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A Dive Into Ethereum 2.0

Published on:
September 2, 2020

Ethereum 2.0 is slated to be launched soon, and given how this network is home to the second-largest crypto by market cap in the world, the transition needs to go smoothly.

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Ethereum 2.0 — also known as Serenity — is the long-awaited upgrade to the Ethereum blockchain.

It's a big deal. Given how this network is home to the world's second-largest cryptocurrency by market cap, the transition needs to go smoothly. Billions of dollars are at stake (quite literally!)

Check out our FAQ to find out the pros and cons of this new-look Ethereum network, what the roadmap looks like and what it means for decentralized applications.

What Is Ethereum 2.0?

In a nutshell, Ethereum 2.0 will result in the blockchain shifting from a proof-of-work consensus mechanism (also used by Bitcoin) to proof-of-stake. This is going to be a marked departure from a tried-and-tested protocol that's been used for five years.

This won't result in a brand-new cryptocurrency being created — your ETH will be exactly the same. Instead, most of the changes are going to be at the backend, technical enhancements you probably won't even notice.

The ETH 2.0 blockchain network has been in the works since 2015, and it won't be implemented overnight. One of the main goals is to boost capacity, meaning that transactions can be executed faster. An explosion in open-source DApps, not to mention the decentralized finance sector, have overwhelmed this blockchain network. 

For an example, just look at what happened when CryptoKitties launched in the heady days of 2017, when Ether and Bitcoin were heading to all-time highs. Demand for these collectible cats reached such a peak that there were tens of transactions stuck and waiting to be processed.

Future-proofing the mainnet to ensure that it is scalable could end up being crucial to its survival. Without it, crypto enthusiasts could end up taking their business somewhere else.

How Is Ethereum 2.0 Different From Ethereum 1.0?

Blockchain technology company ConsenSys has a neat way of describing how ETH 2.0 is different to its predecessor ETH 1.0.

Imagine that Ethereum 1.0 is a busy road with a single lane going in each direction, meaning all of the cars have to crawl through at a slow pace when there's congestion.

Ethereum 2.0 is going to introduce sharding (more on that in our next question,) which has the effect of turning the blockchain into a motorway with dozens of lanes. All of this will boost the number of transactions that can be handled concurrently.

The shift from PoW to PoS is going to be extremely significant, not least in terms of energy efficiency. Proof-of-work uses a jaw-dropping amount of power — so much so that a single transaction on the Bitcoin blockchain has a carbon footprint that's equivalent to 667,551 VISA transactions. One payment on Ethereum 1.0 ends up using more electricity than the typical U.S. household does in a whole day.

Estimates from the Institute of Electrical and Electronics Engineers (that's IEEE for short) suggest that the ETH 2.0 upgrade will cut energy usage by a whopping 99%. This means that, as well as contributing to the quest for financial freedom, the blockchain won't be calamitous for the environment.

What Are Shard Chains?

Sharding is the technology that will make Ethereum 2.0 scalable. It effectively involves splitting the blockchain mainnet into loads of tiny shard chains that run alongside each other. Instead of transactions being executed in a consecutive order, they'll be handled simultaneously — and this is clearly a much cleverer use of computing power.

As the ConsenSys team explained: "Each shard chain is like adding another lane to upgrade Ethereum from a single lane road to a multiple lane highway.  More lanes and parallel processing leads to much higher throughput."

Now, you may be thinking "This is genius! Why wasn't this done from the start?!" — the answer, to be blunt, is that life isn't that simple. 

One of the biggest downsides of sharding is how it can compromise security if it's done poorly. Because fewer validators will be tasked with keeping each of these mini shard chains secure, there is a risk that they could be overtaken by malicious actors. It all harks back to that classic trilemma that has baffled cryptography enthusiasts for years: scalability, decentralization and security — you can pick two.

How Does Staking Work?

A significant change in the Ethereum 2.0 blockchain will be the shift to staking. This will entail a complete rethink about how new blocks are confirmed.

The PoS system, known as Casper, involves validators putting their money where their mouth is. In order to be given the privilege of adding new blocks to the blockchain and receiving a reward, they need to cough up 32 ETH that will be locked away. You could compare this to an insurance policy — just like you'd lose your security deposit if you trashed a hotel room, validators risk losing their ETH if they fail to act in the interests of the blockchain network. 

As you'd imagine, this is vastly different from the way Ethereum works right now. New blocks are mined by those who have the most computing power — technology that's far out of the reach of the everyday consumer. With the proof-of-stake consensus, blocks are usually delegated in a proportional way, based on how much crypto someone has locked up. So: a person who has staked 5% of the total will end up validating 5% of the new blocks, and receiving the reward. With Ethereum 2.0, validators are going to be chosen at random.

