So what is the long-awaited Ethereum 2.0 all about? What is Proof of Stake, the Beacon Chain, Sharding and Docking? And what are the different phases of their rollouts? You’ll find answers to these questions in this article. 

Overview

Let’s start with an overview of what Ethereum 2.0 is and why it’s even needed in the first place. 

Ethereum 2.0 a.k.a Eth2 is a set of interconnected upgrades to the Ethereum network that aims at making Ethereum more scalable, more secure and more sustainable. These changes are worked on by multiple different teams in the Ethereum ecosystem, each team focusing on building a specific part of the whole upgrade. 

Now, let’s quickly go through all of the main goals of Eth2. 

Scalability 

The current Ethereum network supports around 15 transactions per second. This becomes a limiting factor when it comes to onboarding millions of new users and launching many more decentralized applications. To make Ethereum more scalable Eth2 aims at supporting 1000s of transactions per second. One important caveat – the increase in transactions per second should not come at a cost of increasing the size of the nodes in the network. 

Security

Security of a decentralized network is always one of the top priorities. Eth2 aims at increasing the security of the network against all forms of attack including a “51% attack” where someone can force through fraudulent changes by controlling the majority of the network. 

Sustainability

The well-known proof-of-work based consensus model, used by the current Ethereum network, requires a lot of computing power and energy. Eth2 aims at making Ethereum better for the environment by replacing energy-intensive Proof of Work with Proof of Stake.

Initially, the set of changes needed to achieve these goals was called “Serenity”, but now most people refer to it as Ethereum 2.0 or just Eth2.  

What is interesting, is that all of these goals were pretty much always in the Ethereum roadmap, and they had been discussed even before the network officially launched. 

Let’s start with one of the biggest changes – the consensus model shift from Proof of Work to Proof of Stake.

Proof Of Stake

The current Ethereum consensus model – Proof of Work – is a well known and battle-tested approach to building cryptocurrencies. 

In Proof Of Work, miners invest their resources – mainly electricity – to validate transactions and secure the network. This model requires massive amounts of energy to work properly and protect the network from “51% attacks”.

Proof of Stake tries to address the power consumption concerns by getting rid of the miners completely. Instead of machines securing the network by investing their resources, the Proof of Stake consensus model relies on economic incentives. 

In Proof of Stake, users who want to secure the network, stake their ETH and become validators. Each validator is incentivised to validate transactions by receiving, similarly to miners in proof-of-work, both the block reward and the transaction fees. 

To discourage validators from trying to game the system and validate fraudulent transactions, the Proof of Stake system implements a mechanism called “slashing” where validators lose part of their staked ETH if they decide to act dishonestly.

In order to pull off a successful “51% attack” in a Proof of Stake system, the attacker would have to control 51% of the validators which would require owning 51% of all staked ETH – a massive amount of capital. 

In order to become one of the Eth2 Validators, 32 ETH is required. It is also possible to stake with less than 32 ETH by using staking pools, for example, Rocketpool. 

The returns for validators depend on the amount of staked ETH in the system. They can be as high as over 18% annually if there is less than 1M ETH staked and as low as 1.81%, or even lower, if there is more than 100M ETH in the system. 

Proof of Stake addresses all 3 of the Eth2 goals. It makes Ethereum more sustainable by removing energy-intensive miners. It makes it more secure by making a “51% attack” harder. And it makes it more scalable by unlocking sharding that would be much harder to achieve in a Proof of Work model as it would most likely result in diluting the amount of computing power across multiple shards. 

This is actually a good segway into sharding. 

Sharding

The concept of sharding is not specific to the Eth2 upgrade. It’s actually a common process in computer science that allows for splitting a database into multiple instances each containing a portion of the whole data set. Each instance would be known as a “shard”. 

When it comes to Eth2, each “shard” is basically a separate new chain. Initially, there will be 64 of them. This directly addresses Ethereum’s scalability concerns as shards will allow for spreading the network’s load. 

