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What Is Ethereum 2.0 and How Does It Work?

August 8, 2022
5
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Ethereum is a community-run network that became the second-largest cryptocurrency by market capitalization. Learn how once called Ethereum 2.0 the upgrades will be phased in.

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Ethereum (ETH) is the second-largest cryptocurrency by market capitalization, behind only Bitcoin—and as the crypto has grown, it’s been evolving. Ethereum 2.0 is the future of Ethereum, with new scalability and security features rolled out in phases.

Before delving into the upgraded version, here’s a quick primer on the original. Ethereum is a community-run network that powers its crypto, called Ether or ETH. Vitalik Buterin, the driving force behind the project, designed the Ethereum blockchain to be programmable, giving developers a place to build apps with more freedom. The Ethereum network also introduced smart contracts, or programs that self-execute when certain conditions are met, and it allows trading of other cryptocurrencies.

Like many cryptos including Bitcoin, Ethereum uses blockchain technology: an open-source, decentralized, anonymous public ledger that relies on complex cryptography to record every transaction. But ever since the original so-called Ethereum mainnet launched in 2015, the Ethereum Foundation of core developers has always planned to change how that underlying technology works to make it more efficient, fast, and secure.

What is Ethereum 2.0 and how is it different from Ethereum?

Ethereum 2.0, or ETH 2.0, is essentially a network upgrade; ETH holders will still have their Ether tokens even as these back-end changes happen. The first version, Ethereum 1.0, received some updates over the years. Some of these changes were made because of issues like security considerations, while others added features such as processes for reducing the volatility in transaction fees that users pay to utilize the network. But those changes are minor compared with Ethereum 2.0, which completely revamps the processes that the current Ethereum ecosystem is built upon. 

The biggest changes involved in the Ethereum 2.0 release affect its consensus mechanism and the blockchain itself.

Transition to proof-of-stake

Ethereum 1.0 and Bitcoin use the same type of algorithm for their blockchains. It’s called Proof of work (PoW), and it requires computers to solve arbitrary and complex math puzzles to create, or “mine,” new tokens in an energy-intensive process. This process makes it impossible for people to copy and replicate tokens, confirming that every transaction and new token is legitimate rather than duplicated or forged.

It’s an effective consensus mechanism, but PoW’s benefits come with significant costs—both financially and to the environment. The costly computers that are used to mine tokens use huge amounts of power to solve the complicated math problems, driving up electricity bills for miners and leaving a large carbon footprint. According to Cambridge University's Bitcoin Electricity Consumption Index, mining Bitcoin alone used more than 100 terawatt hours of electricity annually as of October 2021—more than the Philippines’ entire energy consumption in 2019.

Ethereum 2.0 uses a newer, greener technology called a Proof-of-stake (PoS) consensus mechanism—instead of the older, more energy-intensive system known as Proof-of-work (PoW). In the simplest terms, PoS relies on groups of validators instead of miners operating enormous server farms to keep things secure and mint new tokens. These validators verify transactions on the network and receive newly minted Ether in return—cooperating in what’s called a stake pool, or a server node that can hold the combined crypto of many users who stake their ETH to reap the rewards. Perhaps most importantly, a recent estimate says PoS could cut Ethereum’s energy consumption by 99.95%.

Sharding

Ethereum 2.0 wasn’t intended just to change the algorithm underpinning the blockchain—it’s also designed to overhaul the Ethereum blockchain itself. Instead of one blockchain, the goal is to create many.

“Sharding” splits a single blockchain into multiple blockchains, known as shard chains or shards. This is meant to increase efficiency and security: Validators are charged with managing the transactions only for their own specific assigned shard, making the process more streamlined than validating across one vast blockchain. 

Additionally, validators frequently move from one shard to another, making it easier to sniff out any would-be bad actors and minimizing the chance of someone sabotaging the security and credibility of the system. 

Ethereum 2.0 phases

Ethereum 2.0 was originally set to roll out in 3 1/2 phases between late 2020 and 2022. 

  • Phase 0: Launched in December 2020, this phase introduced the so-called Beacon Chain to establish the proof of stake-based blockchain and validator registry that will become the center of Ethereum 2.0.
  • Phase 1: According to the Ethereum Foundation, this phase was originally about implementing shard chains in early 2022. But “now, prioritization has shifted to ‘The Merge’”—the next phase. 
  • Phase 1.5: The famed Merge, in which the Ethereum 1.0 mainnet will be merged into the Beacon Chain and become the so-called execution layer of Ethereum 2.0.
  • Phase 2: Just like Phase 1, the original plans for Phase 2 have evolved as the community has expedited the changeover to proof of stake. The Foundation says Phase 2 plans remain “a point of intense research and discussion,” with the core goal now to create a more simplified form of data sharding to increase scalability and efficiency.

Ethereum 2.0 release and prices

A big part of the Ethereum ethos is listening to the community and making modifications based on that input. That’s why the initial plans for the phases have shifted, and as such it’s not clear whether all phases to upgrade the Ethereum network will be completed in 2022 as originally planned. 

In the meantime Ethereum’s price has swung wildly, following the volatility of the cryptocurrency market at large: In 2021 it soared to all-time highs along other cryptos, but it’s plummeted since then. As of mid-July 2022, Ether was trading just under $1,500—about 70% below its peak of almost $4,892 in November 2021.

The bottom line

Launched in 2015, Ethereum is a community-run network that supports the crypto Ether (ETH) and allows trading of other cryptocurrencies, the creation of decentralized applications, and the use of smart contracts. It’s become the second-largest cryptocurrency by market capitalization—but ever since its creation, the community has planned to roll out changes to make Ethereum more scalable and sustainable.

Once called Ethereum 2.0 or Eth2 (names discontinued by the Ethereum Foundation), the upgrades to Ethereum will be phased in. The first of the two biggest changes is a Proof-of-stake (PoS) consensus mechanism, in which Ethereum users are rewarded with new tokens for validating transactions—a much greener alternative to the existing Proof-of-work mechanism that requires lots of computing power to mine new tokens. The second major change is “sharding,” which splits the single blockchain into multiple ones to maximize efficiency.

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