Will Blockchain Finally Go Mainstream?

Ethereum lays all its cards on the table with 2.0

Hi,

This is Ayaan Shah, a new member of Nextrope’s consulting department. I hope to become a familiar face as I lead this project and look forward to interacting with you 😊

The blockchain space is anticipating a big update in the way Ethereum, the second biggest cryptocurrency by market capitalization, works. Here is a useful guide to the coming changes. 

Today we’ll discuss:

🔥 Developments in Ethereum since its launch

❌ Reasons for limited adoption of Ethereum by the wider market

❓ What’s new to Ethereum?

📈 Economics of Ethereum 2.0

If you have any questions, I am happy to answer them, so please don’t hesitate to ask. Since this is my first article, I greatly appreciate any feedback and would love it if you could share this newsletter with your friends and colleagues.

Not financial advice

We have done our best to ensure that the information provided in the Newsletter and the resources available for download are accurate. However, the information contained in this Newsletter and the resources available for download are not intended as, and shall not be understood or construed as, financial advice.

Ethereum: Growing from Strength to Strength

In order to follow the changes that Ethereum will implement in its upcoming updates, it is important to start with where it stands today.

Ethereum, kicked off in 2015, is the second largest cryptocurrency platform by market cap after Bitcoin. Ethereum was a revolutionary addition to the already ground-breaking technology of blockchain as it was the first platform to offer a “Turing-complete programming language”. This essentially enables users to solve any computation problem given enough time and memory. Ethereum has witnessed exponential growth ever since its launch and now enjoys 200,000 active Ethereum developers, four times more than any other platforms in the crypto ecosystem. 

Ethereum’s ecosystem has enabled the development of various use cases such as initial coin offerings (ICOs), Smart contracts, stablecoins, Security token offerings (STOs), Decentralized Autonomous Organisations (DAOs), Decentralized apps (DApps), decentralized exchanges and other decentralized finance (DeFi) applications but I will not go into detail about these in this newsletter. Stay tuned to our newsletter for more on these topics!

Ethereum has been widely adopted-Almost half of all functioning Decentralized Apps (DApps) on the market are based on the Ethereum network with over 600,000 active users. My research shows that the average daily rate of wallet interacting with DApps on Ethereum increased by an average of 15% each month in 2020. Decentralized Finance (DeFi), another major concept built on Ethereum, took off in 2020 with over $8 billion total value locked in. This is a significant increase from less than $1 billion at the beginning of the year and the value is expected to continue growing. DeFi is currently set to take the financial market by storm as it promises a global and open alternative to every financial service we use today, be it savings, loans, trading or insurance.

Source: defipulse

Why Fix What Isn’t Broken?

If all is going so well for Ethereum, why are they making such drastic changes to the existing system? The reason lies behind the four following limitations which are preventing a large-scale adoption: scalability, speed, lack of developers and security. Although other challenges like regulatory uncertainty and lack of standardization have no immediate remedy, these 4 challenges may have a fix.

Source: Forbes

Scalability 

While most users were aware of Ethereum’s scalability issue in 2015, CryptoKitties, a game where users buy and raise digital cats, was launched in 2017 and single-handedly took up 12% of all Ethereum transactions in its first week. This spike in transactions clogged the network and led to transaction costs sky-rocketing. Similarly, I noticed that the recent explosion of DeFi which I mentioned above is pushing transaction fees into the exosphere and will definitely incentivize developers to switch to cheaper alternatives.

Source: Coindesk

Speed

Due to its encrypted, distributed and sequential nature, Ethereum can currently process 15 to 20 transactions per second. This is detrimentally slow compared to Visa, which processes more than 2400 transactions per second. In my opinion, for our David to even consider taking on Goliath, it will require a significant change in tactics.

Source: Medium

Lack of Developers

Ethereum has only allowed the use of Solidity as a programming language for smart contracts which creates a significant barrier to entry for a developer. In my experience, learning a programming language from scratch is a considerable investment and developers are currently not incentivized enough to match the demand.

Security

While Ethereum offers pseudonymity, many potential applications of the blockchain require smart transactions and contracts to be indisputably linked to known identities. This thus raises some important questions about privacy and security of data stored and accessible on the shared ledger.

Developments in Ethereum Ecosystem

The Ethereum eco-system has been aware of these limitations since inception and has made efforts to address these problems. These efforts are categorized as “Layer 1” and “Layer 2” solutions. “Layer 1” refers to the improvement of the core Ethereum protocol and Ethereum 2.0 is the primary project. “Layer 2” refers to technologies that are built on top of the base Ethereum protocol, enabling greater scalability without compromising on security. 

