The Upcoming Ethereum Merge

Ethereum developers have announced that they are deploying the Ethereum Merge on its blockchain on September 19, 2022 (based on transcript from a conference call). The news has been received positively by the market, which led to a rally in ETH market price. This has been a long awaited event, which will consolidate the beacon chain with the main network to transition Ethereum’s blockchain from PoW (Proof-of-Work) to PoS (Proof-of-Stake).

There have been doubts about the merge since it was first delayed in the summer of 2022. Ethereum has a known history of delaying projects, with market panic when the developers cannot deliver on time. The expectations are sometimes too high for even what the developers can accomplish. When the deliverables do arrive, it usually turns sentiment back to bullish as was the case with EIP1559.

Before the merge can become a success, there are still some hurdles to clear. Tests are underway on testnets (e.g. Ropsten) to make sure that the protocols work properly. There are still major tests that will be conducted on the Sepolia and Goerli test networks. Once these chains have been transitioned successfully without much issues to PoS, then the next step is the Ethereum mainnet. This aims to improve the network to scale the number of transactions and lower fees for users.

Although a date has been set for the merge, it is not final. If there are problems during testing that are serious enough to address, then this could lead to further delays. The hope from ETH HODLers and investors alike is for a successful merge to occur in order to increase Ethereum’s value.

Disclaimer: The information provided is for reference and educational purposes only, and is not financial advice. Always DYOR to verify information.

Ethereum Reaches A New Milestone As It Prepares For ETH 2.0

There have been plenty of great developments in the Ethereum blockchain. This has been good for its native currency ETH (Ether) and has restored confidence in holders toward the end of the first quarter of 2022. This has led to a rally in ETH price to above the $3K level, starting in March 22. Some analysts take this as an ominous sign that ETH has turned bullish once again, but what is really the motivation behind it?

Toward the end of 2021, Ethereum developers released the Kintsugi Merge test network. This is a more realistic approach to testing how the Ethereum network will be like post-merge (i.e. when the Beacon Chain merges with the mainnet). This allows developers to test the features of the network in an environment that supports PoS (Proof-of-Stake). This is where smart contracts can be tested without any additional costs to developers.

Ethereum developers have also released the Kiln public test network in March of 2022. This is the final test network before the transition to PoS. This is where developers can test their applications and tools before deploying on the mainnet. Node operators and stakers can also test on Kiln, to evaluate the performance on a simulated blockchain.

Toward the end of March 2022, the number of ETH 2.0 validators has reached 300,000+ with over $28 Billion TVL (Total Value Locked). That is based on the valuation of ETH (~$2900-$3,000 circa March 1, 2022). The total amount of ETH locked (requires 32 per validator) has reached 9.6 Million ETH. At the price of ETH in March 28, 2022 at $3,300.62 (10:46 PM EST), the total value locked would be $31.6 Billion. The value of ETH increases with the market, and any surge also brings up the TVL for the validators.

Ethereum is receiving not just retail support, but institutional as well. Macro guru Raoul Pal has become more bullish on his outlook of Ethereum. He believes it is on track to outperform Bitcoin based on its performance. Pal is looking at long term metrics that show that the market Ethereum is capturing covers a much larger base than Bitcoin. This includes the derivatives and money markets, where billions of dollars are sitting. Should even a small percentage of the money flow into the DeFi space, where ETH is a major currency, it can create network effects that can further drive ETH value higher.

Other reports are coming that banks are positive on Ethereum. It seems banks like JP Morgan had at one time been very critical of cryptocurrency. The sentiment has changed, and they now invest in projects that involve cryptocurrency like Ethereum. Perhaps the recent developments in how Ethereum will become more energy efficient and how it is a platform that facilitates a decentralized financial system opens opportunity for capital investments.

The transition to a new consensus mechanism can greatly impact Ethereum network performance. A faster and more energy efficient system gives it a positive outlook compared to Bitcoin and other energy intensive cryptocurrency that use PoW (Proof-of-Work). The more important matter that investors are keeping an eye on is how the move to ETH 2.0 will improve the network’s overall performance. This attempts to solve the problems of scaling, which Ethereum competitors (e.g. Solana, Harmony, Avalanche) have already been addressing. A more stable network with the capability to process more transactions will be huge for Ethereum, and can establish it as a dominant platform for years to come.

Ethereum Berlin Is Here, Next Stop Is London

The Ethereum blockchain has implemented the Berlin hard fork at block 12,244,000 this past Thursday (April 15, 2021). This was not the anticipated Optimism Rollout yet, but instead are a set of improvement proposals to help the network with gas costs and security.

