October 8

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What is Ethereum 2.0? Understanding the Merge

Ilir Salihi

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Changes are coming to the Ethereum mainnet, and not everybody is loving it. You might have a difficult time finding out just how many opponents there are to the now-completed Ethereum merge. 

It almost seems like it's something we're not allowed to talk about... Ethereum 2.0 is not only the most controversial update in the project history, but it's also the most contentious one. It's the update that essentially created two sides: those who will, for whatever reason, support Ethereum no matter what and those who need to take a step back and rethink their allegiances.

We'll start by going over the changes that Ethereum 2.0 is meant to bring in that are "acceptable to everyone", or rather, have few or no opponents. Then we'll progressively move onto the bad stuff and the issues with the full implementation of the beacon chain, as that will take a considerable amount of space.

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Ethereum 2.0: A tale of Bitcoin's shadow?

Whatever one wants to argue the reason for the change from proof-of-work, or PoW, to proof-of-stake, or PoS, is, there's no denying that Ethereum wants to grow. It was always an ambitious project, constantly trailing Bitcoin as the second most popular cryptocurrency in terms of market cap, name value and everything else on the list.

Ethereum has always had the spectre of Bitcoin surrounding it. However much Vitalik Buterin's team tried, the Ethereum Foundation could never quite take Bitcoin's place. Ethereum itself is supposed to be an upgrade to Bitcoin: faster, more secure, more versatile.

But as prices can tell you, not everyone is buying the hype. Bitcoin, despite having sluggish transactions compared to Ethereum, high fees and little utility, is still the top crypto by far.

The somewhat forceful nature of the Ethereum 2.0 change underscores why Bitcoin is unlikely to move from this position. While there has been a hard fork in the form of Bitcoin Cash, BTC holders generally don't wake up to someone telling them: "Hey, we're going to do this with your investment. If you don't like it, tough."

That's not the case with ETH. Whereas Bitcoin is a truly decentralized project, Ethereum is a centralized one. It's centrally issued, and no amount of good intentions can bolster its appeal compared to the front-runner.

As we get into the nitty-gritty of the arguments against Ethereum 2.0, we'll essentially explain why Bitcoin still enjoys a lot more popularity than ETH despite seemingly being an inferior token. Not only that, but we don't expect this to change. Before that, though, we promised we'd go over the good sides.

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What improvements come with Ethereum 2.0?

As mentioned, Ethereum wants to grow, and growth means scaling. It has long moved past being a token with its own network. Its network is now the base for many popular tokens, though some are understandably trying to move on to having their own.

This popularity has also given room to a number of competing tokens, with Cardano and Solana being perhaps the most notable examples. These two have made it fairly clear that they want to be "Ethereum killers."

In other words, they want projects moved from the ERC-20 network to their own. While this is still a long way off, it's undoubtedly something that Buterin and his team have on their radar. You don't want your project falling off.

An easy way for that to happen is for the network to become slower or have higher fees, which has happened as Ethereum started seeing more and more uses. So scalability became an even bigger priority.

Instead of paying miners to validate transactions, Ethereum 2.0 will now be paying stakers. This will lessen fees and supposedly make the network go from handling around 30 transactions a second to handling 100,000 a second. The latter figure isn't quite here yet, but just that they're outlining it shows you they're aiming pretty high.

Token burning, or making sure you can't print ETH

The Ethereum ecosystem also has a problem of inflation, as it doesn't have a fixed supply. Ethereum 2.0 also introduces token burning which should considerably increase its value over the long-term. Providing it keeps up in popularity, that is.

This is probably the least contentious part of what is referred to as the Ethereum 2.0 upgrade. Having inflationary tokens is something nobody wants. Cryptocurrencies were essentially created to combat inflation.

Bitcoin's whitepaper goes to some lengths about how central banks are abusing their position with ill-conceived monetary policies. It probably hasn't escaped the Ethereum Foundation that centralization is another top issue of fiat currencies that crypto is meant to battle, but…

To avoid having a token that eerily resembles free-to-print fiat currencies, the Ethereum Foundation is going to gradually introduce token burning to the network. It's not nearly as good as having a fixed supply, of course. 

You can't wiggle your way around a fixed supply. But it is a remedy to fix what has undoubtedly been one of Ethereum's primary issues.

Ethereum 2.0: More energy efficient?

The shift to PoS also promises to lower gas fees and make Ethereum 2.0 much more energy efficient. Developers claim that staking is 2,000 times more efficient than mining, and the upgrade should reduce energy consumption on the Ethereum network by 99.5%. 

