Ethereum (CCC:ETH-USD) is moving to implement a major change to how much Ethereum transactions cost. The change to its blockchain code, which I have written about earlier, is called EIP 1559 (Ethereum Improvement Proposal 1559).
This week and for the rest of July it will be installed in various test sites and then eventually rolled out to the whole Ethereum network. I will describe here how it works and what effect it could have on the ETH token price.
How EIP 1559 Will Work For Users
First, EIP 1559 will change the system for Ethereum transaction users in a very positive way. They no longer have to guess how much to pay to get their purchase or sale processed. The system will change from a “first price” auction system to a set fee system.
Here is an analogy. The way the Ethereum platform works now is like driving up to a gas station pump and entering in a price that you think you should pay to buy the gas. The price of the gas is set, and all the pumps have the same price. But the transaction fees are not set. One car at a pump could put in a high offer price for the transaction fee and get his gas right away. Another person could put in a low ball price (whether he knew it or not) and have to wait 30 minutes to get his gas pumped into his car.
Now, with EIP 1559, all Ethereum users will have the same gas price and the same transaction fee. They either agree to the price and pay it, or wait until the price falls. It’s now going to be like buying anything else online. You either pay the shipping or handling fee or you don’t buy the product. You don’t have to set an auction price for those fees.
The second thing that will happen is that a portion of the transaction fees, normally paid to the Ethereum miners, will be diverted. This portion, called the base fee, will pay for ETH tokens that are then “burned.” This reduces the total supply of ETH tokens. However, the reduction effect is not yet clear. Some estimate it at about 20% of the total fees. Others estimate that it will be 4%.
Where This Leaves Ethereum
Some miners are not happy about this reduction in their fees. But the effect will probably be more than positive over the long term. The lower supply of ETH tokens will bring a deflationary force to the demand-and-supply equation. That will help move the price higher over time. This should more than cover the lower fees for miners.
Another positive aspect is that the more stable transaction fees will increase the demand for Ethereum transactions. Users won’t want to buy online goods in Ethereum if they have to haggle for the transaction fees. They are already dealing with the price of the goods or services to be bought. By making the fees more predicable demand will tend to increase over time.
Lastly, the effect of having higher demand for ETH tokens will increase scale and effectively lower transaction fees over time. That is also positive for buyers and overall demand, in a sort of virtuous circle.
Therefore, I suspect that the introduction of EIP 1559 in late July or early August will be a catalyst to push the ETH price higher. Although there may be some implementation or adoption issues, the overall Ethereum platform is bound to benefit from this change.
On the date of publication, Mark R. Hake owned a long position in Ethereum. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.