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Monetary Policy and EIP-1559

In contrast to Bitcoin’s hard-cap approach, the Ethereum community supports a non-hard-cap supply in support of the smallest amount of inflation necessary to secure the chain in the future. The tokens emitted via inflation accrue proportionally to ETH stakers participating in the PoS consensus. Post-Merge, the daily issuance of ETH has decreased from approximately 15,000 ETH to less than 2000 ETH. Due to a drop in issuance and a reasonably stable burn rate, the net supply change of Ethereum has been negative since the Merge, decreasing overall. At this pace, Ethereum's annualized inflation rate is ~0.12%. Before the Merge, the annualized rate of inflation fluctuated between 4 and 5 percent.

ETH inflation, while not algorithmically programmed, has steadily decreased over time.
Image credit: Galaxy Digital

Integral to Ethereum’s long-term plan to act as sound digital money was the implementation of EIP-1559 in August 2021 during the London hard fork. The goal is to create a more efficient and simple gas payment process. EIP-1559 aims to improve user experience by reducing transaction wait times, mitigating fee-market uncertainty/volatility, and improving upon ETH’s imprecise gas usage for a typical transaction; this is in addition to introducing a burn mechanism.

EIP-1559 uses a mechanism similar to Bitcoin’s PoW difficulty adjustment to find a dynamic equilibrium for gas prices automatically. EIP-1559  changed Ethereum to have 2x the current block space but only target blocks to be 50% full (as opposed to nearly 100% currently). Therefore, over time, Ethereum’s blocks and block size will, on average, remain about the same, but the extra block space allows for flexibility with regard to transaction inclusion. If blocks get >50% full, gas costs increase. If blocks are <50% full, gas costs will decrease.

Prior to EIP-1559, Ethereum used a fee auction market structure to organize transactions similar to Bitcoin, where users place bids to compete for space on the next Ethereum block. Miners in PoW generally selected the transactions with the highest bids since they stood to collect all the fees. There was a gas ceiling of 12.5 million per block, meaning some transactions would get priced out until future blocks with a lower accepted fee.

EIP-1559 is a mechanism that enables Ethereum to reduce the net issuance of ETH as a function of the demand to transact on the network. This is the piece that makes ETH a consumable commodity. The combination of the base fee burn coupled with lower validator rewards in PoS plus ETH locked up in staking will result in a net negative issuance and shrinking circulating supply. Researchers estimate the supply equilibrium will eventually be between ~27-50 million ETH. 

Image credit: Galaxy Digital

In addition to introducing variable block sizes to Ethereum, the London Upgrade and EIP-1559 increased the gas limit per block to 30 million; EIP-1559  also updated the structure of transaction fees. There will still be a base fee and a tip (or priority fee). The base fee is set by the protocol and adjusts every block based on network activity. The base fee no longer goes to miners but is instead burned. The tip is set by the market (can be zero in times of little congestion) and will go to the validators. 

Solana Differences

As explained above, while Solana may be an Ethereum competitor, it’s not an Ethereum clone, along with the likes of Binance Chain (BNB), Avalanche’s C-Chain, Fantom, and others (all to varying degrees). Solana isn’t Ethereum Virtual Machine (EVM)-compatible, meaning existing Ethereum dApps and infrastructure can’t be easily ported over to Solana. Rather than the EVM, Solana operates within the LLVM, a standard compiler that separates human readable code (Rust) from assembly, which is low-level code that can take advantage of hardware optimizations. 

In Solana, smart contracts are called “programs,” and the programming languages are Rust C and C++. Rust is generally considered a more difficult programming language to learn than Solidity, and it was chosen by Solana Labs with the hopes that it would primarily only attract “professional programmers” and reduce the amount of copy-and-paste projects seen in Ethereum, BSC, and others. 

Solana's approach to handling transactions sets it apart from other blockchain networks like Ethereum in several key ways. Notably, Solana does not rely on a public mempool where pending transactions are aggregated through peer-to-peer gossip. Instead, these transactions are directly forwarded to the current leader and the next few leaders in line for processing. Moreover, Solana's default validator implementation emphasizes continuous block production, in contrast to Ethereum's 12-second block intervals. This means that priority fees on Solana do not guarantee inclusion within a block.

This continuous process allows for faster pre-confirmation of transactions, offering a significant advantage in terms of speed. However, this approach does not come without its challenges. The continuous nature of block-building in Solana's system can result in a lack of predictability and certain inefficiencies, particularly regarding the inclusion and prioritization of transactions.

The blockchain operates on a multi-threaded mechanism, allowing for the parallel processing of transactions. This structure aims to enhance the throughput and efficiency of the network. Nonetheless, the decision-making behind the allocation of threads and compute units appears to be somewhat arbitrary, raising questions about the optimization and scalability of the system.

One of the most notable features of Solana's design is the concept of local fee markets. These markets are intended to operate independently for different types of transactions, such as NFT mints or DeFi operations. Theoretically, this structure should prevent a high-demand transaction type from disproportionately inflating fees across the network. However, in practice, the realization of local fee markets in Solana has been less than ideal.

The current mechanism for processing transactions in Solana is predominantly a first-price, greedy system. This setup does not provide clear guidance to users on the priority fee required for timely inclusion of their transactions, leading to inefficiencies. Particularly during periods of high network demand, users and protocols may increase their transaction fees in an uncoordinated and empirical manner, leading to an overall inefficient system.

This situation contrasts with Ethereum's implementation of EIP 1559, which introduced a more predictable base fee that adjusts with block saturation, offering a clearer and more efficient way for users to gauge the required transaction fees.

Finally, Solana transactions come with a fixed network fee per signature, typically one signature per transaction, amounting to 0.000005 SOL, approximately $0.0001 at the time of writing. Additionally, users have the option to include a priority fee, measured in the fee paid per requested compute unit, to gain higher priority within the Solana scheduler. It's important to note that Solana's block size limit is determined by compute units used, akin to Ethereum's gas target. Interestingly, Solana's fee structure allocates half of the network fees to burning while the remaining half is awarded to the leader.