A greener Ethereum network is an important upgrade for many, including investors, crypto enthusiasts , gamers, and even NFT artists concerned about the environmental impact cryptocurrencies have on the planet.

Related: What is a Crypto IRA? How to Diversify Your 401(k) with Cryptocurrencies

The move from PoW to PoS: the division starts

On the front of it, the move is a simple one. Until now, Ethereum was obtained by solving complex mathematical puzzles, a process referred to as "mining" in the crypto sphere.

The computers in the network would receive rewards for their computing power in the form of tokens. It was a system very similar to Bitcoin, which gave Ethereum many of the benefits and much of the appeal that Bitcoin had.

One day, the Ethereum Foundation said: no more PoW. As drastic as it sounds, they chose to do away with miners completely. Miners in Ethereum 2.0 are replaced by stakers: staking 32 or more Ethereum makes you a network validator, though there are some plans to make lesser staking possible as well.

As soon as it was announced, this "upgrade" was met with as much criticism as you can conceive and then some. It's probably best to split the major issues and cover them individually, because there's plenty to be said about each. 

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PoS issue #1: Ethereum is a rich people's game now

While you might argue that you needed good computer hardware and enough electricity to mine Ethereum, things weren't nearly as industrialized as in the case of Bitcoin. Until fairly recently, anyone could become a validator on the network by investing in computer hardware. This means individuals instead of companies, and not necessarily particularly wealthy individuals.

Let's just go over the numbers quickly to give you an idea. 32 is the minimum amount of Ethereum necessary to stake to become a validator. Even after its post-merge drop, that amounts to roughly $40,000 that one needs to have to spare.

That's a whole lot more than a good computer rig or two goes for. Of course, suggesting that having 32 staked ETH is going to give you equal say as someone with 32,000 is naive.

From the moment it was mentioned, Buterin's team made it clear that they want to draw in institutional money. They want big names in finance to buy a lot of Ethereum and become network validators.

The more you stake, the bigger your say in the current Ethereum network. While this is true for quite a few other cryptocurrencies, there are notable differences: they are neither as popular nor did they smack their users with PoS out of nowhere. It's these differences that have caused as much conflict as they did in the Ethereum community.

Having big names in finance dictate what a cryptocurrency network will do is kind of antithetical to cryptocurrencies. It's going to put off many who would otherwise buy them precisely to move away from a monetary system that is designed from the ground up to benefit the wealthy. 

It's also exclusionary in nature. With what looks like a straightforward change, Ethereum went from being a people's cryptocurrency to being a rich person's one. The power has been taken away from individual miners and placed into the hands of portfolio managers, large funds and the like. This partly, though not wholly, gives way to the second issue on our list.

Related: Who is Satoshi Nakamoto?

PoS issue #2: Centralization and privacy

Have you ever heard about the projects that run on the existing Ethereum blockchain? They're called decentralized apps, or dApps. Notice the word "decentralized" there? Well, that pretty much goes out the window once you've introduced a PoS system. Sure, the PoW network is slower, but that's because it has many independent validators powering it. The speed of the PoS network comes at expenses that make transaction fees a non-factor.

It's not without coincidence that we started hearing some pretty bizarre things related to Ethereum right around the time PoS was being rolled out. We had the U.S. government sanction Tornado Cash purely because it's private.

We're hearing the Securities and Exchange Commission say that they will have authority over the Ethereum network if the nodes are localized enough to the U.S. and treat it like an exchange. Sounds a little too tight for comfort yet?

It's not really the concern of the end user, whoever that might be, that Ethereum is going to face stiffer regulation prospects as it grows and expands.

It's up to Buterin and his team to figure out a way to maintain the project private and secure for users as development continues. And doesn't that effort have all the makings of failure from where we're standing?

We're being told that Ethereum's network, with a PoS system implementing shard chains, is going to be more resilient to attacks. Does that include things like privacy violations or exertions of force by third-party entities that are supposedly doing it "lawfully"?

Related: Start Buying Cryptocurrencies Like Bitcoin and Ethereum 2.0 (ETH2) Today

Ethereum 2.0

Is Ethereum 2.0 an upgrade?

PoS issue #3: The mine is closed, folks

If you're an Ethereum miner, there's a good chance you don't care about scalability or smart contracts. You might not even care about the project itself, really. All you care about is being able to mine it and get rewards. And with PoW eliminated, you can no longer do that. You have to move your mining efforts to another project.