Let's talk money. How big are the rewards going to be? Well, this will depend on how many validators there are — and it'll diminish over time. Ethereum's roadmap suggests that the maximum gain would be 18.1% on top of the 32 ETH, or as low as 1.56%.

Assuming, as an example, that 1 ETH was worth $300, this would require a total investment of $9,600 in order to become a validator. That's a hefty chunk of change. Because of this, staking pools have emerged where crypto enthusiasts will be able to bring their Ether together and split the proceeds.

Will Proof-of-Stake Be the End of Ethereum Mining?

To cut a long story short... yes. Ethereum mining pools are going to be twiddling their thumbs and looking for something to do once ETH 2.0 is fully launched. They might have to shift their attention to altcoins, or begin a new career as a staker.

That said, they don't need to start boxing up their mining equipment just yet — proof-of-work is still going to be in town for a while as the testnet is put through its paces, and each phase comes into force.

There had been fears that we could end up seeing a massive fightback from the mining community, and some might even stop the PoS consensus from being implemented in order to protect their precious earnings. It is unlikely that this will come to fruition, but there is a risk that there could be a hard fork — a dramatic process where a cryptocurrency splits into two. 

There is a precedent for this. Back in 2016, the original Ethereum network underwent a hard fork after the MakerDAO hack. The original blockchain where the hacker kept the money was rebranded as Ethereum Classic (which will remain proof-of-work), while the newer platform, where the money was returned, retained the Ethereum name.

What Are the Pros and Cons of Ethereum PoS?

As we've mentioned, greater energy efficiency is one of the biggest advantages associated with staking. But this is just the start. Here are some of the other benefits:

  • Lower barriers to entry. Becoming a validator on a proof-of-work blockchain is often prohibitively expensive because of the high tech mining equipment you need. With the PoS consensus, Ethereum's stated goal is to "allow for a typical consumer laptop to process and validate shards."
  • A fairer playing field. Because of the sheer cost of mining equipment, and the electricity consumption required on a PoW consensus mechanism, the responsibility of creating new blocks often falls to a small handful of miners who have the cashflow to make things happen.
  • Network attacks are more expensive. Validators have a financial interest in making sure that the blockchain is safe and secure. For a malicious actor to succeed in attacking the Ether network, they'll have to stake a security deposit — money they would eventually lose.

As you'd expect though, there are disadvantages to the proof-of-stake consensus. They include:

  • Big stakers could end up having an outsized influence. Eliminating mining doesn't mean that you get rid of a power imbalance. Someone with deep pockets could end up staking 32,000 ETH, and hence end up validating 100 times more blocks than everyone else.
  • It's been untested at this scale. Ethereum is going to be the biggest cryptocurrency to ever transition to Proof-of-Stake. Complications and unexpected vulnerabilities could be nothing short of disastrous for the project.

What Are the Main Phases of ETH 2.0?

As you'd imagine, the Ethereum Foundation wants to tread very lightly with the upcoming upgrade. Because of this, the process of switching to ETH 2.0 is perhaps best compared to continuing to live in a house while it is being renovated.

In a nutshell, there are three main phases: Phase 0, Phase 1, and Phase 2. The existing Ethereum 1.0 blockchain will continue to be operational at each stage.

Here's what each step entails:

  • Phase 0 will herald the launch of the Beacon Chain, which is going to be responsible for managing validators and delivering the PoS consensus mechanism — as well as dishing out penalties and rewards. This was scheduled to happen in January 2020.
  • Phase 1 adds sharding to the mix, dividing the Ethereum network into 64 different chains. Although it's logical to think that this would multiply capacity by 64, it could actually mean that ETH 2.0 can handle hundreds of times more transactions per second than its predecessor. This part of the roadmap was penciled in for 2021.
  • Phase 2 will mark the arrival of ETH transfers and withdrawals, along with smart contract functionality, eventually leading to the Ethereum 1.0 blockchain being turned off once and for all. It is hoped that this would be live by 2022 — but when have you ever known such a big project to run on schedule? 

As this Medium.com article by Jeffrey Hancock explains: "Unfortunately, everything behind Phase 2 is in an exceptional state of prediction and there is no reliable information about these phases."

Hundreds of developers are involved with this project, which is being orchestrated by the Ethereum Foundation. All of the complicated technical details are recorded on a dedicated Github page.

Why Has Ethereum 2.0 Been Delayed?

Now you may be thinking "January 2020! Ethereum 2.0 must have launched by now! How did I miss that?!"

Well, don't worry, the news didn't pass you by... the truth of the matter is that this new blockchain's development is running seriously behind schedule.

