Ethereum 2.0 & The London Hard Fork: Here’s What You Need to Know

Ethereum 2.0 & The London Hard Fork: Here’s What You Need to Know

August 3, 2021

Ethereum is gearing up for a system-wide upgrade that will radically change the way the platform is both used and secured. There have been several upgrades over the past five years, intending to improve Ethereum’s usability and scalability. Ethereum 2.0 is a highly anticipated upgrade and is by far the most ambitious and radical change to be implemented in the network and will require several years to fully implement.

On August 4th 2021, Ethereum will undergo its 11th upgrade, which is being called the “London Hard Fork”. The update will contain five Ethereum Improvement Proposals (EIPs) which aim to optimize the protocol

THE HISTORY OF ETHEREUM

Ethereum 1.0

In late 2013, Vitalik Buterin, a programmer and co-founder of Bitcoin Magazine described Ethereum in a white paper where he argued that Bitcoin and blockchain technology have a chance to benefit from other applications besides money. And that, there was a need for a scripting language for application development that could lead to attaching real-world assets such as stocks and property to the blockchain. The announcement of Ethereum was made in January 2014 at the North American Bitcoin Conference in Miami. Thus, Ethereum changed the use cases of the blockchain from an open ledger that facilitates only peer-to-peer transfers of money to a platform where smart contracts and decentralized applications could be built.

Issues with Ethereum 1.0

Ever since the initial launch of the Ethereum network, it has gained widespread popularity and exponential growth. While this demonstrated the credibility of the network, it has also posed many challenges — primarily that of scalability. The current network can handle approximately 30 transactions per second, which has proven insufficient in handling all of Ethereum’s users around the world. The increase in demand has also driven up the gas fees (transaction fees) tremendously. Moreover, there exists the issue of wasteful energy consumption with the Proof-of-Work consensus algorithm that Ethereum 1.0 currently follows.

When it comes to blockchain systems, there are two main consensus algorithms for validating transactions and creating new blocks: Proof-of-work (PoW) and Proof-of-stake (PoS). Currently, Bitcoin, Ethereum and some other networks use PoW to establish network consensus and ensure records of transactions are consistent across all users.

PoW is the mechanism used behind mining, wherein excess energy is consumed to solve complex mathematical algorithms to subsequently validate transactions and create new blocks on cryptocurrency networks. In January 2014, Buterin described the process of mining as effectively “burning computational power on useless calculation to secure the [blockchain] network.”

Another issue with the PoW model has been that of security. The PoW model protects the network from getting hacked only when there are a large number of nodes. Smaller blockchains can be vulnerable to 51% attacks wherein the feasibility of a hacker gaining over half of the network’s computational power is much higher. Hence, the existing Ethereum network is in dire need of improvements.

Why Ethereum 2.0?

The Ethereum 2.0 network aims to solve the above-mentioned challenges. It is mainly characterized by greater scalability leading to quicker transactions, lower fees and better security. This is implemented via the Proof-of-Stake consensus algorithm and sharding.

The PoS algorithm does not rely on large amounts of computational energy to secure blockchain networks. Instead, it relies on large amounts of wealth to be staked by locking up a certain amount of coins as collateral on the network. Not only is this more energy-efficient, but also majorly declines the probability of 51% attack as the attacker would have more to lose than gain as the deposited amount would get relinquished in the event of malpractice.

Sharding is another upgrade to make the network more scalable and secure. Shard chains improve efficiency as the blockchain is split into multiple blockchains to ensure that transactions can be processed simultaneously rather than consecutively. It increases the processing power as validators divide the workload.

ETH 2.0: PHASES OF DEVELOPMENT

In 2015, Ethereum was launched in phases. Similarly, Ethereum 2.0, which is technically the last phase of Ethereum’s original development roadmap will be released.

Phase 0 — Beacon Chain Launch

To begin with, Ethereum 2.0 will launch without the ability to send transactions, store user data and deploy smart contracts. Phase 0 focuses on the activation of Ethereum’s new proof-of-stake (PoS) system that will act as the central coordination and consensus hub of Ethereum 2.0.

Coordinating validators and monitoring their work make up the strict focus of Ethereum 2.0 in phase 0. Validators will be working to secure the backbone of the Ethereum 2.0 system known as the “beacon chain.” This is the blockchain that will create a registry of all Ethereum 2.0 validators, their stake, and assign their roles. Attesting to new blocks and proposing them are the two main roles of a validator.

Transferring of rewards earned as a validator in securing the Ethereum 2.0 network back to the original Ethereum blockchain will not be possible. This aims at reducing system complexities at launch and preventing spillover effects in the event something goes wrong during the rollout of Ethereum 2.0. The existing users will send their transactions as normal on Ethereum’s PoW blockchain, and this is also true for the dapps. In Phase 0, there will be no transactions from Ethereum validated through the new PoS system.

