The Transition of Ethereum to a PoS Blockchain
By Roy C. | 12-07-2022
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In conclusion
Ethereum is without a doubt, at the forefront of the crypto industry. That being said, it has its issues, and the team wasn’t always quick enough to solve them. Ethereum’s The Merge upgrade was delayed multiple times, and this has caused frustration among the community. In the next couple of years, Ethereum will undergo four additional major upgrades that will improve the chain even further. Ethereum is definitely here to stay, and once its flaws are fixed, it’s only a matter of time until it will reach mass adoption worldwide.
Ethereum was initially launched as a proof-of-work (PoW) blockchain, which used an inordinate amount of power resources. This led to a lot of criticism from environmentalists, politicians, and even people from within the crypto community. In addition to Ethereum’s carbon emissions, its PoW blockchain had several other problems such as high gas fees and the network’s inability to scale up.
As a response, Ethereum developers came up with Ethereum 2.0, which constituted a series of network upgrades that are supposed to solve most of these problems. The first part of this effort took place in September 2022 when Ethereum successfully switched its consensus mechanism to proof-of-stake (PoS), which saved up to 99.99% of the network’s energy usage. The transition to PoS changed a lot of Ethereum’s fundamentals. This post will examine Ethereum in its current iteration as a PoS blockchain.
Validators
In the wake of The Merge, many concerns have been raised about Ethereum’s decentralization. There weren’t that many validators and the majority of those nodes were being run by a small number of centralized entities and protocols. As of today, Lido Finance runs 26.6% of all validator nodes, Coinbase 12.3%, Kraken 7.46% and Binance 5.64%.
There’s a simple reason for those numbers. To run a validator node and earn rewards on your staked ETH at home, you would need to pledge at least 32 ETH which, as of today, is worth roughly $37,000. This large amount of money makes it unapproachable for the average investor to run a validator node on their own. Despite those somewhat disturbing numbers, Ethereum validator nodes have more than doubled in number since The Merge. This is a good and healthy sign that the network is going in the right direction.
Security
Ethereum has a substantial market cap and enough validators to make the network secure enough, and this makes attacks on the network extremely costly. For example, in order to perform a 51% attack on the Ethereum network, the malicious actors would have to acquire 51% of all staked ETH. That’s around 8 million ETH, which comes out to roughly $10 billion. Even if they do manage to pony up that much ETH, once they initiate the attack, the network will recognize it and will slash the attackers’ ETH, causing them immense financial loss.
MEV
MEV (Miner Extractable Value) is any value that is being made by block builders who exclude, reorder or include transactions on blocks they are building. Basically, it means sometimes block builders will use the knowledge they have on the transaction being submitted into the meme pool and manipulate the order of the transactions in the meme pool to their own profit and on the user’s expanse. MEV has become less common since the transition to PoS, but it still exists. In the past 3 years $680 million were extracted from users using MEV. According to the ETH 2.0 roadmap, a solution to the risks from MEV will be implemented in the scourge upgrade.
Locked Staking and Liquid Staking
Even though Ethereum has already switched to PoS, users cannot withdraw their rewards just yet. Any ETH being staked on Ethereum is locked on the Beacon chain until the Shanghai upgrade will take place in early 2023.
Once unstaking is enabled, all validators will be incentivised to withdraw any staking balance above 32 ETH, since it doesn’t accumulate rewards. To prevent validators from withdrawing all at once, the protocol will only allow six validators to withdraw every epoch (6.4 minutes), that’s about 43,200 ETH every day from more than 16 million ETH staked. This amount will probably not be significant enough to affect the price in the short term. Another important point is that the withdrawal rate is adjustable and depends on the total ETH staked.
A popular and innovative solution to the locked staking rewards is liquid staking. The idea is simple; you deposit your ETH into a staking pool via a smart contract and receive in return a derivative token that represents your staked ETH in the pool. Once staking rewards withdrawals are enabled, you could switch your staked ETH tokens back to your ETH tokens and earn your staking rewards. This enables users to earn rewards and help decentralize the network while still being able to participate in DeFi activities. While liquid staking has many benefits, it is important to remember that there are risks involved, such as the smart contract risk or the slashing risk.
Scalability and Gas Fees
The Merge was only the first Ethereum 2.0 upgrade among many. The company will make five additional upgrades to the network with the next phase scheduled for Q1 2023. This upgrade, named The Surge, is set to solve one of Ethereum’s biggest problems — scalability.
Ethereum is presently capable of handling 21.93 transactions per second (TPS). The Ethereum fee structure works in a way that if the demand for transactions is higher than network capacity, the network will only validate transactions that paid the highest gas fees. If a user paid the minimum gas for a transaction at a given moment, and at the same time the demand for transactions went up significantly, the transaction might expire before its turn to be validated will arrive — and the user will lose the gas fees they paid without the transaction ever being validated.
Another major problem with this fee structure is the extremely high gas fees. At the peak of the bull market, Ethereum gas fees were reaching up to 200 gwei. Even today, when network volume has fallen by roughly 85% from its peak and the price of Ethereum by almost 80%, the gas fee for Uniswap swap is still around $4.
Sharding
The Surge upgrade will introduce sharding, a type of database architecture that splits a large database into smaller chunks called shards. Each shard is then run on a separate database server. When it comes to Ethereum, the network will be split into 64 “mini-blockchains” that will operate independently. Each shard will have its own transaction record and validators, meaning those shard chains can run simultaneously. Each shard chain will regularly submit its transaction record back to the beacon chain, which is the main chain that keeps this whole operation together.
Sharding will allow the chain to scale to up to 100,000 TPS while maintaining security, and decentralization. It will also make it easier to run a validator node since node operators won’t need to store the entire blockchain.
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