Ethereum is already the king, why does it still go to so much trouble to upgrade to 2.0?

As the leader of the public chain, Ethereum's market value and trading volume far exceed those of other public chains, and it has always firmly sat in the position of the "big boss" of the public chain.

So why is it necessary to upgrade Ethereum 2.0?

1. Demand and Trend

From the data provided by Etherscan.io, we can see that from its inception to now, the number of transactions on the Ethereum chain has increased a thousand-fold, and the highest daily transaction volume is nearly 1,300 times the lowest daily transaction volume. The growth rate is extremely fast, and the high growth in transaction volume has also led to a high growth in demand for Ethereum.

As a platform that carries users and applications, the value of the public chain is actually reflected in the users and their applications. Commercial value is the basis for the existence of the public chain. With the increase in users and applications, more funds and traffic will flow into the public chain, thereby attracting more high-quality applications to be deployed and developed on the chain, which will attract more users and form a good cycle effect.

However, as more and more users get to know and use blockchain technology, people have more requirements for technology and applications. From the perspective of blockchain application development, users' demand for blockchain is more reflected in privacy and new application types based on it, which mainly include safe and transparent application requirements and broader financial needs.

On the one hand, with the development of the Internet, users have an increasingly strong demand for privacy protection and are accustomed to conducting activities in a secretive state. Therefore, a new Internet application that can ensure security and transparency while achieving privacy has become a strong demand among users.

The world of blockchain is an open and transparent world. This feature can generate application value in many fields, such as traceability, but for finance it may not be an advantage but a disadvantage.

Data shows that since February 2021, the TVL locked in the Ethereum chain has basically remained above US$40 billion, reaching a high of nearly US$54.5 billion in mid-April.

Financial applications are the basic applications for the development of Ethereum and are driving the development of Ethereum. The excessive openness and transparency of the blockchain world will obviously become an important restriction on financial development, causing users to have concerns, which is also an important factor restricting the development of Ethereum.

Therefore, how to achieve better privacy protection while ensuring security is actually the focus of blockchain financial application exploration. For Ethereum, which occupies more than half of the market, this indicates one of its future directions.

2. Threat from the rise of similar public chains

Public chains play the role of underlying infrastructure in the blockchain industry and have always been one of the most competitive directions in the industry. In the past, people believed that since Ethereum had formed its own ecological barriers, other public chains with similar functions and positioning to Ethereum would hardly threaten it.

But now, unlike past expectations, this type of public chain has begun to rise and has gained a large amount of traffic and users, which has posed a great threat to Ethereum to some extent.

In the past, the goal of public chains was to kill ETH, but now the goals of public chains are more extensible. They are characterized by compatibility with EVM and belong to the category of Ethereum-connected public chains. This type of public chain refers to a public chain that is extremely similar to Ethereum in terms of execution environment and application design, or an imitation public chain.

Now, they are gradually rising, such as SOL, HECO and BSC, among which BSC chain is the leader, and it is also the public chain that can threaten Ethereum the most at this stage. Why these public chains can threaten Ethereum can be summed up as follows:

(1) Due to the congestion of the Ethereum network, the gas fee for exchanges on its chain is too high, while these public chains have low transaction fees and can meet the needs of a large number of small capital users.

According to Bscscan.io, the BSC chain can process more than 50 exchanges per second, and has processed a total of more than 550 million transactions. This is obviously much higher than the number that Ethereum currently processes per second (about 10-20 transactions).

(2) Some of the new public chains represented by BSC are compatible with Ethereum EVM, and after a considerable period of polishing, the infrastructure has become relatively complete and mature.

(3) Public chains like BSC and SOL are supported by powerful sponsors like Binance and FTX platforms, so they can enjoy "natural" user dividends and financial support to a large extent.

