Ethereum 2.0 Transition to Proof of Stake

Ethereum has been in the spotlight for a while given its gradual transition to Ethereum 2.0 – an essential upgrade that will transform the second-largest cryptocurrency forever as its blockchain adopts the Proof of Stake (PoS) algorithm instead of the current Proof of Work (PoW). In the present article, we discuss this transition and try to foresee the impact on the price. But before getting more in detail, let’s see what Ethereum is and how it is different from other blockchain networks out there.

What is Ethereum?  

Ethereum is a decentralized, open-source platform that relies on blockchain to let developers create and run decentralized applications (known as dapps), which allow users to conduct peer-to-peer transactions, make agreements, and trade goods and services without intermediaries. The key feature of Ethereum is the smart contract, which was a novelty at the time of launch and which has revolutionized the way individuals and businesses conduct deals. For example, users no longer need a lawyer to execute a sales contract since the smart contract executes it automatically based on the predetermined conditions that are input by both parties. Also, Ethereum can be used to bypass banks to transfer funds anywhere in the world, just like Bitcoin.

Similar to any blockchain, Ethereum relies on a global network of computers, called nodes, which interact and act as a supercomputer.

The smart contracts represent the essential element of Ethereum, as they can be used in multiple ways to achieve various goals. Ethereum’s dapps are independent of any third party involvement or manipulation thanks to blockchain’s resistance to tampering. Smart contracts are executed as programmed, thus preventing potential frauds.

Source: Pexels – Ethereum Price Chart

While many online applications can also settle contracts automatically, the main difference is that in the case of Ethereum, the agreements and data related to a transaction is stored in blockchain ledgers rather than in centralized servers like those offered by Facebook or Google.

The Ethereum ecosystem is fueled by Ether, the second-largest cryptocurrency by market cap after Bitcoin. The token has several use cases, one of which is to incentivize programmers to run the ETH blockchain on their computers. Also, ETH can be traded like any other coin on cryptocurrency exchanges.

All in all, Ethereum is similar to Bitcoin in the sense that it relies on blockchain and thus uses a decentralized network. However, its approach and goals are totally different from Bitcoin ones, given that Ethereum offers way more features, having its own Internet browser, coding language and payment system. More importantly, it enables the creation of dapps, which can be simulations of existing concepts or completely new ideas. Some of the most popular dapps on Ethereum are Provenance, EtherTweet, Gnosis, and Augur.

For dapp developers, Ethereum offers Ethereum Virtual Machine (EVM), which is a sandboxed virtual stack able to execute coding scripts based on a global network of public nodes. The EVM’s instruction set is Turing-complete, suggesting that it is capable of performing any logical step of a computational function. The internal transaction pricing mechanism on the network is Gas, which is payable in ETH. Gas is used to prevent transaction spam and allocate resources on the network.

The History and Evolution of Ethereum

Unlike Bitcoin, which has been designed by an entity that is still unknown today, Ethereum has been rolled out in a transparent manner, and there are real people involved in its creation. The key figure in the development of Ethereum is Russian programmer Vitalik Buterin, who chairs the R&D team to this day and is actively involved in the modernization and progress of Ethereum. He is also quite active on social media, especially on Twitter.

Buterin published the whitepaper of Ethereum in 2013, though the project was officially announced in the following year at the North American Bitcoin Conference in Miami, US. The original development team behind Ethereum included Vitalik Buterin himself, Romanian Bitcoin Magazine co-founder Mihai Alisie (who started the magazine together with Buterin), Canadian entrepreneur Anthony Di Iorio, and mathematician Charles Hoskinson, who eventually founded Cardano.

When it was first announced in Miami, the project was received very well, and the team created a nonprofit organization called Ethereum Foundation. Its mission has been

“to promote and support Ethereum platform and base layer research, development and education to bring decentralized protocols and tools to the world that empower developers to produce next-generation decentralized applications (dapps).”

Ethereum’s development and roll-out were financed via an initial coin offering (ICO) launched in July 2014. ICOs were an innovative crowdfunding mechanism at the time and weren’t flooded by scams.

