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One of the inherent issues with the cryptocurrency industry is that it waits for no one. Sit on an idea, procrastinate a little, and chances are your equally profit-hungry competitors will have already labelled themselves as the “next-generation” blockchain. The meteoric rise of decentralised finance (DeFi) and non-fungible tokens (NFTs) has fundamentally redefined the purpose of blockchain technology, creating a frantic rat race to develop networks that are purposely designed to accommodate the explosive influx of investments flowing into the decentralised space.
The introduction of Ethereum in 2015 prompted a seismic shift within the industry because its programmability, or the ability to support decentralised applications (dApps) via smart contract capabilities, revealed blockchain technology’s applications beyond a payments system. Ethereum essentially achieved what its predecessor Bitcoin could not: a global financial and recordkeeping system independent of human intermediaries powered by self-executing smart contracts. It set a precedent for how blockchains should be designed, unlocking a new and completely untapped market for decentralised services.
Ethereum 2.0 (Consensus Layer)
While staunch Ethereum fans will readily gush over the network’s utility, the blockchain does have its flaws. For instance, Ethereum is currently still using the same consensus mechanism as Bitcoin, PoW (Proof-of-Work), which means that the network suffers from significant scalability issues due to its decentralisation. Ethereum can only process a mere 15 TPS (transactions per second) as compared to centralised providers like Visa, which can process up to 1,700 TPS. This means that it’s still a far cry from becoming a reliable and efficient financial system. Furthermore, Ethereum is also notorious for its astronomical transaction fees, or “gas”, which can sometimes amount to more than the transaction itself during periods of congestion. Layer 2 protocols such as Polygon, Optimism, and Arbitrum have all been utilised by smart contract developers as well as prominent DeFi and NFT marketplaces to enhance transaction speeds and lower gas fees.
Ethereum 2.0, recently rebranded to “Consensus Layer”, is believed to be a turning point for the network, potentially making it the go-to blockchain for all things decentralised. And for good reason. Consensus Layer will see Ethereum eventually transit from a PoW to PoS (Proof-of-Stake) blockchain, significantly improving its scalability and reducing the network’s overall carbon footprint. The first phase of the upgrade, known as Phase 0, has already gone live via the Beacon Chain, a foundational network that introduces PoS to Ethereum and exists in parallel with Ethereum’s mainnet. However, because it’s not smart contract enabled, Beacon Chain will eventually have to be merged (in the second phase known as The Merge) with Ethereum’s mainnet for the entire ecosystem to fully operate as a single, smart contract-enabled PoS network.
The Merge has already been delayed for the fourth time, due to complications in implementing the “difficulty bomb” – a mechanism that will force miners to stop producing blocks, therefore making mining unprofitable and disincentivising miners from keeping the chain alive after Ethereum becomes a PoS network. It’s now estimated that The Merge will only be completed in the second quarter of 2022.
The third phase will see the introduction of “sharding” on Ethereum, whereby the ecosystem will be made up of smaller individual chains known as “shards”, therefore spreading the network’s overall load and increasing scalability. Sharding is also perceived to be a step towards a higher degree of decentralisation and security, as it increases network participation while decreasing the attack surface area of the ecosystem. However, the exact release date of shard chains is still unknown, as their very existence depends on the success of The Merge.
Too fast, too late
As a PoS blockchain, Ethereum will become an extremely scalable ecosystem, potentially reaching a maximum of 100,000 TPS, far surpassing that of its competitors and centralised providers. An increase in scalability will also result in a decrease in congestion and network fees, while the implementation of shard chains will help to maintain the network’s decentralisation, therefore making Ethereum a highly efficient and secure blockchain for a range of decentralised applications.
However, the critical question that arises is when will the Consensus Layer actually be fully optimised for use? And when it happens, will it be far too late, given the speed at which the cryptocurrency industry is developing?
Ethereum founder Vitalik Buterin said that post sharding, the Ethereum Consensus Layer upgrade will essentially be completed by 80%. The entire roadmap, however, could well take another six years to complete and only then would it lead to 100% optimisation.
“The risk for Ethereum is that by the time sharding is implemented in 2023, competitors’ ecosystems would have grown by so much that activity won’t return en masse to the Ethereum network. In other words, Ethereum is currently in an intense race to maintain its dominance in the application space with the outcome of that race far from given, in our opinion”, said JP Morgan analysts in a 2021 note.
Ethereum’s current limitations has resulted in the rise of “Ethereum Killers” such as Solana (SOL), Terra (LUNA), and Avalanche (AVAX) – the so-called SoLunAvax trio. All three are already using the PoS consensus mechanism, and while they each have their own flaws and draws, they have largely succeeded in solving two of Ethereum’s biggest problems: scalability and high transaction fees. For example, Solana has become one of the fastest blockchains on the market, with the capacity to process up to nearly 60,000 TPS at a fraction of the cost of Ethereum’s gas fees, making it an extremely attractive ecosystem for NFT marketplaces and DeFi platforms. Networks such as Binance Smart Chain and Avalanche are less scalable than Solana, but also offer extremely low transaction fees.
According to JP Morgan, Ethereum’s share of total value locked (TVL) in DeFi was nearly 100% at the start of 2021, but fell to 70% over the course of the year, with blockchains like Binance Smart Chan and the SoLunAvax trio turning heads and pulling developers and investors away from Ethereum. While the Consensus Layer is undoubtedly a powerful upgrade that will rectify many of the pressing issues that Ethereum currently faces, the ecosystem is taking far too long to implement upgrades that are already being utilised by its competitors.
Interoperability is still key
It’s probably naive to assume that one of Ethereum’s competitors will completely displace Ethereum from its role as the network for decentralised services in the crypto ecosystem. At least in the short-term. But given the breakneck boom in demand for DeFi and NFTs, the lack of a clear timeline for the Consensus Layer upgrade is becoming increasingly worrying and it’s something that investors should be keenly aware of in 2022.
Interoperability between ecosystems will also have to be explored as more individual blockchains, each with its own draws, are built. The reality is that Web 3.0 will not be defined by a single blockchain like Ethereum or any of its competitors, but rather a web of interoperable networks. If interoperability can be achieved between Ethereum and other smart contract-enabled blockchains, then the Consensus Layer upgrade could serve as a significant step towards crypto adoption in Web 3.0.
In the meantime, however, we’ll just have to wait with bated breath for the next six years for a seemingly never materialising upgrade.