Ethereum’s Back Above $4,400

Currently, Ethereum operates on a proof of work (PoW) model, where miners must compete to solve complex puzzles in order to validate transactions. This model gets a lot of criticism due to its environmental impact, as it requires an extreme amount of computer power.

In 2022, Ethereum plans to shift to a proof of stake (PoS) model, where users can only validate transactions according to how many coins they hold.

PoS will no longer require the energy of PoW, reducing the environmental impact of Ethereum by 99%, Tim Beiko, the coordinator for Ethereum’s protocol developers, tells CNBC Make It. Although the full migration to PoS won’t happen in the short-term, Altair is an important “step closer” to it, Beiko says.

Altair is the first upgrade to the Ethereum Beacon Chain since its launch in December 2020. The Beacon Chain is important because it introduces PoS to the Ethereum ecosystem.

Right now, Ethereum has both a PoS and a PoW chain running in parallel with each other, Beiko says. Both chains have validators, but only the PoW chain processes users’ transactions. But in 2022, the Ethereum blockchain will merge fully with the Beacon Chain, shifting it from a PoW model to a PoS model entirely.

Altair is important because it’s a test of sorts to make sure the Beacon Chain “works properly,” Beiko says. The upgrade shows a full transition to PoS is possible, he says.

“It shows we are able to upgrade the PoS mechanism, and that’s a pre-condition to the migration next year,” he explains. “It means there’s a slightly higher chance that things will go well for the [Eth2] transition next year.”

In addition to upgrading the Beacon Chain, Altair also implemented two key changes to the Ethereum network: It added support for “light clients,” or lower-powered devices like mobile phones that can verify transactions, which furthers the decentralization of Ethereum, and it increased penalties for validators who are inactive or frequently offline, among other things.

Once implemented, Ethereum 2.0 will hugely change the network’s infrastructure. It aims to make Ethereum more scalable, secure and sustainable.

PoS supporters also say it will reduce the environmental impact of Ethereum. That will happen in part because Ethereum 2.0 will ultimately make mining on the blockchain obsolete, Beiko says. PoS only allows users staking, or holding, Ethereum to validate transactions, rather than the energy-intensive mining rigs used now.

But if the transition goes smoothly next year, that will also mean that Ethereum mining will no longer generate revenue. Although it’s impossible to predict the future price of any asset, some speculate it may impact the price of ether.

Nonetheless, there’s a long way to go before this transition, Beiko says. The Altair upgrade simply supports that a transition to PoS is likely. Until then, the PoW model remains.

Ethereum has several major problems, however. The first is that gas fees have become very expensive in the last couple of years because the network has become so popular and is therefore very congested.

Validators prioritise users who are willing to pay the highest fees for their transactions. For example, the average transaction at the time of writing on crypto exchange Uniswap costs around US$44 in gas fees.

Bitcoin has comparable issues with congestion, which its developers are trying to solve by building applications like Lightning on top which boast faster transaction speeds.

The second problem for ethereum is that, as it has become more popular, the amount of computational power used by validators has rocketed. It’s the same problem that has brought a lot of negative publicity to bitcoin, because it uses a lot of electricity.

Bitcoin is currently using as much power as the whole of the Philippines, although its supporters argue that much of this is power that would otherwise be wasted – for example, oil rigs burning off natural gas because it’s not profitable to sell it. Proponents also point out that the network is shifting towards using much more renewable power over time.

At any rate, the eventual creation of an ethereum 2.0 will solve these problems by moving the platform’s system of validation from “proof of work” to “proof of stake”. Without getting into too many details, proof of work is a protocol in which validators all attempt to solve complex equations to prove that each proposed transaction is valid. With proof of stake, there’s no need for all validators to do this power-hungry work, because the system chooses one at random to confirm each transaction.

Many in the bitcoin community are against proof of stake because it gives the most power to the biggest validators, potentially allowing them to corrupt the system of validation if they can get control of more than half of the network. Ethereum supporters counter that proof of stake has checks and balances built in that would prevent this from happening.

Either way, ethereum 2.0 promises to reduce the platform’s power consumption by 99.9%, making it far more sustainable. It should also solve the problem with gas fees by raising the platform’s processing ability from 30 transactions a second to potentially 100,000, as well as making possible more sophisticated smart contracts than before.

How it’s going

The transition to ethereum 2.0 has been a slow one, riddled with technical issues that have dragged on for over two years. For the past few months, the new proof-of-stake blockchain has been running in a test format in parallel with the existing system, allowing the developers to prepare it for a merger in 2022.

The forthcoming upgrade is essentially a warm up for this merger. Known as Altair, it introduces numerous technical changes that are designed to keep validators honest and make the system more decentralised. Assuming this goes ahead as planned, all eyes will be on the merger, and then later another change known as “sharding” which will greatly increase the system’s processing capability.

Certainly the price of ether has been strong ahead of the Altair upgrade. The recent surge in bitcoin to all-time highs has been helping to lift the entire crypto market. But some of the price movement in ether probably reflects people betting that the upgrade will succeed, while the rest is from speculators switching from bitcoin, and new money moving into the space.

n the run-up to the merger of ethereum’s two blockchains, it will be interesting to see how all this affects ether’s price in relation to the so-called “eth killers”. These are rival platforms like cardano and solana that have been very popular in recent months partly due to ethereum’s problems with fees.

But ultimately the question is what it will mean for bitcoin. Bitcoiners will continue to argue that their protocol is more decentralised than proof of stake, and they have the advantage of being the crypto brand that investors are most comfortable risking their money with.

The question is whether these advantages are outweighed by ethereum 2.0’s greener credentials and the fact that it can handle more transactions. Bitcoin is currently worth about double ether, but talk comes and goes about a “flippening” where ether overtakes it. Could it happen in 2022? With bitcoin’s hegemony at stake, it will be fascinating to find out.