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Coin Metrics Report: Why is Ethereum Gas Fee So High?

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In early 2021, Ethereum transaction fees have soared to new highs.

Original source: Encryption Valley

The adoption of Ethereum is growing at an unprecedented rate. Decentralized finance (DeFi) continues its meteoric rise, stablecoins are adopted globally, and NFTs are becoming an everyday topic.

The use of Ethereum is a very good signal for the long-term prospects of the network. But in the short term, it caused some growing pains. In early 2021, Ethereum transaction fees have soared to new highs.

For background, at the peak of the 2017/2018 bull market, the average Ethereum transaction fee hit $5.70. Since January 18, 2021, the average Ethereum transaction fee has exceeded $5.70 every day. The median transaction fee has been above $10 for most of the year.

Source: Coin Metrics Network Data Chart

Part of the reason for the increase in transaction fees A massive increase in the price of Ethereum. As Ethereum becomes more valuable, transaction fees will also become more expensive in U.S. dollar terms. But this is also due to the sharp increase in Gas fees caused by network congestion.

To make things even more complicated, now that the Ethereum Improvement Proposal EIP 1559 is officially confirmed to be included in the upcoming London hard fork, the fee structure of Ethereum will be changed in July this year change.

In this report, we will first look at Ethereum's current fee mechanism and what is driving the high fees. Then we'll look at EIP-1559, and how it will change Ethereum's fees going forward.

Ethereum GAS overview

To send transactions or communicate with Ethereum decentralized applications ( dapp) interaction, users need to pay fees. Ethereum fees are often referred to as Gas. Similar to a car needs gas to run, Ethereum applications need Gas to execute.

Gas is essentially a measure of the computational effort required to perform an operation on Ethereum. More complex operations require more Gas to run, while relatively simple transactions, such as single token transfers, require less Gas. Ultimately, Gas is just another way of measuring transaction fees. Gas fees are paid in Ethereum and denominated in GWEI. GWEI is just a smaller denomination of Ethereum, similar to how a penny is a smaller denomination of a dollar. 1 GWEI is worth 0.000000001 Ethereum.

There are currently two factors that determine the cost of each transaction: Gas Cost and Gas Price.

Gas Cost

Different Ethereum transactions require different calculations. Simple transactions like token transfers require a relatively small amount of Gas. But more complex transactions, such as transactions that require the interaction of multiple smart contracts, require more Gas. For example, a simple Ethereum transfer requires 21,000 Gas. But executing a transaction on a decentralized exchange may require 100,000 Gas or more.

"Gas limit" refers to the maximum amount of Gas that a user is willing to use in a single transaction. Ethereum users can specify their desired gas limit when sending transactions. However, changing the gas limiti does not change the actual amount of gas required to perform the operation. The gas limit is just a safeguard to protect users from dapps that might try to use large amounts of gas without their knowledge. Any unused gas below the gas limit is returned to the sender's wallet. However, if they are set too low, the trades will not be executed, but they will still be charged.

Since January 2020, Gas per transaction has shown a downward trend. This suggests that increased transaction complexity is not the reason for high transaction fees.

Source: Coin Metrics Network Data Chart

Gas price

The second Gas price. People can specify any gas price they want, no matter how high or low.

Gas price only determines the amount that users need to pay for each unit of Gas used, and does not change the amount of Gas required to execute a transaction. Therefore, the exact same smart contract interaction executed at different times may have very different Gas costs depending on the Gas price used. This tends to lead to confusion, especially for new users.

Gas price also tends to fluctuate and depends on demand for block space. Average gas prices soared to all-time highs in the summer of 2020 due to the rise (and fall) of DeFi. The growth of decentralized exchanges, on-chain arbitrage, yield farming, and new token launches has all contributed to a sharp rise in competition for transaction priority, resulting in rising Gas prices.

On September 17, 2020, after Uniswap's unexpected UNI Token airdrop, the average price reached a peak, exceeding 500GWEI. In 2021, as DeFi continues to soar, Gas prices will soar again, and the sharp rise in Ethereum prices will also bring new traders and speculators.

Source: Coin Metrics Network Data Chart

Gas Auction

So, since users can choose to pay the lowest gas fee, why should they choose to pay high gas fee? In short, higher gas fees lead to faster transaction confirmations.

Imagine a bus stop with thousands of people waiting to catch the next bus. A new bus comes every 15 minutes or so, but each bus only has 50 seats. Seats on the bus are auctioned off to the highest bidder.

If at least 50 people are willing to pay 1,000 yuan to get on the bus, then the price of the ticket is at least 1,000 yuan. If the most people are willing to pay is $10, the price will be $10 or less. But if you only have 10 yuan, and there are hundreds of people willing to pay 1,000 yuan, you may have to wait a while before you can afford to get on the bus.

