What is Ethereum 2.0?


Ethereum 2.0

At the “Ethereum (ETH) Shanghai Web 3.0 Developer Summit” in late May 2022, Ethereum co-founder Vitalik Buterin said that the merging of two blockchains (“the merge”) will be completed this summer.
The upgrade will move Ethereum from a so-called proof-of-work model to a proof-of-stake consensus mechanism. “If there are no problems, the merge will take place in August,” Buterin said.

What is Ethereum (ETH) 2.0?

Ethereum 2.0 is a new version of the Ethereum blockchain that uses a proof-of-stake consensus mechanism to verify transactions. Users indicate how much cryptocurrency they are willing to stake in order to verify crypto transactions. The English “stake” means stake.

Ethereum 2.0’s staking mechanism will replace the proof-of-work model, in which miners of cryptocurrencies use powerful computers to complete complex mathematical functions. The mining process requires an ever-increasing amount of power to verify Ethereum transactions before they are recorded in the public blockchain.

Proof-of-work systems consume an enormous amount of electricity. Bitcoin mining, for example, currently consumes 127 terawatt hours (TWh) of electricity annually. This is currently higher than the electricity consumption of the entire country of Norway.

ETH’s annual electricity consumption is roughly equivalent to that of Finland, resulting in a carbon footprint similar to that of Switzerland. Fortunately, the merger is expected to reduce Ethereum’s carbon footprint by up to 99.95%, eliminating one of the main criticisms of the cryptocurrency.

Ethereum vs. Ethereum 2.0: What’s the difference?

Since April 2022, Ethereum has been running two parallel blockchains, one that uses Proof of Work and a test chain that uses Proof of Stake. The merger will combine the old Ethereum Mainnet blockchain (ETH1) and the new Beacon Chain (ETH2) into a unified blockchain.

Ethereum developers recently abandoned the ETH1 and ETH2 designations because they feared they would confuse users ahead of the merger.

Some investors who own Ether, the native cryptocurrency of the Ethereum network, may have been confused by what appeared to be two versions of the coin on Coinbase and other popular cryptocurrency exchanges.

When users deploy their Ether on Coinbase, it is converted from ETH to ETH2. The prices of ETH and ETH2 are identical. Once the merger is complete, these two versions of Ether will be combined into a single token.

Ethereum 2.0 image

Ethereum moves from mining to staking

Staking is the process that will replace mining to verify Ethereum transactions once the merger is complete.

Staking requires users to stake a certain amount of cryptocurrency to participate in transaction verification. In a proof-of-stake model, an algorithm selects which validator gets to add the next block to the blockchain based on how much cryptocurrency the validator has staked.

Investors must wager at least 32 ETH to become an Ethereum validator. Currently, there are more than 300,0000 Ethereum validators. The more ETH each validator stakes, the more likely they are to produce blocks. Each time a validator produces blocks, they receive a reward in Ethereum for completing the validation tasks.

Currently, the return for wagers on Ethereum’s Beacon Chain is 4.3 to 5.4 percent of the annual interest rate.

With the Ethereum price at around $1,900 (€1,770) and a minimum requirement of 32 ETH, which equates to more than $59,000 (just over €55,000), staking can be quite costly for the average investor.

However, individual investors can also participate in staking pools, which are collections of Ethereum stakers who pool their resources and split the rewards. Most major cryptocurrency exchanges also offer staking services for investors who are unwilling or unable to invest 32 ETH on their own.

The energy problem of cryptocurrencies

Critics of Bitcoin, Ethereum, and other proof-of-work cryptocurrencies have often pointed to the massive energy costs of mining, especially on a large scale.

In recent years, screening investments based on environmental, social, and governance (ESG) standards has become increasingly popular. A recent Forbes survey found that many investors would consider investing elsewhere if they knew their investment in cryptocurrency had a negative impact on the environment.

John Warren, CEO of Bitcoin mining company GEM Mining, says there is no linear correlation between Bitcoin’s price growth and its energy consumption. Bitcoin currently has no plans to move to a proof-of-stake verification model. According to Warren, the model doesn’t make sense for Bitcoin.

“While there is certainly plenty of room for growth in the proof-of-stake ecosystem, Bitcoin is the core protocol for all cryptocurrencies and therefore needs the most robust and secure consensus model available,” Warren says.

He says the energy consumed by proof-of-work verification demonstrates the security and strength of the model.

“You can think of Bitcoin as untouchable security. The most important thing for the protocol is security, which is best provided by following the proof-of-work process,” Warren said.

Staci Warden, CEO of the Algorand Foundation, said energy consumption of a cryptocurrency is an important factor in its ability to scale effectively.

“On the supply side, a protocol can only scale to the extent that it has access to reliable energy sources with marginal costs that are lower than its marginal revenue,” Warden says.

She says subsidized or low-cost energy is necessary for proof-of-work cryptocurrencies to scale. That’s why cryptocurrency prices have come under so much pressure in 2022, she says.

“On the demand side, the scalability of a proof-of-work protocol becomes limited. That’s because the public normally isn’t necessarily willing to tolerate fossil fuel-based protocols. Instead, they prefer the growing availability of carbon-negative alternatives,” Warden says.

Ethereum vs. Bitcoin

Bitcoin and Ethereum are the two most popular cryptocurrencies, together accounting for 63.6 percent of the global crypto market capitalization.

Ethereum’s price has increased by 648 percent over the past three years; more than twice as much as Bitcoin over the same period. The BTC price increased by 250 percent.

The merger (“the merge”) makes Ethereum a more attractive investment than Bitcoin from an ESG perspective, but it does not necessarily make ETH a threat to Bitcoin as the world’s leading cryptocurrency.

Chris Kline, chief operating officer and co-founder of Bitcoin IRA, says Bitcoin and Ethereum would complement rather than compete in the crypto market.

“Bitcoin and Ethereum serve different purposes. Bitcoin is a proof-of-work, limited asset, monetary crypto, while Ethereum’s utility [is as] a Web 3.0 backbone. Both serve as critical and distinct elements of the overall digital asset ecosystem,” Kline says.

While crypto investors await the merge to Ethereum 2.0 in the summer, the next major event on the path to proof-of-stake for Ethereum will take place in June.

Ethereum is expected to complete a major “merge” test in June, using the Ropsten test network. Once the Ropsten upgrade is complete, Ethereum developers will only need to upgrade two more test networks before the main Ethereum network is merged.

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