What Is Ethereum 2.0 And How Might It Affect The Price of ETH?

BY Chris Andreou

|August 31, 2021

The crypto community is holding its breath for the rollout of Ethereum 2.0, also known as Serenity or ETH 2.0.

The new protocol is an upgrade to the existing Ethereum network on several levels. The primary objective is to reduce transaction fees, increase the network’s capacity and ensure its sustainability. The main way that Ethereum will accomplish these goals is by changing its “consensus mechanism”.

Some quick facts:

  • Ethereum 2.0 represents a switch from a “proof-of-work” (PoW) to a “proof-of-stake” consensus model.
  • Current fees on the network are very high. A successful upgrade will see fees reduced substantially.
  • The new model allows for lower fees and higher transaction speeds.
  • The proof-of-stake model promises to reward Ethereum holders who lock their ETH in “stake pools”, which will grow their holdings over time.
  • A scaling method called “sharding” will increase Ethereum 2.0’s capacity to potentially 100,000 transactions per second, compared to the 30 transactions per second it can currently handle.
  • The upgrade could have a profound effect on the price of ETH, as it expects to increase demand quite considerably.

What Is Consensus On The Ethereum Network?

Each organisation uses a database that holds large quantities of information – be it names, email addresses, user preferences or any other data. The computers that store these databases tend to exist in a single location, operated by a few people called admins.

A blockchain is essentially a database, but instead of living in a single location and being under the supervision of a few administrators, it is spread out across many locations (nodes) and has far more users overseeing its upkeep. This way, there is no single point of failure. If one computer goes down or one validator finds a new gig, the network can still continue as though nothing happened.

For all versions to match, the individuals who contribute to validating transactions on the blockchain must find a way to agree on the correct set of data in the database. To form this consensus, a method of validation is necessary. These methods are referred to as the consensus method of a particular network.

Proof of Stake vs Proof of Work

Proof-of-work is the traditional method that has been used by blockchains. PoW lets individual nodes on the network compete against each other to process transactions and earn rewards. This process is extremely time consuming and energy intensive.

For this reason, Ethereum 2.0 (and other blockchains) have opted for another method – proof of stake. With PoS, consensus among the network is after a node is chosen to win the right to process transactions, rather than the nodes competing between themselves. A node will be chosen by the Ethereum 2.0 algorithm, and it will then have the right to process the next block of transactions on the network. These nodes are commonly referred to as “stake pools” and will have several individuals contributing their ETH to them. To be eligible for nomination, every node will need to commit a minimum amount of ETH to the pool.

Stake pools are chosen based on the “size” of the pool. The size of the pool is how many coins it holds. So the more Ethereum a particular stake pool holds, the more likely it is to be chosen to forge a block and earn rewards. Other criteria will also factor into the selection process to ensure that the wealthiest pools do not always win the right to forge a new block. Holders can stake their Ethereum to a stake pool (node), and when their node is selected, the rewards for validating the transactions are distributed amongst the individual backers.

What Are The Implications For DeFi?

Ethereum hosts a massive decentralised financial system called DeFi (decentralised finance). DeFi has been a major contributor to the rise of the ETH in the last few years, and should Ethereum 2.0 be successful, it will have a massive drastic impact on improving the financial ecosystem. Currently, the congestion on the network can cause the transaction fees to be higher than the amount of money being processed.

In its current state, only those with larger holdings can truly benefit from DeFi, which is counterproductive to the stated aim of many projects in that space. A single transaction on the popular DeFi exchange, Uniswap, costs more than $80 on average. This makes sending a few dollars worth of ETH or altcoins nonsensical.

The reason the fees are currently so high is because of the network’s dependence on miners (those who compete to solve algorithms). PoS aims to eradicate this issue entirely by removing competition from the equation.

When Will ETH 2.0 Be Ready?

The Ethereum upgrade will be happening in phases. In fact, the first phase (phase 0) is already live. Phase 0 introduced the beacon chain, which is the new PoS blockchain that current-day Ethereum will eventually merge with.

The second phase, phase 1, is the merge onto the beacon chain. The merge is the critical phase when PoS becomes the consensus mechanism for Ethereum. This is expected to take place either in late 2021 or the first few months of 2022.

Ethereum holders will not need to convert their coins or do anything to use their coins on the new blockchain. Everything will happen automatically.

The third phase, phase 2, introduces sharding. Normally, all nodes on a blockchain hold the entire database. With sharding, the database is divided up between the nodes to reduce processing power and storage requirements.

How Will Ethereum 2.0 Affect The Price of ETH?

The million-dollar question. Many analysts are expecting that the Ethereum upgrade could be swiftly followed, or pre-empted, by a dramatic rise in the price of ETH. These analyses are predicated on the theory that DeFi will become far more accessible to the average person.

Fees will drop far enough to allow users of DeFi to transact small amounts of money without paying exorbitant fees.

Crypto enthusiasts believe that the general public stands to benefit the most from DeFi and Ethereum 2.0, in particular those with limited income and those living in parts of the third world without accessible banking.

Many countries also lack the infrastructure to provide their citizens with proper forms of identification, making it impossible to use any modern payment apps. DeFi’s decentralised promise allows those encumbered by such circumstances to access savings accounts, loans, investments, and many other financial products, which are currently out of reach.

With drastically reduced fees likely leading to an increase in accessibility, DeFi has the potential to grow far beyond its already impressive reach – and the price of Ethereum may well rise along with it. If, of course, Ethereum 2.0 can deliver.

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Chris Andreou

Experienced independent trader

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