The massive influx of user traffic and unreserved financial support have enabled these public chains to grow rapidly, but the most fundamental reason is that the current Ethereum ecosystem has low exchange efficiency and network congestion has led to high transaction fees, making it difficult for ordinary users to continue to use the Ethereum public chain for daily interactions. This has led to an outflow of users and funds, giving similar public chains with similar functions and applications an excellent opportunity to rise and develop.

This further "reminds" Ethereum that it needs to enter ETH2.0 as soon as possible to solve the problem of network congestion, improve efficiency, and reduce its transaction fees, so that it can sit firmly on its "throne."

3. Ethereum itself

Ethereum's low efficiency and high exchange fees have always been criticized, and many development teams have developed related applications in a targeted manner in order to solve these problems.

At present, the most successful one is Flashbots, which was developed with the support of the Paradigm Foundation and launched some time ago. It significantly reduces the transaction fees on the Ethereum chain by attacking the preemptive redemption robots on Ethereum and reducing the negative external impact and risks of MEV (miner extractable value) on the smart contract blockchain.

According to Etherscan.io data, the average Ethereum Gas fee price has dropped significantly from its highest point in April, 166Gwei on April 19, after Flashbots was officially launched on April 20. In mid-to-late April, the average daily Gas fee was about 50Gwei.

However, after entering the first and middle of May, the Ethereum Gas fee rose rapidly again. When a large number of frequent exchanges occurred on the chain, its Gas fee rose rapidly again.

For example, on the evening of May 19, due to the sharp market fluctuations, the Ethereum Gas fee rose extremely quickly. According to data, its rapid confirmation Gas fee once rose to above 2000GWei.

Although Ethereum can improve exchange efficiency and reduce fees to a certain extent by relying on external applications, when a large number of on-chain transaction demands arise, those "old problems" will still appear on the Ethereum chain.

Therefore, if Ethereum wants to solve this problem more thoroughly, it still has to solve it from the root, that is, to improve and solve this problem from within the Ethereum public chain. Therefore, whether from an external or internal perspective, Ethereum upgrades are a rigid demand, and many factors are driving the need to speed up its pace.

Major upgrades of ETH2.0

Performance has greatly limited the number of Ethereum transactions and inhibited the growth of public chain users. Ethereum 2.0 has focused on solving this problem in this upgrade, the most important of which is the addition of two new technologies/mechanisms: Shard Chains and Proof of Stake.

1. Shard Chain

Shard chains are a scalability mechanism that can greatly increase the throughput of the Ethereum blockchain.

Currently, Ethereum can generally only process a dozen or so exchanges per second, which is very inefficient. The purpose of sharding is to divide all network computing resources into shards so that nodes do not have to process, calculate, store and read every exchange in the blockchain history to make new exchanges (write and upload).

In Ethereum 2.0, each "shard" is basically an independent new chain, which will directly solve Ethereum's scalability and efficiency problems, because sharding will greatly increase the network's workload.

The beacon chain basically creates a new proof-of-stake network that runs in parallel with the current Ethereum network. As a hub chain, the beacon chain will become a shard for two-way communication with the other 64 shards for information transmission.

Through two-way communication, a shard block can hold much more data than the ETH1.0 chain block can currently hold. Most importantly, each Ethereum node only needs to run one shard.

This means that only a small amount of data is stored and nodes can be run more easily without powerful hardware. Ease of running nodes will attract more network participants, bringing more decentralization and higher security.

But initially, shards will only provide additional data, and shard chains cannot process exchanges or smart contracts. At this point, you may have a question: How can sharding improve scalability without processing? This is because of the expansion of Layer 2 - especially Rollups.

Rollups is a Layer 2 expansion solution. Through Rollups, all exchange status and execution are performed off-chain, and the Ethereum main chain only stores transaction data.

Rollups allow for off-chain packaging, redemption and execution of smart contracts, generating cryptographic proofs and submitting them to the chain. This process only requires one available data shard to store the proof, which means it can be used with the initial version of the shard. The combination of data sharding and Rollups makes it possible for Ethereum to process more than 100,000 transactions per second.

Rollups is also considered to be the most ideal scaling solution at present.

