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Ethereum 2.0, also known as Serenity or ETH 2.0, is an upgrade to Ethereum on a number of levels. Its primary objective is to increase Ethereum's capacity for transactions, reduce fees and make the network more sustainable. To accomplish this, Ethereum will change its consensus mechanism from proof-of-work (PoW) to proof-of-stake (PoS). 

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Fast Facts:

  • Ethereum 2.0 represents Ethereum's switch to a new "proof-of-stake" consensus model.
  • Proof-of-stake allows for faster transactions and lower fees compared to its previous proof-of-work model.
  • The proof-of-stake model allows Ethereum holders to "stake" their holdings to "stake pools" that will earn rewards and grow their holdings over time.
  • Ethereum holders can stake their holdings right now on a number of popular exchanges like Kraken, Coinbase and Binance.
  • Ethereum 2.0 will implement a method known as sharding that will greatly increase transaction speeds, potentially scaling its ability to 100,000 transactions per second or more.
  • The current cost for transactions on Ethereum's network is very high and prevents many from using it. If this update is successful, the reduced fees it will bring will make the network more practical for average users.
  • Ethereum's upgrade could have a profound effect on its price as its lower fees and faster transactions open the network up to a broader demographic of users. 

What Is a Consensus Mechanism? 

Companies and organizations typically have databases that hold user information like emails, names and addresses. The computers that hold databases usually exist in one singular location and are operated by one person or a small group, known as administrators. 

A blockchain is a type of database, but instead of its information being in one central location and under the supervision and control of a few, it is dispersed among many individuals and locations. This way, if one computer goes down there are plenty of others keeping the data and network alive.

These individuals must find a way to agree on the correct set of data so that all of their versions of data match. To form this consensus some sort of mechanism is necessary. 

There are various types of consensus mechanisms that blockchains employ to ensure that the data (in the case of a cryptocurrency this data is transactions) stays consistent across all the nodes (individual computers) in the system.

Moving to Proof-of-Stake

The original mechanism used by blockchains is proof-of-work. PoW requires computers to compete against each other to process transactions and get rewards. This process is highly energy-intensive and also time-consuming.

For this reason, some newer cryptocurrencies have opted to go another route — proof-of-stake. Ethereum's upgrade to version 2.0 will have it transition to PoS to allow for far faster transactions and lower fees. 

With PoS, consensus is reached by using an algorithm that chooses a node to win a block of transactions, rather than the nodes competing to win the block by using large amounts of power. When a node is chosen it forges the next block of transactions in the chain. With PoS, these nodes are generally referred to as "stake pools." 

Nodes, or stake pools, are chosen based on the size of the "stake" it holds. In other words, the more coins a stake pool holds the more likely it is to be chosen to forge a block and get rewards. To ensure that the wealthiest pools do not always win, other criteria, like the amount of time coins have been staked, can factor into the selection process. Holders of the coin can "stake" their holdings to a stake pool and when a pool (node) is selected to forge a block the reward it receives is distributed among the individual stakers. 

Some PoS blockchains have added a degree of randomization into the process so that older and larger stakes do not always win. So, in PoS, miners are replaced with stake pools where people stake their coins. Individuals can "stake," or place their coins with various stake pools, just the same as miners joining a mining pool to earn more rewards. 

Where Can I Stake My Ethereum?

Ethereum 2.0 is obviously not out quite yet, but some services do allow Ethereum holders to stake their holdings on the testnet now. It's important to first understand that staking your ETH will lock them in place until the full release of Ethereum 2.0. Your Ether will of course earn staking rewards while it is locked, but stakers can not remove their ETH from the stake pool.

Staking to Ethereum's testnet through a stake pool is a bit tricky and comes with a good deal of risk. For that reason, it's best left for the more technically advanced. For those that wish to take an easier more hands-off approach, staking on an exchange is probably best. Some of the exchanges that allow Ethereum holders to stake right now include Kraken, Coinbase, Binance and more. Staking on an exchange does include higher fees, with most exchanges charging 15% of staking rewards or more.

