One of the main problems with cryptocurrencies is the scalability issue, partially due to the proof of work algorithm (partially due to the increasing size of the block). Proof of work has other disadvantages too, like the energy required, time to verify transactions, etc. Another important drawback is the fact that once the network reaches a certain size the computational complexity becomes too big for small individuals to take part in mining (as the cost of expensive hardware becomes prohibitory). Also, some analysts have noted that since the rewards are given away as tokens and miners need to cover their cost of operation, most miners just sell their rewards for cash as soon as they receive it. This is similar to capital flight from a country. Another alternative to proof of work is proof of staking. Even though it doesn’t solve all the problems of the original proof of concept, it still offers a significant improvement. With this in mind, Vitalik Buterin has released Ethereum 2.0 with proof of staking at its center.
Ethereum 2.0 at DevCon5: Price Implications
The new-and-improved Ethereum 2.0 has been announced. Just a couple of weeks ago, the largest Ethereum development event, DevCon 5, was held in Osaka and more details about the upcoming protocol upgrades were announced. The changes are significant and will improve important properties like transaction speed, scalability, and finality. The development on the project has been going on for some time, but there was no confirmation about the features (except that it will incorporate proof of stake). One of the most important features of Ethereum 2.0 is the ability to earn passive income by staking.
Proof of stakes
The main attraction of Ethereum 2.0 is nothing but proof of stake. Proof-of-Stake (PoS) blockchains essentially allows network participants to passively earn a form of “interest” by depositing their tokens to both maintain the network and potentially earn rewards. As opposed to Proof-of-Work (PoW) blockchains like Bitcoin, nodes in a PoS network are engaged in validating blocks rather than mining them. A deterministic algorithm selects block validators based on the number of tokens a given node has staked in their wallet — i.e. deposited as collateral in order to complete the addition of the next block to the chain.
Returns on staking
As reported a few days back, a senior ConsenSys executive has revealed that Ethereum 2.0 validators can expect to earn from 4.6% to 10.3% as rewards for staking on an annual basis. To become a validator, participants are required to hold a minimum of 32 Ether (ETH) — worth $5,952 by press time. The transition to Ethereum 2.0 is currently slated for January 2020. This will bring into crypto people other than speculators and tech-savvy people, which in turn will, in the long run, reduce volatility. Another opportunity here is for institutional investors as they can earn good returns over the traditional form of investments. There is a high probability we will see a 2017 style rise in prices for Ethereum after the launch.
Other technical changes
Once fully deployed, Ethereum 2.0 will have 64 shards (sets of partitions) that will function simultaneously and have independent transaction histories and states. New execution environments can be created as a separate segregation mechanism on top of it, providing enhanced utility and features through WebAssembly (WASM). Moreover, with the introduction of proof of stake as a consensus protocol in the new Ethereum 2.0, the transactions will be considered final and will not be subject to the same 51% attack reversal tactic as in the proof of work. Another major difference due to staking is that only people who stake Ethereum will be allowed to verify transactions. Also, the cost of hardware for running Ethereum 2.0 validator software might increase as a result of a new design proposal by Vitalik Buterin. Other parts remain same like keeping inflation rates below 1% and a dynamically adjusting rewards scale for validators. These measures ensure a less volatile market, thereby increasing the viability of Ethereum as a long term investment avenue.
However, despite the obvious positives and the financial and technological opportunities that will become available, the new protocol maintains several key risk areas that must be addressed soon.
- The necessary work is extremely technical and not many people are qualified to turn a complex research paper into a practical solution.
- Currently, all the work is being done by several teams located in different parts of the world, with different agendas and different timelines.
- Everyone is working towards the same goal but the inherited friction of having distributed teams is present.
- The transition to Ethereum 2.0 is so complex that it involves wrapping up the current network and placing it inside the new chain so that they will run together for a period of time.
- There is a significant chance that certain existing functionality and smart contracts will break.
- There is the potential for a hard-fork split, as Ethereum 1.0 and Ethereum 2.0 will co-exist and the transition might not be successful, with some node operators choosing to run the old chain.
Many hail Ethereum 2.0 as a great step to a matured crypto market, in a sense it will accomplish that. Long term investors will stabilize volatility, which will indeed bring in more capital which will ultimately lead to Ethereum gaining a substantial valuation. With a new inflow of capital, Ethereum projects will get good funding. However, this does not take into account what a small investor is going to face, like the barrier of entry for staking. Overall, we can expect a huge increase in Ethereum’s price after the launch of Ethereum 2.0.