Introduction

The launchpad for Ethereum 2.0 went live during election day. This marks the beginning of the official launch of Ethereum 2.0. After years of development and various testnets over the last 12 months it is the biggest development milestone for Ethereum ever. Ethereum 2.0 is set to go live on the 1st of December 2020 if 524,288 ETH is deposited into the contract on the 24th of November 2020. This upgrade will prepare Ethereum to become the widely used open financial infrastructure while also making the native asset, Ether, a yield bearing bond like asset.

Ethereum 2.0

Before looking forward, it is in order to provide a brief overview of what Ethereum 2.0 entails. Ever since the launch of Ethereum in 2015, a switch to proof-of-stake has been on the roadmap. It is an astounding open-source software effort by over 100 researchers and developers worldwide finally coming to fruition. Ethereum 2.0 has two major components, namely proof-of-stake and sharding.

Proof-of-stake is a different protocol than proof-of-work, which is currently the main standard among the majority of blockchain networks. Both are used to determine the probability of being selected to add another block to the blockchain in exchange for fees and a block reward. However, in PoW your probability is determined by the amount of computing you deliver and in PoS the probability depends on the amount of assets you staked. Therefore, in PoW the opportunity cost of incorrect verification is the wasted computing power, whereas in PoS this is the (digital) assets deposited. Proponents of PoS argue that it is more energy efficient and secure.

In addition to the PoS, Ethereum 2.0 will also introduce a scaling concept called “sharding”. The demand for scaling of Ethereum has been noticeable for a while. For example, during the summer 2020, the network became congested once again due to an increased DeFi usage. Sharding is a concept that has been around the space for a long time and refers to the splitting of a database architecture. In a blockchain network it means that you can increase the throughput by deploying additional states verified by a subset of validators within the network. A more basic explanation could be an excel sheet where you would be able to use only 1 column or 64 columns at once. Obviously, the use of 64 columns allows you to handle much more information compared to just one. In this example, the columns represent shards of a database. The outcome of introducing sharding to Ethereum is that it will become 64x more scalable, which in turn will increase its ability to handle more users.

Yield

What are the consequences of the launch taking place? First, it means that the concept of Ethereum 2.0, which for a long time was only an iteration and software specification for researchers and developers, will actually become reality. Secondly, it adds a yield component to Ether, the native asset of Ethereum. The yield is a result of the PoS rewards mentioned above. By staking your Ether and becoming a validator you get access to a block reward (and fees) similar to the incentive currently implemented for miners. The yield consists of two components, the block reward and the fees. Block reward yield is a constant, therefore the larger the number of validators, the smaller will be the yield. The resulting yield curve is shown on the graphic below. Furthermore, the fees will be variable and will depend on the usage of the network. These can not be modelled out yet, as Ethereum 2.0 will be limited in its capabilities during the first phase of the roll out. More detailed roadmap and milestones are discussed in the next section.

Roadmap

Ethereum 2.0 will be released in several phases. The main idea behind it is to break up the transition from PoW to PoS into phases each focusing on a different aspect of ETH 2.0. The roadmap is shown below.

Phase 0: Beacon chain

Expected 1st of December

The Beacon chain will manage the PoS protocol and all of the shard chains. In particular, Beacon chain’s main role in ETH 2.0 is making sure that all the shards have the most up-to-date data. Therefore, it is worth noticing that the Beacon chain will not be fully operational right away as there won’t be any shard chains available, so there will be nothing to keep in sync other than itself. Thus, at first, the beacon chain will be responsible for registering validators and coordinating everyone’s staked ETH.

Once the Beacon chain is launched, the users will be able to stake their real ETH tokens. The main drawback associated with the phasing of the ETH 2.0 is that the deposited ETH will not be available for withdrawals until the finalization of the Phase 1 (expected to take place within 2021). The reason for this is that the staking in Phase 0 will be handled by a smart contract on the existing mainnet (current PoW Ethereum), thus a full transition to the PoS and sharding is needed before the users will be able to move their staked tokens.

Phase 1: Shard chains and the switch of the mainnet

Expected late 2021

Phase 1 will be primarily concerned with the construction, validity, and consensus of the data of the shard chains. It does not specify their state execution or account balances which will be introduced in Phase 2. Thus, Phase 1 should be treated as a trial run for the sharding structure rather than an attempt to use shards to scale.

Phase 1 will also bring a transition of the mainnets – the current PoW system will become a PoS and the mainnet will officially become a shard.

The current Ethereum network and Ethereum 2.0 will operate simultaneously. This means that the rewards will be paid to both Ethereum 2.0 validators as well as to the miners operating on the old chain. Therefore, the combined inflation will spike initially, but with the passage of time, it will start to gradually decrease towards the 0-1% range as the activity on the PoW chain is minimised.

Phase 2: Fully formed shards and the state execution

Expected after 2021

Phase 2 is where the functionality of the entire system will start to come together. Each shard will manage a virtual machine and support accounts, contracts, state, and other abstractions seen in Solidity language. Moreover, shards will be fully compatible with smart contracts and they will be able to communicate with each other more freely.

Conclusion

We think that the Ethereum 2.0 launch marks a major milestone for Ethereum and the whole industry. The years of research and development start to pay off, which should be seen as a promising sign for the future. Furthermore, it represents a major step towards the Ethereum envisioned in 2013, with Ether being the native and yield generating asset to this platform. Even though there are risks associated with the future update phases, the first hurdle was taken by Ethereum towards becoming a generalized, scalable, PoS smart contract platform. In the meantime, we will be monitoring the deposit contract to see if enough Ether will be staked.