How It Scales

Ethereum 2.0 plans to scale its capacity by using a method called sharding. This is a common technique among a number of newer PoS cryptocurrencies as it allows them to scale without major sacrifices to security and decentralization.

Sharding is a way to partition a database into smaller pieces that are more manageable. With a PoW blockchain, most nodes, or computers in the network, have an entire copy of the history of transactions. This entire history can take up a lot of space, especially for older cryptocurrencies with a long history of transactions.

With sharding, the blockchain is cut up into parallel sections, and nodes are assigned to one section instead of having to hold the entirety of the chain's data. This allows more transactions to be processed simultaneously, greatly increasing throughput and transaction speed.

What Does This Mean For DeFi?

Should ETH 2.0 prove successful, it will have a drastic effect on the current bottlenecks that slow it down now. Ethereum has a massive decentralized financial ecosystem, but most of it is nearly unusable as it is too slow and congested. This congestion can cause transaction fees to be larger than the amount of money the user is trying to move in the first place.

In Ethereum's current state, only those with larger holdings can make use of the benefits of its ecosystem. At the time of writing, swapping cryptos on Uniswap, a decentralized exchange and liquidity provider on Ethereum's network, costs nearly $150. This makes sending a few dollars or trading small amounts of money impossible.

The fees to make transactions are so high because they are controlled by miners, creating a rather large conflict of interest. With PoS, these issues will essentially no longer exist. 

Right now, Ethereum can only handle around 30 transactions per second. Vitalik Buterin, one of the founders of Ethereum, has alleged that 2.0 may eventually scale to as many as 100,000 transactions per second using sharding and other tactics. 

"ETH2 scaling for data will be available *before* ETH2 scaling for general computation. This implies that rollups will be the dominant scaling paradigm for at least a couple of years: first ~2-3k TPS with eth1 as data layer, then ~100k TPS with eth2 (phase 1). Adjust accordingly," Buterin said in a 2020 tweet. 

When Will Ethereum 2.0 Be Released?

The upgrade to Ethereum has been happening in phases. The first phase, "phase 0," is already live. Phase 0 introduces the beacon chain

The beacon chain is essentially a new PoS blockchain that Ethereum's current chain will eventually merge with. The beacon chain introduces PoS and sets Ethereum up for staking and shard chains and is sort of a testnet for the future PoS version of the ethereum. 

The second phase, or "phase 1," is called the merge. The merge represents the official switch to the PoS consensus model where the existing Ethereum network will merge with the beacon chain. 

Ethereum developers also refer to the merge as "the docking" and expect this to take place sometime in late 2021 or 2022. After the merge, Ethereum will be a PoS blockchain that allows Ethereum holders to stake their ether and earn rewards. 

It's important to note that Ethereum holders do not need to do anything while Ethereum goes through this merge phase. This process will be automatic.

The third phase, "phase 2," actually implements sharding so that Ethereum can scale and allow for a higher transaction capacity. Shard chains are expected to be enabled sometime in 2022 after the merge. 

Will This Effect Ethereum's Price?

Many have speculated that Ethereum's upgrade could be followed by an increase in its price. This is mainly due to the fact that Ethereum and its DeFi network will become far more practical to the average person that may not have a lot of money.

Fees to make transactions on Ethereum will likely drop to a point that allows users to move smaller amounts of value. Right now, only those with more money can take the immense transaction fees. 

Those who stand to benefit the most from Ethereum's upgrade are those who do not have access to the modern banking system that exists today. 

These people include third-world citizens, refugees and the nearly 2 billion individuals that do not have access to modern financial products like bank or investment accounts. 

Many people live in nations without the infrastructure to provide identification to their citizens, without which you cannot get a bank account or use any modern payment apps. Ethereum's decentralized financial ecosystem allows these types of people to access financial accounts, loans, investment opportunities and more.

With low fees and a lowered barrier to entry, DeFi has the potential to grow significantly, and Ethereum's price along with it. That, of course, all depends on the success of Ethereum 2.0.