Ethereum (ETH)

L2 scaling is still critical to DeFi’s future, even with Ethereum 2.0 in the works

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Ethereum 2.0 has the capacity to realize the true goal of DeFi by including scaling solutions such as rollups and sidechains.

Over the previous few years, the Ethereum network has come a long way. The network has become the most compelling attempt to install a ‘global computer,’ thanks to everything from the growth of decentralized finance (DeFi) to the recent London upgrade, but there is still work to be done.

The network will need the benefits that the Eth 2.0 upgrade promises to deliver if global adoption is to form the backbone of Web 3.0. However, scaling for a new wave of decentralized applications (DApps) would require a lot more, and layer-two solutions appear to be the only option.

The promises of ETH 2.0

Ethereum’s much-anticipated London upgrade was implemented in August. This hard fork is the first step on the path to Ethereum 2.0, and it brought a slew of crucial changes to the network in preparation for the upgrade. Ethereum continued to suffer under the weight of recent booms in both the DeFi and nonfungible token (NFT) markets as it arrived in London. Many DApps have been rendered unusable due to transaction speeds and prices, undercutting the benefits that decentralized platforms were designed to address.

EIP-1559, which aims to improve inflation rates and stabilize transaction costs on the network, is one of the more prominent innovations adopted by London. To do this, it is implementing a system in which transaction base fees are burnt rather than paid to miners. Miners will continue to get block rewards, and users can add “tips” to their transactions to incentivize priority, but every block will see a fixed amount of Ether (ETH) permanently withdrawn from the network.

Ethereum, unlike Bitcoin, does not have a hard cap, meaning its total supply grows with each block. Because of the open-ended expansion, many people are concerned about long-term inflation. EIP-1559 does not make Ethereum deflationary, but it does limit how quickly the supply can grow.

While an important first step, London was only the tip of the iceberg in terms of Ethereum scaling.

Call to action for ETH 2.0

The majority of Ethereum’s operational challenges originate from the network’s fundamental lack of scalability, which limits the network’s native transaction speeds. To put things in context, the Ethereum network can now execute about 30 transactions per second (tx/s). A typical payment system like Visa, on the other hand, is intended to handle 1,700 transactions per second.

Ethereum needs to catch up, and Ethereum 2.0 aims to do just that. For starters, the network will convert from proof-of-work (PoW) to proof-of-stake (PoS), which means nodes will stake assets to validate blocks instead of competing to solve complicated math problems. While PoS is more efficient than PoW, increasing network speeds to roughly 50 tx/s, it falls short of what a worldwide payment system requires.

This is where sharding, another key feature of Ethereum 2.0, comes into play. Sharding is a technique for dividing each block into 64 “shards” that can be handled in parallel. In other words, we can multiply the 50 tx/s estimate by 64 to get a little over 3,000 tx/s, which is significantly ahead of Visa and more than enough to serve as a competing payment network.

It isn’t enough to overcome Visa

While sharding would allow Ethereum to compete with, if not outperform, legacy payment infrastructure, this may not be enough. Traditional payment systems are primarily concerned with transactions that are relatively straightforward. For many years, this was OK, but the internet, and now DeFi, is pushing things beyond our wildest dreams.

We’re now looking at decentralized exchanges that are open 24 hours a day, NFT markets, NFT-powered virtual worlds, and blockchain games. All of these necessitate a far higher volume of sophisticated transactions than most traditional payment systems can handle. In a blockchain game, for example, a single player may be making many transactions per minute, and pausing gameplay to wait for each transaction to complete will simply not work. When you consider DeFi’s grandiose goal of disrupting the existing finance sector, you can see how much weight the Ethereum network may have to bear.

The point is that even 3,000 tx/s would be insufficient to serve these services if they were to gain widespread acceptance.

Ethereum, on the other hand, has the ability to scale to 100,000 transactions per second by including additional scaling methods such as “rollups” and “sidechains.” This would get it far closer to the high-throughput applications that DeFi promises, but what do these answers look like?

Scaling up for the future

To begin, there are rollups. Optimistic, Validium, Plasma, and ZK are only few of the names for these. Rollups are a scalability solution that handles transaction loads by running them off-chain and then writing a cryptographic proof of validity to the chain once they’re done. This frees up resources on the main chain, which helps speed things up.

Then there are sidechains, which are also known as “second layer” solutions. These are effectively secondary blockchains that connect to the primary chain. These can be deployed numerous times and handle different tasks, relieving the base layer of a lot of work. Sidechains also provide additional liquidity, throughput, and cross-compatibility for connected chains by acting as interoperable “bridges” across numerous base networks.

Consider a cryptocurrency future in which a whole ecosystem of primary chains, such as Ethereum, interacts with one another via a succession of side chains. Different networks may be used for different solutions, but cryptographic approaches would ensure that data was always verifiably secure. This could ultimately deliver the necessary speed at a low enough cost to realize DeFi’s actual vision of a financial system that is accessible and inexpensive to everyone.

There is no investment advice or recommendation in this article. Every investing and trading decision entails risk, and readers should do their own due diligence before making a decision.

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