11 November 2020 | ZebPay Trade-Desk
Ethereum 2.0 (ETH2) is essentially an upgrade to the current Ethereum public mainnet. It has been designed to further Ethereum’s usage as well as its adoption by improving its performance, and usability. Ethereum 2.0 has been in talks for a while in the Ethereum community. The launch of Ethereum 2.0 is especially significant compared to past upgrades as the implementation will be a Proof of Stake consensus mechanism, moving the network away from its existing Proof of Work architecture. Ethereum 2.0 is an ambitious project, and will take a few years to complete and be fully functional as it is intended to.
From Proof of Work (PoW) to Proof of Stake (PoS)
Proof of Stake (PoS) is the most crucial and significant change in Ethereum 2.0. It fundamentally reforms the structure in which the blockchain is validated. Today, Ethereum’s architecture is maintained by a Proof of Work (PoW) consensus mechanism. This is a well known concept in the blockchain community, and is utilized among most blockchains including Bitcoin, Ethereum, Litecoin, and more. In Proof of Work, miners run nodes and are fueled by computational energy, with the aim to solve complex mathematical problems to mine one block after the other.
Significant time and money is deployed by miners to run hardware and expend electricity on PoW chains. They are rewarded as they validate the chain through block rewards, which are distributed to miners who successfully mine a block into existence. PoW chains are very secure. The computational power required to compromise a well-established PoW blockchain like Bitcoin or Ethereum would cost an unfathomable amount of money, but more importantly that sort of energy may not even be possible to garner at a single point in time. Although extremely secure, PoW blockchains suffer from scalability and accessibility issues.
In Ethereum 2.0, PoS aims to level the playing field by allowing more individual validators to participate, and earn rewards for preserving the integrity of the network. Proof of Stake replaces two crucial components of PoW (miners & electricity) with validators and stake on Ethereum 2.0. Very briefly, validators take the place of miners as the individuals who maintain the agreed-upon state of the network and receive rewards for randomly selecting the next block of data. Unlike in PoW, in which miners use physical energy (called hash power) and burn electricity to validate and confirm blocks, validators in a PoS system commit 32 ETH as ‘skin in the game’ for this purpose.
Ethereum 2.0 posits that validators must stake at least 32 ETH by depositing the funds into the official deposit contract that has been developed by the Ethereum Foundation. Validators need to download and run the Ethereum 2.0 client software. The client software will randomly select a validator, to propose and attest to blocks on the Ethereum 2.0 blockchain. Validators who correctly confirm this block will receive a reward of ETH as a percentage of their stake. On this network, if a validator fails to stay online long enough to execute his/her share of responsibilities, their block reward will moderately decrease in order to incentivize validators to stay online as consistently as possible. If a validator maliciously attempts to compromise the network, all or some of their 32 staked ETH will be slashed. Proof of Stake will be launched in the first stage of Ethereum 2.0’s upgrade; Phase 0. ETH 2.0 will be rolled out in phases, beginning with Phase 0 in 2020.
Scale and Security
The upgrade to Ethereum 2.0 allows for scalability. The current Ethereum 1.0 network can support approximately 30 transactions per second, causing delays and congestion. Ethereum 2.0 can process up to 100,000 transactions per second. This will be made possible, thanks to shard chains. The current Ethereum blockchain is a single chain with consecutive blocks. Though secure, it is slow and inefficient. With the introduction of shard chains, the blockchain will split up, and transactions will pass through parallel chains instead of consecutive ones. This speeds up the network, and makes it more scalable.
Ethereum 2.0 has kept security at the forefront in its development. Unlike most proof of stake networks, which consist of a small set of validators, that makes for a more centralized system coupled with decreased network security; Ethereum 2.0 requires a minimum of 16,384 validators, making it much more decentralized, and hence, secure. Security audits of Ethereum 2.0 code are being carried out by organizations continuously. The Ethereum Foundation is setting up a dedicated security team for Ethereum 2.0 to research possible cybersecurity problems which might arise and the network further develops in the cryptocurrency.
