Ethereum's Fee Collapse

The recent drastic drop in Ethereum's base fees is eliciting worry and curiosity among those who keep a pulse on the network's health. With ETH burning hitting its lowest point this year, only 210 ETH burned as of August 10th, that made for quite an alarming case for a network touting its deflationary mechanism, equivalent to $50 million dollars.

Why did this happen?

Image source

The answer lies in the steep drop of gas fees to almost 0.8 Gwei, a multi-year low. On the surface, this may seem like good news for users who have been complaining for a long time about high transaction costs. However, all of this isn't just about cheaper transactions, it's about the very nature of Ethereum's economics.

For a long while, its value proposition has been equated with the idea that ETH is a deflationary asset thanks to the burning mechanism put in place by the London hard fork, or EIP-1559. When fees are low, less ETH gets burned into the network, affecting the inflation rate. On the other end, with net ETH emissions now at more than 2,000 ETH, one could look at this situation as being backwards for those who believe in Ethereum's deflationary promise over the long run.

Some voices, like Gnosis founder Martin Köppelmann, have been urging an increase in the gas limit to spur more Layer 1 activity. Logic here may sound counterintuitive—why increase the gas limit when fees are already so low? But the idea is to revitalize the main Ethereum network activity, which has been losing users to Layer 2 solutions and other cheaper alternatives.

Does this really solve the problem, or is it mainly a Band-Aid for something deeper?

If anything, this shift to Layer 2 solutions has sapped some of the main Ethereum network's vitality. This shift is partly pushed along by the introduction of blob transactions from the recent Dencun upgrade, which had an actually quite large cost reduction on Layer 2 networks. It's a double-edged sword, as much as Layer 2s have been key to scaling, their rise seems to suck all the oxygen up away from Ethereum's core.

Image source

This fee collapse also casts a doubt on whether Ethereum can retain its position in the fast-changing crypto space.

If Layer 1 becomes less appealing, with reduced activity and fewer ETH burned, it would be hard for the network to keep claiming the spot as the number one smart contract platform. That strong network effect has been the strength of Ethereum all along. That could weaken if users and developers start looking at Layer 2 solutions or even other blockchains as more viable alternatives.