Is Ethereum losing the smart contract platform war to Binance Smart Chain?
Binance Chain launched in Apr’2019 and Binance Smart Chain launched in Sept’2020.
BNB, the native token of Binance Chain has in a short time become the fourth-largest cryptocurrency by market cap.
On 21 Feb’2021, roughly 6 months after launch, Binance Smart Chain recorded higher daily transactions than Ethereum and at the time of writing processes almost 4x the number of transactions daily as Ethereum.
Total Value Locked (TVL) is $61 billion at Ethereum and $20 billion at Binance Smart Chain. Ethereum’s TVL has grown 50%since the beginning of the year, while BSC’s TVL has grown 3x in the same time. At this rate, Binance Smart Chain might soon flippen Ethereum on TVL as well.
What weakness in Ethereum is Binance Smart Chain filling?
The point of DeFi (Decentralized Finance) is to democratize finance i.e. make it possible for everyone, the privileged and disenfranchised alike to access financial products. It does so by removing fee-guzzling middlemen who act as gatekeepers to financial product access. One major obstacle to this has been the high transaction fees on Ethereum, where the bulk of DeFi is currently based. Because of the high fees, only transactions involving large sums of money can be profitable. And guess who has large sums of money? The rich! Those with small savings are unable to take advantage of say the yield farming opportunities in DeFi as yield farming opportunities are profitable only when moving six-figure sums across platforms.
ETH 2.0 is likely to reduce fees, but the full implementation including migration to Proof-of-Stake and Sharding is 3-5 years away. In the meantime, Ethereum Improvement Proposal (EIP) 1559 addresses the problem to a small extent. The more promising mechanism is Layer 2 Scaling Solutions like sidechains, plasma chains, optimistic rollups, and zero-knowledge rollups on which they are working with teams like the one at Polygon.
The situation is urgent because unless Ethereum finds at least a temporary solution to high transaction fees, till ETH 2.0 becomes a reality, it is going to lose market share to a faster smart contract platform.
Ethereum Co-Founders, Gavin Wood, and Charles Hoskinson, have been working on 2 high-profile Eth-Killers called Polkadot and Cardano respectively, but those aren’t anywhere close to commercial deployment. The real threat to Ethereum has come from Binance Smart Chain which is being driven by the very aggressive Changpeng Zhao (CZ).
What is Binance Smart Chain?
Binance Chain was launched in Apr’2019 to issue, use and exchange digital assets. Its main goal was to facilitate quick trades at a fraction of the cost compared to Ethereum, but it lacked smart contract functionality. Binance Smart Chain was launched as a parallel chain with smart contract functionality to run alongside Binance Chain. The ecosystem consisting of Binance Chain and Binance Smart Chain together are able to create smart contracts and complex dApps (decentralized apps), and trade the same quickly and efficiently.
BNB is the native token of Binance Chain and Binance Smart Chain. It was launched in 2017 with a total supply of 200 million BNB. It is a deflationary token. There is no block subsidy. Validators are compensated through transaction fees alone. Additionally, Binance burns BNB each quarter based on the trading volume in the previous quarter. Over 1 million BNB tokens were burnt in the last quarter. Binance has committed to burning half the total initial supply.
Ether on the other hand is an inflationary cryptocurrency seeing inflation of 3.77% currently. If and when EIP1559 does go live, the ETH paid in transaction fees will be burnt, which could turn ETH into a deflationary crypto.
Binance Smart Chain uses a consensus mechanism called Proof-of-Staked Authority (POSA). 21 nodes with the highest BNB staked are selected. Each node takes turns to finalize blocks. Each of the 21 nodes has an equal opportunity to create blocks and earn transaction fees i.e. a node’s probability of creating blocks is not dependent on how much BNB is staked. Staking your BNB with the validator with the highest amount of BNB, therefore, gives lower returns than staking with the 21st Validator. This architecture incentivizes all nodes to be similar in size and no single validator exercises excess control.
Having said that, the 21 selected nodes together exercise large control that makes Binance Smart Chain a centralized blockchain compared to Ethereum which currently has over 4,000 nodes.
The design of any blockchain makes trade-offs between decentralization and scalability. An increase in scalability requires a sacrifice of decentralization. Binance Smart Chain achieves its higher speed and throughput from its consensus mechanism that depends on only 21 nodes.
Further, the only way to access BSC is through the centralized Binance Exchange or Centralized Binance Bridge. The central provider has full control and can stop deposits and withdrawals at any time.
Binance Smart Chain has been able to create a much-needed, faster, and cheaper alternative to Ethereum, and brought it to market in record time. For this it deserves praise. Having said that, it has made design choices that sacrifice decentralization. That means that it isn’t too different from the traditional financial institutions that DeFi aims to replace.
Binance Smart Chain is not creating a decentralized financial ecosystem. But then again, neither is Ethereum, whose high transaction fees represent an insurmountable barrier to wide participation. Ethereum will be a clearly superior choice if and when the transaction fees are brought down and throughput is scaled up.