On top of that, each Ethereum node will only have to run one of the shards. This means storing only a small subset of data and making it easier to run a node without having powerful hardware. Making nodes easier to run should result in more network participants which equals more decentralization and more security. 

Initially, sharding will just provide extra data. Sharded chains won’t be able to handle transactions or smart contracts. 

At this point, you’re probably asking the question. So how can sharding improve scalability without handling transactions or smart contracts? 

Improving scalability will be possible because of layer 2 scaling – in particular rollups. Rollups allow for bundling transactions (and smart contract executions) off-chain, generating a cryptographic proof and submitting it to the chain. This process only requires a data shard to be available to store the proof which means it can be used with the initial version of sharding. 

You can learn more about Layer 2 scaling and rollups here.

This is not the end. Although the mix of data sharding and rollups should result in Ethereum being able to process over 100,000 transactions per second, there is also another improvement that can be made. There is a possibility to upgrade shards and make them fully executable in the same way as the current Ethereum chain. It remains to be seen if this improvement will be needed or not depending on how popular the data sharding and rollups solution becomes.   

It is also important to mention that in the data sharding model, the current Ethereum chain becomes one of the shards. And this is the only shard that is able to handle transactions and smart contracts. 

The Beacon Chain

The Beacon Chain is the next important concept to grasp to fully understand the Eth2 upgrade. 

The Beacon Chain is responsible for coordinating a Proof of Stake based system by randomly assigning stakers to validate different shards. Randomness is important as it prevents stakers from colluding and taking over a shard. 

The Beacon Chain basically creates a new Proof of Stake network that runs in parallel to the current Ethereum chain. Launching it is one of the first things in the Eth2 roadmap.

Initially, validators will be adding new blocks to the Beacon Chain but they won’t be validating the current Ethereum mainnet transactions. This will be possible, once the current chain becomes one of the Eth2 shards.

Docking

This brings us to the last piece of the whole Eth2 puzzle – Docking. 

Docking is a process in which the current Ethereum chain becomes one of the shards in the Eth2 Proof of Stake system. 

This process will also mark the end of Proof of Work Ethereum that we know today and the full transition to the new Proof of Stake model.

Docking will bring the ability to run smart contracts into the Proof Of Stake system. On top of that, it will provide the full history and the current state of Ethereum, allowing a smooth transition for all the ETH holders and users.  

Phases 

Let’s see how all the concepts that we just discussed fit into the Eth2 timeline. The whole development process is split into multiple phases. 

Phase 0 is the first phase of shipping Eth2 that focuses on launching the Beacon Chain. To achieve this, a threshold of 16,384 validators has to be reached. The required amount of validators was reached on the 24th of November which allows Phase 0 to be launched on the earliest possible date – 1st of December 2020. 

The next phase, Phase 1 focuses on sharding or to be specific – data sharding that we described earlier. 

Once Phase 1 is established, next up is Phase 1.5 that focuses on Docking – making the current Ethereum chain one of the shards in Eth2. It looks like both – Phase 1 and Phase 1.5 will be delivered as early as 2021.

After Phase 1.5 is reached, there are 2 possible scenarios. Either the combination of data sharding and rollups will be enough and there is no need for further phases. Or maybe there will still be a need for the full sharding solution which would bring us to the final phase, Phase 2. This will remain to be seen after Phase 1.5 is successfully completed. 

Summary 

It’s also worth mentioning that even though the initial Phase 0 doesn’t change much when it comes to the current Ethereum chain. It may still have some potentially significant economic implications. This is because the ETH that is being sent to Eth2 validators becomes locked and cannot be withdrawn until Phase 1.5 is complete, which means less circulating ETH in the current system. 

When it comes to DeFi, it looks like most activities will be concentrated on either the executable shard or one of the layer 2 rollup solutions – at least initially. This is because DeFi takes huge advantage of smart contract composability and more complex transactions, so having different DeFi protocols that cannot communicate with each other easily doesn’t make much sense. 