After the original deadline was missed, it was hoped that ETH 2.0 would launch in July — just in time for the blockchain's fifth anniversary. Champagne corks would fly, and the unpleasant delays would be forgotten about. Alas, this didn't happen either.

The problem is, the Beacon Chain can only launch when a public testnet and a bug bounty program have been running for several months — and Justin Drake, a member of the Ethereum Foundation, has expressed skepticism that this is achievable in the third quarter of 2020. He thinks Phase 0's debut may only be achievable in January 2021 — a full year behind schedule.

Following on from Drake's remarks in mid-July, one of Ethereum's founders, Vitalik Buterin, went to great lengths to play down this pessimism. He pointed out that the Altona testnet launched in July, and suggested that Phase 0 could kick off in November. Replying to Drake on Reddit, Buterin said: "I personally quite disagree with this and I would favor launching phase 0 significantly before [2021] regardless of level of readiness."

That's a bold, brash, high-stakes statement. Launching before you're fully ready could result in some major disruption for those who rely on the ETH blockchain, crash the price and unearth nasty security vulnerabilities.

By mid-August, Buterin seemed to be rowing back on this...perhaps all the way back to the boathouse. Interviewed on a podcast, he said: "I definitely freely admit that Ethereum 2.0 is much harder than we expected to implement from a technical perspective. I definitely don't think that we discovered any fundamental flaws that make it impossible, and I do think it will be finished. It's just a matter of time, and it's actually been progressing quite quickly lately."

What's Going to Happen to the ETH 1.0 Blockchain?

When Ethereum 2.0 eventually does launch, it'll run in tandem with Ethereum 1.0 for a couple of years at least.

Once ETH 2.0 is fully built and functional, ConsenSys says: "The current plan is for the Ethereum 1.0 chain to effectively become the first shard on Ethereum 2.0 when Phase 1 launches."

There actually are some pretty snazzy analogies out there that describe how the switch is going to work.

One ConsenSys employee, Jimmy Ragosa, tried to explain it simply by comparing Ethereum 1.0 to a bus, and Ethereum 2.0 to a train.

Ragosa paints a picture where the train is being built while the bus is on its way — and bus passengers will be allowed to continue their trip on the train as soon as the Beacon Chain is out. "In the end, the whole bus is loaded on the train," he wrote.

What Happens to the ETH That I Own Now?

If you currently own Ether, you might be really worried that your ETH will be worthless as soon as the new blockchain roars to life. 

Here's the important thing to remember: it isn't going to be the cryptocurrency that's different when ETH 2.0 launches, it'll be the blockchain technology that underpins it that changes. There won't be any new token that you need to buy, nor will you have to make fiddly conversions from one digital asset to another.

But if you are sitting on a decent amount of ETH, one thing you might want to consider is putting your cryptocurrency to good use through staking. A word of warning though, you might not want to do it straightaway. Validators who join at the Beacon Chain phase won't be able to withdraw the Ether that they've staked until Phase 2 of the upgrade, which could be two or three years away. 

Once again, it's important to stress that you won't be able to buy ETH 2.0 tokens once the upgrade is complete. It'll be the same old Ether that you know and love, in the same Ethereum wallet you've always used.

How Will ETH 2.0 Affect DeFi?

Ethereum 2.0 could make decentralized finance far more practical, both in terms of speed and transaction fees.

At present, ETH 1.0 can only manage about 25 transactions per second (TPS). That's barely enough for a single DeFi protocol, let alone a whole blockchain network.

Vitalik Buterin has previously suggested that ETH 2.0's capacity could quickly jump up to 100,000 TPS once each phase has been implemented correctly.

But Kyle Samani, the founder of Multicoin Capital, believes that even this may not cut the mustard if decentralized finance manages to become more popular. 

Warning about the challenges that lie ahead during a Twitter discussion in May, he wrote: "Can you please explain to me how you can run the global financial system on 25 TPS? Or even 2,500 TPS? Or even 25,000? I'm fairly certain you need at least 1,000,000 TPS for crypto to function at global scale."

One million transactions per second! All of this could suggest that, even when ETH 2.0's new blockchain network launches, a whole round of additional improvements will need to be made so the platform can keep up with the demands of users.

Will This New Blockchain Technology Affect Ethereum DApps?

One concern surrounding ETH 2.0 is the impact that this upgrade could have on existing DApps. Are we going to end up with a scenario like Apple, where newer iPhones no longer support apps that were designed for older devices?

Ultimately, there isn't necessarily a risk that DApps will no longer be compatible with this blockchain. A bigger danger is that bumps in the road as the network is rolled out could cause business disruption that slows activity down.

