What is Ethereum 2.0 & ETH 2.0 Staking

The advent of the Ethereum blockchain expanded the scope and use cases of blockchain technology far beyond the peer-to-peer payment system created by Bitcoin. It promised decentralization on a much larger scale.

Ethereum is an open-source blockchain platform where developers can build applications that do not rely on a centralized entity or server. The thousands of applications so far built on top of the Ethereum network have created an internet of autonomous applications that no central entity or government can restrict or ban.

Ethereum launched in 2015 with the proof-of-work (PoW) consensus protocol and was dubbed Ethereum 1.0. Since its launch, the most talked-about milestone listed on the Ethereum roadmap was its transition to Ethereum 2.0. With this, the network will switch from the proof-of-work to the proof-of-stake (PoS) protocol.

The Ethereum update has always been considered significant for security and scalability reasons and has been long anticipated by the community. And now that the transition to Ethereum 2.0 is around the corner, it is the best time to learn about Ethereum 2.0 and what the entails.

Before we delve into Ethereum 2.0, we must understand the difference between PoW and PoS consensus protocols.

Proof-of-work is a consensus protocol or algorithm used by blockchain networks like Ethereum to confirm legitimate transactions and discard illegitimate ones. To achieve that in a decentralized network, multiple network validators, commonly called miners, compete to solve complex cryptographic problems that prove the legitimacy of the transactions.

Once a validator authenticates a transaction, it is processed and recorded on the blockchain. The validator first solves the puzzle and receives freshly mined cryptocurrencies as a reward for their contribution to operating the network.

The puzzle, however, is extremely difficult to solve and validators utilize high computing power devices to run millions of possible solutions per second to guess the one right answer. This makes PoW energy-intensive. A general comparison of the electricity consumption in PoW protocols will give a clearer idea about the protocol’s inefficiency:

• One block of Bitcoin transactions utilizes electrical energy equivalent to that used by an average U.S. household in almost 24 days.
• A block of Ethereum transaction consumes electricity equivalent to that used by a U.S. household in one day.

As a replacement for mining, Proof-of-Stake relies on the process of minting. The validators of a PoS protocol need to stake the native currency of the blockchain. The PoS blockchain then chooses a validator to propose a new block of transactions depending on the amount a validator has staked and the time for which they’ve staked that amount.

The amount and time are used as a metric by the network to decide how trustworthy a validator is to propose a block without any bias. Once a validator proposes a new block of transactions, other validators on the network must affirm the block to add it to the blockchain.

By using this process, PoS makes blockchains far more energy-efficient compared to PoW blockchains. This is one of the main reasons for the Ethereum update expected to begin in 2020.

As the Ethereum team defines it, Ethereum 2.0 or Eth2 will be exactly the same on the surface as the current Ethereum network. The major changes will be on the backend.

Ethereum 2.0 will use the proof-of-stake protocol instead of proof-of-work. The new version of the Ethereum blockchain is expected to make the 1,000s of times faster, extremely energy efficient, and more secure.

The transition of Ethereum to Ethereum 2.0 will happen in four phases, starting in 2020 and continuing beyond 2021. Here are the reasons Ethereum is switching from the PoW to the PoS protocol:

• As already discussed, the PoW protocol used in Ethereum is energy-intensive and is not a sustainable means to operate the network for a long time. The use of PoS in Ethereum 2.0 will make the network operation more efficient and sustainable.
• Even with such high energy consumption, PoW protocols are slow. Ethereum can currently process only up to 15 transactions per second. To put that into perspective, the largest payment processor Visa processes almost 1,500 transactions per second on an average. It can handle more than 24,000 of them every second.
• Ethereum 2.0, with the PoS protocol and a process called sharding, will untether extreme levels of scalability for the network. It is expected that 2.0 will be able to process as many as 100,000 transactions per second; if only there ever is a need for that many transactions.