So what do you think about Eth2? Do you think it will eventually make other smart contract blockchains a.k.a. the “Ethereum killers” irrelevant? 

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what is EIP-1559 a.k.a the fee burn proposal all about? Will it lower Ethereum’s gas fees? And how can it make ETH deflationary? We’ll answer all of these questions in this article. 

EIPs 

Let’s start with what EIPs actually are. 

EIP stands for Ethereum Improvement Proposal and it is a common way of requesting changes to the Ethereum Network inspired by Bitcoin Improvement Proposals (BIPs). An EIP is a design document covering technical specifications of the proposed change and rationale behind it. 

The majority of EIPs focus on improving technical details of Ethereum and they are not widely discussed outside of the core Ethereum developers community. 

EIP-1559 is one of the exceptions. This is because the proposal has some big implications when it comes to the ETH monetary policy and client applications such as wallets. 

Ethereum Fee Model

EIP 1559 describes changes to the Ethereum fee model and it was put forward by Vitalik Buterin in 2019. 

To understand why we need this proposal in the first place, let’s quickly review how the current Ethereum fee model works. 

The current fee model is based on a simple auction mechanism also known as a first price auction. The users who want to have their transaction picked up by a miner have to essentially bid for their space in a block. 

This is done by submitting a gas price that they are willing to pay for a particular transaction.  

The miners are incentivised to pick up transactions by sorting them by the highest gas price and including the most profitable ones first. 

This can be quite inefficient and usually results in users overpaying for their transactions. 

The model is also quite problematic when it comes to the wallets. Metamask, for example, allows the users to adjust their fee by choosing between slow, average and fast confirmation time or by specifying a gas price manually. 

Less sophisticated users who are unlucky enough to submit their transaction with a default fee just before a spike in gas fees may end up waiting for their transaction to be confirmed for a long period of time. This is of course not ideal from the user experience point of view.  

This is also where EIP 1559 comes into play. The proposal was made to accommodate these problems and it aims to achieve the following goals. 

1. Making transaction fees more predictable 
2. Reducing delays in transaction confirmation
3. Improving user experience by automating the fee bidding system 
4. Creating a positive feedback loop between network activity and the ETH supply 

Now, let’s see what the proposed change is all about. 

EIP 1559

EIP 1559 introduces a new concept of a base fee (BASEFEE). 

The base fee represents the minimum fee that has to be paid by a transaction to be included in a block. The base fee is set per block and it can be adjusted up or down depending on how congested the Ethereum network is. 

The next big part of EIP 1559 is an increase in the network capacity, achieved by changing the max gas limit per block from 12.5M to 25M gas, basically doubling the block size.

With the base fee and increased network capacity, EIP 1559 can build the following logic: 

• When the network is at > 50% utilization, the base fee is incremented 
• When the network is at < 50% utilization, the base fee is decremented 

This basically means that the network aims at achieving equilibrium at 50% capacity by adjusting fees accordingly to the network utilization.

EIP 1559 also introduces a miner tip – a separate fee that can be paid directly to the miner to incentive them to prioritise a transaction. 

This is very similar to the current mechanism where the miners can be incentivised by higher gas fees. This feature is really important for transactions that take advantage of quick confirmation such as arbitrage transactions.

Now, let’s go through a quick example to see how the EIP 1559 fee model compares to the existing model during a period of high network activity. 

Let’s start with the current fee model.

Imagine the min gas fee to be included in a previous block was 50 gwei. The network activity seems to remain the same so users start submitting their transactions with 50 gwei trying to be included in the next block. At the same time, a new highly anticipated token is launched causing users who want to buy it to dramatically increase their bids. Now, to be included in the next block the min required fee is 100 gwei. If the network activity remains high for multiple subsequent blocks, the users who already submitted their transactions with 50 gwei may wait for their confirmations for a long period of time. 

In this case, the block size is capped at 12.5M gas and the only way to get into a block is to bid higher than the other users. 