Challenges and Risks
In Phase 0, there isn’t any data, or transactions taking place. All that exists is the validator registry. The hardest part is getting this backbone together, by maintaining the set of validators and progressing the beacon chain and reaching finality with Phase 0. A large set of people are undecided if they’re going to become validators or not, as they are still ‘testing the waters’. The first and most important step is simply having Phase 0 live and watching people send ETH over to the deposit contract and watching this beacon chain move along and actually be functional. Then the next big ones will be eventually a two-way bridge where people can move ETH back and forth between the ETH and ETH2 chains Then, a very major step is going to be merging the two together.
Even with proof-of-work there are risks. If the hardware isn’t run properly or if it gets burned out, collateral there will be destroyed. Similarly with proof-of-stake protocols, there are risks with the collateral that is posted to join the network. Being offline and the penalties associated with that are much less severe than the risk associated with improper key management. Hence key management and security are key. In addition, right now in Phase 0, it is a one way move only. That is, once converted the ETH can’t be reversed, till the bridge is established in the next phases. Hence, early adopters need to weigh this in, before migrating.
Ethereum 2.0 Roadmap
|Phase 0||Beacon Chain Launch for the ETH 2.0 Network. Enable PoS implementation to manage registry of validators.|
|Phase 1||Shard chain implementation to provide scalability for ETH 2.0.Ethereum blockchain will split into 64 separate chains (called shard chains) that run parallel to one another and interoperate seamlessly. Sharding will allow ETH 2.0 blockchain to process multiple transactions at the same time.|
|Phase 1.5||Merging of the original PoW and PoS ETH blockchain. PoW blockchain will integrate with Ethereum 2.0 and exist as one of the 64 shard chains alongside the beacon chain, meaning there will be no break in continuity or data history. ETH holders won’t have to undergo any token transfer or swap between Ethereum 1.0 and 2.0.|
|Phase 2 & Beyond||Phase 2 is currently less defined than either Phase 0 or Phase 1. Once Proof of Stake and sharding are successfully implemented, Phase 2 will enable ether accounts, transactions, transfers and withdrawals, and smart contract execution.|
ETH 2.0 Market Dynamics
One can think of a few ways in which ETH 2.0 might impact the crypto markets. For the time period during which ETH is split into networks, leading to increased rewards, it may devalue the asset value. Although the added issuance at the launch of ETH 2.0 is estimated to be minuscule, apart from this at least 500k ETHs will be locked as a one way deposit contract in phase 0, this should reduce the supply and move price positively.
The launch of ETH 2.0 will be proof for an alternative system of transaction validation using less energy. In phase I, throughput will be greatly increased (64 times that of original ETH) . All the above factors look positive for ETH, yet if the above possibilities don’t materialize and phase 0 or 1 are not the success they are expected to be, ETH may suffer.
For the beacon chain to launch successfully, it will need to crowdsource a minimum of 524,288 ETH. Given the unique design of Ethereum 2.0 as a separate and parallel network to the original, ethereum blockchain investors and traders may see the creation of entirely new digital assets. As a way of seeking financial return, the tokens created to give exposure to the risk and rewards of validating on Ethereum 2.0 will likely grow and expand usage of decentralized finance (DeFi) products on Ethereum.
Ethereum 2.0 has been in the making for a few years now, and long-anticipated among those in the blockchain ecosystem. Proof of Stake (PoS) and sharding will bring considerable improvements to scalability, security, and accessibility. For ETH holders, Ethereum 2.0 will provide a new way of participating and engaging with the network. The Ethereum ecosystem will provide a host of different products and solutions, for those who wish to secure their own validators with 32 ETH, use a third party provider to stake their 32 ETH, or pool their funds with others. The development and surety of the beacon chain, in Phase 0 is the key to ETH’s 2.0 success. The beacon chain remains the core piece upon which the rest of the Ethereum 2.0 system, and its scalability and efficiency gains depend.
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