One of the biggest problems that blockchain networks have had over the past several years is scaling to meet growing demand. Blockchain networks have become congested and expensive, making them more difficult to use.
The developers of Ethereum recognised this issue and decided to attack it head-on, with a redesign of its blockchain architecture and a mission of scaling its network to lengths never before seen. The redesign, known as Ethereum 2.0, will radically change how the Ethereum network functions.
Here is everything you need to know about Ethereum 2.0.
What is Ethereum 2.0?
Ethereum 2.0 is a set of upgrades to the Ethereum blockchain, designed to increase the network’s usability, efficiency, and scalability. This new Ethereum is also being called Eth2, Eth 2.0, or Serenity. Ethereum 2.0 has taken years of planning and implementation, and hundreds of developers working together to make these improvements.
Why Eth 2.0?
Over the years, many tokens and decentralised applications have been launched on the Ethereum blockchain. While this is positive news for the network, it has led to a slower performing network and higher transaction fees — which Ethereum refers to as “gas” — both of which are roadblocks to mass adoption. Eth 2.0 is set to improve the performance and functionality of the Ethereum blockchain through its new structure. As a result, network fees, which have made the network almost unusable, will decrease substantially.
Do Ether holders need to do anything?
No. Ethereum 2.0 is designed to be implemented without any changes to the Ether cryptocurrency. These changes will not cause any hard fork or migration of Ether, so as long as you have your Ether secured in a wallet or on an exchange like eToro, you are all set. The same goes for holders of Ethereum-based tokens, including any ERC-20 or ERC-721 tokens, which will not be affected by the upgrade.
Key changes/upgrades to Ethereum 2.0
Proof-of-Stake
Instead of relying on miners to validate blocks on its blockchain, Ethereum 2.0 will move the network into a proof-of-stake (PoS) model. In PoS, network validators verify transactions on the blockchain. In order to ensure that these validators act in the best interests of the network, they are required to stake Ether in the process. If they act maliciously, the staked Ether is lost, thus creating an economic incentive for all validators to act in the best interests of the network. If validators verify transactions properly, they are rewarded with newly minted Ether.
To increase its security, the developers of Ethereum are taking several steps to ensure that the new PoS model requires stakeholders to act in the best interests of the network.
- Requires a minimum of 16,384 validators to reduce the risk of centralisation
- Confiscates staked cryptocurrency by bad actors and removes their ability to stake again
- Allows anyone to validate transactions, not just those with high-powered computing equipment
Sharding
To increase the network’s scalability, Ethereum 2.0 will implement shard chains. The process of sharding allows the blockchain to be split into various chains to divide the work of validating nodes. Think about sharding like opening more lanes on a highway to allow for a greater flow of traffic. It allows more transactions to be processed in parallel, allowing more transactions to be verified in a shorter period of time, thereby, increasing the network’s capacity in the process.
Beacon Chain
The Beacon Chain is set to introduce PoS into the Ethereum network slowly over time. It acts as the coordination mechanism of the entire network and is the functionality that rewards validators for securing the network and creating new blocks on the blockchain. The Beacon Chain is also the bridge between the existing Ethereum network and Eth 2.0.
Ethereum vs Ethereum 2.0
The Ethereum blockchain has come a long way since the project’s initial coin offering (ICO) in 2014. The newly proposed changes in Eth 2.0 mean that the issues of the past could be completely eliminated in its new architecture.
| Ethereum | Ethereum 2.0 | |
| Consensus mechanism | Proof-of-Work | Proof-of-Stake |
| Transactions per second | 30 | 100,000 |
| Environmentally friendly? | No | Yes |
| Scalable? | No | Yes |
| Shard chains? | No | Yes |
Ethereum roadmap
The upgrade to Ethereum 2.0 won’t happen all at once, and instead, will occur in distinct phases. The hope is that by rolling out major changes to the blockchain in phases, any issues or problems with the Ethereum update can be caught in real time and dealt with appropriately.
The initial part of this process began with rolling out changes on the Ethereum testnet, where the changes could be implemented and tested without fear of errors. After successful launches on its testnets, the developers of Ethereum are ready to implement Ethereum 2.0 in its multiphase rollout process.
The Ethereum roadmap is as follows:
- Phase 0 – Introduce the Beacon Chain and start of PoS
- Phase 1 – Introduce shard chains
- Phase 1.5 – An intermediary phase to merge the Ethereum mainnet to the Beacon Chain
- Phase 2 – Make shard chains compatible with the entire network, including smart contracts
Source: https://ethereum.org/en/eth2/
How does proof-of-stake differ from proof-of-work?
All blockchains have a consensus mechanism, or, a way in which blockchain transactions are verified to be accurate and true. This is the backbone of the system that allows blockchains to remain decentralised, verifying transactions and taking control of the network.
The first and best-known consensus mechanism employed by cryptocurrencies is called proof-of-work. In this mechanism, miners solve complex mathematical equations to find the cryptographic hash of the most recent block on the blockchain. Once a miner verifies a block, it is broadcast to the entire network for verification, and then the block is posted to the blockchain. In other words, miners use significant amounts of power and energy to secure transactions on the network, and in return, are rewarded for their efforts. This is the consensus mechanism utilised by Bitcoin and many other cryptocurrencies.
