Ethereum has just activated its London hard fork, and it’s a big problem

Ethereum’s much-publicized and somewhat controversial “London” hard fork has just been activated.

So far, news of the successful upgrade has coincided with a ramp-up in the price of ether, the native token of the Ethereum blockchain. The cryptocurrency is at $ 2,620, up 3.9% in the last 24 hours.

Much of the excitement has to do with the fact that the software upgrade means a few big – and necessary – changes are being made to the code behind the world’s second largest cryptocurrency.

It has always been a difficult task for Ethereum users. Blockchain has a long-standing problem with scaling, and its highly unpredictable and sometimes exorbitant transaction fees can annoy even its biggest fans.

The problem has worsened in recent months thanks to a resurgence of interest in non-fungible tokens, which are mostly built on Ethereum’s blockchain, as well as explosive growth in the world of decentralized finance, or DeFi, which also makes extensive use of Ethereum’s blockchain.

Thursday’s code changes, which have little to do with the City of London, are designed to address many of these issues by destroying or “burning” the Ether Coins and changing how transaction fees work so that ‘they are more predictable.

If you think of Ethereum as a highway, London is adding a few lanes to slow traffic down and standardize toll prices.

“It adds a lot of complexity to the fee logic, but it’s an interesting approach that could potentially stabilize the fee dynamics,” said Nic Carter, general partner of Castle Island Ventures and co-founder of Coin Metrics.

Even though the Ethereum blockchain gets a makeover all the time – for those keeping track, this marks hard fork # 11 – the “London” upgrade is a game-changer, experts say.

The hard fork itself consists of five Ethereum improvement proposals. They are called EIP for short, and each offers a set of code changes.

The one that everyone is hanging on to is EIP-1559.

Prior to the upgrade, users would essentially participate in an open auction every block, where they would have to place a bid with a miner in what is called a “first price auction.” The closed auction setting meant that users often scrambled to come up with transaction fees (known as “gasoline prices”), choosing a number they believed would ensure inclusion in the next block of transactions.

Some users who felt the need to prioritize their trade would offer to pay a premium higher than their bid to try and gain preferred status within the block itself.

“Fifteen-fifty-nine is really meant to create an ecosystem that encourages lower gas costs,” said Auston Bunsen, co-founder and CTO of QuikNode, which provides blockchain infrastructure for developers and businesses.

“Sometimes people are willing to pay a lot to get into a block. Fifteen-fifty-nine seeks to solve this problem by creating a base fee,” Bunsen continued.

Rather than holding a blind auction every block to determine the price of gas, Ethereum’s protocol will algorithmically decide transaction fees based on aggregate demand on the network.

The fact that the protocol decides on a uniform gas price should prevent significant price spikes, although that does not necessarily mean that it will be cheaper for buyers. Essentially, this is a great hedge against total market deregulation.

However, upgrading will still allow users to skip the queue by tipping.

But a bigger change instigated by EIP-1559 is a doubling of the block size.

While in theory that means twice as many transactions can occur in each block, the upgrade was actually designed so that the protocol wouldn’t want the block to be half full. This is intended to help alleviate peaks in demand, thereby helping gas prices to remain stable.

Matt Hougan, CIO of Bitwise Asset Management, uses the metaphor of a ferry to explain the design logic.

If ferry operators have priced a ticket too low, they may need all that extra seat capacity to accommodate passengers standing on the dock who want to board at the base ticket price.

“But the price goes up very quickly, and algorithmically, to the point where you should come up with a clearing price that allows the block to be half full, and certainly allows all the trades that want to go through to be processed. Hougan explained.

Making the block size dynamic so that it can adapt to fluctuations in demand is what ultimately stabilizes the base charge.

“It sounds simple enough, but it’s a really elegant design solution to a problem that has plagued Ethereum since its inception,” he said.

The not-so-quiet elephant in the room is the fact that the upgrade redirects some income from miners to existing token holders.

Ether that would otherwise go to the miner will now be “burned”, permanently destroying some of the digital currency that would otherwise be recycled back into circulation.

Some have argued that upgrading the EIP-1559 will create a kind of deflationary pressure on Ethereum, as a lower supply can lead to higher prices. But this reasoning makes some major assumptions.

“It only creates deflationary pressure on the condition that the costs burned actually exceed the new issues,” Carter said. “This is only the case in times of extreme tariff intensity.”

Carter says the burning of gas prices probably wouldn’t end up being net deflationary, at least not under the current royalty regime.

But burning those fees will also mean a major change for miners, effectively leaving them with only two sources of income.

Miners can still sell their computing power to the network and hope to earn a reward of newly created aether, if they win a block.

They can also always receive advice from users seeking to prioritize their position in the block.

But in the short term, miners won’t make as much money as they did before the hard fork.

Hougan argues that because miners are organically tied to the overall value of ethereum, the hope is that they eventually make up for these losses as the price of ethereum rises through these protocol changes.

But experts tell CNBC the problem with that logic is that in the next few years Ethereum miners are approaching a cliff that will make them obsolete. In fact, among Thursday’s upgrades there is a stipulation that deals with this very mining Armageddon.

Although it does not receive the same attention as EIP-1559, another of the EIPs included in the London Fork is EIP-3554 and its importance cannot be underestimated. This code change paves the way for ethereum 2.0, an upgrade and total overhaul of the system, which has been in the works for years.

Ethereum 2.0 would shift the network from the power-hungry “proof of work” mining system, where miners solve difficult mathematical equations to create new coins, to a “proof of stake”, which simply requires users to take advantage of their ether cache as a way to verify transactions and create new tokens. This change will be huge not only for Ethereum, but for the entire cryptocurrency community.

EIP-3554 takes an important deadline that will encourage Ethereum miners to upgrade their software to prepare for the change – known as the “difficulty time bomb” – and moves that deadline to summer 2022 to December.

“The purpose of the Difficulty Bomb is to force miners and node operators to upgrade their software after a predetermined amount of time,” Carter explained.

As Bunsen describes, the proof-of-stake transition would essentially render Ethereum inoperable once activated. In other words, in a few years, once the protocol has fully migrated to a proof-of-stake model, the entire industry around Ethereum mining as it exists today will no longer be. relevant.

So why London? The Ethereum community has just started naming their hard forks after the cities where their international Devcon developer conference was held. Next on the bridge: Shanghai.