The platform was finally launched in 2015 and was fully operational in 2016, when it introduced the protocol Homestead.

Buterin and Alisie were good friends at the time and were both fascinated by the possibilities of blockchain. However, they realized the limits of Bitcoin, even though it was the only and most promising project in those years. They wanted to extend blockchain’s use cases and allow developers to become creative by experimenting with new decentralized applications. Besides this, Ethereum is more scalable and energy-efficient than Bitcoin.

As mentioned, the key feature of Ethereum is the smart contract, the concept of which was first described by Nick Szabo, who many claim could be Satoshi Nakamoto himself.

In 2016, Ethereum experienced a difficult period when it was split into two separate blockchains after a hacker stole over $50 million worth of funds that had been raised on the DAO, an investment fund built on Ethereum. The Ethereum Foundation wanted the funds to be returned to victims, but it was technically impossible given that Ethereum blockchain is immutable. However, the fact that 14% of ETH was blocked in the DAO project was a too big failure to ignore. Buterin and other core members of the Ethereum community promoted a hard fork that would clone the blockchain until the point of hack and omit it as if nothing happened.

If all the community moved to the new, cloned blockchain, then the tokens held by hackers would have cost nothing at all given the drop in demand. Buterin moved on with his proposal, and Ethereum was split at that time. However, there were people that criticized this approach and remained with the old version, which is now called Ethereum Classic. At the time of writing, the latter is the 32nd largest cryptocurrency by market cap, so it still has value.

Transition to Ethereum 2.0

In the last few years, Ethereum passed through several minor updates, including the Metropolis Byzantium and Metropolis Constantinople hardfork updates. However, the most important change is happening right now, as Ethereum is moving from its traditional Proof of Work mechanism to Proof of Stake. This means that the blockchain won’t be maintained by miners anymore, but by validators. It also means an even more scalable and energy-efficient Ethereum version.

The main goal of Ethereum 2.0 is to improve the network’s security and scalability by implementing changes to the main infrastructure, including by adopting PoS. The upgrade, commonly known as Serenity, will enhance the speed and efficiency of the network so that Ethereum could handle even more transactions.

Ethereum 2.0 is launching in three main phases, with the first one scheduled towards the end of this year.

The main difference between Ethereum 2.0 and the initial version is the consensus mechanism. In the current PoW system, miners have to use computer hardware-based processing power to solve mathematical puzzles in order to validate new transactions and create new blocks. Bitcoin still relies on a PoW mechanism. However, this approach requires much energy and is very slow at processing multiple transactions. In the upcoming PoS system, the validators won’t use computing power but would stake their Ether tokens to fight for the right to create new blocks. The validators will be picked by the protocol to propose the new blocks based on how many tokens they hold and for how long they’ve held it for. Those who stake their tokens will become eligible to receive rewards.

Will Ethereum 2.0 Perform Better in Terms of Scalability?

Yes. At least that is what the development team pledges. Today, the network can support only about 30 transactions per second. While this is a lot when compared to Bitcoin, it still cannot support global ambitions. Ethereum 2.0 will be capable of processing up to 100,000 transactions per second – at least that is the target. This astronomical leap will be achieved through the implementation of so-called sharding, which is the splitting of the whole network into smaller pieces that will be handled by different groups of validators. Thus, Ethereum 2.0 won’t resemble a single chain of consecutive blocks but rather a network of parallel chains.

Will Ethereum 2.0 be More Secure?

It’s hard to tell before the launch, but Ethereum 2.0 has been planned with security in mind. Usually, most PoS networks have a limited number of validators, which makes the network more centralized than PoW systems and consequently has more security issues. Ethereum 2.0 will require a minimum of 16,384 validators, which will make it more decentralized and secure.

The Ethereum Foundation is forming a security team that will look for potential cybersecurity problems in Ethereum 2.0.

Will I Be Able to Stake Ethereum?

