Ethereum 2.0: Effects on Users, DApps, DeFi, and Markets

Ethereum (ETH), recognized as the second-largest cryptocurrency by market capitalization, is set to unveil its highly anticipated ETH 2.0 upgrade in the latter half of 2020. This upgrade represents a significant transformation for the blockchain network as it transitions from a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) system, aiming to enhance scalability and introduce innovative features.

Overview of the Upgrade

·  Commonly referred to as Serenity, the ETH 2.0 upgrade was initially revealed during a speech by Ethereum co-founder Vitalik Buterin at the 2018 Devcon conference.

·  The upgrade consists of four phases (Phase 0 through Phase 3).

o  Phase 0 was intended for launch in 2019.

o  Phase 3 was projected to conclude by 2022.

·  The timeline has faced several delays, primarily due to alterations in the governance structure of the core development team.

Current Developments

·  Recently, Buterin indicated that Q3 2020 might be a viable timeframe for the launch.

·  OKX Insights is evaluating the implications of the shift to PoS, the introduction of staking, and the overall effects of the upgrade on existing ecosystems, including Decentralized Finance (DeFi) and Decentralized Applications (DApps).

This transition to Ethereum 2.0 is expected to significantly influence the landscape of cryptocurrency, enhancing user experience and expanding the capabilities of the Ethereum network.

PoW vs PoS: Energy Savings at Stake

Ethereum's choice to alter its consensus mechanism has reignited the ongoing debate between supporters of Proof-of-Work (PoW) and Proof-of-Stake (PoS). PoW is the original consensus model for blockchain, as outlined by Satoshi Nakamoto in the Bitcoin whitepaper. This method necessitates "miners" to verify transactions and generate new blocks using substantial computing power.

Challenges of Proof-of-Work

·  As competition intensifies and the complexity of mining new bitcoins increases, the demand for computing power also escalates.

·  This escalation results in high energy consumption and raises significant environmental concerns.

·  According to the Bitcoin Energy Consumption Index, the estimated annual energy consumption of Bitcoin is 58.6 TWh.

o  If Bitcoin were a country, it would rank 48th globally in energy consumption, surpassing nations like Bangladesh and Romania.

Emergence of Proof-of-Stake

Due to the growing concerns surrounding Bitcoin's energy usage, alternative consensus mechanisms have gained traction, including PoS. This protocol eliminates the need for extensive computing power, thereby conserving energy, and substitutes miners with "validators" who verify transactions and generate new blocks.

Perspectives on Ethereum's Upgrade

Jehan Chu, founder of the Ethereum Hong Kong community and co-founder of Kenetic Capital, highlighted the energy savings as a significant advantage of Ethereum's forthcoming upgrade:

“With the upgrade to Proof of Stake, ethereum holders will be able to more directly participate in and benefit from maintaining the network by staking (a minimum of 32 eth) rather than running complicated hardware and burning electricity.”

Chu also expressed skepticism about Bitcoin’s ability to transition to PoS, despite its potential environmental benefits:

“While Ethereum’s move to POS is a strong signal for the industry, it is unlikely that Bitcoin will ever move to POS due to its sheer size, value, and governance model. This makes Bitcoin’s success bittersweet as the environmental impact will only worsen as Bitcoin gains value.”

While the transition to PoS is expected to yield a positive environmental impact, it will also bring about various changes and new challenges for users and developers within the Ethereum ecosystem.

Migration from ETH 1.0 to ETH 2.0: What to Expect for Your ETH

For those curious about the transition from the current Ethereum blockchain to the ETH 2.0 chain, it involves two main stages: the transfer of users' ETH and the status transition of the Ethereum blockchain.

Migration Process

1.  Phase 0 Launch:

·  The migration begins with the first stage of the ETH 2.0 upgrade, known as Phase 0, which introduces the Beacon Chain—the new Proof-of-Stake (PoS) blockchain for Ethereum.

2.  One-Way Bridge Mechanism:

·  Users will lock their ETH on the current Ethereum blockchain into a contract.

·  In return, they will receive the same amount of ETH on the Beacon Chain.

3.  Staking on ETH 2.0:

·  Users with more than 32 ETH can stake their credited ether and start earning rewards on the ETH 2.0 chain.

