ETH 2.0: Why the transition to Proof of Stake matters for blockchain scaling

Ethereum is the world’s most popular smart-contract network. Conceived by Vitalik Buterin and a small team of developers in 2015, it has grown into a sprawling ecosystem that boasts more daily transactions than Bitcoin, more active addresses and more developers than every other blockchain combined.

Gamers use it to collect in-game items such as non-fungible tokens (NFTs), traders use it to trustlessly swap tokens on decentralised exchanges (DEXs) and liquidity aggregators, decentralised finance (defi) projects launch new applications on it, and enterprises use Ethereum to issue bonds worth hundreds of millions of dollars. Ethereum is many things to many people – millions of people in fact, who rely on ETH to gain access to the permissionless financial system it supports.

More than 1 million ETH is sent a day on Ethereum and smart-contract usage is at an all-time high. Source: CoinMetrics.

To all intents and purposes, Ethereum is crypto. But the network, which has just celebrated its fifth birthday, has been a victim of its own success. Bottlenecks due to high demand for block space have limited the number of transactions Ethereum can process and caused gas prices to sky-rocket ("gas" being the cost to transact on the the blockchain). A year ago, it was possible to transfer ETH, stablecoins such as USDT, and other ERC20 tokens for a couple of cents. Today, the same transaction will cost anywhere from $1-$5.

At present, Ethereum cannot scale to meet the demands that are being made of it by network users - but there are plans in place to remedy that.

We’ll examine these plans in a moment, but first we need to consider why scaling a blockchain to increase its capacity is so difficult.

Why blockchain scaling is hard

Because blockchains exist as a series of distributed nodes, operated by users around the world, information takes time to propagate. When you make a transaction on Ethereum, the information is broadcast to a node for inclusion in the next block, and then verified by all of the other nodes to ensure that the transaction accords to the network consensus rules.

There are various ways to speed up this process, such as clustering nodes together, or by relying on systems like delegated proof of stake, in which participants trust a smaller number of nodes to validate transactions. The trouble is, this incurs trade-offs in terms of decentralization. If a blockchain becomes too centralized, its security is weakened. Robust finality assurances are the main value proposition of crypto networks. Start tampering with this in a bid to increase the number of transactions that can be processed per second (TPS) and you risk weakening the network.

To alleviate the congestion on the Ethereum blockchain and lower transaction costs, its developers are preparing to change its architecture from proof of work (PoW) to proof of stake (PoS).

This will be the biggest change ever made to Ethereum - and is a complex feat to pull off. Its developers seem confident, however, that they can achieve this without impairing the network

But what of other blockchains? If Ethereum is so congested, why don’t users switch to other smart-contract networks that have higher TPS and lower fees? As the saying goes, there’s no such thing as a free lunch - and moving to newer, flashier blockchains carries its own risk.

The trouble with ‘Ethereum killers’

While there are indeed lots of other smart-contract networks that can process more transactions than Ethereum, they are more centralized and thus less secure. That isn't necessarily a problem, as most on-chain transactions don't require the same security assurances as Bitcoin or Ethereum can provide. Using a blockchain to record a new in-game avatar or to send a few dollars of value is different to sending $100 million of BTC.

The reason why so-called “Ethereum killers” such as EOS, Tezos and Cardano have failed to displace Ethereum, despite being faster, is because they lack ETH's network effects. Convincing an entire community to migrate to a new blockchain ecosystem, with its own programming language, developer stack and framework, is a big ask.

Ethereum might not be the fastest or cheapest blockchain to use right now, but it’s the most popular because of the ability to interact with all the other projects and users within its ecosystem.

Ethereum is a sprawling metropolis, while rival networks are more like country hamlets: pleasant to visit, but with fewer economic opportunities

ETH 2.0 - the shift from PoW to PoS

Ethereum’s designers are working hard to finalize a major upgrade to the network, which will be known as ETH 2.0 or ‘Serenity.’ Once introduced, ETH 2.0 will be able to process more TPS due to a process known as sharding.

Sharding entails splitting data into segments - shards - and assigning it to nodes to process in parallel. The process can be likened to using multi-threading to speed up a computer’s CPU.

To achieve this, ETH 2.0 will switch from PoW to PoS. Instead of securing the network by miners providing computational power (a la Bitcoin), ETH 2.0 will require node operators to lock up - or stake - ETH. Just as miners are invested in the crypto network they secure due to the hardware and energy costs involved, stakers are motivated to act ethically due to the cost of the ETH they have locked.

How PoS works

The proof of stake concept was proposed by Sunny King and Scott Nadal in 2012 as an alternative to PoW.

PoS is achieved by each node via a hashing scheme that bears similarities to Bitcoin, but has several key differences.

Cryptocurrencies using PoS rely on an algorithm to choose nodes based on the number of coins (stake) owned by individuals, with stakers (“validators”) given more opportunities to add blocks to the chain and claim rewards if they pledge more coins.

Ethereum initially favoured a PoW consensus like Bitcoin when it launched in 2015, but will transition to PoS with the launch of Serenity in 2020. After the next network upgrade, a minimum of 32 ETH will be required to participate in staking, and validators will need to run a validator node.

The advantages of PoS over PoW include:

• Energy efficiency

• Scalability

• No special mining equipment required

Why ETH 2.0 is such a big deal

At present, Ethereum can only process around 15 TPS. ETH 2.0, aided by a scaling technology called zk-rollups, will ultimately be able to handle up to 100,000 TPS, giving it a capacity greater than that of payment networks such as Visa and Mastercard.

ETH 2.0 is on course to launch in November 2020, or by January 2021 at the very latest. When that occurs, Ethereum will enter the Serenity era, bringing scalable blockchain technology to millions of users and driving down the cost of transactions.

Not only is this a big deal for Ethereum, but it will prove a decisive moment for PoS, heralding its introduction to the world’s most active crypto network. If successful, Ethereum may spur other PoW chains to follow suit and transition to PoS, while putting further distance between itself and the chasing pack.

ETH 2.0 will be a big step for Ethereum - and a giant leap for blockchain scaling.