Berlin was supposed to implemented in 2020, but as with most Ethereum projects it got pushed back. There were centralization concerns around the Geth client on which most Ethereum nodes operate. An important feature of Berlin is the live swapping of Ethereum from a proof-of-work to a proof-of-stake blockchain.

Other important features of Berlin are optimizations for smart contracts including gas efficiency, updates to EVM code and protection against DDOS attacks.

The upgrade implements the following:

EIP-2565, reduces gas cost for a specific transaction type that uses modular exponentiation.
EIP-2718, makes all transaction types “backwards compatible” using so-called “envelope transactions,” which allows the addition of new transaction logic into Ethereum.
EIP-2929, increases gas costs for “op code” transactions, a pain point for denial of service attacks on Ethereum in the past.
EIP-2930, a new transaction type (made possible by EIP-2718’s envelope transactions) which allows its users to create templates for future, complex transactions in a bid to lower gas costs.

The upgrades are in line with the bigger upgrade that will introduce EIP 1559 called London.

The Cardano Principles For Scalability, Interoperability and Sustainability

Cardano is a unique cryptocurrency project that is based on sound principles rooted in science and engineering. Its application goes beyond financial systems, but implements a blockchain that covers a wider variety of applications. While it is available as a coin on digital exchanges, it does not yet have an actual use case (as of this posting). It is a development in progress that aims to nail the foundations for a well designed blockchain.

We can consider Cardano a Third Generation Blockchain. The First Generation uses Bitcoin’s Proof-of-Work (PoW) consensus mechanism and the UTXO model. Ethereum forms the basis for the Second Generation, which implements Turing complete Smart Contracts or EDCC (Executable Distributed Code Contracts). The Third Generation, which include other cryptocurrency like EOS and Tron, were based on Ethereum but innovate on consensus mechanisms. Like other Third Gen blockchains, it was also issued using an ICO that raised $62 Million.

Cardano, like Ethereum, uses a smart contract based system. The token or digital asset used on the network is called Ada. Ada provides balances to users with the Daedalus digital wallet. Cardano is also a platform for technological innovation and development. It will provide an operating system layer for DApp (Decentralized Applications) that run on the Cardano network. These DApp provide an interface to smart contracts that execute code to transfer value (e.g. payments, transfers, change of ownership, etc.). Cardano will facilitate these transactions and record it on its own blockchain for immutability and transparency purposes.

Cardano has 3 main features in its blockchain.

Scalability – The network must be able to scale to meet the demands for high volume transaction processing. The developers address the issue of scaling by adopting a different consensus protocol mechanism that is based on Proof-of-Stake (PoS). Scalable systems are faster and more efficient, which is what a blockchain needs in order to handle production level processing of transactions. The network architecture for Cardano proposes using RINA (Recursive Internetwork Architecture).
Interoperability – Many blockchains cannot directly interoperate with one another. There are solutions now that allow for “atomic swaps”, which essentially provides a way for two blockchains to transfer value between each other. Prior to that, digital exchanges were the only way to go. That creates an intermediary which is something a blockchain using direct P2P transfers can remove. With a third party, the cost of transactions increases and it can be tampered, censored or rejected.
Sustainability – Many critics have called Bitcoin inefficient and unsustainable in the long run due to the way it consumes resources. A sustainable system is always more ideal in terms of efficiency and reliability. Sustainable systems have a way to last thus ensuring some degree of surviving into the future. Many blockchain projects lack this feature and have to end for a variety of reasons.

PHILOSOPHY

The following are Cardano’s philosophical principles taken from their website.

Separation of accounting and computation into different layers
Implementation of core components in highly modular functional code
Small groups of academics and developers competing with peer-reviewed research
Heavy use of interdisciplinary teams including early use of InfoSec experts
Fast iteration between white papers, implementation and new research required to correct issues discovered during review
Building in the ability to upgrade post-deployed systems without destroying the network
Development of a decentralized funding mechanism for future work
A long-term view on improving the design of cryptocurrencies so they can work on mobile devices with a reasonable and secure user experience
Bringing stakeholders closer to the operations and maintenance of their cryptocurrency
Acknowledging the need to account for multiple assets in the same ledger
Abstracting transactions to include optional metadata in order to better conform to the needs of legacy systems
Learning from the nearly 1,000 altcoins by embracing features that make sense
Adopt a standards-driven process inspired by the Internet Engineering Task Force using a dedicated foundation to lock down the final protocol design
Explore the social elements of commerce
Find a healthy middle ground for regulators to interact with commerce without compromising some core principles inherited from Bitcoin