·  The transfer to ETH 2.0 is a one-way transaction, meaning the original ETH on the Ethereum blockchain will be burned.

Risks and Considerations

·  Lock-Up Risk:

-  The non-reversible nature of the transaction introduces a "lock-up risk," where users staking their ETH cannot sell it for a specific period. This could be problematic if the price of ETH drops during that time.

·  Future Developments:

-  ETH 2.0 lead developer Danny Ryan mentioned that there is interest in creating a two-way bridge, but this proposal will be evaluated later. Developers aim to make the transition as seamless as possible for ETH holders.

State Transition: Migrating Data from ETH 1.0 to 2.0

·  Definition:

-  The state transition involves moving existing blockchain data to the new architecture.

·  Initial Plans:

-  The original plan was to transfer the ETH 1.0 chain to a "shard" on the ETH 2.0 chain. However, challenges arose, which are now being addressed in a new proposal by **Vitalik Buterin**.

·  Current Status:

-  Ryan indicated that Buterin's new proposal has support from core developers and is likely to be implemented soon.

Despite the migration challenges, the ETH 2.0 upgrade is set to enhance support for staking and scalability, which could significantly impact existing ecosystems that rely on the Ethereum network, such as decentralized finance (DeFi) and decentralized applications (DApps).

Staking Support for ETH Holders

Staking is set to replace mining in Proof-of-Stake (PoS) networks, where validators lock up their coins to earn rewards for maintaining the blockchain ledger. These rewards function similarly to interest accrued on bank deposits, positioning staking as a prominent passive income opportunity within the cryptocurrency landscape.

Staking Participation Insights

The Ethereum 2.0 Staking Ecosystem Report by ConsenSys outlines that ETH holders can participate in staking by either:

·  Running their own validator nodes.

·  Utilizing third-party staking providers.

The report also highlights survey findings from 287 respondents:

·  32.8% plan to run their own validator nodes.

·  33.1% intend to use a third-party staking provider.

Expected Returns

According to the report, participants who stake their ETH by operating validator nodes can anticipate an average return of 5.8%. In contrast, those opting for third-party providers can expect a higher average reward of 7.6%.

Potential Validator Insights

As of May 5, 2020, data from Glassnode indicates there are 114,550 Ethereum addresses holding at least 32 ETH, the minimum required to become a validator and earn rewards. This number provides insight into the potential pool of validators for ETH 2.0.

Encouraging Wider Participation

Ethereum’s staking support is anticipated to foster greater network participation in comparison to the mining model of the previous version. Charles d’Haussy from ConsenSys shared insights on these incentives:

“For people who hold ETH, Proof of Stake marks a more inclusive way to maintain the security of the ETH 2.0 network, along with comparatively high rewards for contributing to the security costs…platforms like exchanges, funds, and wallets offering staking will be a great way to contribute and benefit from ETH 2.0.”

Jehan Chu from Kenetic Capital emphasized the accessibility of third-party solutions that simplify the staking process:

“A high technical bar prevented many users from participating in the network but companies supporting ETH 2.0 with turnkey solutions like Alchemy or Blockdaemon (and eventually your favorite exchanges), make staking as quick and easy as signing up for an email address. This is critical in securing the network with a massive, diverse and decentralized validator group to guarantee security and resilience for the next 100 years and more!”

DeFi Solutions Becoming More Competitive

Decentralized Finance (DeFi) holds a significant position in the Ethereum ecosystem, representing 60% of the total value of Ethereum DApps as of May 2020. At that time, over 2.5 million ETH (valued at over $600 million) were locked in DeFi DApps, and this figure is anticipated to rise as users increasingly seek alternatives to traditional financial services.

Challenges of Scalability

Despite its growth, scalability continues to be a major hurdle for decentralized finance applications compared to traditional systems. For instance, the Visa network can process thousands of transactions per second (tps), while the Ethereum network is currently limited to less than 50 tps at its peak.

The Promise of ETH 2.0

The ETH 2.0 upgrade aims to address these scalability issues through technological advancements such as sharding. This implementation is expected to significantly enhance the number of transactions processed per second on the network, potentially aligning DeFi applications with the efficiency of traditional financial solutions.