Well… yes, at least in theory, because the entry barrier is really high. In order to become eligible to stake the upgraded Ethereum, users have to hold no less than 32 ETH, which is worth about $11,200 in current prices. However, you’ll most likely end up using the staking services provided by a pool or better Binance, which will definitely add ETH 2.0 sooner than later.

Besides holding the minimum amount of Ether, stakers will be required to run a validator node, which can be done on a regular PC or laptop. Also, they will have to be online on a regular basis or be ready to face penalties.

How is the Upgrade Going to Take Place and Where Are We Right Now?

Before the gradual roll-out of Ethereum 2.0, the blockchain is going through several testnet launches, including Topaz, Medalla, and Spadina. Next, the launch of the actual network will happen in three phases as follows:

  • Phase 0 – scheduled for the end of 2020, Phase 0 sees the implementation of the Beacon Chain, which deploys the PoS mechanism and stores and manages the registry of validators. For a while, the original PoW will run together with Beacon Chain to ensure a smooth transition.
  • Phase 1 – this phase is planned for next year and will see the integration of PoS shard chains. The network is expected to launch with 64 shards. However, initially, they won’t support smart contracts and accounts. There will be a Phase 1.5, when the Ethereum mainnet will become a shard and adopt PoS.
  • Phase 2 – expected to launch by the end of 2021 or the beginning of 2022, this phase will see shards becoming fully operational and supporting smart contracts. Also, Ether accounts will become supported as well, along with transfers, withdrawals, cross-shard transfers, and contract calls. The current EVM will be replaced with Ethereum WebAssembly (EWASM) virtual machine.

However, the evolution of Ethereum doesn’t stop at Phase 2. Vitalik Buterin said that further upgrades may follow to meet the demand of users for more scalable and efficient solutions. He presented a visual roadmap of what the next 5 to 10 years might look like for Ethereum 2.0 (the chronology is from left to right):

Ethereum 2.0 Proof of Stake PoS
Source: Twitter – Vitalik Buterin Ethereum 2.0 Roadmap

As of the end of September 2020, the latest testnet, called Spadina, has been launched with mixed success. The test network was launched on September 29 and was planned to last for 72 hours so that potential ETH stakers could test the deposit and launch tools before the Phase 0 genesis block. While no major issues have been detected so far, participation rates in the validation process were very low, a situation observed in the Medalla testnet launch as well. The first few rounds of validation experienced less than 34% of the stake joining the consensus process even though the target was 80%. Still, developers claim that this behavior is caused by the fact that the testnet Ether has no value, so stakers don’t care if they’re penalized for while they are offline. When the real Ethereum 2.0 goes live, the participation rates will be much higher.

Meanwhile, the Medalla testnet is still ongoing. So far, stakers say that the detected bugs and problems are minor and typical for any PoS testnet. As of September 28, almost 2 million test Ethers were staked to validate the Medalla network blocks. Active validators have increased above 63% to more than 62,000, which inspires optimism ahead of the launch. 

The Final Note

So far, the noise surrounding the transition to Ethereum 2.0 bodes well for the second-largest cryptocurrency, which has reacted positively and has increased year-to-date (YTD). The price of one Ether has tripled since January, but the bullish trend also has to do with the DeFi boom, since most DeFi projects are based on Ethereum blockchain.

Still, crypto investors are optimistic about the upgrade, despite the occasional bugs in the test networks. The fact that Ether will be available for staking is a huge selling point that can’t be ignored.

Ethereum has managed to outperform Bitcoin in 2020, despite the latter’s rally that got steeper in July. 

Ethereum 2.0 Price Outlook
Source: CoinMarketCap – Ethereum Charts

If you want to get exposure to Ethereum including during its transition to PoS, you can trade Ethereum futures on the Binance derivatives platform, either in pair with USDT or USD. On Binance Futures, you can trade on margin, opting for up to 125 leverage, but you should consider the risks.

Last week, Binance Futures announced that the platform had handled $1 trillion in year-to-date (YTD) volume. While Bitcoin-related contracts are the most traded ones, Ethereum futures, especially ETH/USDT, are also in the top.

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