OUROBOROS

Cardano’s consensus algorithm uses PoS and is called Ouroboros. This determines how participating computers called nodes come to a consensus on the network. Instead of miners like in PoW consensus algorithms (used by Bitcoin), PoS requires staking funds to qualify or participate as a validator node. These “stakeholders” must contribute to secure and process blocks of transactions on the network and in return they will be incentivized in Ada. If a “stakeholder” is dishonest or attempts to attack the network, they can lose the funds they staked so there is a consequence. This aims to make “stakeholders” good faith actors rather than become bad actors. Once “stakeholders” validate a block it is added to the main network’s blockchain.

What makes Cardano different from other PoS-based networks is according to their own website:

“For a blockchain to be secure, the means of selecting a stakeholder to make a block must be truly random. An innovation of Ouroboros to produce the randomness for the leader election process is to do this by way of a secure, multiparty implementation of a coin-flipping protocol.”

DEVELOPMENT COMMUNITY

Cardano also fosters a development community since it is an open source project. There are no barriers to entry for those who want to contribute, but is mostly on a voluntary basis. Developers are rewarded in Ada for their efforts. Cardano’s code is available for others to use in order to develop applications for the platform.

At the moment, Cardano is being managed by the IOHK (Input Output Hong Kong). They will be a part of the project until 2020 according to their contract.

FUNCTIONAL PROGRAMMING

The main programming language used in Cardano is Haskell which is functional, strong and static typed. One of the reasons it was used is due to its reliability in mission critical systems. They provide a solid and secure foundation for back end systems that handle massive workloads. This means the code and logic is stable enough to be able to scale and provide reliability with little room for failures.

In functional programming if there is a function f(x) that we want to use to calculate a function g(x) to get the results of yet another function h(x). Rather than solving in sequence, it can be simplified to a single function:

h(g(f(x)))

This provides a mathematically simpler way of computing. These form the foundations for Cardano Smart Contracts. It aids in Formal Verification to prove how a program acts and what its results will be. This gives Cardano a “High Assurance Code” property.

THE PROJECT ROAD MAP

Cardano follows a road map for its development. It is divided into 5 phases called eras: Byron, Shelley, Goguen, Basho and Voltaire. It is now in the Voltaire era in 2020, which will decide the digital governance used on the network.

For more on the road map, click here.

THOUGHTS

Like any cryptocurrency project, I don’t suggest buying their token just because the project looks good on paper. This is how Cardano is like. While it is based on a sound foundation, it has not yet been applied to solving real world problems. It offers a theoretical solution that is yet to be proven. If it does deliver on its goals, Cardano’s prices may not really go up either, since it depends on the asset’s liquidity and volume. The project looks promising and that can spur certain expectations.

Note: This is not financial advice. DYOR always to verify facts.

Proof-of-Stake Consensus Mechanism

The power of cryptocurrency is not just security and decentralization. It is also due to what is called the consensus mechanism, which allows participants called nodes in a decentralized system to come to an agreement to validate the truth on a blockchain. The most popular is the consensus used in Bitcoin, called PoW (Proof-of-Work) which requires mining to create coins on the network. Although it has been tried, tested and proven true, it has issues with scalability and sustainability. Although mining is reliable, it can be energy intensive to participant nodes because it requires plenty of computing resources (hash rate) to solve cryptographic puzzles to add a block to the blockchain. That translates to larger electric bills and thus will not be ideal for payment systems that require mass volume transactions that need to be processed daily 24/7/365. It is also slow because in a blockchain, the data is sent to all nodes rather than just one server processing the transactions. It had its limitations called out by developers, thus leading to other consensus mechanisms that used more efficient algorithms that also increase the transaction velocity on the network.

This is why a new type of consensus mechanism was developed called PoS (Proof-of-Stake).

What is PoS?

This is not the same as Point-of-Sale, that is a totally different system for payments. Proof-of-Stake is a consensus mechanism algorithm that requires no mining to validate transactions and create blocks. Instead it requires to stake a certain amount of funds to become validators on the network. These funds are a % of the total coins that exist on the network.

Let f = fund staked as %, Ts = total supply of coins, Ta = total amount staked

f = (Ta / Ts) x 100

PoS and variations of it are being used in cryptocurrency like EOS, Tron, Tezos and soon it will be implemented on the Ethereum network.

