The most significant blockchain network upgrade in history is just around the block.
On 14 March 2022, Ethereum, the largest DeFi blockchain, moved one step closer to its ultimate goal: Ethereum 2.0. The Ethereum Foundation announced on Monday that “The Merge” was successfully completed on Kiln, the final testnet (a working prototype). And Ether (ETH), the native token of Ethereum, immediately gained, breaching $3,000 for the first time in two weeks.
There’s a lot to take in. Before we get into why Ethereum 2.0 is such a big deal or the technical stuff, let us try and understand what it tries to solve and why it is happening.
The Blockchain Trilemma
Coined by Ethereum co-creator Vitalik Buterin, the term “Blockchain Trilemma” addresses the challenges developers face while creating a well-balanced blockchain ecosystem. It refers to the fact that a blockchain should ideally strive to be decentralized, scalable, and secure all at once—without compromising on any of the three.
Most projects fail to achieve this balance. And Ethereum is no different.
Issues with Ethereum 1.0
Ethereum is currently operating on the Proof-of-Work (PoW) consensus mechanism to make transactions possible—a mechanism that is energy-consuming and hard to scale.
Right now, Ethereum can handle a maximum of 30 transactions per second (TPS), leading to long wait times and high fees of as much as $200 per transaction. Comparing this with Solana’s 65,000 TPS and its near-zero transaction cost puts Ethereum in a dark spot.
So the question is how Ethereum’s scalability issue can be solved, creating a balanced blockchain. The answer?
What is Ethereum 2.0?
Ethereum 2.0, also known as Serenity or ETH 2.0, is an upgrade to Ethereum’s existing blockchain. Its primary objective is to increase capacity, reduce transaction costs, and make the network sustainable. To this end, Ethereum will migrate from Proof-of-Work to a Proof-of-Stake (PoS) consensus mechanism.
Briefly put, PoW requires thousands of computer users (miners) competing with each other to process transactions and earn rewards. Thus, the process is both energy-intensive and time-consuming.
On the contrary, the PoS model relies on “stake pools” to get the job done. Here, the size of the pool (number of coins and the time for which they are held) decides who gets to add transaction data to the block and earn the consequent rewards, making it more eco-friendly.
Cardano, Solana, Polkadot, and Avalanche are some popular proof-of-stake blockchains.
How Does Scaling Happen in ETH 2.0?
Moving to PoS helps address many of the capacity issues plaguing Ethereum 1.0. The Ethereum blockchain has a limited data storage capacity at any given time, and this causes wasteful delays and higher costs.
In newer PoS blockchains, including Ethereum 2.0, scaling is achieved through a method called Sharding. Sharding helps distribute data across multiple machines on the PoS network, thereby addressing the issue of scalability.
When Will Ethereum 2.0 Happen?
Ethereum was launched in 2015, and the shift towards a sustainable PoS model was first ideated in 2017. The actual upgrade started in 2020, and that will continue until sometime in 2022.
The Ethereum 2.0 upgrade process is scheduled in three phases, with phase 0 already live for some time now.
The Beacon Chain: Phase 0
Initially, the Ethereum team was faced with the tricky question of how to enable the transition without disturbing the network.
The answer they found was the Beacon chain, an independent PoS network created to run parallelly with the existing PoW Ethereum mainnet. Since its launch in December 2020, the chain’s performance has been satisfactory in relation to setting Ethereum up for staking.
The Merge: Phase 1
Currently, Ethereum is living two lives—with the main Ethereum on PoW and Beacon on PoS.
In the second phase—that is, phase 1—called The Merge or The Docking, that duality is resolved. As the name suggests, the ongoing step involves officially switching to the PoS model by merging the Beacon chain with the existing Ethereum network.
Last week, the final merge testnet, called Kiln, went live. And the actual Merge is set to happen in June or July of this year.
The Merge is a critical step in solving the Blockchain Trilemma. The beauty of the current merge is that existing holders of Ether (ETH) crypto need not do anything while the transition unfolds.
After The Merge: Phase 2
Post the Merge, the third phase or phase 2 will implement Sharding. This is scheduled to happen in 2022 and will enhance Ethereum’s transactional capacity.
Triple Halving of Ethereum: What’s That?
On 5 August 2021, an Ethereum upgrade called the EIP-1559, or The London Hard Fork was implemented. The hard fork was part of the larger Ethereum 2.0 transition and mainly aimed at improving Ethereum’s transaction speed. Read all about it here.
To cut a long story short, the upgrade involves reducing ETH supply in circulation through a process called burning, thus generating a “deflationary pressure” on the network. Simply put, the scarcity created will make the prices of ETH go up.
The process is precisely similar to Bitcoin Halving, which happens every four years. Since the effect is equivalent to three Bitcoin halvings, it is called Triple Halving.
EIP-1559, combined with the move toward a PoS Ethereum, will dramatically reduce the issuance of ETH.
What Does This Mean for Investors?
The demand for ETH could drastically increase in the coming days as Ethereum slashes nearly 99% of its energy consumption post the Merge. This, along with the inbuilt deflationary pressure, could make the prices drastically shoot up.
From the industry perspective, Ethereum 2.0 will cement the crypto’s position as a leader in DeFi and Web3, leaving little to no room for its rivals. However, a successful Merge followed by Sharding and scalability is necessary for the prophecy to come true.
Disclaimer : Crypto products and NFTs are unregulated and can be highly risky. There may be no regulatory recourse for any loss from such transactions. The information provided in this post is not to be considered as investment/financial advice from CoinSwitch. Any action taken upon the information shall be at user's own risk.
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