October 05, 2022
Even if you are a stranger to cryptocurrency, you’ve probably heard of Ethereum before. The world’s second biggest cryptocurrency (second to only Bitcoin) has become the largest network for decentralized applications, disintermediated transactions, and decentralized finance (DeFi). And, in the next 12 months, it will be seeing more updates and changes than it ever has before.
The fun will kick off this summer when Ethereum developers roll out the London hard fork in July, which will bring EIP 1559 to the main chain. In 2022, they’ll follow on the heels of that update with an even bigger one: Ethereum 2.0 (Eth2 for short). However, to most casual crypto fans and investors, that must just sound like a bunch of numbers and weird words. What you need to know is that EIP 1559 and Eth2 are monumental for Ethereum.
In order to understand why, let’s explain how cryptocurrency works and how Ethereum fits in that puzzle:
How does Ethereum work?
In the beginning, there was Bitcoin. The world’s first and largest cryptocurrency made its first presence on the internet in January 2009, created by an unknown and shadowy figure who goes by Satoshi Nakamoto. Many years would pass before it entered the mainstream, but a niche microcosm of highly-online, finance-interested hackers and nerds began to adopt the cryptocurrency. These adopters began to make up the crypto community, which transacted in Bitcoin.
It might be hard to believe, but up until this point, there was no decentralized solution for exchanging value (at least in a way that didn’t cause double-sending or duplication of funds, which would be a massive problem). When Satoshi Nakamoto disappeared from the community, many of these people continued to develop Bitcoin and its software. Over time, copycats of Bitcoin looked to improve upon its core software and make their own changes. This is when other “legacy” coins such as Litecoin and Dogecoin came to fruition.
Of course, these first-generation blockchains were all very straightforward. They were essentially decentralized networks for exchanging value (a certain coin), which were kept alive by two things. These two things were nodes (people hosting servers, which kept and updated the ledger of transactions on the blockchain) and miners (people running computer equipment in order to authenticate transactions).
This model of mostly plagiarising Bitcoin and making improvements on it by launching a new network was a persistent one until 2015. In 2015, Ethereum launched. Ethereum was like Bitcoin and its contemporaries in a few ways, but it kicked off the second-generation of blockchain. In the first-generation, blockchains were exclusively used for the exchange of value through coins.
Ethereum made the concept of decentralized applications, a decentralized internet, transactions, tokens, and many more ideas a reality, which were naive to the world of blockchain. Since then, Ethereum has grown to become the second-biggest cryptocurrency in the world. And, like with Bitcoin, many cryptocurrencies have attempted to follow in its tracks by improving upon its most successful and innovative ideas.
But now, Ethereum has grown so quickly and broadly that the old-fashioned model of “mining” cryptocurrency to verify transactions and introduce new coins into circulation is no longer sufficient. This model is called proof-of-work (PoW) and over the last few years, new cryptocurrencies have used alternatives to PoW in order to achieve greater efficiency and sustainability. The reason why is simple: PoW often means higher fees for blockchain users (compared to alternatives) and longer wait times for transactions to confirm (because of congestion).
So, how are they fixing this? With software updates to Ethereum’s blockchain. The first update will be EIP 1559, which will be part of the London hard fork in July 2021. Then, the many updates and revisions made by Eth2 will bring Ethereum up to speed.
What does the London hard fork do for Ethereum?
As mentioned, many cryptocurrencies attempted to plagiarize Bitcoin when it was first launched. Now, many cryptocurrencies model themselves after Ethereum. And, it is important to underscore that there are a number of new, second-generation blockchains that take after Ethereum. Among them are Binance Smart Chain (BSC), Cardano, Solana, and Polkadot. They might not be as hot and active as Ethereum yet, but each of them are using a model that is more efficient and scalable than Ethereum. In the long-run, that means that they could present an existential threat to Ethereum if it doesn’t attack its scalability & sustainable problems soon.
The London hard fork is an upcoming update that looks to address one part of the problem on Ethereum. It has colloquially come to be called “Eth1.5” by some users in the community because of its importance. The London hard fork will make two changes. The first is called EIP-1559, which will change the auction system for mining transactions. The second is called EIP-3238, which is a “difficulty time bomb” that will make mining difficult in order to help facilitate quicker adoption of Eth2 once it launches for all users.
Under the current system, people who want to get their transaction approved quicker can pay more to do that. In Ethereum, this is called the gas fee. If you pay a higher gas fee, your transaction will be prioritized to the miners. If you pay a lower fee, you might have to wait awhile. During times of high congestion, this auction model can result in transactions getting quite expensive.