Let’s go through the same scenario, this time with EIP 1559 in place. 

In the previous block, the 50 gwei was the base fee and the network utilization was at 50% with most blocks using 12.5M gas – half of the max gas limit. 

The spike caused by the release of the new token results in users submitting their transactions with a higher miner tip. 

Seeing the high demand for the block space and a lot of transactions with high miner tips, the miners produce a block that is at the max cap limit of 25M gas. This results in more transactions being included in a block, but it also causes the base fee to be increased in the following block as the current block is 100% full (>50% network utilization). 

If the network activity and demand for block space remain high, the miners would keep producing full blocks,  increasing the base fee with each subsequent block. At some point, the fee would become high enough to drive off some of the users, causing the network to start coming back to below 50% network utilization and lowering the fees in the subsequent blocks.

The base fee can increase or decrease by a maximum of 12.5% per block, so it would take roughly 20 blocks (5 minutes) for gas prices to 10x and 40 blocks to 100x. In our example, the second block would have a base fee of 56.25 gwei. 

This example demonstrates how spikes in network fees can be smoothed out when EIP 1559 is implemented. Another way of thinking about this model is to imagine that it basically swaps high volatility in the fee prices for volatility in the block size. 

Because the increments and decrements are constrained, the difference in the base fee from block to block can be easily calculated. 

This allows wallets to automatically set the base fee based on the information from the previous blocks. 

To avoid a situation where miners can collude and artificially inflate the base fee for their own benefit, the entire base fee is burnt. 

Let’s repeat this –  the base fee is always entirely burnt, the “miner tip” is always entirely received by the miner. 

There is also one more important new concept, known as a FEECAP. This can be set by users who would like to limit how much they want to pay for a particular transaction, instead of just paying the current base fee. A transaction with a FEECAP that is lower than the current basefee would have to wait until the base fee is lower than the max fee set in FEECAP to be included in a block.

The fee changes are also backward compatible. The legacy Ethereum transaction would still work under the new fee system although they would not benefit directly from the new pricing model. 

Implications

Changes proposed in EIP 1559 have a lot of implications, some of them quite severe. 

Less profit for the miners. The miners in the current fee system receive both the block subsidy reward and the entire gas fee. With the recent high gas prices caused by DeFi,  miners were able to collect more money from the fees than the actual block rewards even though historically block rewards were always much bigger than the extra fees collected from transactions.

After the changes in EIP 1559 are implemented, the miners would only receive the block reward + the miner tip. This is also why most miners are quite reluctant when it comes to implementing the proposal, suggesting to push the change to ETH 2.0. 

Another major implication is the change required by the wallets. With EIP 1559 in place, wallets don’t have to estimate the gas fees anymore. They can just set the base fee automatically based on the information available in the previous block. This should simplify wallets’ user interfaces. 

The base fee burning also has major implications when it comes to the ETH supply. This is also why EIP 1559 is very often discussed by ETH investors. 

Burning the base fee creates an interesting feedback loop between the network usage and the ETH supply. More network activity = more ETH burnt = less ETH available to be sold on the market by miners, making the already existing ETH more valuable. 

Burning the base fee basically rewards the users of the network by making their ETH more scarce instead of overpaying miners. 

The fee burning mechanism also sparked a few discussions about ETH becoming deflationary. This would be possible if the block reward is lower than the base fee burnt. That would be the case, for example, during the recent DeFi gas fee craze where the network was constantly under heavy utilization. 

One potential drawback when it comes to burning the base fee is the fact of losing control over the long term monetary policy of ETH. With this change, ETH would end up being sometimes inflationary and sometimes deflationary. This doesn’t look like a major problem as the max inflation would be capped at around 0.5-2% per year anyway.  

So will EIP 1559 make gas fees much lower? 

Not really, it will clearly optimise the fee model by smoothing fee spikes and limiting the number of overpaid transactions, but the main ways of lowering gas fees are still ETH 2.0 and Layer 2 scaling solutions. 

When EIP 1559?