Phase 1

Sharding starts in phase 1. In computer science, sharding means partitioning a database across multiple machines. In blockchain, sharding refers to splitting up a single cryptocurrency network across several blockchains. With the foundation — the beacon chain and its PoS network– running smoothly, Phase 1 will activate sharding which is Ethereum 2.0’s scalability solution.

In Ethereum 2.0, shard refers to the individual PoS blockchain. Alternatively, users will have the chance of choosing one of many shards to send their transactions to, instead of validating all transactions through a single blockchain with limited throughput. Each shard randomly selects its own set of validators, and with this, it is able to process transactions and create new blocks concurrently with other shards.

There is a need for a bridge between all shards, this is made possible by the beacon chain which contains summaries of shard data in one central blockchain. Through sharding, Ethereum is essentially splitting up transaction load across multiple blockchains in an effort to multiply network throughput and speed. Initially, in phase 1, there will be 64 chards created.

Phase 1.5

Phase 1.5 will merge the original PoW Ethereum with the new PoS chain by enabling a bridge between the two blockchain environments. Before Phase 1.5, Ethereum 2.0 is a separate network from Ethereum. Transfers of ETH made from Ethereum to Ethereum 2.0 are irreversible and dApps built in one environment do not exist in the other.

Phase 2

The major features of Phase 2 are enabling smart contract execution and cross-shard communication. In Phase 2, users will be enabled to store and deploy new smart contract data on any of the shards in the Ethereum 2.0 network. This phase will serve as a feature to create execution environments that can mimic the protocols of a different blockchain like Bitcoin. At the moment, smart contracts on Ethereum can only be coded in the programming language Solidity. Nonetheless, Ethereum 2.0 will enable dapps to be coded in any programming language after Phase 1.5/2.

Phase 3

Unlike the other phases, Phase 3 is not well defined. Basically, it refers to other items that can be added to Ethereum 2.0 down the line. This could mean further scaling and the addition of more shards to the network. Also, it could refer to new cryptographic technology such as Zero Knowledge Scalable Transparent Arguments of Knowledge (ZK-STARKs). These enable users to share data and perform computations without revealing that data or computation to third parties, and with these, there would be an increase in the privacy of Ethereum 2.0.

The expected duration of each phase or whether one phase will require more time than the other is unclear. However, Buterin predicts the entire Ethereum 2.0 roadmap will take between five to ten years to complete.

Ethereum 2.0 Economics

The Ethereum 2.0 upgrade is expected to bring with it a switch from Proof of Work to Proof of Stake. This implies that the validator will be paid to perform assigned rules and secure the network instead of miners competing for a block reward. For the network to stay healthy and secure, it is of great importance to get the economics of staking right. The incentive must not be too high or too low. Consistent cross-shards communication needs to be maintained, and there is a minimum amount of validators required for this. On the condition that the incentive to stake is too low, the network will not get the minimum amount of validators required. Likewise, the network is paying too much for security and inflating at a rate that is inimical to the economics of the network as a whole if the incentive is too high.

For the beacon chain to begin, there is a 16,384 validator count requirement. However, it has already been attained and exceeded on several Ethereum 2.0 test networks. On Ethereum, a validator deposit contract will be created once testing for Ethereum 2.0 is completed. Every user interested in being a validator for Phase 0 can lock in their 32 ETH in this deposit contract. Users are able to run more than one validator on Ethereum 2.0 by locking up additional increments of 32ETH. The new Ethereum 2.0 network will automatically be launched at midnight UTC (Coordinated Universal Time) the following day once this contract hits the minimum threshold of 524,288 ETH (32 ETH x 16,384 validators). Approximately, every six minutes, rewards are distributed into the accounts of validators, and they will begin earning rewards on their locked ETH in the form of annualized interest.

As a definition, staking is how users of a PoS blockchain become validators in the network. A validator is a participant in the Ethereum 2.0 consensus. The locked-up coins are referred to as stake. Validators, through a gradual process, earn rewards on their stake in the form of annual percentage return (APR) in the form of network-issued coins.

According to Collin Myers, validators can expect to earn roughly 20% interest on their staked ETH initially. However, as the validators grow in number, interest rates will reduce. The reason for this: the economics of Ethereum 2.0 operates on a sliding scale of rewards that adjusts dynamically based on the total network stake. This means that if the total ETH staked is very low, the return rate per validator increases. Contrarily, the total annual issuance increases to fund those validators, while they individually will receive fewer rewards as the stake rises. Unstaking is an option for validators to turn off their machines and disconnecting from Ethereum 2.0 network indefinitely. Ethereum 2.0 validators have the chance to unstake their 32 ETH from the network at any point and stop earning rewards. Nonetheless, before Phase 1.5, the 32 ETH and any added rewards obtained as a validator cannot be transferred back to the original Ethereum blockchain. Ethereum will cease to generate block rewards after Phase 1.5. As a substitute, Ethereum will become one of 64 PoS shards in the network. This suggests that the validators on Ethereum 2.0 will effectively take over the responsibility of transaction validation and block creation.