2. Proof of Stake

The current Ethereum network runs on Proof of Work (PoW), which requires a lot of computing power and energy. In Ethereum 2.0, Proof of Stake (PoS) will replace Proof of Work, which consumes a lot of energy.

Proof of Stake (PoS) 2.0 improves the security and scalability of the network and is more resource-efficient. After entering the Proof of Stake (PoS) mechanism, new blocks will be built by relying on validators and staking ETH. By replacing a large number of mining equipment with a smol server, miners are replaced with validators.

Proof of Stake attempts to solve the problem of electricity consumption by completely separating itself from miners. It will protect network security by relying on economic incentives, which will reduce Ethereum's energy consumption by more than 99%. In this way, Ethereum 2.0 may be able to achieve better sustainability and reduce external doubts.

In the POV Crypto podcast, Vitalik also emphasized the impact of the transition to PoS on the Ethereum network and ecosystem, and why such a transition is a good fit for Ethereum and its issuance model.

“One of the reasons for doing PoS is that we want to significantly reduce issuance,” he noted. “I think we’ve calculated that the theoretical maximum issuance of ETH 2.0 is about 2 million per year if everyone participates.”

By combining the PoS mechanism, it can help solve the problems that have always existed in Ethereum 1.0, reduce the issuance of ETH, and implement a gradual deflation mechanism, which will give or maintain ETH (higher) value.

PoS Staking for ETH2.0

During ETH1.0, Ethereum used the PoW consensus mechanism, which is the same system used by many other blockchains, such as Bitcoin. Miners process packaging exchanges and receive ETH for this.

However, using the PoW mechanism for staking has the following disadvantages: long consensus time, high energy consumption, high accounting costs, and the trend of computing power centralization is becoming stronger and stronger.

The PoS used in ETH2.0 does not require the entire network's computing power to simultaneously grab a block like PoW. A large amount of computing power is required to protect the network, resulting in a large waste of computing power and low processing efficiency.

Under the proof-of-stake mechanism, users only need to pledge ETH to become a validator on the network to obtain proof of stake representing their shares. In the proof-of-stake PoS model, there is a term called coin age. The system will distribute interest (i.e. income) based on the coin age, and determine the packaging rights of the next block based on the number of your staked coins and the coin age.

The change in the staking mechanism is to change the original packaging of the entire network's computing power into one block, to differentiate the entire network's computing power, and then assign each block to the differentiated computing power, so that the entire network's computing power can be packaged into multiple blocks at the same time, increasing the efficiency of the entire network in processing data.

So how to participate? First, you need to have 32 ETH.

Because, in order to become a validator of ETH 2.0, users must deposit 32 ETH into the ETH2.0 deposit contract, which is a necessary condition for becoming a validator and being activated. That is, you can only stake and get rewards if you have a minimum of 32 ETH.

In addition, two key parameters must be specified at the same time: the validator public key and the withdrawal voucher of the deposited 32 ETH.

To prevent validators from gaming the system and verifying fraudulent transactions, the Proof of Stake system implements a mechanism called slashing. If a validator behaves dishonestly, they lose part of their staked tokens.

Users then need to run an ETH2.0 validator node and sign blocks when it is their turn, otherwise they will be penalized for not complying with the protocol.

But a key point here is that the public key and the withdrawal voucher do not need to be controlled by the same entity. Therefore, if you do not want to build your own facilities but want to participate, you can entrust the validator's private key to a third-party staking service provider to participate in the consensus, but you need to guard against single point failure risks such as the third party running away and being punished.

Currently, ETH2.0 is still in phase 0 (beacon chain), that is, in this phase the Ethereum network will have two chains, one is the PoW chain, the token is ETH1, and the other is the PoS chain, the token is ETH2.

However, since it is still a one-way movement, users can transfer ETH1 to ETH2, but cannot redeem ETH2 back to ETH2. The ETH2.0 upgrade is not a simple hard fork upgrade. In the past hard fork upgrades of ETH, the old chain stopped and the new chain ran.

