What is Ethereum 2.0?

Ethereum 2.0 is a major upgrade to one of the world’s most popular blockchains. The update, several years in the making, promises to make the Ethereum blockchain faster, cheaper and more environmentally friendly. This could make the network more attractive for decentralized application developers, potentially helping the booming market for Ethereum’s eponymous cryptocurrency.

What is Ethereum?

Let’s back up a bit. Before we expound on why Ethereum 2.0 might be the next big thing, it might be helpful to give a quick rundown on exactly what it is that is getting an update.

Put simply, what is Ethereum?

Ethereum is a blockchain. This is a fancy word to describe any decentralized financial network. It’s similar to Bitcoin, the most popular blockchain, in lots of key ways: anonymous users, spread across the world, maintain a large book of all the orders on the network, detailing exactly who owns what at any given time and who sends what to whom. Transactions are processed by other computers, known as miners, who solve complicated math problems to earn newly minted Ethereum.

The great innovation of blockchains is this idea of decentralization; it means that the payments network is run by an anonymous network, not a bank or a government. It’s hard for governments to shut down or hackers to exploit blockchains.

That innovation was what Bitcoin introduced to the world in 2008. However, its limitations quickly became apparent; Bitcoin is slow, expensive to use and you can’t do much apart from send and receive Bitcoin. Ethereum came out in 2015 and aimed to innovate on Bitcoin. It was created by a bunch of top crypto developers, most prominently the then-21-year-old Vitalik Buterin, and introduced something called “smart contracts” to blockchains.

This idea, which had been kicking around for about 20 years, refers to self-executing bits of computer code. If X then Y, that sort of thing. Adding smart contracts to blockchains means that developers can create decentralized applications, or dApps, as diverse as digital art and gambling apps and complicated synthetic derivatives. And on Ethereum, you can also create smart contracts for new tokens—cryptocurrencies that operate on the Ethereum network itself. There are now hundreds of these tokens, and the combined market cap is in the hundreds of billions.

This innovation made Ethereum—the coin that powers the whole blockchain—the second-most valuable cryptocurrency by market cap. As of July 21, 2021, Ethereum has a market cap of $223 billion, or about 37% of Bitcoin’s market cap of $592 billion.

Ethereum’s problems

But problems started to creep up. While it brought this great innovation to the crypto industry, and was certainly faster than Bitcoin, it became so popular that it strained under its own weight. Within a few years, Ethereum’s applications became prohibitively expensive to use and the blockchain often got clogged up with Ponzi schemes, which couldn’t be deleted due to the immutable structure of the blockchain.

At the height of the 2021 crypto boom, during which Ethereum hit all-time highs of $4,362, it cost as much as $70 to send a single Ethereum transaction. Compare that to the $0 it costs you to transfer money between bank accounts. And that’s just for simple transactions—trading a penny’s worth of cryptocurrency on decentralized exchange Uniswap, one of Etheruem’s most popular applications, could cost north of $300.

Adding to that, these trades were slow; the network can only process a maximum of about 14 transactions per second. Plus, the network’s fit to bursting; as of July 21, 2021, 98.26% of the network is in use, according to data from YCharts.

And all of these transactions were processed via an immensely wasteful mechanism called proof-of-work. The amount of energy used by the Ethereum blockchain increased by about 7.5 times between July, 2020, and July, 2021, and is comparable to the energy consumption of Uzbekistan and the carbon footprint of Syria, according to data from Digiconomist.

Ethereum 2.0

Ethereum 2.0 effectively promises to solve all of those problems. But even though serious progress has now been made, Ethereum 2.0 won’t be launched in full for a couple of years. (That’s a problem for Ethereum, because rival blockchains, like Solana and Polkadot, are nipping at its feet to pick up any developers who’ve given up on Ethereum.) Here’s what it promises to do:

First, it moves away from the wasteful proof-of-work consensus mechanism. Under proof-of-work, computers race to solve complicated math puzzles, and are rewarded in Ethereum for performing this work. These computers require a lot of electricity; the amount of power they need increases as the network becomes more popular. Importantly, only the winners of these races actually get that Ethereum; the rest get zilch.

