How do Ethereum transaction fees work now that EIP-1559 is live?

Ethereum’s London hard fork — in particular, the part known as EIP-1559 — has made transactions more reliable to price, which was the upgrade’s stated goal. But it has also made them more complicated. 

On the surface, users now have an additional decision to make when choosing how much to pay a miner for adding a new transaction to the blockchain. Below the surface, what’s actually happening is all a bit confusing.

So here’s a simple guide to what you need to know.

Ethereum transaction fees: the basics

Ethereum transactions require “gas.” The term is used to make transaction fees — which are paid to miners for adding transactions to the blockchain — feel more familiar (It’s just like filling up a car!). In reality, transaction fees are paid for in ether and usually denominated in a unit representing a minuscule amount of ether, called gwei.

Two numbers determine how much an Ethereum user must pay for gas: The amount of gas you need to spend and the price that you’re willing to pay for that gas. 

The amount of gas you need to spend relates to the complexity of the transaction you want to execute. If it is super complicated, with lots of moving parts, then it will take up more gas. This cost reflects the computational complexity of the transaction. The more work you ask a miner to do, the more you need to compensate them for it.

How much should you be willing to pay for that gas? That will likely depend on how much competition there is for space in a block at the time you are hoping to execute your transaction. If loads of people are vying to make Ethereum transactions, transaction fees will rise. If you choose a price that’s too low, the transaction may sit in limbo for a while before fees fall again and a miner finds it worthwhile to take it up and include it in a block. 

Prior to this latest upgrade, it was relatively simple to choose a transaction fee. In the background, your wallet would guess at how much gas you need and then you would choose how much you want to pay for the gas (depending on how quickly you want the transaction to be processed). So you just had to select one number.

So what has changed?

The London hard fork made three main changes to the way fees are paid:

First, it instituted a “base fee” for all transactions, which is calculated based on the size of the previous block and its base fee. This fee does not go to miners, however. Instead, it gets “burned,” which in this case means it is destroyed. 

Second, Ethereum users can add what’s called a priority fee —  also known as a “tip” — on top of the base fee. This goes to miners and is meant to encourage them to prioritize the transaction. This is very similar to how transaction fees used to work.

Third, users can now specify a maximum fee for the transaction, which puts a hard limit on how much they’re willing to spend. It’s designed to give a bit of leeway for the fee process (more on that later).

In addition, the upgrade has doubled the maximum size that a new block can be. Before London, blocks could contain transactions that add up to 15 million gas. Now they can contain transactions worth up to 30 million gas.

What’s the base fee?

The base fee is a new part of the transaction fee. The intention behind the base fee is to lower demand for block space when the network is congested, and to encourage more payments when there is less congestion. Combined with the larger block size, the goal is to make the network handle moments of high demand without causing gas prices to skyrocket.

The base fee fluctuates, and is based on what happened in the previous block. If the last block was chock full of transactions, then the base fee will rise to counterbalance the demand. 

Specifically, the mechanism is designed to keep blocks around half full, because if they are more than half full then transactions get more expensive and vice versa. If the last block was above 15 million in gas (the halfway point), the network will raise the base fee to counteract the demand. If it was below 15 million in gas, the base fee will drop to acknowledge the lack of demand. 

There are some limits to how quickly the base fee can rise or fall. It can fluctuate by up to 12.5% each block, meaning it can double over six blocks.

What’s the priority fee?

The priority fee, or tip, is what lets the user compensate miners. 

This money can be used to encourage miners to favor your transaction over someone else’s. While the tip isn’t necessary in the same way the base fee is, it can help speed up a transaction. 

But to make things more complicated, this isn’t a fixed number. Users set a maximum priority fee, for how much they’re willing to tip the miner. The miner will take as much of it as they can — minus the base fee — up until they reach the “maximum fee” for the whole transaction. 

What’s the “maximum fee?”

Before the upgrade, users only had to choose one number: the transaction fee itself. As mentioned, setting the new “priority fee” is similar. But now, users have to pick two numbers: the priority fee and the maximum fee. This second number must include the base fee, the priority fee and any extra room they want to give the transaction to account for the possibility that the base fee rises..

Mempool tracking site Blocknative’s rule of thumb is that the maximum fee should be two times the base fee (because it can rise quite sharply) plus the priority fee. So if the base fee in the previous block was 42 gwei and the priority fee is 10 gwei, Blocknative reckons the maximum fee should be set at around 94 gwei, according to its gas estimator.

Since block sizes can be quite variable, so can the base fee. If there’s an empty block then the network thinks the base fee should be quite low.

But then there might be a spate of full blocks, which would rapidly ramp up the base fee. That’s the argument for leaving a bit of leeway in the maximum fee.

Here’s an example transaction

Let’s say I want to make an Ethereum transaction and I’m estimating the base fee to be around $10. I’m happy to tip the miner $20 for their efforts but I don’t want to spend more than $40 in total, which I set as the maximum fee.

If the base fee is indeed $10, then the miner will take the whole $20 tip. In total, I will end up spending $30 on the transaction.

But say the base fee jumped a lot higher before the transaction went through and ended up being $30. Since the maximum I’m happy to pay is $40 — as set by my maximum fee — then the miner will only be able to take $10 of the tip before reaching the cap. 

This explains why the priority fee is a maximum too. It’s so that, if the base fee rises, you don’t end up paying the whole wack. Instead, it’s overruled by the maximum fee, saving you a few dollars.

H/T to Blocknative for assisting with this article.

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