Ethereum 2.0, also known as Serenity or ETH 2.0, is a tiered upgrade to Ethereum. Its main goal is to increase Ethereum’s transaction capacity, reduce fees, and make the network more sustainable. To do this, Ethereum will change its consensus mechanism from Proof of Work (PoW) to Proof of Stake (PoS).
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- Ethereum 2.0 represents the transition from Ethereum to a new “proof of participation“consensus model.
- Proof of stake allows for faster transactions and lower fees compared to its previous one proof of work model.
- The proof of stake model allows Ethereum Holders of “wagering” their holdings in “wagering pools” which will earn rewards and increase their holdings over time.
- Ethereum holders can stake their holdings right now on a number of popular exchanges like Kraken, Coinbase and Binance.
- Ethereum 2.0 will implement a method known as sharding that will dramatically increase transaction speeds, potentially increasing its capacity to 100,000 transactions per second or more.
- The current cost of trading on the Ethereum network is very high and prevents many from using it. If this update is successful, the reduced fees it will bring will make the network more convenient for average users.
- Upgrading Ethereum could have a profound effect on its price, as its lower fees and faster transactions open up the network to a larger population of users.
What is a consensus mechanism?
Businesses and organizations typically have databases that contain information about users such as emails, names, and addresses. The computers that contain the databases usually exist in one place and are operated by one person or a small group, called administrators.
A blockchain is a type of database, but instead of its information being in a central location and under the supervision and control of a few, it is dispersed among many individuals and locations. This way, if one computer crashes, many others keep the data and the network alive.
These people need to find a way to agree on the right set of data so that all of their data versions match. To form this consensus, some sort of mechanism is needed.
There are different types of consensus mechanisms that blockchains use to ensure that data (in the case of a cryptocurrency, this data is transactions) remains consistent across all nodes (individual computers) in the system.
Switch to proof of participation
The original mechanism used by blockchains is proof of work. PoW requires computers to compete with each other to process transactions and earn rewards. This process is very energy intensive and also takes time.
For this reason, some newer cryptocurrencies have chosen to go another route: proof of stake. Upgrading Ethereum to version 2.0 will move it to PoS to allow much faster transactions and lower fees.
With PoS, consensus is achieved by using an algorithm that chooses a node to win a block of transactions, rather than the nodes competing to win the block using large amounts of power. When a node is chosen, it forges the next block of transactions in the chain. With PoS, these nodes are generally referred to as “stake pools”.
Nodes, or stake pools, are chosen based on the size of the “stake” they hold. In other words, the more coins a betting pool holds, the more likely it is to be chosen to forge a block and get rewards. To ensure that the richest pools do not always win, other criteria, such as the duration of the coin stakes, may be taken into account in the selection process. Coin holders can “stake” their holdings in a betting pool and when a pool (node) is selected to forge a block, the reward it receives is distributed among the various players.
Some PoS blockchains have added a degree of randomization to the process so that older, higher stakes don’t always win. So, in PoS, miners are replaced by betting pools where people bet their coins. Individuals can “wager” or place their coins in various wagering pools, just like miners joining a mining pool to earn more rewards.
Where can I stake my Ethereum?
Ethereum 2.0 is obviously not out yet, but some services now allow Ethereum holders to put their holdings on the testnet. It’s important to understand first that staking your ETH will lock them in place until the full release of Ethereum 2.0. Your Ether will of course earn wagering rewards while locked, but players cannot remove their ETH from the wagering pool.
Staking Ethereum’s testnet through a stake pool is a bit tricky and comes with a lot of risk. For this reason, it is best to leave it to the more technically advanced. For those who wish to take a simpler and more hands-off approach, it is probably best to bet on a trade. Some of the exchanges that allow Ethereum holders to bet currently include Kraken, Coinbase, Binance, and more. Staking on an exchange has a higher fee, with most exchanges charging 15% of the staking rewards or more.
