July 2020

The Road to Ethereum 2.0

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In November 2019, we wrote about the proposed rollout of Ethereum 2.0. The first phase of this upgrade is expected to take place in Q3 2020 and is being eagerly monitored by the crypto community.

In November 2019, we wrote about the proposed rollout of Ethereum 2.0. The first phase of this upgrade is expected to take place in H2 2020 and is being eagerly monitored by the crypto community. The upgrade will enable Ethereum to handle far greater transaction volumes, allowing it to “actually be the world computer” that Vitalik Buterin envisioned back in 2014. Ethereum 2.0 (also known as Eth2) is an ambitious update that incorporates proof-of-stake, a new consensus mechanism, as well as sharding, a scaling method. Eth2 will dramatically increase throughput volumes while maintaining network security properties. It will allow new and existing Ethereum applications to scale up to millions of users all transacting over an Internet of Value. This month we are going to look at the progress that has been made with Eth2 and what we can expect for the rest of 2020.

By way of a recap, Eth2 will become a more scalable and secure version of the current mainnet implementation of Ethereum. When complete, Eth2 is expected to expand the network’s transaction speed up to 100,000 transactions per second; a major improvement to the current 14 transactions per second. The upgrade incorporates two features that diverge significantly from the existing system; proof-of-stake and sharding. Proof-of-stake is a consensus mechanism and a way of getting all participants in the network to agree on the current state. This consensus mechanism will replace the existing proof-of-work consensus engine, which is energy inefficient and slow.

For additional throughput, Eth2 is scaling horizontally through sharding. In computer science there are generally two ways to scale a system:

  1. Vertical scaling: this is where hardware used in the network is improved. With more powerful machinery, a network has greater processing power. The problem with this in a blockchain setting is that it becomes expensive to be a validator, leading to centralization. This results in ordinary users being unable to process their own transactions and take part in network consensus. There are also security implications as only large entities take part in operating the network.
  2. Horizontal scaling: this is where more nodes or computers are added to a system to provide it with more power. In a blockchain setting, horizontal scaling is where a network is partitioned into multiple “shards”, with each shard processing its own transactions. Hardware requirements can be kept to a minimum in a sharded system, meaning that users in the future may be able to validate blocks using their smartphones. Horizontal scaling will convert Ethereum’s existing “single shard” system into a fractured network with multiple shards.

There are 7 stages to the roll out of Eth2, with phases 0 to 2 the most imminent and arguably the most important. Phase 0 is the “Beacon Chain”, which is the heart of the proof-of-stake consensus mechanism. The Beacon Chain is the system through which all network participants come to agreement as to what has taken place. Most newer proof-of-stake systems have a validator set of around 100 validators, as is the case in Cosmos and Solana. By contrast, Eth2 is designed to have a bare minimum of 16,000 validators with the expectation that there will be hundreds of thousands of validators within a couple of years. If this plays out, Ethereum will likely become the most secure proof of stake network in the world. It will also be one of the most complex, having to handle networking, resource consumption and consensus amongst a very large group of nodes.

Once the Beacon Chain is ready for mainnet, the Eth2 staking contract will be published to the Eth1 mainnet. To become a validator in Eth2, validators must deposit 32 ETH into this contract. The Beacon Chain will start operations once it has at least 16,384 validators (524,288 ETH locked in the contract). By depositing ETH in the contract and validating the Beacon Chain, validators are rewarded with issuance of new ETH. The less total ETH that is staked in the entire network, the greater the staking reward will be. In the first days of the Beacon Chain, it is expected that rewards could be upwards of 20%, attracting people to join Eth2.

You can think of the Beacon Chain as the heartbeat of Eth2 in that it provides a steady tempo for the system to come to agreement on the state of each shard. In terms of timing, every 12 seconds represents a “slot” in the Beacon Chain and 32 slots make an “Epoch”. Validators are randomly sorted into committees that will validate specific slots and shards, with at least 128 validators per committee.

Phase 1 is where shard chains are created and there will be 64 shards to start with. Each shard is its own blockchain with its own subset of applications. Shards get their security from the Beacon Chain, with validators from the Beacon Chain given random short-term assignments to build and validate shard chains. At “phase 1.5”, the current Ethereum mainnet will be integrated into Eth2 as a shard. The big change here is that current Ethereum will go from being validated by proof of work miners to proof of stake validators. Application users should see no difference in the system other than superior performance, while developers will see better security properties, faster finality of transactions and lower costs. It is at phase 1.5 where Eth2 really becomes Ethereum as it will encompass the existing Ethereum mainnet.

The current status of Eth2 is that numerous testnets of the Beacon Chain have been launched, with Altona being the latest. These testnets are becoming increasingly stable and it is expected that in H2 2020 phase 0 will go live, with the Beacon Chain launching its mainnet. At this point, staking will be enabled and we can expect to see a significant amount of Ether (524,288 ETH at a minimum) get locked into the Eth2 validator contracts. In particular, long term ETH holders may look to benefit from higher staking rewards by being early adopters. Once the Beacon Chain is live, we can expect to see the testing of multiple shard chains with a view towards launching shard chains and phase 1.

Today, Ethereum is approaching full capacity. There are a number of alternative smart contract platforms that are competing with Ethereum in the race to become the "world computer". These competitors are trying to convince existing Ethereum applications to migrate onto their platforms. Eth2 is a vital upgrade that Ethereum needs to execute on in order to maintain its pole position as the leading smart contract platform. While the rollout of Eth2 has been slow, enthusiasm for Ethereum has remained steadfast. We anticipate Eth2’s Beacon Chain rolling out successfully in H2 2020. The resulting lock up of staked ETH (reducing supply), coupled with the media fanfare that will accompany the launch (boosting demand) should have a positive impact on Ethereum and the price of ETH.