So PoS has spiked interest among institutional investors because they can buy a lot of Ethereum and stake it for profit and network influence. And it has, on the opposite side, killed interest among anyone who would obtain mining rewards. Institutional investors bring money, but miners bring diversity, decentralization and a lot more that is now gone.

Ethereum Classic has served as an alternative to Ethereum that was introduced the moment it became clear that Buterin's team wasn't going to adhere to the project's initial principles.

ETHPoW is a more recent and dubious take. Both are hard forks of Ethereum that tell us there was a point in the project's history when a significant part of users couldn't agree with what the Ethereum Foundation mapped.

Bitcoin has its forks, too, but Bitcoin hasn't deviated close to the extreme that Ethereum has from its founding principles. In reality, most of its forks are the result of someone wanting to make money off of a new project. In the case of Ethereum, both of the aforementioned forks really do have a plausible reason for existence. And that in itself is problematic.

Related: Why is Crypto Crashing? Inside Look at Why Crypto Market is Down

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Where is Ethereum headed?

The Ethereum 2.0 update is one that the Ethereum Foundation admits could take years to fully implement. But already, we're getting hints of what Ethereum will look like down the line. More and more, it's going to become a token and a network of big players and even governments. There isn't much one can say to deny that reality.

The very same thing keeping Bitcoin above Ethereum perpetually despite its seeming utilitarian faults is the very same thing that is likely to keep Ethereum above other, perhaps better, projects.

Despite essentially betraying the trust of a massive part of its userbase, it still has more trust than competing networks due to name value. That's another thing we can't seem to change, even though we might like to.

Ethereum probably won't change a lot in the meantime. But here are some guesses as to what one might expect down the line:

  • The diversity of the projects allowed to run on the Ethereum network will diminish
  • The projects will be scrutinized more, often unduly so
  • The government and other large intrusive entities will have an increasingly greater say in how the network operates
  • End user privacy will lessen, bringing on decreased network security overall

On the flip side, less vulnerability to attacks and price appreciation are generally expected by most. Still, those are some pretty massive negative sides to go along with the positive ones.

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Is PoS the future of cryptocurrencies?

Over the past few years, staking has undoubtedly become one of the main buzzwords in the crypto sphere. There are benefits to staking, of course. Crypto is known for volatility, which brings on massive gains but also losses. 

What staking does is introduce a ground floor: with so many people having their tokens locked, the price can only fall so far. From this point of view, mass selling can be seen as a form of attack on the network, and having the network rely on stakers does indeed make it secure from this. 

Staking is becoming popular with exchanges, too. The rewards aren't great yet, but they might already outstrip those of bonds. You heard that right: perhaps the riskiest asset class is giving better safe returns than one of the supposed havens.

Again, total project collapse is the primary roadblock here, which is why name value is so important. It gives faith in a project much like faith in a government is necessary to hold its debt. 

That's why a lot of PoS projects are taking the slow and steady road towards establishing themselves as Ethereum's rival, though many focus on other things, such as lending. Whatever their purpose, though, it's clear that they want to have some years of smooth operation under their belt in order to attract stakers.

Related: Gold Vs Bitcoin - Which is a Better Investment?

Prediction: PoS is to remain just one facet of the cryptocurrency market

The cryptocurrency market is so broad that it has many different asset types in itself, which is one of the reasons we like it. The bond market is, well, bonds. You can say there are good bonds and bad bonds, but they all do the same thing. 

For all the detracting we've heard regarding cryptocurrencies, nobody has been able to place their utility into question yet. However detractors want to spin it, they have to admit that cryptocurrencies already serve as multiple financial instruments:

  1. A method of facilitating financial transactions without an alternative
  2. An asset to speculate over in both the short and long-term
  3. A reward for network operators, whether they come in the form of miners or stakers

This is, of course, not taking into account all of the promises that every crypto project makes. These promises may or may not materialize, but the underlying case for cryptocurrencies remains the same, and it's very much immobile. 

As we understand that, we can only hope that PoS, exchanges aside, becomes a cornerstone of only a part of crypto projects. Others will utilize a different consensus mechanism, making way for the colorful market we have today, though no doubt with plenty of innovations down the line.

Ethereum's case is pretty straightforward, too. You are either down with wherever Buterin's taken the project or have already turned to alternatives. In a sense, Ethereum's contentious move has brought to the forefront one of the best things about the crypto market, and that's having options.

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About the Author

Ilir writes about personal finance, entrepreneurship, and digital marketing. When he's not creating content online, he's spending time with his family in Washington, DC.

Ilir Salihi


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