PROBABLE MARKET REACTIONS

There are a few speculations and theories about how crypto markets might react. The creation of a new tokenized form of ETH locked in Ethereum 2.0 to boost asset liquidity may occur. Lending and borrowing decentralized finance (DeFi) applications on Ethereum may face increased competition from service providers like Binance, Coinbase, and several others offering users a way of earning rewards as a validator while committing all validator responsibilities to a third-party. Instead of running software and actively managing their stake, some users will opt for hiring a crypto company to run the technical responsibilities of being a validator. In return, these companies take a percentage of the rewards earned on the network. Any user who manages his machines by himself can earn roughly up to 20% APR at Ethereum 2.0 launch. On the other hand, it’s estimated a user can earn roughly 15% APR at launch if he leverages staking services from companies such as Coinbase and Binance.

ETHEREUM 2.0 DELAY

Ethereum 2.0 was due to launch this year in 2021. While the research and development began early on, the launch of Ethereum 2.0 has taken a while. The Beacon chain went live in December 2020 which introduced the proof-of-stake consensus model to the Ethereum network. The next phase, merging the beacon chain with the mainnet Ethereum network, was supposed to take place in 2021, but now appears to be delayed till 2022.

In May 2021, in an interview, Buterin admitted that developing Ethereum 2.0 has taken much longer than expected. While most people suspected that this was due to computational challenges, the delay has been attributed more to internal team conflicts rather than technical issues.

During Hong Kong’s StartmeupHK Festival 2021, Buterin stated, “One of the biggest problems I’ve found with our project is not the technical problems, it’s problems related with people.”

While this has demonstrated the need for a compatible team, it also shows that the said upgrades are technologically possible and would be implemented in the future — mostly likely the next few years.

THE ‘BERLIN HARD FORK’

Earlier this year in April 2021, Ethereum underwent a hard fork that incorporated four EIPs which slightly changed the gas prices and allowed for new transaction types. The ‘Berlin’ name relates to Germany’s capital city which hosted Ethereum’s first Devcon event. The updates were minor, however, and were classed as a ‘stepping stone to the bigger ‘London Hard Fork’.

THE ‘LONDON HARD FORK’

The upcoming ‘London Hard Fork’ has been one of the most talked-about hard forks. The name, like Berlin, relates to the second-ever Devcon which was held in England’s capital city back in 2015. Even though there are planned to be five EIPs, EIP-1559 is the most notable and has been hitting the headlines with it being a significant and contentious alteration to the Ethereum blockchain.

The other EIPs included in the London Hard Fork are:

  • EIP-3198: a ‘sister’ proposal to 1559 which improves user experience and benefits around creating smart contracts
  • EIP-3529: reduces the refunds on the Ethereum network and offsets the block size variance of 1559
  • EIP-3541: enables the deployment of new types of smart contracts
  • EIP-3554: is the famous ‘difficulty bomb’ which is explained further later in this article. However, the network still isn’t ready for this upgrade so it’s been delayed to later this year.

What is EIP-1559?

In 2018, EIP-1559 was first proposed by Vitalik Buterin. Ethereum Improvement Proposal (EIP) 1559 aims at making Ethereum transactions more efficient by the use of a hybrid system of base fees and tips to more evenly incentivize miners in periods of high and low network congestion. The variable first-price auction model currently used to decide Ethereum transaction fees will be replaced with a more deterministic base fee model. In the first-price auction model, transactors submit gas prices they are willing to pay for a transaction and compete with each other for space on the Ethereum block. These bids are monitored, then filtered by miners to know who is willing to pay the highest gas price to maximize profits. This means that: to get included into blocks by miners, users have to place high bids in periods of network congestion. Asides from being inefficient, this system lacks transparency.

Conventionally, a gas fee is sent by a user to a miner for a transaction to be included in a block. Now, the gas fee is going to be conveyed to the network itself as a sort of “burn” referred to as basefee with only an optional tip paid to miners. The burnt fee is set as well, making it easier for users to pay a fair fee.

When will EIP-1559 be launched?

EIP-1559 is set to arrive as a part of the London Hard Fork and this anticipated upgrade will overhaul the network’s much-maligned fee structure. With the implementation of EIP-1559, transaction fees will be more predictable. It will reduce delays in transaction confirmation and Improve user experience by automating the fee bidding system. In addition, it will create a positive feedback loop between network activity and the ETH supply.