How it evolves
Ethereum 2.0 plans to increase its capacity using a method called sharding. This is a common technique among a number of newer PoS cryptocurrencies because it allows them to scale without major sacrifices in security and decentralization.
Partitioning is a way to partition a database into smaller pieces that are easier to manage. With a PoW blockchain, most nodes or computers on the network have a complete copy of the transaction history. All of this history can take up a lot of space, especially for older cryptocurrencies with a long transaction history.
With sharding, the blockchain is sliced into parallel sections and nodes are assigned to a section instead of having to contain all of the data in the chain. This allows more transactions to be processed simultaneously, dramatically increasing transaction throughput and speed.
What does this mean for DeFi?
If ETH 2.0 is successful, it will have a drastic effect on the current bottlenecks that are currently slowing it down. Ethereum has a massive decentralized financial ecosystem, but most of it is almost unusable because it is too slow and crowded. This congestion can result in transaction fees that are greater than the amount of money the user is trying to move in the first place.
In the current state of Ethereum, only those with larger farms can reap the benefits of its ecosystem. At the time of writing, trading crypto on Uniswap, a decentralized exchange and liquidity provider on the Ethereum network, costs around $ 84. This makes it impossible to send a few dollars or exchange small amounts of money.
The fees for making transactions are so high because they are controlled by the miners creating quite a significant conflict of interest. With PoS, these problems will hardly exist any more.
Currently, Ethereum can only handle around 30 transactions per second. Vitalik Buterin, one of the founders of Ethereum, has alleged that version 2.0 could potentially reach 100,000 transactions per second using sharding and other tactics.
“ETH2 scaling for data will be available * before * ETH2 scaling for general computation. This implies that rollups will be the dominant scaling paradigm for at least a few years: first ~ 2-3k TPS with eth1 as the data layer, then ~ 100k TPS with eth2 (phase 1). Adjust accordingly, “Buterin noted in a 2020 tweet.
When will Ethereum 2.0 be released?
The upgrade to Ethereum has been phased. The first phase, “phase 0”, is already online. Phase 0 introduces the tag chain.
The Beacon Chain is essentially a new PoS blockchain that Ethereum’s current chain will eventually merge with. The beacon chain introduces PoS and configures Ethereum for staking and shard chains and is sort of a test network for the future PoS version of Ethereum.
The second phase, or “phase 1”, is called the merger. The merger represents the official shift to the PoS consensus model where the existing Ethereum network will merge with the beacon chain.
Ethereum developers also call the merger “docking” and expect it to happen in late 2021 or 2022. After the merger, Ethereum will be a PoS blockchain that will allow Ethereum holders to stake their ether and to earn rewards.
It is important to note that Ethereum holders have nothing to do while Ethereum goes through this phase of merger. This process will be automatic.
The third phase, “phase 2”, actually implements sharding so that Ethereum can scale and allow higher transaction capacity. The fragment chains are expected to be activated sometime in 2022 after the merger.
Will this affect the price of Ethereum?
Many have speculated that the Ethereum upgrade could be followed by an increase in its price. This is mainly due to the fact that Ethereum and its DeFi network will become much more convenient for the average person who may not have a lot of money.
The fees for trading on Ethereum will likely drop to a point that allows users to move smaller amounts of value. Right now, only those with more money can afford the huge transaction fees.
Those who will benefit the most from upgrading Ethereum are those who do not have access to the modern banking system that exists today.
These people include third world citizens, refugees and nearly 2 billion people who do not have access to modern financial products like bank or investment accounts.
Many people live in countries without an infrastructure to provide identification to their citizens, without which you cannot get a bank account or use modern payment apps. Ethereum’s decentralized financial ecosystem allows these types of people to access financial accounts, loans, investment opportunities, etc.
With low fees and a lowered barrier to entry, DeFi has the potential to grow significantly, and the price of Ethereum with it. That, of course, all depends on the success of Ethereum 2.0.