This article sorts out the ins and outs of ETH1.0, ETH2.0, and Layer2

There are many articles on the Internet about terms such as ETH1.0, ETH2.0, POS, sharding, Layer2, zkRollup, and Optimistic, but the content is often scattered. It is still difficult for non-technical readers to understand the relationship between these terms as a whole, let alone speculate on future possibilities and investment directions.

So I wrote this original content, hoping to clarify the relationship between these words and make some bold speculations about the next investment and project directions.

It is not surprising that most people think that blockchain and BTC are bubbles or air. Since the development of blockchain in 2009, there are not many projects or protocols that have been truly implemented and applied. In summary, there are only three types:

1. BTC: Becomes a payment method that transcends regulation.

2. ETH: Supports developers to efficiently issue coins for financing, replacing the traditional lengthy equity financing process.

3. DeFi: ETH-based developers created a series of blockchain protocols last year that were really used by many people - decentralized financial protocols, such as the decentralized exchange Uniswap, which had a fee income of 67 million US dollars in Q3 2020, and users have currently deposited approximately 43.52 billion US dollars in assets in the DeFi protocol!

In addition to constantly searching for real application scenarios for blockchain, one of the most core factors limiting the development of blockchain is TPS (transactions processed per second). Alibaba's TPS peak can reach 500,000, VISA's TPS is 45,000, but ETH1.0 currently has only 15. The huge gap not only shows that blockchain technology is still in its early stages, but also shows that there is huge room for growth in blockchain technology.

If the blockchain only needs to support fast transfers, a TPS of 100,000 may be enough. However, if it wants to support more assets and even record various human behaviors on the chain in the future, then the TPS needs to be able to challenge the millions or even tens of millions. So how have the technical solutions been promoted step by step in the past few years? To what extent have they been developed so far? Why have ETH2.0 and Layer2 received so much attention this year? And how do EOS in 2017 and DOT at the beginning of this year want to impact ETH's status?

Blockchain technology has gone through three important stages in improving TPS:

Phase 1 solution: By increasing the block capacity, TPS can usually be increased several times. This parameter can be customized by public chain developers. For example, BCH changed the block storage space to 4 times that of BTC, thereby increasing TPS by 4 times. However, the problem that followed was that the cost of mining machines was also increased, so there was also a phase 2 solution.

Phase 2 plan: Change the POW mechanism to POS, reduce the number of validators, reduce the cost of mining machines, and continue to increase TPS by a hundred times. The number of validators corresponding to POW is in the thousands, and there are only 32 EOS nodes using the POS mechanism. The first phase of ETH2.0 has been launched, and the POW has been changed to the POS mechanism. But the problem arises again, the security will also decrease after the number of validator nodes is reduced.

Phase 3 solution: Sharding technology can be used to increase TPS by multiples without an upper limit. What is sharding technology? To use a popular analogy, for example, a long transaction chain can have the first 1/2 verified by a part of the nodes, and the second 1/2 verified by another part of the nodes. The efficiency of the nodes acting separately will be improved. If it can be divided into N parts for separate verification, and N has no upper limit, the TPS can be increased by multiples without an upper limit (this is not a professional explanation, but just for easy understanding). Currently, ETH2.0 has also adopted sharding technology in the first phase, and DOT has also adopted sharding technology in its cross-chain solution.

While the ETH mainnet continues to improve TPS from 1.0 to 2.0, it has also added the Layer2 solution. The Layer2 solution and ETH2.0 are advancing in parallel in terms of time:

ETH1.0 and ETH2.0 are both mainnets, i.e. Layer1, and there will be many rollups on top of the mainnet as Layer2. Our assets are on the ETH mainnet, and the ones on L2 are "shadow tokens". The rollups on Layer2 carry the "computing" function, and the ETH mainnet as Layer1 plays the "verification" role. There is no communication between Layer2s, and Layer2 will aggregate the data and transmit it back to the ETH mainnet, and the actual withdrawal will be completed on the ETH mainnet.

Rollup means aggregation, but what does aggregation mean? Because in the process of uploading data to the chain, the transaction records and other data need to be recorded on the chain first (for example, A transfers 1 BTC to B), and the withdrawer B uses his own address to verify on the chain. If the verification is successful (B's address is an address that can receive 1 BTC), B can take the coins in his account. In this process, rollup is responsible for aggregating many transaction records into a transaction result. After that, rollup submits this transaction result to the ETH main network, which saves space and improves efficiency. After a series of transactions are performed on the rollup, the user can use his own address to complete the verification on the main network and withdraw the coins.

