Ethereum and its virtual machine

All in all, 2020 has seen multiple crazes that thrust ether into the spotlight. More than any other cryptocurrency, ether has wowed the world with blockchain technology.

On July 30, 2015, the genesis block on the Ethereum blockchain as we know it was mined. Back then, most users were crypto geeks, who only dreamed of the ensuing growth of ether.

However, Ethereum was created not as a currency, but as an infrastructure to house a virtual machine. Like its cousin bitcoin, ether runs on a blockchain, which uses distributed ledger technology (DLT).

In addition to sending amounts of tokens (ether, in this case), the blockchain can also execute code or store memory. In other words, it is like a big, distributed computer that anyone can use.

The way this is familiar to most is the smart contracts. Smart contracts are small pieces of code that execute when certain conditions are met. This allows for trustless transactions, which, these days, are best known to the public through decentralized finance.

The distributed technology makes it so that any one party cannot “cheat” the code. For example, when Party A sends tokens (for example, USDT) to Party B, Party B automatically sends another type of token in return (this might be an ERC-20 token with Uniswap, or a DeFi token like Compound’s cUSDT). Since many computers validate the transaction, it is hard, and perhaps impossible, for anyone to cheat. Likewise, there is no middle man.

But all this comes at a cost —  gas. Gas is the amount of ether tokens charged for a transaction to get executed on the virtual machine, and as Ethereum is by far the most popular smart contract, gas costs are getting high.

In some tragic cases, users have spent thousands of dollars in gas for a single transaction. Ethereum is slow, as it only allows approximately 35 transactions per second (tps). With DeFi rocketing the popularity of Ethereum, the system needed a scalability solution. And that solution has been in the works since 2014. 

At the time, Ethereum founder Vitalik Buterin said of the slow low transaction rate: 

“We will either solve the scalability and consensus problems or die trying.”

How will Eth2 work?

While Ethereum as it is has a proof-of-work (PoW) mining algorithm, Eth2 will use proof-of-stake (PoS) consensus. This means that mining hardware, which has become virtually unprofitable in recent years, validates most transactions.

In order to scale up Ethereum, Eth2 will use PoS. This means that individual users can lock in their ether tokens to validate blocks for rewards. Devs hope this will allow a lot more power to go behind validation, and will increase the tps Ethereum can do.

 

 

 

 

Of course, with such a large community, Eth2 has more up its sleeve. This is by way of having multiple blockchains in the ecosystem. One way to make more transactions per second is the use of shard chains. The ETH network is huge, and each validator needs to keep up with the others to be current and confirm transactions.

Sharding gets around this by creating “side chains,” which do not need to have all of Ethereum’s history behind it. Using these chains, the EVM will be more available for thousands of transactions per second, rather than tens.

 

 

But these shard chains will need to talk to each other, and for that Ethereum needs the mother of all Eth2 chains. This is the Beacon Chain, and this is the chain that produces all the buzz.

Diagram of Ethereum 2.0 Chain Source: &vert: Hsiao-Wei Wang

Another way Eth2 will scale is rollups. Rollups are a “layer 2” solution, meaning that certain transactions will be processed on different chains in order to free up space.

In a nutshell, rollups will take several transactions and “roll them up” into one, in order to allow more transactions per second. 

Furthermore, Ethereum still remains a decentralized project. These scaling improvements were made publicly and by the community, as exemplified by this tweet, openly discussing changes to the protocol:

 

 

The beacon of many chains

The Beacon Chain’s genesis block is set to be mined on Dec. 1, 2020. This will be the first real block outside of testnets to be mined, and was the first step to making Eth2 a reality.

Simply put, the Beacon Chain will make sure that all the shard chains talk to each other, and work a security protocol to make sure other chains are playing nice. Should two pieces of code need to talk to each other across shards, they will go through Beacon Chain.

Still, in order for Beacon Chain to have its consensus, it needs a while to build a history. Sharding may begin relatively soon, but the migration of Ethereum to a full PoS Ethereum 2.0 may take years.

As with the many testnets created for Eth2, developers want to make sure everything will be secure, especially with billions of dollars on the line.

In the meantime, Buterin announced the deposit contract for Eth2 on Nov. 4, 2020. ETH holders could put their tokens in the contract to be staked in the future. For enough support to warrant launch, the contract needed 524,288 ETH ($326 million, at press time) to be deposited. This threshold was met on Nov. 24, 2020, and thus the Beacon Chain could be launched.