The full-fledged launch of Ethereum 2.0 is supposed to happen over the course of a year or more and is subdivided into four phases:

• Phase 0 (2020): Phase 0 will launch only the beacon chain. The beacon chain is a new blockchain at the core of Eth2 that will keep the new and old versions of the Ethereum network in sync. The primary use of this chain is to ensure that the data on all shard chains (explained next) is up to date.
• Phase 1 (2021):  In this phase, the network will add shard chains. Shard, as the word suggests, is a small portion of something. To that note, shard chains will be a part of Eth2,  and they will take and process small portions of the total transactions sent to the Ethereum network. This will render high speed and scalability to Ethereum. In this phase, Ethereum developers plan to add 64 shard chains.
• Phase 1.5 (2021): Until this phase, the Ethereum mainnet, or the older version of Ethereum, will still be using the proof-of-work protocol. Phase 1.5 will convert the Ethereum mainnet into a shard chain that will use the proof-of-stake protocol.
• Phase 2 (after 2021): This will be the final phase of the Eth2 rollout and following this, all shards will be fully functional chains with support for smart contracts.

Now that the Ethereum network is switching from proof-of-work to proof-of-stake protocol, validators will no longer need to use high computing hardware to mine on Ethereum. Instead, users will have to stake the network’s native cryptocurrency Ether (ETH), also very often called Ethereum, to become a network validator.

In simple terms, Ethereum 2.0 staking is a better, faster, and more efficient way of validating transactions on the Ethereum network and earning rewards for doing so.

According to the sharding proposal of Ethereum, Ethereum 2.0 will require network participants to lock a minimum of 32 ETH (~CA$16400 on Oct. 31, 2020) in order to become an Ethereum validator. The locking period for the staked ETH varies between three to 12 months. To do that, the stakers will first have to move their ETH tokens from Ethereum 1.0 to Ethereum 2.0. This is because the older version of the network will still operate with PoW protocol until the phase 2 rollout.

Once a user stakes 32 ETH, they can run an Eth2 node on their usual computer system. They must then remain online most of the time to increase their chances of proposing a new block and getting ETH rewards. To ensure most validators remain online to support the network transactions, Ethereum 2.0 will offer negative rewards, or penalties, to validators who go offline.

The network also has a mechanism called “slashing” that will levy a fine of more than 1/32th of the validator’s total stake in case they commit malicious activity on the network. In that case, Ethereum will also push the validator out of the network.

As per the set schedule, Ethereum 2.0 should allow staking ETH before the end of 2020. That is, users will be able to stake ETH upon the rollout of the beacon chain, or phase 0. At present, one may also get a hang of Ethereum 2.0 staking by participating in the Ethereum 2.0 testnet, Medalla.

The 32 ETH threshold to become a validator on the Ethereum network is out of the league for many individuals. But in that case, staking pools come to the rescue of people who still want to participate in Ethereum staking.

Staking pools are services that act as a common system where multiple individuals can lock smaller funds to reach the minimum threshold of 32 ETH. They can then collectively act as one node for the Ethereum network to propose new blocks and earn ETH rewards. The rewards collected through their contribution are divided among all participants of a pool in proportion to their staked amount.

Cryptocurrencies including Ether are volatile assets. The biggest risk with locking ETH to become a validator is that the total value of the ETH holdings may decline in case the price of ETH starts to fall.

What makes it even riskier is the fact that the transfer of ETH from Ethereum 1.0 to Ethereum 2.0 will be one-way until the completion of phase 2. And as Ethereum 2.0 will likely remain almost unusable for a long time before the shard chains are fully functional, the staked ETH can be used for nothing except staking. There may also be a lack of liquidity of ETH on Ethereum 2.0, which means users may not be able to liquidate their holdings in case the ETH price goes south.

Those staking through liquidity pools will face the risk of centralization. As there’s a great chance that centralized entities will operate these pools, there will be a risk of hacks and the funds being stolen. Users who choose to stake through staking pools must be well aware of such threats and carefully analyze the staking pools before taking the leap.

As it stands, Ethereum 1.0 will stick around for the coming few years. However the transition towards an improved version of the world’s most widely used blockchain network will begin in 2020. It is still hard to predict when the Ethereum 2.0 rollout will conclude, but we are surely headed for exciting times in the world of decentralized internet and applications.

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