Update about Ethereum 2.0 adoption

Market Insights Jul 15, 2021

Ethereum 2.0, or Eth2, refers to a set of interconnected upgrades that will release the pressure off the blockchain and improve its performance and scalability. The blockchain will gradually migrate from proof-of-work to proof-of-stake consensus. We introduced the concept of PoS in one of our previous papers: Proof of Stake consensus winning the battle of scalability and sustainability.

The set of upgrades currently built by multiple teams across the Ethereum ecosystem are addressing different issues:

  • Scalability

There is a scalability challenge due to inherent properties of the Ethereum blockchain in which each node in the network has to process each transaction. That restricts block generation to between 7-15 transactions per second. According to Vitalik Buterin, founder of Ethereum, the change to PoS consensus should allow Ethereum to process two or three thousand transactions per second. The high level of demand on the network is also driving up the transaction fees (also called gas fees) and making Ethereum expensive for the average user.

  • Sustainability

Ethereum and other blockchains like Bitcoin are using a lot of energy because of mining. The underlying proof-of-work consensus algorithm that keeps Ethereum secure and decentralised has a big environmental impact.

  • Security

In the PoS protocol, the validators who secure the network must stake significant amounts of ETH into the protocol. If they try to attack the network, the protocol can automatically destroy their ETH. The Eth2 upgrades will improve the blockchain security against coordinated attacks, like a 51% attack. This is a type of attack where, if someone controls the majority of the network, they can force through fraudulent changes. Staking also means you don’t need to invest in elite hardware to 'run' an Ethereum node. This should encourage more people to become a validator, increasing the network’s decentralisation and decreasing the attack surface area.

Ethereum upgrades are coming in three main phases:

1- The Beacon Chain (Dec 2020)

The Ethereum Beacon Chain brings PoS to the Ethereum network. It is shipped separately from the mainnet, as a separate proof of stake network inside the "old" Ethereum blockchain (Eth1).

There is no immediate functional impact on the main blockchain but, despite the long road still ahead, the Beacon Chain proves that things are moving and the promise of Eth2, made years ago, is coming to fruition.

The boom of Layer 2 protocols such as Polygon, Raiden Network, Omisego, Celer, Skale Network or Omisego has unclogged the network and allowed a reduction in the pressure on gas fees. The high fees on Ethereum noticed earlier this year were mainly due to the huge growth of decentralised apps.

Ethereum Average Gas Price

16.41 Gwei for Jul 04 2021

Source: ycharts.com

2- The merge (or formerly referred to as the docking) - expected in Q1 2022

The phase will merge the Beacon Chain and Eth1. The Eth2 Beacon Chain will become the "real" Ethereum blockchain, while Eth1 becomes another shard. At this stage Ethereum will be a fully-fledged high-scalability proof-of-stake blockchain.

This eliminates the need for energy-intensive mining and instead secures the network using staked Ether. Mining will no longer be required at this point, so it's expected that miners will invest their earnings into staking in the new PoS system.

Originally, the plan was to work on shard chains before the merge to address scalability; however, with the boom of L2 protocols , the priority has shifted to swapping PoW to PoS via the merge.

3- Shard chain  (expected in 2022)

In computer science, sharding is the practice of splitting up a database to spread the load across multiple servers. It's the same in Ethereum, where this phase will see the blockchain split up across 64 shards that will run alongside one another. It will improve Ethereum’s scalability and capacity. When implemented, it will improve the network throughput by probably a 100-fold.

The introduction of shards and roll-up technology means that validating a block will be quicker and cheaper because less data is included. Rollups are solutions that perform transaction execution outside the main Ethereum chain (layer 1) but post transaction data on layer 1. They therefore inherit the security properties of layer 1, while performing execution outside.

Another positive effect of reducing computational load will be to allow more lightweight devices such as laptops or phones to run on Ethereum. Beyond making Ethereum more generally portable and accessible, this will also reduce the network's reliance on intermediaries and hosting services, contributing to more effective decentralisation.

Finally, Eth2 will introduce a base "interest rate" to the network's economics, measured by the returns earned from staking Ethereum. It is speculated that this will serve as a benchmark against which the returns from DeFi yield-earning applications and other tools can be measured. It is estimated that stakers will need returns of between about 3% and 12%, depending on market conditions, to consider staking sufficiently financially rewarding, so those are roughly the returns targeted.

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Caroline Jacquard

Seasoned marketing manager with 15+ years of experience in the financial industry: traditional finance, alternative investment and digital assets. Advisor @trakx.io