Layer 1 - Ethereum 2.0 

Vinay Gupta, who helped coordinate the Ethereum launch, outlined four “stages” for Ethereum in 2015: Frontier, Homestead, Metropolis, and Serenity. Having successfully completed the first three stages, Ethereum is currently at the Serenity update stage. The Serenity update is further divided into multiple phases with Phase 0 scheduled for 1:30 PM EDT on September 10, 2020. Vitalik Buterin, the co-founder of Ethereum, tweeted that he expects the entire Ethereum 2.0 roadmap to take between five to ten years to complete with each phase lasting between 8 months to a year.

Source:  coindesk

Phase 0

To maintain an element of trust, blockchains need to test users before they can validate process transactions and add new blocks to the chain. One such test is called Proof of work (PoW) and requires users to solve complex mathematical equations. Upon completion, users earn (also referred to as “mine”) the currency of the blockchain (eg. Bitcoin, ether etc.). Most blockchains, including Ethereum, currently run on PoW. While I consider PoW an amazing invention, it is very limited in the number of transactions it can process at a time and also has significant electricity requirements to power the computers.

An alternate method called Proof of Stake (PoS) was introduced in 2012 to solve the major problems in PoW. PoS is similar in objective, but replaces the mathematical equations with a significant financial commitment (32 Ether worth $11314 at writing), is seized if fraud is identified. In PoS, the validation of transactions is no longer contingent on computing power and is therefore more scalable while using significantly less electricity. Ethereum will initiate the switch from PoW to PoS in Phase 0 of Serenity. 

Phase 1

With its PoS system running smoothly, Phase 1 will activate Ethereum 2.0’s primary scalability solution called “sharding”. Sharding, while operationally complex, essentially refers to splitting a single blockchain across several blockchains, dividing transaction load to multiply network throughput and speed. So, instead of validating all transactions through a single blockchain, shards will enable users to choose one of many shards to send their transactions to with its own set of randomly selected validators. 

Phase 2

This phase is where the functionality of the entire system will start to come together, as it will enable deployment of Decentralized Apps (Dapps) natively on Ethereum 2.0. As mentioned previously, smart contracts on ethereum could only be coded in programming language Solidity but after Phase 2, any programming language could be utilized to deploy DApps and will help remove the barriers to entry for developers. While incredibly promising, this phase is still under R&D.

Phase 3

The final phase is basically a catch-all term for everything that is being planned by the Ethereum community. This phase could potentially see Ethereum 2.0 getting more shards or a new cryptographic technology such as Zero Knowledge Scalable Transparent Arguments of Knowledge (ZK-STARKs). This will help enable users to perform computations without revealing the data, therefore enhancing security. The technology is also currently under R&D.

Economics of Ethereum 2.0

A key requirement for Ethereum 2.0 launch is a buy-in from 16,384 validators each ‘staking’ 32 ETH, a total of 524288 ETH (worth $175 million at time of writing). According to my research, this number has been chosen as it is considered a large enough sum to discourage early attacks on the network whilst remaining realistic in terms of participants. There are currently about 120,000 accounts on Ethereum with a minimum balance of 32 ETH and I believe that the goal of 16,384 seems reasonable, with few users buying more than one stake. 

Once launched, validators will begin earning rewards on their collateral in the form of annualized interest. Validators can expect to earn roughly 20% interest on their staked ETH initially as there are significant risks associated with the viability of PoS on such a large scale and the danger of attacks. However, as the number of validators grows, interest rates will decrease to around 5 to 10 percent as it operates on a sliding scale of rewards that adjusts dynamically based on the total amount of staked wealth in the network. 

Source: coindesk

Layer 2 – The under-rated hero

While Layer 1 solutions are promising, they will take a significant amount of time to become fully operational and Ethereum needs some quick fixes to resolve pressing issues like the sky-rocketing transaction costs. That is where Layer 2 solutions come in seeking to provide most of the functionality and security of Ethereum, while using the blockchain in a different way. Ethereum has placed a lot of emphasis on Layer 2 solutions and Buterin (Ethereum’s founder) also tweeted in June 2020 that the blockchain network’s “layer 2 strategy has basically succeeded”.

While I won’t go into detail about the technicalities of these solutions, they will definitely help relieve the Ethereum network of congestion in the short term while also keeping the main blockchain free of “unnecessary” transaction history in the long-term. 

Conclusion

Ethereum 2.0 has really gotten me excited about the future of blockchain since it addresses some of the really core problems that Ethereum, and blockchains in general face. While various questions such as how the current Ethereum blockchain will be merged with Ethereum 2.0 and how susceptible to attacks it will be remains unanswered it has already piqued the interests of developers, crypto economists and investors with ETH price increasing 96% between mid-July and August end 2020 making bitcoin’s 30% growth in the same time period look pale.

We will continue to follow this story and share any new and exciting trends in the blockchain industry. If you have any questions, feel free to message me at a.shah@nextrope.com.