However, in ETH2.0, the Ethereum Foundation believes that the old chain, the PoW chain, will coexist in parallel with the PoS chain for at least 3-5 years. (That is, Phase 1.5: the dividing point when PoW is completely transformed into PoS) But there are also reports that ETH developers conservatively plan to end PoW Staking by the end of 2021.

1. Obstacles to participating in ETH2.0 PoS staking

To become an ETH 2.0 validator, users must deposit 32 ETH into the ETH2 deposit contract, specify two key parameters: the validator public key and withdrawal proof, and bear the cost of the verification node and supporting facilities.

Especially since the minimum participation requirement is 32 ETH, how many users can meet it? All other things being equal, I believe they will prefer to be able to stake any amount of ETH, delegate the work of running the facility to others, and withdraw their deposit instantly.

In contrast, participating in ETH2.0's PoS Staking through well-known platforms or institutions with scale has become the best choice for ordinary users.

Because these institutions, on the one hand, are highly trustworthy and have relatively complete risk mechanisms, the risk of running away is greatly reduced; on the other hand, they have professional technical operation and maintenance teams that can operate 24 hours a day. If any penalties are imposed, they will be borne by the institutions, and the costs of verifying nodes and facilities are also mostly borne by them.

The most important thing is: most platforms only require 0.1 ETH or even 0.01 to participate in ETH2.0 Staking, which greatly lowers the threshold.

Finally, although the staked ETH cannot be redeemed due to the development progress of ETH2.0, during the stage of coexistence of the two chains, there will be a new native ETH 2.0 staked Token called "BETH" on ETH2.0. BETH can be exchanged and circulated in the market on the platform. When the ETH 2.0 mainnet is enabled, BETH can be exchanged back to ETH at a 1:1 ratio, which can reduce risks.

2. The pros and cons of participating in ETH2.0 PoS

But there are both advantages and disadvantages to participating in ETH2.0 Staking at this time.

(1) Disadvantages

The threshold for participating in staking is relatively high: 32 ETH; the lock-up time is too long and cannot be redeemed. The specific time needs to be determined according to the development progress of ETH2.0. For miners, this is a relatively large risk and disadvantage, which will lead to insufficient liquidity; in the early operation stage of ETH 2.0, various aspects of technology are not yet stable, there may be some loopholes, and there are certain technical risks, causing losses, which has happened before; compared with other Staking, the rate of return of participating in ETH2.0 Staking is not high, especially compared with the extremely high annualized rate of return of DeFi Staking and other methods, and the general 6%-20% (or even lower) of ETH 2.0 is very low in comparison.

(2) Advantages

Once 2.0 is fully implemented, the PoS mechanism Staking will greatly reduce the market circulation of Ethereum, which will greatly solve the current inflation problem of Ethereum. The market supply and demand relationship will change, and demand will gradually exceed supply, which is conducive to the value increase of ETH. With the stable advancement and implementation of ETH2.0, the development of its ecology can also be more diverse, which is very beneficial to the potential value increase of ETH in the future. From this perspective, early participation may bring greater benefits.

In summary, since the parallel development phase of ETH 1.0 and ETH 2.0 is expected to last for an uncertain and possibly long time, for users who do not have high liquidity requirements and are cautious but interested in participating in ETH2.0, participating in ETH 2.0 Staking with platform institutions would be a good choice.

summary

Looking at the market, the PoW consensus mechanism ecosystem of ETH1.0 has formed a relatively large system. ETH1.0 will continue to exist, and the construction of 2.0 will also proceed steadily.

ETH2.0 targets the deficiencies in ETH1.0 by making changes to the PoS mechanism and in-depth reference to data sharding and basic upgrades, which will affect the entire blockchain technology and market.

As the king of public chains, Ethereum has accumulated a large number of native users and excellent development teams for its ecosystem through its past development. We believe that it will continue to provide strong support for its future development.