It looks like EIP 1559 would be a great change to the Ethereum fee system. This also seems to be the consensus within the Ethereum community with the majority of people rooting for the change to be implemented.  

There are still a few challenges to overcome, especially when it comes to making sure that miners can safely process bigger blocks without making the whole network more prone to Denial of Service attacks. 

EIP 1559 belongs to the Core category of EIPs which means that the change affects the Ethereum consensus and requires all the clients to upgrade at the same time (hard fork). 

From the timeline perspective, it looks like EIP 1559 could be implemented in the next hard fork after the Berlin hard fork which is somewhere in 2021. 

The team leading the charge received funding from the Ethereum Foundation and from the EIP 1559 Gitcoin grant. Most of the coordination work is done by Tim Beiko. 

Depending on the timeline, EIP 1559 can be either implemented in both Ethereum 1.0 and 2.0 or potentially only in Ethereum 2.0 if there are some delays in place. 

So what do you think about EIP-1559? Will it have any impact on the ETH price?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.

So what is Ethereum Layer 2 scaling all about? And what is the difference between projects such as Optimism, xDai, OMG and Loopring? We’ll answer all of these questions in this article. 

Need For Scaling

Ethereum scaling has been one of the most discussed topics pretty much since the time when the network launched. The scaling debate always heats up after a period of major network congestion. 

One of the first periods like this was the 2017 crypto bull market where infamous CryptoKitties, together with ICOs, were able to clog up the entire Ethereum network causing a major spike in the gas fees. 

This year the network congestion came back even stronger, this time caused by the popularity of DeFi and yield farming. There were periods of time when even gas fees as high as 500+ gwei would not get your transaction verified for a while. 

When it comes to scaling Ethereum or blockchains in general, there are 2 major ways of doing it: scaling the base layer itself (Layer 1) or scaling the network by offloading some of the work to another layer – Layer 2. 

Layers 1 vs Layer 2 Scaling 

Layer 1 is our standard base consensus layer where pretty much all transactions are currently settled. The concept of layers is not an Ethereum-specific concept. Other blockchains such as Bitcon or Zcash also use it extensively.   

Layer 2 is another layer built on top of Layer 1. There are a few important points here. Layer 2 doesn’t require any changes in Layer 1, it can be just built on top of Layer 1 using its existing elements such as smart contracts. Layer 2 also leverages the security of Layer 1 by anchoring its state into Layer 1.

Ethereum can currently process around 15 transactions per second on its base layer (Layer 1). Layer 2 scaling can dramatically increase the number of transactions. Depending on the solution, we’re talking about processing between 2000-4000 tx/second. 

How about Ethereum 2.0? Wasn’t that supposed to scale Ethereum? 

Yes. Ethereum 2.0 introduces Proof of Stake and sharding that will dramatically increase the transaction throughput on the base layer. 

Does it mean we don’t need Layer 2 scaling when Ethereum 2.0 ships? 

Not really, even with sharding Ethereum will still need Layer 2 scaling to be able to handle hundreds of thousands or even millions of tx per second in the future. 

This is also where the famous Scalability Trilemma comes into play. In theory, we could just skip Layer 2 entirely and focus on scaling the base layer instead. This would require highly specialized nodes to handle the increased workload which would lead to higher centralization and, therefore, lowering security and censorship-resistant properties of the network. 

Sticking to the fact that scalability should never come at the expense of security and decentralization, we are left with a combination of Layer 1 and Layer 2 scaling going forward into the future. 

Layer 2 Scaling Solutions

Layer 2 scaling is a collective term for solutions that help with increasing the capabilities of Layer 1 by handling transactions off-chain (off Layer 1). The 2 main capabilities that can be improved are transaction speed and transaction throughput. On top of that, Layer 2 solutions can greatly reduce the gas fees. 

When it comes to actual scaling solutions there are multiple options available. Whilst some of the options are available right now and can increase Ethereum network throughput in the near to medium-term, others are aiming for a medium to long-term time horizon.  