Unfortunately, waiting in line at a bus stop doesn't necessarily give you an advantage. If someone keeps showing up willing to pay more than you, they'll keep getting prioritized, even if you're waiting there longer.

This is a slightly simplified version of how the Ethereum Gas auction works. Ethereum blocks are mined roughly every 15 seconds. Each Ethereum block has a maximum size, which limits the amount of data that can be contained. The current maximum block size is set at 12.5M Gas, and the last increase was in July 2020. Since the maximum block size is in units of Gas, and different transactions have different Gas consumptions according to their complexity, there is no consistent maximum number of transactions that can be included in a block. But on average, each block contains about 160-200 transactions.

Source: Coin Metrics Network Data Chart

Ethereum Gas Fee Final Payment To Ethereum miners, miners earn income through a combination of transaction fees and block rewards (i.e. newly issued ETH). With the surge in Ethereum fees, transaction fees now account for 50% of the revenue of Ethereum miners.

When a new block is mined, the miner needs to specify which transactions to include. Due to the maximum block size, each block can only contain a limited number of transactions. So miners will naturally give priority to the transactions with the highest gas fees, because they will make more money if they are included.

Sending a transaction with a relatively high gas fee makes it more likely for miners to include it in the next block, since they have an incentive to include the highest gas fee transaction. But there is no guarantee that it will be included. If a certain number of users are willing to pay a higher gas price, then the transaction will not be confirmed until a later block.

This is even more troublesome when blocks are consistently full. Full blocks escalate the intensity of gas auctions, as transaction senders are bidding for scarce space. Since the rise of DeFi in the summer of 2020, blocks have remained around 95% full or more. In March 2021, the average block full rate is 97%-98%.

Source: Coin Metrics Network Data Chart

Over the years, block Gas The limit is occasionally raised, which causes a small increase in the number of transactions per block. But there are some trade-offs that prevent it from increasing too often. The larger the Gas block limit, the faster the state of the Ethereum blockchain will grow. Larger blockchains require more node operator resources, which favors larger-scale operations and hurts network decentralization.

To make things even more complicated, Ethereum Gas prices fluctuate greatly from block to block. There are services like ETH Gas Station, which will recommend what gas fee to set according to the required confirmation speed. But estimating the gas fee for the current block can be difficult, especially if there is a sudden or unexpected escalation in block space requirements.

UNI Airdrop and Rising Demand

Ethereum Gas Fee Rising Corresponding to the rise of DeFi, DeFi may still be the biggest contributor to high gas fees. For example, Uniswap’s UNI airdrop provides a small case study of what happens when demand for block space suddenly increases.

At 00:13 UTC on September 17 (8:13 EST on September 16), Uniswap announced an airdrop of their new UNI Token. Suddenly, thousands of people rushed to Uniswap to start trading UNI.

Uniswap is the largest decentralized exchange (DEX) on Ethereum, all their transactions are executed on the chain, which means that every time Every time a transaction occurs, a transaction is sent to the Ethereum blockchain. This is in stark contrast to centralized exchanges like Coinbase and Binance, where transactions happen off-chain and are only sent when users need to deposit or withdraw funds.

There are many benefits to on-chain transactions used by Uniswap and other DEXs. But one downside is that it puts upward pressure on gas fees. Executing transactions faster than others often brings direct economic benefits, so many DEX users are willing to pay high gas fees.

The figure below shows the gas fee for each block before and after the UNI airdrop. Each point represents the average Gas price of a single block, denominated in GWEI. The color of each dot represents the median transaction fee per block, in USD. As gas fees soared, the median transaction fee was temporarily above $12.

When UNI Token was launched, traders flocked to Uniswap to start trading. This caused a sudden spike in gas fees as traders competed for block space. In the chart below you can see that shortly after midnight UTC (00:00), the price of Gas suddenly went vertical and continued to increase for the next 24 hours.

If you send a transaction with a gas price of 200 GWEI before midnight, you would expect it to be faster based on the average gas price over the past 12 hours are included in a block. But due to the sudden increase in gas prices, your 200 GWEI transaction may not be included in a block for a day or more, until demand subsides and gas prices eventually fall back.

Source: Coin Metrics Network Data Professional Edition

Although it is as large as UNI Airdrops are relatively rare, but DeFi applications and usage contribute to high gas fees in many other ways. One particularly big reason for this is on-chain arbitrage between different DEXs, which is often performed by bots. On-chain arbitrage can lead to higher gas prices as bots compete against each other to be the first to execute a trade before the opportunity is gone.