DApps to Benefit from Scalability and New Opportunities

In the realm of Decentralized Applications (DApps), data from Dapp.com reveals that Ethereum continues to dominate, boasting a 71% market share in daily trading volumes, while its main competitor, EOS, holds merely 24%.

Jon Jordon, director of communications at DappRadar, considers the transition to ETH 2.0 a significant milestone for developers in the DApp ecosystem. He stated:

“In some regard, users shouldn’t really care about ETH 2.0. For example, they shouldn’t have to do anything different. The scalability that comes with Eth 2.0 will enable developers to create much more interesting and fluid DAppsapps [sic] however, which is something to be excited about.”

Jordon believes that all types of DApps will benefit from the ETH 2.0 upgrade, emphasizing that this scalability will pave the way for new kinds of applications:

“Any DApp that requires faster transactions will benefit; gaming is definitely high on the list. But what I think is the most exciting is the opportunity for new types of DApps we haven’t yet seen on Ethereum but we do see in the normal Web 2.0 world such as social DApps.”

A critical change in ETH 2.0 is the elimination of the “gas” fee, which could further enhance DApp usage. Gas fees are the costs associated with executing transactions on the Ethereum network. As the network gained traction, there were times when rising gas fees led to a decline in DApp usage, particularly due to the increasing demand for the Ethereum-based stablecoin Tether (USDT), which often caused network congestion.

When discussing the impact of gas fees on gaming DApps, Jordon remarked:

“Higher gas prices generally reduce user activity because it costs more to get a transaction validated. However, this impacts different categories of DApps differently. For users moving around large amounts of value – say +$1,000 – in DeFi or exchange dapps, the fact the gas price has increased by a couple of dollars isn’t a big factor.

For games and other dapps where transaction value is much smaller, the gas price might be higher. It makes no sense to spend $5 on a $2 transaction so usage drops. In ETH 2.0 there is no gas fee as it uses a proof of stake consensus.”

Markets Preparing for ETH 2.0

As the launch of ETH 2.0 approaches, there is a notable increase in market interest regarding Ether Options. Options are derivative products that grant holders the right, but not the obligation, to buy or sell an asset— in this case, ETH— at a predetermined price before a specified date.

Recent data from Skew indicates that the Open Interest in ETH options has reached a new all-time high of $151 million, signaling a significant influx of new capital into the market. The primary exchanges facilitating ETH options trading are Deribit and OKX, and the rising open interest may be interpreted as a bullish indicator for Ethereum.

Experts Anticipate Multiple Benefits from the ETH Upgrade

The ETH 2.0 upgrade is designed to enhance scalability within the Ethereum network while improving security without compromising the historical integrity of transactions.

According to industry experts:

“ETH 2.0 will primarily benefit the scalability, throughput, and security of the Ethereum public mainnet. ETH 2.0 will not eliminate any of the data history, transaction records, or asset ownership of the ETH 1.0 chain.”

D’Haussy emphasized that ETH 2.0 has the potential to broaden the scope of decentralized applications (DApps):

“Ethereum remains the best candidate to serve the function of being the lowest-level common frame of reference for distributed systems. Eth2 will further extend the range of applications that can be served.”

In addition, Chu from Kenetic Capital believes that the new economic model introduced by ETH 2.0 could create a “virtuous cycle of ecosystem value and growth”:

“ETH 2.0 changes the economic model by creating easier access to participate in the network, reducing environmental impact, and directly incentivizing long-term staking of the token to support the network.

This lockup combined with increasing utility of ether to power generations of dapps creates strong propositions for value accrual in the token itself, and hopefully leads to a virtuous cycle of ecosystem value and growth.”

Lennix Lai, Director of Financial Markets at OKX, commented on the anticipated impact of ETH 2.0 on market sentiment:

“The upcoming ETH 2.0 [upgrade] shall encourage more people to stake ETH and ultimately benefit the sentiments of the crypto market as a whole.”

Given Ethereum’s dominant role in the crypto landscape, any changes or upgrades it undergoes can significantly influence development trends and market sentiments. Furthermore, due to the rapid pace of the tech industry—especially in the realm of cryptocurrency—regular upgrades are essential for maintaining a competitive edge, even for industry leaders. While there is considerable excitement surrounding the release of ETH 2.0, its actual impact over the next few years will foster intriguing discussions, provided it launches as scheduled this time.