 

 

Those who deposited may have to wait years to see a positive return (which could be up to 20 per cent APY). They will have to lock their tokens in and forfeit any potential swing trading of ETH in the meantime. The minimum amount of ETH, 32 tokens, is about $19,900, at press time.

To show his support for the project, Buterin put in 3,200 ETH, according to Trustnodes. This is about $1.9 million worth of tokens.

Allegedly, Vitalik Buterin sent 3,200 ETH to the Eth2 deposit contract. Source: Trustnodes

Why ETH?

Though there are some developers who are dedicated to certain community initiatives, some critics come from without. Why should all this happen just to extend the life of Ethereum when other already-scaled smart contract platforms exist?

For one thing, Ethereum has been around. It has a larger community, and that community has proved itself to be dedicated to an ideal of decentralized guidance. No one person, not even Buterin, makes or breaks decisions. Likewise, even with the widespread use of ETH and all the platforms it supports, the EVM code itself has not been disastrously hacked, suggesting long-term security.

 

 

At the same time, there is nothing to say that other platforms now, or in the future, cannot serve the same function. This year has seen hundreds of millions of dollars in value poured into PolkaDot (DOT), whose founders worked on Ethereum, and Cardano (ADA), which has yet to launch a mainnet, promises many of the things that Eth2 does as well.

The first use cases platform

One of the first major use cases of crypto tokens was, of course, kitties. When Cryptokitties launched in 2017, nobody knew how big it would become. However, this was perhaps the first major congestion of the Ethereum network that revealed issues of speed and scalability. Sep. 4, 2018, saw the sale of a digital kitty named Dragon for 600 ETH ($374,076, at press time). Thus began the rise of non-fungible tokens (NFT).

Then came AAVE, Compound Finance, and yEarn.finance. These decentralized finance platforms were but a few of many to use smart contracts to perform the functions of a bank without a bank. This meant a trustless lending/borrowing platform with insane interest returns.

This, in turn, led to yield farming, whereby holders of tokens moved funds around and compounded borrowings to gain massive APY returns in interest. Yield farming even extended beyond ETH to other chains such as Binance Chain.

 

 

With all its success, DeFi engendered insane gas fees and insane scams. Millions of dollars were being stolen in attacks and exit scams left and right.

Meanwhile, automatic market makers, led by Uniswap, were using smart contracts to do away with centralized exchanges. While before a token’s progenitors had to pay huge fees to be listed on an exchange, anyone who could code could sell their token for millions based only on hype and hopium.

This also led to a liquidity mining craze, in which users were incentivized to temporarily provide liquidity for automatic market makers, for huge short-term gains. Often, liquidity miners moved around funds from platform to platform in search of better gains, congesting the Ethereum network.

Following DeFi and Uniswap, NFTs became a short-lived next big thing.

Because of the nature of the EVM, true ownership of digital items such as art could be guaranteed, even when such an item was easily reproducible. The success of NFTs led to speculation of the “tokenization of everything.” Under this model, all assets — be they art or property — could be sold and secured publicly as tokens, with trustless proof of ownership. 

Aside from stocks and token shares of companies, these tokens could also be like deeds to real estate.

The dust settles

So after all these new industries, ether became really expensive. Perhaps the height came when Uniswap airdropped 400 UNI tokens to every user, worth about $1,400, at the time. Rushes to dump to token sent fees sky high, with users paying hundreds in gas per transaction.

Gas fees increased especially in September/October 2020 | Source: yCharts

Since then, however, gas fees have calmed down. ETH transactions are not as fast or as cheap as some other blockchains, but they are still worthwhile. Perhaps more importantly, users are familiar with ETH, and all the infrastructure created using Ethereum in the past months still exists, if no longer in an exuberant craze.

The year of Ethereum

There is plenty of use for bitcoin, whether it is considered cash, gold, collateral or a store of value. But it is Ethereum and its smart contracts that have really widened the imagination of crypto users. Though competitors wait at the sidelines, Ethereum still seems to be the virtual machine of the future.

If Ethereum 2.0’s speed and scale really do live up to intentions, it will not suffer the limitations of Eth1. Perhaps more importantly, the flexibility and size of the developer team suggests that Ethereum will be able to adapt to whatever challenges blockchain faces in the future.