Some of the scaling solutions are application-specific, for example, payment channels. Others, such as optimistic rollups, can be used for any arbitrary contract executions.

To understand these differences better let’s explore the most popular Layer 2 scaling solutions.

Channels

Channels are one of the first widely discussed scaling solutions. They allow participants to exchange their transactions off-chain a number of times while only submitting two transactions to the base layer.  

The most popular types of channels are state channels and their subtype – payment channels.

Although channels have the potential to easily process thousands of transactions per second, they come with a few downsides. They don’t offer open participation – participants have to be known upfront and users have to lock up their funds in a multisig contract. On top of that, this scaling solution is application-specific and cannot be used to scale general-purpose smart contracts. 

The main project that leverages the power of state channels on Ethereum is Raiden. The concept of payment channels is also extensively used by Bitcoin’s Lightning Network. 

Plasma

Plasma is a Layer 2 scaling solution that was originally proposed by Joseph Poon and Vitalik Buterin. It’s a framework for building scalable applications on Ethereum.

Plasma leverages the use of smart contracts and Merkle trees to enable the creation of an unlimited number of child chains – copies of the parent Ethereum blockchain. 

Offloading transactions from the main chain into child chains allows for fast and cheap transactions. One of the drawbacks of Plasma is a long waiting period for users who want to withdraw their funds from Layer 2. Plasma, similarly to channels, cannot be used to scale general-purpose smart contracts.

The OMG Network is built on their own implementation of Plasma, called MoreViable Plasma. Matic Network is another example of a platform using an adapted version of the Plasma framework. 

Sidechains 

Sidechains are Ethereum-compatible, independent blockchains with their own consensus models and block parameters.

Interoperability with Ethereum is made possible by using the same Ethereum Virtual Machine, so contracts deployed to the Ethereum base layer can be directly deployed to the sidechain. xDai is an example of such a sidechain. 

Rollups 

Rollups provide scaling by bundling or “rolling up” sidechain transactions into a single transaction and generating a cryptographic proof, also known as a SNARK (succinct non-interactive argument of knowledge). Only this proof is submitted to the base layer. 

With rollups, all transaction state and execution are handled in sidechains. The main Ethereum chain only stores transaction data. 

There are 2 types of rollups: Zk rollups and optimistic rollups. 

Zk rollups, although faster and more efficient than optimistic rollups, do not provide an easy way for the existing smart contracts to migrate to Layer 2. 

Optimistic rollups run an EVM compatible Virtual Machine called OVM (Optimistic Virtual Machine) which allows for executing the same smart contracts as can be executed on Ethereum. This is really important as it makes it easier for the existing smart contracts to maintain their composability, which is extremely relevant in DeFi where all major smart contracts were already battle-tested.  

One of the main projects working on optimistic rollups is Optimism, which is getting closer and closer to their mainnet launch. 

When it comes to Zk rollups, Loopring and Deversifi are good examples of decentralized exchanges built on Layer 2. On top of that we have ZkSync enabling scalable crypto payments.

Rollups’s scalability can also be magnified by Ethereum 2.0. In fact, because rollups only need the data layer to be scaled, they can get a tremendous boost already in Ethereum 2.0 Phase 1 which is about the sharding of data.

Summary

Despite a spectrum of Layer 2 scaling solutions available, it looks like the Ethereum community is converging on the approach of mainly scaling through rollups and Ethereum 2.0 Phase 1 data sharding. 

This approach was also confirmed in a recent post by Vitalik Buterin called “A rollup centric Ethereum roadmap” that I will link in the description box below. 

In our future articles, we’ll explore the base layer scaling with Ethereum 2.0 and how both layer 1 and layer 2 scaling can help with making decentralized finance more accessible to everyone. Stay tuned by subscribing to the channel. 

So what do you think about Ethereum’s approach to scaling? And which scaling solution would you like to learn more about?

If you enjoyed reading this article you can also check out Finematics on Youtube and Twitter.