Proof-of-stake, on the other hand, uses a method of economic game theory to keep a decentralised network secure. In this mechanism, validators — known as stakers — stake their own cryptocurrency to the network for the right to validate transactions. If stakers validate transactions correctly, they are rewarded with cryptocurrency, but, if they attempt to act maliciously and trick the network, their previously staked cryptocurrency is lost forever.
This creates an economic incentive for all stakers to act in the best interests of the network. PoS also eliminates the need for energy-intensive processes, since no complex calculations are needed by stakers to validate transactions.
| Proof-of-work | Proof-of-stake | |
| Who secures transactions? | Miners | Stakers |
| High energy consumption? | Yes | No |
| Special equipment needed? | Depends on network | No |
| How to attack the network | Control a majority of the network’s computing power | Obtain a majority of the network’s cryptocurrency |
So you want to stake your Ether…
As previously discussed, anyone can stake Ether to become a network validator and receive rewards for validating transactions on the network. But not so fast. This doesn’t come without its own caveats. Here are some things to remember if you are looking to stake Ether in Ethereum 2.0:
Ether staking requirements
- A minimum of 32 ETH is required to run your own staking node.
- Your Ether may be locked for an undetermined amount of time and is dependent on when the current Ethereum mainnet is combined with the Eth 2.0 upgrades.
- If your staking node goes offline for an extended period of time, you will lose a portion of your staked Ether.
Staking pools
If you don’t have the required 32 ETH to operate your own node, you can stake your Ether in a staking pool instead. Staking pools take funds and pool them together for staking on the network. But be warned, using a staking pool this early in the process of Ethereum 2.0 comes with risks. For one, some pools take full control of your Ether, and in theory, can defraud you at a moment’s notice. Staking pools also take a fee for their service, which greatly reduces your staking rewards, and may not make the endeavour worthwhile, given the risks. Ethereum does not officially endorse any staking pools, which should be a telltale sign of their inherent risks.
Ethereum 2.0 and Bitcoin
The proposed changes in Eth 2.0 move Ethereum further away from Bitcoin. While these two networks are often compared to one another, Ethereum 2.0 creates an even wider gap in the differences between the two. While Bitcoin remains on a proof-of-work (PoW) consensus mechanism, Ethereum is moving to a PoS mechanism, which promises higher throughput while reducing its energy consumption.
Ethereum co-creator Vitalik Buterin noted why PoS is an important aspect of Eth 2.0, and how it improves upon the PoW mechanism utilised by Bitcoin and other blockchain networks.
“Proof-of-stake is more censorship-resistant. GPU mining and ASIC mining are both very easy to detect: they require huge amounts of electricity consumption, expensive hardware purchases, and large warehouses. PoS staking, on the other hand, can be done on an unassuming laptop and even over a VPN.”
If the PoS upgrade to Ethereum is successful, it could lead Bitcoin developers to wonder if such an upgrade would be worthwhile on its network. Doing so would greatly reduce the environmental impact of Bitcoin, which has been one of the major points of contention in its development and growth, and could change the definition of the Bitcoin network along the way.
Ethereum 2.0 effects on DeFi
Decentralised finance — otherwise known as DeFi — has been the first major use case developed on the Ethereum blockchain. However, with the current Ethereum network, it is often too costly to carry out smart contracts and transactions needed for the DeFi market. Ethereum 2.0 promises to reduce transaction costs and make it easier to carry out smart contracts needed for DeFi applications.
However, the DeFi market could experience some economic drawbacks to these changes as well. In the new PoS mechanism, staking Ether to the network rewards validators in a similar way to staking on DeFi protocols. This could cause a shift in the market share for some DeFi projects, which could reduce usage as Ethereum staking increases.
Potential challenges to Ethereum 2.0
- One wrong line of code or error could create issues with the entire network moving forward.
- The update might not go as planned and could take more time than anticipated. Both investors and users of the network could see this as a negative sign and move to other, competing networks as a result.
- The staking system now utilised by Ethereum will lock up a large amount of Ether for an extended period of time. This could have a negative impact on liquidity in the market, as less Ether is available.
The future of Ethereum
Ethereum 2.0 represents the next evolution for Ethereum. The move from proof-of-work to proof-of-stake underscores how big this change really is for the entire network. The developers of Ethereum hope that, with such changes, its network will not only scale more easily, but will provide users with cheaper transaction fees and increase the network’s usability. If these goals do come true, it is not hard to imagine Ethereum controlling the market as one of the top blockchain networks for decades to come.
Discover Ethereum with eToro
This information is for educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any financial instruments.
This material has been prepared without regard to any particular investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Not all of the financial instruments and services referred to are offered by eToro and any references to past performance of a financial instrument, index, or a packaged investment product are not, and should not be taken as, a reliable indicator of future results.
eToro makes no representation and assumes no liability as to the accuracy or completeness of the content of this guide. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose.
Cryptoassets are offered as CFDs. eToro AUS Capital Pty Ltd, ABN 66 612 791 803 AFSL 491139. CFDs are highly leveraged and risky, and may not be suitable for all investors. You may lose substantially more than your initial investment. This information is general only and has been prepared without taking your objectives, financial situation or needs into account. You should obtain independent advice and refer to our PDS before deciding whether to trade with us. You can get a copy of the PDS from https://etoroprod.wpengine.com/customer-service/terms-conditions/