When you are mining for blocks using PoW, like in Bitcoin, you must compete with other nodes called miners in order to validate blocks. This is done by trying to solve what is called the nonce which is a value (based on a difficulty target) that contains a hash of numbers. The value is either less than or equal to the nonce, and must be discovered by miners within an average time of 10 minutes. The miner who is able to compute the nonce first becomes the block validator who creates the blocks and in return receives Bitcoins as a reward.

On PoS, there is no need to compete with other nodes to solve a cryptographic puzzle. Instead, there are a set number of nodes called stakers who will help validate transactions. In some systems, like in a delegated PoS network, token holders can vote for block validators (called producers in EOS) who have staked a large investment into capital resources (e.g. data center, servers, etc.). The code than provides a time when block validators will create blocks and in return they will receive their reward in the cryptocurrency’s tokens.

If we have two staking nodes called f1 and f2:

If f1 = (Ta / Ts) x 100 > f2 = (Ta / Ts) x 100

This means f1 will be the block validator based on what was staked or weight of their % of coins.

Here is one example of PoS. According to Ethereum founder Vitalik Buterin from his blog:

The simplest formula for this (PoS) is:

SHA256(prevhash + address + timestamp) <= 2^256 * balance / diff

prevhash is the hash of the previous block
address is the address of the stake-miner
timestamp is the current Unix time in seconds
balance is the account balance of the stack-miner
diff is an adjustable global difficulty parameter

“If a given account satisfies this equation at any particular second, it may produce a valid block, giving that account some block reward.”

The idea behind PoS is to encourage honest participation among trustless participants using game theory. You cannot know for sure who is acting on good faith or who is the bad actor. Thus, the idea of putting your own funds as a stake to being a validator is what shows your willingness to help in the network. Otherwise, that participant will lose their staked funds if they become dishonest or try to attack the network. The consensus among all nodes can deny the participant’s block if they attempt to cheat. They either lose their stake or get rejected from the network and even blacklisted. It all comes down to the protocols of the digital governance on the network, something that is a feature of PoS systems.

Another thing to note is that PoS is also based on the weight or amount a node has put at stake. Therefore, the more funds you stake the better your chances are for becoming a block validator. The validators can be chosen by random selection or voted by the token holders as mentioned earlier. This process is much faster to resolve than the 10 minute block propagation time in Bitcoin’s PoW because it requires no mining to solve for the nonce. It can actually be more instantaneous since the selected block validator can process the transactions and create the block which then updates all nodes on the blockchain. Much faster than having all nodes try to validate the block at the same time by discovering a nonce. This allows for faster transactions speeds that are more suitable for micropayments and retail transactions i.e. buying a cup of coffee with cryptocurrency.

This consensus mechanism is also more energy efficient. Producing a block on the network doesn’t require expending a lot of electricity like in Bitcoin. This saves not just costs, but also time. This has been the main argument for PoS among its proponents.

Despite its more refined algorithm, there are also issues with PoS. The following will discuss some of the well known issues.

Stake Inequality

If you are to look at the algorithm, it favors wealth. Critics argue that in a PoS system, those with more at stake or resources available will surely always come out as the validators. This is not exactly fair, and can lead to a sort of network oligarchy which can control the blockchain. If this is the case, what have PoS developers done about such issue?

To make sure that things are fair, code was written to randomize block validator selection that is still based on the amount at stake. This means that anyone who is staking is likely to get selected based on how much they have staked. When the load of transactions is even greater to process, a node that has staked more will likely become the validator because their stake can prove that they have the resources available to create the block. Now the argument against this is that it still shows that it will be favorable only to those with higher incomes. They can even collude to become block validators based on their stakes and collect all the fees from transactions. This creates a barrier to entry that limits decentralization. This then can lead to centralization, which is what blockchains are not supposed to be.

Centralized Validators

Centralization is indeed counter to the ideology of a blockchain. In order to prevent only a few validators from ever gaining control of the network, different methods have been developed.