EIP-1559 will look to kill this system, replacing it with a base fee for each block. Historically, the gas fee would be paid forward to miners (along with block rewards). Going forward, this fee will be burned in order to reduce the supply of Ethereum. In essence, this means that Ethereum could become a deflationary currency. Some proponents of EIP 1559 have said that making Ethereum deflationary could be extremely bullish for the price. In the new system, you can add a tip for miners to prioritize your transaction like in the former model, but it probably won’t be necessary.
EIP-1559 means that miners will be making less money already, but that’s by design. EIP-3238 and EIP-1559 exist to make mining difficult (code for: mostly unprofitable). In the minds of the Ethereum developers, making mining difficult will encourage people to move over to Eth2 and participate in a more efficient model, rather than use legacy mining. Ethereum developers hope that this will start to do away with the excessive gas fees that we have seen, which should make transactions cheaper.
That’s where we pivot our conversation to Eth2.
What does Eth2 do?
So, Ethereum’s developers are making it harder to mine the cryptocurrency. Why? Because just a few months after the London hard fork, Ethereum will undergo a series of updates that will look to decouple it from the old-fashioned proof-of-work (PoW) model. Going forward, Ethereum will move to a more efficient model called proof-of-stake (PoS).
Proof-of-stake is a model that replaces miners with HODLers. That’s to say: those who have ETH and volunteer it to the network to verify transactions. PoS is a model which has been around for awhile. In fact, it’s a model which has become a popular choice for new, second-generation cryptocurrencies, such as Cardano and Polkadot. Volunteering for ETH is a little more complicated than holding it in a wallet, though. Those who volunteer their crypto up to the market will have to stake it, but those who do will be rewarded for doing so.
Staking is a significant improvement over mining (proof-of-work) for a number of reasons. As Ethereum.org observes, it doesn’t consume as much energy, reduces the barriers to entry, makes the blockchain more secure, and helps scale the network. And, though the rewards for staking might not be astronomical, they are still attractive for Ethereum maximalists.
How will Eth2 roll out?
So, how will this work? In phases. Rome wasn’t built in a day and nor will Eth2 be (it has taken forever to build). The first phase of Ethereum 2.0’s launch, Phase 0, launched the Beacon Chain. The Beacon Chain went live in December 2020 and launched staking. This phase is liken to putting down the foundation of a house. Since the launch of the Beacon Chain, Ethereum HODLers have been enticed (with rewards) to move crypto over to Eth2 to help accelerate the rollout of the new and improved chain. The only downside? Once money goes over the bridge from Eth1 to Eth2, it can’t come back until Eth2 is fully live. Stakers will have to wait until 2022 to start moving their money again.
While that money is staking and paying out rewards to ETH maximalists, developers will be plotting the next stage of Eth2’s rollout, Phase 1. Phase 1 will create the shard chains. Shard chains are individual blockchains that can store information (and eventually store/execute smart contracts and accounts), which is why it’s best to think of them as hard drives for the core Ethereum blockchain. It’s also super useful, for a number of reasons. By going from one to many chains, Ethereum will have much greater capacity for storing and accessing data.
Then, the current Ethereum mainnet will be plugged into all the action in Phase 1.5 by becoming a shard in the new Ethereum chain. Once everything is up and running, Eth2 will have hit Phase 2 and fully rolled out. Of course, this sounds really cool and exciting. But, it’s a long way off. It might be as late as the fourth quarter of 2022 before we reach the latter phases of this update. Regardless, the wait is worth it. Eth2 is a significant undertaking that will monumentally upgrade the world’s largest decentralized network.
What does this mean for Ethereum?
Considering the significant updates coming to Ethereum, it’s fair to say that investors have a reason to be bullish. Ethereum will be significantly faster, cheaper to operate on, and more secure because of all these forthcoming updates. But, when you add in the rumors that Ethereum will go deflationary and the fact that you can get staking updates for locking up your coin? Some investors have gone feral for Ethereum, abandoning other cryptos (including Bitcoin) for the appeal of the world’s second-biggest crypto.
As of June 11, 2021, Ethereum is worth $2,286. It’s down over 43.6% from it’s all-time high. But that hasn’t disturbed some investors who believe in ETH and want to be paid for their patience. There’s over 5.3 million ETH in the Beacon Chain. And with retail now having access to buy and stake on mainstream platforms such as Coinbase or Kraken? Confidence in Ethereum and its future looks strong.