Let's take a vivid example to illustrate the necessity of Layer2, as well as what is "calculation" and what is "verification"? For example, when UBI.city airdropped CITY tokens to 92,000 on-chain addresses, the number of CITY airdropped to each address was different. If more than 92,000 pieces of data were recorded on the ETH mainnet in the format of "address, number of CITY", on the one hand, the cost would be very high, and on the other hand, it would look like a lot of garbage data for ETH1.0, which has only 15 TPS. So when processing the airdrop data, a rollup-like work was done to aggregate 92,000 pieces of data into one piece of data, and then this one piece of data was uploaded to the ETH mainnet. Users took the address that can receive the airdrop to verify this one piece of data. If the verification is successful, they can get the number of CITY airdrops corresponding to the address. Seeing this, you may be curious, how are 92,000 pieces of data aggregated into one piece of data? Here, the aggregation is completed using the Merkle tree and hash algorithm, and the Optimistic solution of Layer2 is also completed in this way. More specific algorithms about the Merkle tree and hash will be explained separately in subsequent articles.

There are many technical solutions in Layer2. ETH founder Vitalik Buterin believes that Optimistic is a better choice for supporting contracts at this stage, but in the long run, zkRollup may be the future:

The figure below lists the performance of the mainstream technical solutions for Layer2. Among them, State channels (the previous Lightning Network in the BTC ecosystem used the state channel technology) and Plasma have been denied by Vitalik. Currently, the most supported are Optimistic and zkRollup. However, currently only Optimistic supports smart contracts, and zkRollup will support it in the future.

Layer2 rollup can support higher TPS because it has fewer validators. L2 needs to wait for the withdrawal time before transmitting data back to the main network, and users can withdraw money on the main network. Users who trade on Optimistic rollup need to wait for 1 week before they can withdraw money on the ETH main network, and on zkRollup they need to wait for 10 minutes.

What investment opportunities might Layer2 bring? What capabilities do blockchain projects and teams need?

Compared with DOT ecology and NFT, I personally think that Layer2 is a track where feasible blockchain projects are more likely to appear. When Layer2 improves TPS and greatly reduces gas fees, it can support more applications with large user volumes. Optimistic will be released this month (March), which will bring great investment opportunities in the Layer2 field, and the favorable application directions of this investment opportunity may be:

• Layer2 basic technical facilities: For example, the communication and transfer protocol between rollups, users can transfer money from rollup A to rollup B directly without going through the main network. More technical infrastructure solution requirements will be the focus of the following article.

• DeFi: Currently, the gas fee for a transaction on Uniswap on the ETH mainnet is between 230 and 500 yuan (even up to 800 yuan), and the gas cost of depositing a liquidity is 0.4ETH (about 5,000 yuan). Many new users are immediately discouraged by this threshold; on BSC, the transfer gas is about 0.6 yuan, and the gas fee for a transaction on Pancake is about 2 yuan. We can see from the transaction data of CITY that in about 1 week, hundreds of addresses completed about 800 transactions in Pancake's CITY/USDT currency pair, while the data on Uniswap is very deserted. However, in terms of my personal trading experience, if DEX only has the AMM mechanism, it is not enough to support B-side behaviors such as market value management and quantitative trading, which is the main trading behavior in CEX. For example, the low gas fee of Layer2 is more likely to attract more small-amount, high-frequency transactions, but if the settlement has to go back to the main network, then there will still be a gas fee of 4 to 10 US dollars, so Layer2 will need a cash out function. These are all areas where DeFi can try after Layer2.

• Social money: With the improvement of TPS, blockchain can not only be used to record asset transfers, but also to record complex human behaviors on the chain. The behaviors on the chain may also become an asset (for example, Sesame Credit calculates a score based on our account behavior, thereby calculating our personal loan amount). The imagination space in this field may be very broad. The complexity of human behavior is far higher than that of asset transfers. Many technical solutions and decentralized product applications may be born here. For example, UBI.city is trying to provide solutions in this field.

Based on these speculations, we will find that blockchain technology has developed to the initial stage of application level. This may mean that blockchain project teams from Layer2 onwards need to not only understand technology, but also have user operation capabilities. Otherwise, even if the technical solution is open sourced, it is easy to be forked by a team that is better at operations and then truly promoted.

ETH2.0 and Layer2 will be a direction worth studying for quite a long time. I hope this direction can go beyond the circle and let more people experience truly usable and easy-to-use blockchain products, rather than just using them for currency speculation.

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UBI.city - Agreement on the future organizational structure. We will release more ideas and design mechanisms about UBI.city in the near future. Interested blockchain technology enthusiasts, community initiators, and research analysts are welcome to contact Gavin and Iris to discuss the future possibilities of UBI.

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