ConsenSys: Ethereum roadmap, unresolved threats of mergers, and the future of institutional DeFi

Author | Clemens Wan, Nicole Adarme, Ryan Ho, Simran Jagdev, Yan Lin Fu

This week is a very important week in Ethereum’s history. The most anticipated upgrade since its launch, the switch to the Proof of Stake (PoS) consensus mechanism, was completed on September 15. This upgrade, known as a merge, is the first step in the Ethereum roadmap and will future-proof the network’s infrastructure and prepare it for improved security, sustainability, and scalability.

In our recently released “Impact of the Merge on Institutions” report, we discussed in detail the opportunities that the merger will create for institutions in the Web3 world. The report, written by MetaMask Institutions and the ConsenSys Cryptoeconomic Research Team, also explored factors such as network activity, security, and valuation that set Ethereum up for long-term growth and success. You can find the full report here: https://pages.consensys.net/impact-of-the-merge-on-institutions-insight-report-sept-2022

While the merger means institutions will have more attractive staking opportunities, greater security, and client diversity and interoperability, some long-standing criticisms of Ethereum, such as high transaction costs and slow transaction processing speeds, remain. In this post, we’ll look at some of the threats to the Ethereum ecosystem that will remain after the merger, some further upgrades planned after the merger, and what the future of decentralized finance (DeFi) looks like for institutional investors.

Merge unresolved threats

The PoS mechanism may increase the risk of centralization, censorship, and fraud in Ethereum. After the merger, ETH whales could theoretically interfere with the performance of the network. While this would not extend to catastrophic events such as rolling back transactions, it could hinder the accuracy of results. An example of this threat is Lido Finance, Rocket Pool, and similar protocols. For example, Lido now controls nearly a third of the staked ETH. Despite the decentralization within Lido (for example, there are 21 validators on Lido responsible for staking), potential attack vectors still exist.

Improvements in interoperability pose an existential threat to Ethereum. This includes the emergence of cross-chain messaging protocols such as Axelar, the proliferation of protocols with built-in interoperability such as Cosmos and Polkadot, and improvements in bridging technology. All of these factors enable developers to build chain-agnostic applications while allowing users to seamlessly transfer between chains in a more secure manner.

While the merger may not directly address some of these criticisms, it does prepare Ethereum for further upgrades outlined in its roadmap. The merger is a step in the right direction, but only a first step.

Ethereum Roadmap

The Surge

The first update after the merger will be Surge, which will allow the Ethereum network to massively scale through sharding. As an overall concept, sharding splits the data processing responsibilities of a database (decentralized or otherwise) across many nodes, allowing for parallel transactions, storage, and processing of information. As we mentioned in the previous section, sharding will split the Ethereum network into shards that will work as independent blockchains. Currently, Ethereum processes an average of 15 transactions per second (TPS). Ethereum co-founder Vitalik Buterin said that Ethereum's processing power can reach 100,000 TPS once its roadmap is completed.

Sharding will also address the existential threat posed to Ethereum by Layer 2 (L2) blockchains such as Arbitrum and Polygon. Currently, Ethereum is significantly more expensive to use than most L2s.

Mature OP rollups like Optimism and under-development ZK rollups like Starkware will use a base layer away from Ethereum, while settlement is still resolved on the base layer.

Improving transaction processing speed will allow Ethereum to reduce network congestion, which in turn can reduce transaction costs. This is achieved by L2 layering of tasks in rollups and parallel processing of unrelated tasks through sharding. At first, these shards will function similar to rollups, bundling multiple transactions on each shard into one, and then publishing that transaction to the mainnet. Eventually, these shards will be able to operate like independent blockchains, with their own smart contracts and account balances, and transactions between different blocks will occur through cross-shard communication.

The Verge

The next phase of the Ethereum roadmap, Verge, will focus on further improving the scalability of the network. This upgrade will work on optimizing storage through Verkle Trees, a type of mathematical proof that is an upgrade to the Merkle proofs currently used by Ethereum. By reducing the amount of data that validators need to store on their computers to run operations, node size will decrease and allow more users to become validators. This will further decentralize the network and improve security.

The Purge

Purge will reduce hardware requirements and simplify storage for validators by eliminating historical data and technical debt. This, in turn, will further reduce network congestion.

The Splurge

The final stage of the ethereum roadmap is a minor upgrade that will only fine-tune the network. Buterin called these upgrades “fun stuff.”

One thing to keep in mind here is that these upgrades are not necessarily coming one after the other. They are fairly independent and are being rolled out in parallel. The order in which these upgrades will be rolled out has not yet been decided, but work on all of them is being done at the same time.

The Future of Institutional DeFi

The Ethereum ecosystem is being built for the long term. Despite the current geopolitical, macroeconomic factors, and market volatility, the community is still committed to building innovative products and systems, and institutions still have a strong desire to be part of these innovations. Financial institutions—investment banks such as Goldman Sachs and Barclays, hedge funds such as Citadel Securities and Point72 Ventures, and commercial banks such as Banco Santander and Itau Unibanco—are all investing money in crypto assets or have further plans to offer crypto asset investment options to their clients.

As we continue to build through the bear market, we believe the future of institutional DeFi is bright.

For a long time, the debate around institutional investment in crypto assets was about traditional finance (TradFi) versus DeFi. The growing popularity of DeFi is often considered the death knell of TradFi. However, the digital asset management strategies of some TradFi companies during the downturn show that TradFi and DeFi are now coming together and complementing each other. This trend may increase after the merger as institutions recognize that this is all a long-term game.

As the merger improves the security of the Ethereum network and prepares it for future scalability, we expect institutions to become even more enthusiastic about participating in the Web3 ecosystem.

Over the past two years, innovations in DeFi have created the infrastructure and tools needed for institutional adoption of DeFi. From permissioned lending pools that ensure only KYC participants, to on-chain asset management, MEV-resistant best execution protocols, and decentralized identity, more and more institutional-focused projects have entered the market.

We also see L2 projects such as Optimism, Polygon, and Arbitrum increasing DeFi transaction volume through high yields. We expect more institutional-focused projects to enter the market as the combined L2 scale accelerates.

The transition to PoS creates compelling reward opportunities for institutions. As ETH whales — including crypto exchanges, funds, and custodians — have recognized that holding ETH has a strong position in the DeFi world, they have been able to earn an annualized yield of 4.06% on their ETH positions. Combined, we expect the actual yield on ETH staking to be between 5.5% and 13.2%, depending on several factors such as block rewards, transaction fees, and the maximum extractable value (MEV) accumulated by validators.

The opportunity for institutional DeFi is huge, and Merge will help the market mature and create opportunities for investors to chase returns in high-risk areas. Institutional investors who may have previously been skeptical of DeFi investment opportunities now recognize that the growth of Web3 and its related financial instruments is inevitable. They may not fully understand the drivers behind DeFi or Web3, but they already know that the asset class cannot be ignored.

The next phase of Ethereum’s roadmap will address scaling challenges and thereby build confidence in the ecosystem, especially among those who may consider crypto assets too risky to invest in. We expect progress and innovation to come quickly, both from crypto funds and DAOs and traditional Web2 institutions.

This post is adapted from our exclusive report “The Institutional Impact of the Merger”, in which we discussed how changes to the Ethereum network resulting from the merger will translate into opportunities for institutional investors.

Original link: https://consensys.net/blog/ethereum-2-0/future-of-institutional-defi-and-ethereum/?utm_source=rss&utm_medium=rss&utm_campaign=future-of-institutional-defi-and-ethereum