If the Ethereum 2.0 rollout is done right, this could trigger a new wave of innovation on the blockchain as developers, previously fed up with high transaction fees and slow confirmation times, begin to return from smaller platforms.

According to Dapp.com's market report for Q2 2020, there are currently 1,394 active decentralized apps. Of those, 575 — roughly 41% of the total, run on Ethereum. Back in the heady days of 2017, this blockchain was one of the few options for developers who wanted to build their own applications — but these days, they're spoiled for choice.

In the fullness of time, we could begin to see Ethereum retake some of the market share it has lost over the years. The Dapp report shows that Ethereum managed to double the number of active decentralized app users in Q2, reaching an all-time high of 1.25 million. This was largely driven by the demand for DeFi apps.

What Does Vitalik Buterin Think About Ethereum 2.0?

As we've seen, Buterin is determined to get this blockchain launched — and it looks like he won't be resting on his laurels once ETH 2.0 comes to fruition, either. In March 2020, he released a detailed Ethereum roadmap of "what the next five to 10 years of ETH 2.0 and beyond might look like."

He has also been a staunch defender against claims that Ethereum 2.0's design remains inferior to how Bitcoin was built all the way back in 2009. Buterin insists that sharding, along with cutting-edge technology known as zero-knowledge proofs, will result in the blockchain network being much cheaper to use than BTC.

The programmer went on to list the PoS consensus, as well as stateless verification and 12-second block times, as other unique selling points for the fully fledged network.

But despite all of these benefits, it all comes back to the one single issue that Ethereum developers are desperate to solve. "ETH 2.0 is all about scale," he wrote.

What Are the Main Downsides of ETH 2.0?

Buterin has admitted that one of the main disadvantages of the switch to proof-of-stake is how it is "definitely more technically complicated because you have to deal with validators."

This all points to a wider issue — one that's crucial in cracking mainstream adoption once and for all. Blockchains and cryptocurrencies are immensely complicated things. Sometimes, even someone with a PhD in computer science will need to take a moment to ensure that they're understanding a crypto startup's technical paper correctly.

Making the platform more technical risks alienating everyday consumers who may have otherwise considered making their tentative first steps into the crypto market.

DeFi, the industry that's also driving this newfound, frenzied demand for the blockchain network, also often lacks simplicity and usability — especially for people who haven't had exposure to digital assets before. 

In mid-August, even Buterin tweeted: "Reminder: you do NOT have to participate in 'the latest hot DeFi thing' to be in Ethereum. In fact, unless you *really* understand what's going on, it's likely best to sit out or participate only with very small amounts. There are many other kinds of ETH dapps, explore them!"

As we mentioned earlier, one of the big downsides with Ethereum 2.0 is how it's taking a massive leap into the unknown, as there are no other blockchain platforms that plan to use PoS on such a massive scale. Although audits of its framework and codebase have been largely optimistic so far (despite a few security vulnerabilities that were identified in March,) Ethereum could have a PR disaster on its hands if snags make it through to the mainnet.

Will the New Blockchain Increase Ether Prices?

The question on the lips of many traders is what effect ETH 2.0 will have on the value of Ether once it's fully launched.

Of course, there's little point having a crystal ball when it comes to the crypto markets, as things can change dramatically in the space of a few hours. (Just look at what happened during the crypto flash crash in March 2020, when ETH fell off a cliff, suddenly liquidating positions in DeFi protocols.)

A recent CoinDesk report — released to coincide with Ethereum turning five years old — looked at how ETH could react if the upgrade goes smoothly... and if it doesn't.

The authors wrote: "The successful launch and development of Ethereum 2.0 through its initial two phases could greatly boost Ethereum’s value proposition in the eyes of investors. The launch of Ethereum 2.0 would be concrete evidence of a working alternative system of transaction validation that is more energy efficient."

Sounds promising. But likewise, the report warned that traders and investors need to keep a close eye on Phases 0 and 1 of this ambitious project. If there's little concrete evidence of a working PoS blockchain network, it predicts that ETH's value could start to dwindle.

The final factor to bear in mind — which runs in parallel to the development of this new blockchain — is whether DeFi represents the future, or whether the industry is a bubble that's going to burst. 

Ethereum has been at the beating heart of crypto crazes before. When ICOs were booming, with new projects popping up left, right and center in 2017, many start-ups were building on this blockchain and releasing ERC-20 tokens. (Those with long memories will remember that a sizable number of these companies never ended up launching, let alone turning a profit.) 

Ultimately, the future of Ethereum very much hinges upon what happens in the next couple of years. With some in the crypto community beginning to lose confidence in the blockchain because of the repeated delays in the launch of Phase 0, with DeFi pushing the blockchain network to its limits, it's no wonder that the Ethereum Foundation is beginning to feel the heat.


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