EIP-1559 & Ethereum's new Gas mechanism

After a lot of debate, Ethereum Improvement Proposal (EIP) 1559 has been approved and will be included in Ethereum's upcoming London hard fork this summer. EIP-1559 will fundamentally change Ethereum's gas mechanism. Ethereum transactions will have an algorithmically calculated base fee instead of a user-specified gas price. It will also introduce a new block target size mechanism, the purpose of which is to allow blocks to continuously reach their maximum capacity.

Target block size

EIP-1559 will introduce the target block size mechanism, and Instead of a fixed maximum block size, the goal is to keep the block capacity at 50%. According to EIP-1559, the maximum block size will be doubled from 12.5MGas to 25MGas. But the target block size will remain at 12.5M.

The block size mechanism will maintain a 50% full block rate by adjusting the base fee, as detailed below:

Base Fee

EIP-1559 will introduce an algorithmically calculated price (per unit of Gas) called the base fee. Transaction senders must pay a base fee to have their transactions included in a block.

The base fee will be a function of the previous block and increase or decrease depending on the fullness of the block. If the previous block is larger than the target block size (i.e. more than 50% full), the base fee will increase. This escalating base fee will eventually make the transaction cost too high for some users, reduce congestion, and bring the block fullness back down to 50%. Conversely, if the block fullness falls below the 50% target, the base fee is lowered, making it cheaper to send transactions.

The base fee will effectively automate the Gas price bidding system. Base fees will be calculated by the protocol itself rather than relying on recommended gas prices based on current gas price estimates.

In addition, the base fee will not be paid to miners, but burned. The burned portion will permanently remove it from the supply, effectively reducing the overall supply of Ethereum. This will benefit the supply economics of Ethereum as it will effectively reduce the supply inflation of Ethereum. It even has the potential to make Ethereum deflationary if fees become high enough.

The chart below shows the current supply of Ethereum compared to the supply if all transaction fees were burned, which is about 3M ETH in total. This is an oversimplification of what happened after EIP-1559 was enacted, as only base fees would be burned, not tips. But it offers an idea of how supply inflation will slow after EIP-1559 rolls out.

Source: Coin Metrics Network Data Chart

But it is also subject to some miners Businesses objected that it might reduce their overall income, at least in the short term. After intense debate, most major mining pools have endorsed the transition to EIP-1559, albeit reluctantly.

This base fee target block size mechanism will hopefully keep blocks below the maximum capacity for long periods of time and prevent the Ethereum blockchain from clogging up as it currently does. But if the demand is high enough or suddenly escalates, there may still be a situation where most blocks end up almost full (at least for a short period of time), similar to the current Gas mechanism.

Tips

In addition to the basic fee, the transaction sender can also choose Add a tip. Tips are paid directly to miners, similar to current transaction fees. Paying a high tip will incentivize miners to prioritize transactions when blocks are close to capacity.

When sending a transaction, the user sets a fee cap. A fee cap is the most a sender is willing to pay, including base fees and tips. If the fee cap is lower than the base fee, the transaction will not be included in a block. If the fee cap is higher than the base fee, the difference is sent as a tip to the miner of the block.

If the block continues to be full, the tip function may be similar to the current Gas mechanism, and miners will be motivated to include transactions with high Gas prices. However, the target block size mechanism of EIP-1559 will hopefully prevent blocks from reaching their maximum capacity in the long run.

Will EIP-1559 reduce gas fees?

Will EIP-1559 solve today's high gas fees and greatly reduce Ethereum transaction fees? The short answer is probably not.

High transaction fees are fundamentally a scalability problem. If Ethereum can only process a few hundred transactions per block (on average), high fees will continue to occur as long as dapp usage continues to increase. As long as the competition for block space is fierce, the Gas fee will continue to rise.

While it likely won't solve the problem of high fees, EIP-1559 will help improve Ethereum's user experience and make fees more predictable. EIP-1559 should help reduce variance in gas fees, giving users more clarity on what they actually need to pay.

However, to truly reduce transaction fees in the long-term, Layer 2 scaling solutions, and eventually Ethereum 2.0, will be required. By all means, scalability solutions will increase the amount of transactions that can be processed per block, which will help alleviate congestion that leads to high fees.

There has been a lot of progress on L2 solutions, including Optimism, Loopring, and Immutable X, to name a few. Due to the debate surrounding EIP-1559, Ethereum 2.0 may even arrive earlier than previously planned. But most solutions have a lot of complexity, and it will take time to incorporate scalability solutions into the entire network.

Conclusion

Ethereum transaction fees are at an all-time high. DeFi usage and high competition for block space lead to full blocks and congestion, driving up gas fees. EIP-1559 will help improve Ethereum’s transaction fee user experience, but it may not ultimately solve the high gas fee problem. But an Ethereum scalability solution is on the way, and it will be a real long-term solution to lower transaction fees.