As EIP-1559 provides a more consistent UX for users, removes fee manipulation, and reduces inflation on ETH, it doesn’t come without risks or security considerations. It is worthy of note, that miner’s income will be directly impacted as basefee gets burned. Since over 40% of miner’s revenue comes from transaction fees, they (miners) have been gathering in opposition against the proposal as it progressed toward mainnet.

EIP-1559, though a major upgrade and improvement in the Ethereum network, is not a cure-all. It will make transactions more structured, but it will not fix network bloat for the reason that it is not a scaling solution.

STAKING ETHEREUM

In the first half-year of Beacon Chain’s outset, 4.6 million ETH has been staked. As new liquidity models emerged for individuals and increasing numbers of institutions became ready to participate, concerns over the short-term lack of withdrawals on staking have settled.

Thus far, a substantial portion of the community has concentrated on the ~13% deposited by two big exchanges. However, 55% of stakes do not provide evident allocation. This group also includes stakes being managed by some of the other staking providers or individuals running their own staking activities.

ETHEREUM’S NEXT STEPS

Since the genesis of the Beacon Chain, there is an evolution in the roadmap of upgrading Ethereum into a scalable and sustainable network which is reflected by the change in the names of Eth2 and Ethereum 2.0. It is believed that, as time goes, these names will be retired by the community, then leave us with a consensus layer (Eth2/Beacon chain) and an execution layer (Eth1 mainnet).

This will bring execution onto the PoS Beacon Chain. It is currently expected that withdrawals from validator accounts will be enabled very soon after the Merge is delivered. Without this, sharding and various other more technical changes will not be delivered. Rayonism hackathon is smoothly being run to test the viability of the Merge which is estimated to be delivered by Q1 2022.

Changing Rewards

The gas fee associated with the transaction being processed will be the reward of validators selected for block proposals. This happens once the Beacon Chain becomes executable. Although they won’t reach current heights, there is going to be an effect on the total percentage rewards being earned by validators on the network.

Even though this reduces as more validators come online, rewards could rise as high as 25% in the first instance. Certainly, this depends on how well the validators are being run and increasing demand for layer 2 transactions as the ecosystem migrates toward cheaper and faster execution.

CONCLUSION

In the history of blockchain, Ethereum 2.0 is the most highly anticipated upgrade and also the most delayed upgrade. In 2015, it was anticipated to be developed in the space of one year and four months of network launch. The developers baked a “difficult bomb” into the core code protocol of Ethereum. The difficult bomb is expected to increase Ethereum’s mining difficulty gradually to unmanageable levels. It was originally placed there primarily to ensure a successful upgrade from PoW to PoS, an upgrade that removes miners entirely from the design of the network. The time during which the mining difficulty is increasing is known as the “Ice Age”. Notably, the effects of the difficulty bomb have been pushed back and delayed several times.

In a short time, developers are expected to roll-out PoS and migrate both users and applications to the new Ethereum 2.0 network. Most developers, at first, agreed that the biggest hurdle to Ethereum 2.0 rollout will be launching the beacon chain. Considering the distinctive design of Ethereum 2.0 as a separate and parallel network to the original Ethereum blockchain, investors and traders may see the creation of absolutely new digital assets. These digital assets will likely be tokenized representations of the work and returns of validators in the new PoS system.

Switching from a PoW to a PoS system has never occurred in any blockchain of Ethereum’s scale. The question remains how and when the current Ethereum blockchain will be merged into Ethereum 2.0.

Sam Ameen
Sam Ameen
Marketing
More from Hex Trust
The Custody 3.0 Era: Institutional Participation in the Decentralized Economy
June 22, 2022
The Custody 3.0 Era: Institutional Participation in the Decentralized Economy
Our Managing Director, Calvin Shen, shares his views on Custody 3.0: how the evolution of digital asset markets and growing demand for institutional participation in the decentralized economy is shaping the role of the digital asset custodian.
Read More ⟩
Finding Shelter in DeFi During Turbulent Times
April 14, 2022
Finding Shelter in DeFi During Turbulent Times
Our Head of Financing, Dario Capodici, shares his views on the alternative investment opportunities that DeFi offers in times of financial instability and macroeconomic concerns: money market protocols, liquidity staking and yield farming.
Read More ⟩
How Bitcoin could become the Pristine Collateral Layer for the Digital Asset Economy
April 8, 2022
How Bitcoin could become the Pristine Collateral Layer for the Digital Asset Economy
Our Head of Marketing, Joe Caselin, shares his take on how the stablecoin sector is presenting huge implications for the broader digital asset industry.
Read More ⟩