According to Bitcoin, Ethereum is the most important blockchain in the world. After five years, Ethereum is now facing the biggest update in its history. So far there is no fixed data about a possible market launch of Ethereum 2.0, but the cornerstones of the completely renewed blockchain should already be laid in summer 2020. The public testnet for the new iteration should be available on August 4. We would like to take a closer look at what the update means for Ethereum.
ETH2 – the retreading of Ethereum
When we talk about Ethereum 2.0 or ETH2, there are basically two key elements that characterize this update. On the one hand, the blockchain should say goodbye to mining with the upgrade and focus on staking. Accordingly, the energy-hungry proof of work algorithm is replaced by an energy-efficient proof of stake algorithm. On the other hand, sharing is also one of the relevant upgrades. It can be assumed that the Ethereum Blockchain, as it exists today, will no longer exist afterwards.
However, such an extensive change cannot take place on a key date. Accordingly, the developers have decided to divide this change into several phases. The transition is expected to continue until 2021 or even 2022. Nevertheless, the developers address two fundamental problems of the blockchain with the upgrade:
- High energy expenditure for mining
- Scaling problems due to low number of transactions
In the following we go into a little more detail on the individual problems and the proposed solutions.
Why proof of work is out of date
Bitcoin and Ethereum, the two largest blockchains on the market, have one thing in common – the proof of work approach. And this algorithm has a fundamental disadvantage, because computing power is required for mining. However, a high level of performance requires the corresponding energy – the effects on climate protection are conceivable.
The example of Bitcoin shows how high the requirements can be. Data shows that the annual CO2 emissions alone are 29 megatons – this corresponds to the total annual emissions of Myanmar. 249.90 kg of CO2 are generated per block. Converted to energy, we speak of an annual energy requirement of 61.11 TWh or 526.1 kWh – this corresponds to the energy that a US household needs in 17.78 days. However, the environmental impact does not end here, because around 9.54 kilotons of electrical waste are generated every year.
While the data above does not apply to Ethereum, the trend is clear. PoW is extremely energy-hungry and no longer corresponds to the current zeitgeist.
Proof of Stake – Ethereum 2.0 ensures energy efficiency
But blocks can also be completed without solving particularly complex tasks. Staking shows how this can work. It no longer matters how much computing power the participants make available to the network. All that matters is participation in the network. An algorithm determines which participant is responsible for the validation of which blocks. The distribution of the new coins is based on the personal share. Accordingly, investors who hold 5% of ETH hold 5% of all new coins. Accordingly, the treasury shares are not diluted.
Compared to the PoW there are no mining rigs at PoS anymore. Instead, investors need a working computer. This device should also have a minimum level of performance. Nevertheless, mining farms are no longer required from this point on.
With this approach, the big problem of environmental pollution can be solved quickly and easily.
“Proof of stake is to be welcomed from an ecological point of view. This solves the previous, and rightly criticized, problem that extremely large amounts of electricity are used during mining. ”- Bernhard Blaha, Cryptix .
How does the proof of stake work with Ethereum 2.0?
Anyone wishing to take part in Ethereum staking must have a minimum deposit of 32 ETH. These 32 ETH must be saved on a corresponding wallet. If we follow the current ETH rate, the 32 ETH are equivalent to around $ 9,800. For many small investors, such a position in an asset class is often not possible or corresponds to a clear overweight in the overall portfolio. Accordingly, it can be assumed that investors who already hold larger positions in Ethereum will benefit from staking.
According to Bernhard Blaha, however, it cannot be assumed that only wealthy investors will build up a corresponding position. Rather, staking is significantly fairer than mining, because investors have to continuously invest in hardware there. As a result, Blaha does not believe that staking helps the rich get richer. In addition, Blaha also notes that there are staking pools. Here investors can make their Ethereum available to the pool and still participate in the staking.
Ethereum and the problem of scalability
Mining is not the only current problem with the Ethereum blockchain. Rather, users complain about the comparatively low scalability of the blockchain. What is meant here is the small number of transactions that can be processed every second. At the current time, Ethereum can process around 15 transactions per second. Taking real use cases into account, this is a very small number. Other blockchains also impress with significantly better scalability.
Transactions in the area of finance or in the context of processing smart contracts are particularly important. Here, for example, the Visa payment network illustrates the high latency of the network. This can process around 50,000 transactions per second and is essential for a functioning global payment transaction. However, a high transaction speed is also essential for the processing of smart contracts.
In particular, the fact that Ethereum is a platform for dApps and smart contracts shows that the current limitation is an obstacle to further adaptation. But also a look at the average transaction costs shows that the limitation is a financial disadvantage for the users. Since DeFi has grown rapidly, transaction prices have risen sharply. The stablecoin tether (USDT) and the DeFi applications Kyber Network and Uniswap are particularly in focus. These three applications alone require numerous transactions and thus contribute to increasing transaction prices in the network.
Sharding improves scalability with Ethereum 2.0
With the upcoming update from Ethereum, the problem of scalability will now be solved and the blockchain made fit for the future. So Ethereum 2.0 should not only be able to process 15 transactions per second, but several thousand transactions. A hard fork from Bitcoin has also focused on scalability in the past. With Bitcoin Cash, however, the developers only increased the block size, so the nodes may have to process larger amounts of data.
Since Bitcoin Cash is also based on mining, larger blocks also mean that more computing power is required to process the hashing of the blocks. As a result, there is a latent risk that mining will focus on larger providers and data centers and lead to centralization.
Ethereum 2.0 uses a different approach, called sharding . Sharding divides the entire blockchain into several shards (sharding is a kind of fragmentation of the blockchain). The processing of the shard chains takes place via the beacon chain. It is theoretically possible that individual shard chains specialize in certain areas of application and, for example, emulate the functionality of other blockchains.
The Beacon Chain heralds the start of Ethereum 2.0
The change described above does not happen all at once. Rather, the migration will take place over a longer period of time, which will open up new investment opportunities. The beacon chain could already start in the current half of the year and herald the change from Ether 1.0 to Ether 2.0.
The beacon chain should enable investors to exchange their existing ether for ether 2.0. The number of tradable Ether 1.0 is reduced accordingly – price increases could be the immediate consequence.
In addition, the native coins of the beacon chain, Ether 2.0, should only be issued against Ether 1.0. Those who invest in Ether 2.0 receive attractive interest by participating in staking. At the beginning, this interest rate could be around 10%. From 3 million coins stacked, a correction to 7% could be made. As soon as around 10 million ETH have been stacked, a further reduction in the interest rate to 3.3% can be expected.
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Conclusion: Ethereum 2.0 could replace Bitcoin as the leading blockchain
The proposed optimizations of the Ethereum Blockchain are inherently logical and sensible. While the blockchain sharding and the creation of numerous subchains lead to better scalability, staking contributes to a fairer and more sustainable validation of the transactions.
However, the migration from Ethereum 2.0 does not take place in one step, but over a longer period of time. Accordingly, attractive opportunities open up for investors. On the one hand, investors can start staking with the publication of the beacon chain – provided they have a corresponding position. On the other hand, the Ether 1.0 resources are becoming scarcer, so that rising prices could be the immediate consequence.
In my view, an investment in Ethereum with a defined exit scenario is quite interesting and lucrative. Anyone who notifies the liquidation of their Ethereum position can represent this trade at low tax rates via eToro or Plus500. On the other hand, if you want to participate in staking, you urgently need to invest in physical coins. Here it is worth buying via a crypto exchange – you can find a comparison of the best exchanges here .