Here are some of those methods:

Randomized Selection – This will ensure that validators who have validated before will not be the only validators. Instead the algorithm will randomly select a new validator each time. A validator who has validated before will get their chance again in the future. Some networks will actually allow for x number of validators only, while others can allow for unlimited numbers of potential validators.
Elections – Other cryptocurrency use digital elections or delegated PoS (e.g. EOS and Tron) to determine who the block validators will be. In EOS they are called Block Producers, while in Tron they are Super Representatives. The network allows all token holders with voting rights to ‘freeze’ funds for candidates to become validators. In EOS 21 are elected while in Tron it is 27. This appears to be a smaller number of nodes, but the logic behind this is that although it is less decentralized, it helps to scale up processing for faster transaction processing. The network can then call for a new round of elections to select new validators to make sure that it is not too centralized.
Time Allotment – In this scheme, anyone who has staked joins a queue to become a block validator. It will be a fixed amount, and so the system is not based on who has staked the most. The node will then wait for their turn to become a block validator. The problem with this type of scheme is if anyone can validate, how can we be sure they have the resources to do so? What if they are using only a low end PC or just their smartphone? Will that be enough compute power to create blocks? In this case, such a system can work for nanopayments or even non-compute intensive micropayments that use smaller block sizes. All the node needs to do is add the block after the consensus has determined it is valid. In return the node receives their fees.
Validation By Delegation – In Tezos this is the PoS scheme, called Liquid PoS. In this system, a validator can delegate their validation rights to other validators on the network. This is done using a process called baking. The node called a baker has block producing rights based on their stake. This model is more or less a way of sharing the rewards. This is because by process of validation by delegation, the baker can delegate production to another baker without transferring their ownership of stake. Instead they keep the stake and get rewards which they then share with the delegated baker. This works well if the baker has a good reputation and integrity on the network.

Network Attacks

The problem with centralization is that a rogue node can accumulate a majority of the cryptocurrency’s tokens. If they were to gain 51% of the coins and stake them on the network, that can lead to attacks. Now the question is, does that even make sense? It definitely requires a lot of investing into the cryptocurrency to have a majority hold on its coins. This is also called the 51% Attack and it can also be possible of PoW systems.

f = (Ta / Ts) x 100 = 51

In a post made on the Qtum blog:

“In PoS, after a rollback, the attacker address can be blacklisted and those coins simply ‘deleted’. This would make the remaining coins in the system go up in value and the attacker would have to repurchase the coins in an effort to relaunch the attack. This is especially risky for them if they were shorting the coins, as they no longer have access to them and have to pay back the lender.”

In this case it would make things more expensive to attack the network so it discourages bad actors. As of this writing (September 2019), there has never been a successful attack on a PoS blockchain that demonstrates this example.

Nothing At Stake

The Nothing At Stake theory is a problem that arises on the blockchain due to its distributed nature. This type of attack can delay and complicate transactions on the network. Staking is a process that adds value to the network. What is being staked is actually the % of coins that a user has of the total supply. It is thus in their best interest to make sure that the network is secured, otherwise they will lose their value. This incentivizes the node that stakes to behave honestly or else risk devaluing their network.

This problem can occur when there is a fork or series of forks on the network. A fork is another chain that forms from the main network during a contentious moment in which the network becomes split. One network supports one block while the other half refuses to go along with it. This also occurs when there are simultaneously two block validators trying to produce a block for the network. During a fork, a node can put their stake on both chains because they have nothing to lose from it. This type of behavior is not exactly approved by consensus.

The node can get away with it though. This is because the node will get their reward no matter which chain wins. This can lead to what is called a double spend. The node that has put a stake on both chains loses nothing because they will get their reward from the chain that wins. Now imagine if all nodes followed this lead. It makes two chains exist at once, which means there is really no main network. The node has nothing at stake because they don’t incur any costs to doing this.

This makes the network less secure and prone to more discrepancies. One of the chains can overtake the other, and any bad transaction on one chain is considered good on the other chain. Thus, a node has nothing to lose since the eventual chain that wins will reverse any bad transactions they had on the failed chain. The node collects fees no matter which chain they are on, and this can lead to many inconsistencies on the blockchain.

To address this issue, developers have come up with mechanisms that prevent or discourage this. To explain in simple terms, when the network detects a node attempting a nothing at stake attack, they will be reprimanded. The consequence is that the node will lose their stake, which is something to lose. This encourages honesty among the nodes because of the penalty of malicious intent to the network.

Critical Factors

A great feature of PoS is to allow more participation among token holders and involve the community when it comes to consensus. However a cryptocurrency chooses to implement their PoS protocols, the thing to remember is that this is an alternative option to PoW. The benefits are clear, but there are also issues that need to be addressed. Some have tried to implement a hybrid PoS and PoW system to reap the benefits of both consensus mechanisms. Overall, these systems will eventually mature and develop over time, so there is plenty to observe once they have been in production.