Ethereum 2.0 transitions the network to something called proof-of-stake, which allows people who lock up lots of Ethereum in smart contracts to validate transactions. In May, 2021, the Ethereum Foundation, the non-profit that oversees development of the Ethereum blockchain, estimated that the transition to proof-of-stake, in tandem with a couple of other tweaks, make the network 2,000 times more energy-efficient and would result in a 99.95% decrease in total energy use.

You can already stake money through Ethereum 2.0, and as of July 21, 2021, about $12 billion of Ethereum has been locked up on Ethereum 2.0, or 5% of all Ethereum. Rewards on staking pools generally return 6% a year, although this reward is volatile, as is the price of Ethereum.

Second, Ethereum 2.0 makes the blockchain much faster. One of the ways it does this is by increasing the number of nodes—computers that maintain the ledger. This is accomplished by something called sharding, which distributes the traffic on the blockchain into lots of little blockchains, making it easier to process transactions.

The shard upgrades will spread the work onto 64 new chains, and each validator will only need to run their little piece of the blockchain, not the entire Ethereum chain. This makes the network easier to handle and incentivizes more people to run nodes, since maintaining the network comes with lower hardware requirements. The Ethereum Foundation expects to ship shard chains sometime in 2022, “depending on how quickly work progresses after the merge”—when the current version of Ethereum merges with the rudimentary Ethereum 2.0 smart contract, which is estimated to happen later in 2021.

Third, the blockchain will “scale”—it will be able to support more transactions without slowing down. This, again, is accomplished through sharding. Sharding works in two phases: the first shard chains won’t handle transactions or smart contracts but will just provide a bit more oomph to the network. The “version 2” upgrade to sharding would let shards process smart contracts and handle accounts, but the network’s community is still debating whether this is really necessary.

When will Ethereum 2.0 launch?

Ethereum 2.0 has already launched! Kind of. It’ll still take a few years until it resembles anything like the Ethereum 1.0 blockchain that’s popular today. December 1, 2020, marked the launch of the Ethereum 2.0 “Beacon Chain”, which functions like a coordination chain for shards and proof of stake staking. As mentioned, you can already send Ethereum to the Beacon Chain smart contract and lock it up to earn returns.

The next major development is something called EIP-1559, which burns a lot of the fees that the network would pay to miners. The update, which goes live in August 2021, isn’t strictly related to Ethereum 2.0 but is supposed to disincentivize miners from processing transactions and to encourage developers to hasten the launch of Ethereum 2.0. The next milestone is the “merge”, which marks the end of proof-of-work staking on Ethereum 1.0 and officially transitions the network to proof-of-stake. This is predicted to go live by the end of the year. Shard chains come next; the Ethereum Foundation predicts that this feature will ship in 2022.

So it’ll be a long time until Ethereum 2.0 is completely implemented. Last June, Ethereum co-founder Buterin said that transactions per second will increase to about 2,000-3,000 for a couple of years before increasing to about 100,000.

Meanwhile, rival blockchains already profess to have achieved what Ethereum 2.0 set out to accomplish. Proof-of-stake blockchain Polkadot implements “parachains”—parallel blockchains—that it claims could process more than 1 million transactions per second, and Cardano expects to increase transaction speeds to 100 transactions per second for each validator. So far, there are 2,076 validators on Cardano—combined, those validators would produce a little over 200,000 transactions per second or double that of Ethereum 2.0.

For Ethereum, there’s a risk that the transition to 2.0 will be too little, too late. If the community’s morale isn’t sufficiently high to prevent rival blockchains from siphoning developers, and buzz around Ethereum projects wanes, Ethereum 2.0 could fall on deaf ears. But if Ethereum can pull off the transition to 2.0, it might truly fulfill its promise of being the next big thing.