What is Ethereum 2.0?

Updated: Apr 15, 2021

The Ethereum network is up for a major overhaul. Phase 0 of this overhaul is likely to be launched in 2020.

Why is there a need for change? What problem does the upgrade solve?

While Bitcoin and Ether are both digital currencies, they’re fundamentally very different. Bitcoin aims to be a decentralized currency, Ethereum on the other hand aims to become a global computer on which one can run Decentralised Apps (DApps). Both Bitcoin and Ethereum use a Proof-of-Work consensus mechanism to create new blocks. Here miners solve complex, computationally intensive math problems. The solution serves as evidence that miners have put in the work(effort) and hence deserve the opportunity to create a block for which they’re rewarded with coins. In case an invalid block is proposed then the miner loses the coins rewarded which means that the money spent on computation is wasted. The system is groundbreaking in many ways but also slow and energy inefficient. Ethereum is the most widely used blockchain for DApps. Several games, prediction markets, and DeFi services have been launched on the platform. The success of Ethereum has meant, that given current capacity, the network often gets clogged. Transactions don’t go through and those that do, cost more to process than they should. The popularity of CryptoKitties for example clogged the network in 2017. The same happened at the time of the sudden crash in cryptocurrency prices in Mar’2020.

So what is the solution?

To tackle the scalability and energy inefficiency problems, Ethereum 2.0 will move to a Proof-of-Stake protocol. Validators (instead of miners) will stake Ether as collateral (instead of spending computational power). In each round, a validator will be randomly selected to propose and attest a block. Correctly proposing and attesting blocks will lead to block rewards. Incorrect validation will result in one’s stake getting slashed.

How exactly will the transition pan out? Ethereum 2.0 is not a new idea. At the time of the launch of the original Ethereum blockchain in 2015, a schedule of upgrades was already planned. The schedule of upgrades had 4 phases - Frontier, Homestead, Metropolis, and Serenity. Ethereum 2.0 was the last phase, Serenity. Serenity itself will be divided into 4 phases.

Phase 0- will see the launch of a brand new blockchain called Beacon based on a Proof-of-Stake algorithm called Casper. Beacon will manage the registry of validators and their stakes. No smart contracts will be processed at this stage. Ethereum 2.0 must be launched with a large enough value that it is too expensive for a malicious actor to attack the network. It has been decided that at least 16,384 validators need to stake 32 ETH each at the time of launch. i.e. at least 524,288 ETH must be staked. The higher the amount of ETH staked , the safer the network (This is similar to proof-of-work, where a high number of miners makes the blockchain less vulnerable to a 51% attack). Once Ethereum 2.0 is launched the staked coins will begin to earn interest. In the early stages, the interest could be as high as 20% (according to Collin Myers of Consensys Codefi). This will decrease as more validators join the network.

Phase 1- will see the creation of a new scaling method called sharding. The original Ethereum requires that every node store data of every transaction ever processed on the blockchain. This limits the number of transactions that can be processed. With sharding, the blockchain is split into child blockchains called shards and the job of processing transactions is divided among them. Transactions can then be processed simultaneously instead of consecutively. This will increase network capacity from the current 15 transactions per second. Initially, Ethereum 2.0 will have 64 shards. A user can decide which shard they want to send their transactions to. All shards will in parallel, and process the different transactions sent to it. The summary of the data in each shard will be maintained in the central Beacon chain which will also facilitate communication between shards.

Phase 1.5- Till Phase 1, the original Ethereum blockchain and Ethereum 2.0 will continue to run side-by-side. Phase 1.5 will see the merger of the two with users and DApps transitioning to the new chain. The original Ethereum blockchain will become one of the 64 shards of Ethereum 2.0. Phase 2- will see smart contract execution getting activated. Once communication between the shards and the Beacon chain has been tested, storage and deployment of smart contracts on the shards will be enabled. Phase 3- will see the final touches being added with the implementation of miscellaneous technology like ZK-STARKS (Zero-Knowledge Scalable Transparent Argument of Knowledge) => The implementation of all 4 phases is likely to take 5-10 years.

How will ETH price behave as a result of this change? Successful execution of Ethereum 2.0 should increase the usefulness of the network and hence the value of the network and its token-ETH. From a technical point of view, 3 things will happen: 1. Staking would take a sizeable number of ETH (16,384*32) out of circulation which could increase the value per ETH. 2. During Phase 0 and Phase 1 when blocks are being created in both blockchains, there will be an increase in the number of ETH created. The increase in supply could lead to a drop in value per ETH. 3. The block reward per block is lower for Ethereum 2.0 as validators do not need to spend as much on energy and computation equipment. Therefore, after Ethereum is discontinued, the rate of ETH creation will drop. References: