Ethereum 2.0, or is it 0.2?

Often in business and technology what is sold as an upgrade is in fact a sideways step to a different system, sometimes in a cost-cutting attempt, and other times it is bad management altogether. Sometimes the upgrade is a legitimately positive upgrade, but other times it is a downgrade that is sold as something that is meant to be better or more.

The power of fake narratives and misleading marketing isn’t without potency. Take a look at the ill-fated Segwit “upgrade” for BTC and you quickly see what we mean. After all, this upgrade was meant to be the saving grace for Bitcoin’s scalability woes, which would enable on-chain and off-chain transaction scalability… only, it is 2020, and we are still managing to hit averages of US$5 transaction fees on the network…

What of Ethereum 2.0? Or is it Casper? Or is it the serenity upgrade… whichever you choose to call it, it is being heavily thrust through media channels as another ‘saving grace’. Albeit, one that has been delayed heavily already, and questions are arising as to the efficacy of it. In this piece we will examine the ins and outs of this upgrade to the Ethereum network, and we will analyze the merits on the basis of both the technical, and the societal.

But first, let’s recap what this upgrade is all about…

At the height of the ICO bubble, Ethereum came to a grinding halt. The relatively heavy usage of the Ethereum network, the daily average transaction fees spiked up to 4 USD/tx. With unscalable blockchains, fees go up when the demand for transactions cannot be met by miners… and so users who transact must compete to have their transaction processed by paying a superior fee to the miners to get them ahead of the queue. ETH can do on average about 15 transactions per second (a mere 5 times more than BTC), beyond that, things start getting chaotic as evidenced on numerous occasions.

Because of the fundamental architectural flaw in the design of Ethereum, where every node processes every smart contract function, its ability to scale globally quickly cascades, and we fall into delayed transactions, huge backlogs, high fees and volatile confirmation times. It’s a heck of a problem that BTC users know all too much about.

While Bitcoin SV (BSV) chose to increase through-put by not artificially limiting the blocksize, the ETH conundrum is a little more nuanced, and certainly more complicated to resolve. As mentioned, Ethereum’s congestion woes aren’t so much about “space” inside blocks, but more so around the fundamental architecture in which the way Eth nodes process smart contract functions. A notable way around this is “sharding.”

Sharding is a means of partitioning a database or in this case, a blockchain, horizontally into more manageable parts. If you have 60 shards for example, you can also parallelize 60 transactions at the same time—in theory. This method of database scalability is not new and has been around for quite some time. Only this is relatively new waters when it comes to blockchains. The number of shards may directly correlate to the number of parallel transactions, but this does come at the cost of security. One major public POW blockchain is incredibly more secure than smaller partitions that make a whole. ETH is incorporating a number of measures designed to thwart off attackers, such as randomizing the shard attributed to a node. This makes predictability for an attacker more difficult, and therefore the risk is reduced.

Sharding with blockchains and maintaining visibility, security, and decentralization is a notoriously difficult task to undertake. There needs to be a trusted way to pick up the overall state of the network at any given time—particularly as each shard works as its own little blockchain. Getting the big picture view relies on separate set of tools and network data.

Unfortunately for ETH, proof of work (POW) blockchains like Bitcoin and modern-day Ethereum cannot be sharded since all participating nodes need to be involved in transaction validation, but shards only house partial information from the volume of transactions. This is where Proof of Stake comes in.

Proof of Stake is being marketed as the green and energy friendly alternative to Proof of Work (POW) mining. When comparing it to POW it brings with it virtually almost no carbon footprint. Instead of transaction processors, or miners, investing in and competing with advancing hardware, transaction validators are instead chosen at random, with probabilistic favour given to the validator who ‘stakes’ the most coins.

While on the surface this may look like shiny new tech, it is not what it appears to be under the hood. The argument is often made that Proof of Stake validators do what processors do but without the carbon footprint, and I beg to differ. Both POW miners and POS validators make an investment – we are on the same page so far. On one hand, one must purchase coin (for example Ethereum), and accumulate a stake, and on the other hand, a miner must invest in and purchase mining hardware. So far we’re on the same page. There is a major investment on both sides of the fence, and both investments seek a greater return. This is where the similarities end.

Majority stakers on POS networks will be incentivized to stake their majority instead of spending, and will over time accumulate more and more as a direct result of this staking. Not only does this sort of social system descend very quickly into oligarchy but it also transcends into creating a bigger divide between rich and poor. Why oligarchy? Well consensus on blockchain systems is dictated by the majority validator, which happens to be the majority staker.

So how is POW any different?  While the majority staker inevitably grows to become a bigger majority staker in a POS systems, it is not so in a POW world. The competition among POW miners is fierce, but invest too much and you could shoot yourself in the foot. Produce a bad ASIC and you could shoot yourself in the foot. Inevitably, technology grows old and newer tech comes. Every miner requires a continuous cycle of reinvestment. And that’s where the special sauce is. In the midst of strategic reinvestment, one false move could change your fate. Conversely, a newcomer with a great new invention in ASIC mining could perhaps take the lead… Not so in a POS world. One only needs to study the short history of Bitmain to see the momentous rise and then fall of this once mining giant. In a POS world Bitmain would likely have remained king forever after.

A society that rewards competitiveness, risk, and investment is far superior to a society that rewards oligarchy and the descent into the hands of another. POS recreates the system of the Fed and it moves it into an entirely new arena. Really take a moment to understand the implication of what such a system at scale achieves and what kind of world this evolves to.

But further this creates legal ramifications for any business than wants to be involved in the staking process. Staking creates a hybrid contract in which the validator is promised a return on investment, equating this to a securities contract.

But this is where ETH heads into murky waters. No doubt this will have a very positive spin on it. The ETH 2.0 branding is the beginning of this marketing blitz that is to come.

While ETH 2.0 was supposed to happen back in January, it is now accepted that Phase 0 of the project will begin at some point later this year. Phase 0 is essentially kick-starting the Proof of Stake process, where the basic environment and POS chain comes into existence. However, it will not drive the ETH network yet, it will merely run alongside it for some time while the rest of the environment is made ready. Phase 1, sometime later (perhaps a year on), will introduce the sharded infrastructure, and yet some time after that in the next phase, the main Ethereum POW chain will be merged with one of the POS shards, and thereby signalling the end of Ethereum’s Proof of Work. So the end result is actually still some time away…

What we end up with is a scalability effort that is delivered at the cost of validator centralization (oligarchy), blockchain security and overall visibility, all in the name of achieving a bigger transactional throughput. No doubt there will be many angles where this will be painted in greener light. Particularly the ‘energy friendly’ component. But Ethereum certainly is at a crossroads, and if it seeks to survive, it must make tough decisions on its scalability path given its flawed architecture.

Perhaps ETH2 will spend negligible amounts of energy compared to Bitcoin. But then, what is the cost of sound money? Is it an oligopoly? A dictatorship? A fed?

Before getting carried away, let’s acknowledge, that Bitcoin itself spends less than 1% in CO2 emissions than what banks worldwide use. That figure is inclusive BSV and every other protocol that forked away from the original protocol such as BCH/BTC… Further, a study undertaken last year identified that almost 75% of all Bitcoin mining is in fact done via renewable energies. This number is expected to grow as miners look for cheaper alternatives to keep electricity costs down.

It’s intriguing how Bitcoin SV proves that Proof of Work blockchains were always scalable and how Satoshi actually had it right from the very beginning… It’s also equally fascinating when we hear Ethereum’s co-founders explicitly say that they knew Ethereum wasn’t going to scale, and I quote Lubin verbatim: “We knew it wasn’t going to be scalable for sure,” to which Vitalik nods.

Eli Afram

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