Earlier on, we have discussed how Ethereum utilizes an auction-like process to determine the prices users have to pay for initiating transactions on top of the smart contract blockchain.

Now, EIP-1559 will almost entirely eliminate this process and replace users’ bids with a base fee. Everyone within the network has to pay this base fee – which costs the same for all market participants – that serves as the minimum for executing a transfer on Ethereum.

According to the developers, this base fee will be automatically calculated based on the network’s current activity. Considering Ethereum’s current scalability and throughput, the ideal capacity for each block is a maximum of 15 million gas.

While EIP-1559 allows blocks to expand to a maximum of 30 million gas, the network will automatically increase the base fee by 12.5% with every block that is bigger than the ideal 15 million gas size.

On the other hand, when activity within the network decreases and a block contains less than 15 million gas, the base fee will automatically decrease by 12.5% with every block until it reaches almost zero.

As you can see, this change will offer a much more easier way for users to estimate the costs of their transactions as they don’t have to outbid others to get their transfers processed faster.

Although, it’s important to note that users can optionally pay an inclusion fee, which serves as an incentive for miners to prioritize certain transactions over others. That said, covering the base fee alone will be expected to offer normal transfer processing times for senders in most cases.

Interestingly, while EIP-1559 won’t improve Ethereum’s scalability, the enhanced accuracy in terms of fee estimations will prevent users from overpaying for their transactions. For that reason, the smart contract blockchain’s developers expect the London upgrade to introduce an around 20% gas cost reduction for ETH transfers.

Burning Transaction Fees

Maybe the most controversial part of EIP-1559 is how it plans to control the ETH supply.

As you may already know – just like in the case of Bitcoin –, Ethereum miners generate revenue in two ways: by receiving rewards from mining new blocks and fees for processing transactions.

However, after EIP-1559 goes live, miners will only get block rewards but not the base fees of transactions. Instead, the network will automatically burn all ETH spent on covering base fees without the option to distribute the coins to validators (miners will only receive the inclusion fees).

While this deprives miners of a vital revenue stream, burning the ETH users pay on base transaction fees ties the value of the cryptocurrency directly to the usage of the network. When more people utilize Ethereum dApps, the more users will pay for transfers, and the more coins will get burned (and vice versa).

In a bit similar way to Bitcoin’s halving that reduces the growth of the new supply by 50% roughly every four years, this is a deflationary mechanism that allows Ethereum to combat its native cryptocurrency’s inflation and facilitate a long-term price increase.

This is definitely good news for investors as they will be able to hold a coin with a projected annual issuance rate that is either zero or negative (instead of the current 4%).

On the other hand, it is possible that miners won’t be so happy about this upgrade. As they operate expensive hardware to maintain the network by solving complex mathematical puzzles, some will need the extra revenue from transaction fees to stay in business. While they will still earn inclusion fees, it won’t be nearly as much as what they would normally generate with auction-style bids.

For that reason, EIP-1559 is expected to drive away a portion of miners from the smart contract blockchain to another (more profitable) network, which can come in handy for Ethereum’s competitors. As miners cease their activities, it will reduce the blockchain’s hash power, which makes the network less secure against attacks if that rate falls below a certain level (although it has to decrease significantly to affect the safety of users).

That said, if EIP-1559 comes with major bullish movements for ETH due to the decrease of the supply, the increased profits from mining ETH will likely encourage miners to stay in the network.

EIP-3198

As the sister proposal of EIP-1559, EIP-3198 will extend the changes introduced to transfers in the prior upgrade to smart contracts.

Based on the changes introduced by EIP-3198, the BASEFEE opcode will return the value of the base fee of the current block it is executing in. In other terms, it means that the base fee structure is rolled out for smart contract-powered transactions as well.

EIP-3529

While it may seem a small change compared to EIP-1559, EIP-3529 is an essential proposal that fixes a functionality that users have exploited for a long time.

Until the London upgrade, Ethereum featured a mechanism that incentivizes developers to free up block space by removing smart contracts and data they no longer need. In exchange for doing so, devs can get a small gas refund.

If everyone utilized gas refunds in the way they were meant to be used, it wouldn’t make any sense to modify this functionality as it would provide value to developers and the network itself. However, that’s not the case here.

Instead, many users and developers filled the network with “junk” data at times when gas fees were low. After that, they waited until Ethereum experienced high usage and gas prices have skyrocketed to claim their refunds.

This led to the creation of gas tokens that have basically automatized this process and allowed developers to access low transaction fees even in times of extremely high network usage.

Since saving block space is crucial for Ethereum, EIP-3529 eliminates gas refunds for certain operations and reduces the sum developers can claim back to prevent participants from exploiting the mechanism and avoid clogging up the network with junk data.

While this is expected to make Ethereum more stable, it will very likely render most gas tokens useless as holders won’t be able to utilize them to access cheap gas prices anymore.

EIP-3541

Unlike the previous three proposals, EIP-3541 won’t significantly affect Ethereum after it gets implemented by developers. Instead, it is designed to get the blockchain ready for the transition to Ethereum 2.0.

EIP-3541 will automatically reject the deployment of new smart contracts starting with the “0xEF” byte while keeping the existing ones untouched. Simply put, changes introduced in EIP-3541 allow developers to integrate a new format of smart contracts (EIP-3540) more seamlessly at a later date.

Expected to be introduced with the upcoming Shanghai hard fork (projected to take place around October 2021), EIP-3540 rolls out a new format called EVM Object Format (EOF) for smart contracts that offers developers a way to validate code during the contract creation process along with other benefits.

EIP-3554

EIP-3554 is the last proposal included in the London upgrade that delays Ethereum’s difficulty bomb until December 2021.

Simply put, when the difficulty bomb “blows up,” it makes it much harder for miners to validate blocks and earn rewards by using their computational power and hardware equipment via the PoW algorithm. As Ethereum still uses this form of block validation to secure the ecosystem, implementing the difficulty bomb now would cripple the network.

However, since the current Ethereum blockchain and the new Ethereum 2.0 chains are expected to merge before December 2021, the difficulty bomb will incentivize miners to shift from PoW mining to staking ETH via the PoS algorithm to validate blocks.

Ethereum Gets Ready for ETH 2.0 With an Important Upgrade

It seems Ethereum developers are laser-focused on transitioning the smart contract blockchain to Ethereum 2.0.

What proves this best is the number of major upgrades rolled out for the network in the past few months. In addition to launching the PoS-based Beacon Chain for Ethereum 2.0 last December, devs implemented the Berlin hard fork in April that introduced optimized gas costs and support for multiple transaction types.

And now, the London upgrade is launching soon, which will enhance the tokenomics of ETH via a deflationary mechanism, change how fees are paid for transactions to offer more accurate estimates for users, fix an exploit regarding gas refunds, and get the chain ready for the Ethereum 2.0 merge.

At the same time, the Altair hard fork – the first major upgrade for the Beacon Chain is in progress to improve the efficiency of the PoS-based blockchain – is in progress and is expected to get implemented soon.

Next on, the smart contract blockchain will roll out the Shanghai upgrade in October 2021. Whether at this or a later date, the current Ethereum chain will then merge with the Beacon Chain, which will start the network’s transition to Ethereum 2.0.