What is Ethereum 2.0?

1. What is Ethereum 2.0?

Ethereum 2.0 is an update to the Ethereum network that is expected to take place during 2020.

Once launched, Ethereum 2.0 will predominantly be a testnet to test the Proof-of-Stake consensus algorithm system. Much of the economic activity and smart contracts will continue to operate on the original Ethereum network, which will remain as a system parallel to Ethereum 2.0. Developers will implement the ability to transition Eth1 to Eth2, but the reverse will not be possible.

2. What are the four phases of Ethereum 2.0 deployment?

Phase 0: Beacon Chain.

This phase starts on December 1, 2020. It only includes the testing of the new Proof-of-Stake mechanism, so the network will be mostly of a test nature, although it will use real Ethereum tokens. As part of this phase, the following aspects of PoS should become functional:

  • Stacker Set Management;
  • Stacker means management;
  • A random number generator to help select block producers and staking curators;
  • Voting of stakers for block size suggestions;
  • Handing out awards and assigning penalties to steakers.

Phase 1: Sharding.

Initially, an experimental network with 64 shards will be deployed. While phase 0 aims to test the basic PoS infrastructure in the absence of significant economic activity, phase 1 aims to test the basic sharding model. During this phase, 65 blockchains will operate in parallel – the Beacon Chain that existed in phase 0 and 64 new shards. There will also be two-way communication and a linking mechanism between Beacon Chain and all 64 shards.

Phase 1.5: Merging Ethereum’s PoW blockchain with the new PoS blockchain

It will not affect the historical data of the current network in any way, since the PoW blockchain will be one of the fragmented chains in the new mechanism. Miners should keep in mind that the PoW blockchain will not support the PoW mechanism itself.

Phase 2: Implementation of the new mode of operation

It is expected that in this phase, smart contracts will start to work on the network and economic activity will begin. Shards will no longer be source data stores, but will begin to resemble Ethereum 1.0 virtual machines and smart contracts. The specifications for Phase 2 are under development.

One-Way Commitment.

Once Ethereum 2.0 launches, there will be two networks, Eth1 and Eth2, running in parallel. Initially it will be possible to convert Eth1 coins into Eth2 coins, but not vice versa, so theoretically Eth2 coins should trade at less than or equal to Eth1 coins. However, it is unlikely that in the early stages of the transition, Eth2 coins would be priced or supported by exchanges at all, as their only use would be for stacking. Even basis transactions will not be possible.

To transfer Eth1 to Eth2, a deposit agreement on Eth1 will be required. This agreement destroys the coins on Eth1, and then the destruction can be used as confirmation to issue new Eth2 coins. Coins are permanently burned, although coin recovery can be implemented through a protocol change as a result of a hardfork.

Coins transferred to Eth2 automatically go into the validator pool.

3. Proof-of-Stake

According to the proof-of-stake concept, the “weight” of the vote and the amount of the validator reward is determined by the value of the coins in the stack. Eth2 specifications stipulate that each validator must have 32 ETH. If there are more than 32 ETH coming into the contract, the stacker does not receive a reward from those extra coins. If the coins are less than 32 ETH, the stacker will not be activated. Therefore, it will be necessary to transfer ETH into Eth2 in portions of 32 coins. Each portion of 32 ETH can be a separate shaker.

4. What will coin issuance look like?

Eth1 will continue to function based on Proof-of-Work, and Eth2 will function based on Proof of Ownership (Proof-of-Stake).

During this period, both groups of validators, miners, and stackers will be rewarded, so Ethereum’s inflation rate will rise – at least until the two systems merge.

Eth2’s issuance level will depend on the number of tokens involved in the stacking process. The annual issue level will be based on an algorithm in which Eth2 is the number of Ethereum tokens involved in the Proof-of-Stake validation pool (the source of these numbers is a post by Vitalik Buterin published in April 2019):

The formula is based on the notion that the more ETH is converted to Eth2, the more new coins will be issued, but the investment income will decrease in proportion to the number of coins in the stack. Graph illustrating Ethereum 2.0 inflation rate:

Note: Beacon Chain requires surpassing the 16,000 ETH limit to launch

Ethereum 2.0 Inflation Rate:

The rate of issue determines the size of the reward. The reward is designed to motivate users to move coins to Eth2 and to Steak. The size of the reward will decrease in proportion to the number of coins moved, as the success of Eth2 will reduce the need for them. Such a model would ensure that the number of coins moved would be sufficient to significantly grow the size of the network; at the same time, the issuance would not become too high if Eth2 proves popular.
It seems that such a model contradicts Ethereum’s original plan of “permanent linear inflation”.

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There are factors that can mitigate the effects of a potential increase in the inflation rate:

  • In Phase 1, the fee system is expected to include two elements: a base fee, where coins are burned, and a premium fee for stackers. Coins burned will reduce the inflation rate.
  • If validators are unable to participate in the validation process – for example, if the nodes stop working or lose connection to the network – then the stacking reward is cancelled.
  • If validators violate the rules, they are fined and confiscated coins are burned.

These mechanisms could lead to a large number of Ethereum tokens being burned, potentially mitigating the effect of high inflation.

5. How will the blockchain merger play out?

In the long run, Eth1 and Eth2 could merge back into one system in a few years. In fact, Eth1 will become a shard within Eth2, allowing Ethereum to move between shards in both directions, and the two coins will merge into one. Presumably, most of the economic activity now happening on Eth1 will continue to take place inside the Eth2 shard.

The next step could be to merge consensus systems. The Eth1 shard may gradually move to Proof-of-Stake.

Proof-of-Work could continue, but after a given number of blocks – for example, after every 100 blocks – block consensus would be determined by Proof-of-Stake. Eventually, it will be possible to do away with Proof-of-Work altogether: block rewards under the Proof-of-Work model will become unnecessary. This will give users and investors in Ethereum more certainty about the inflation schedule.

6. What are the key technical features that the network developers are proposing?

7. How will Proof-of-Stake work in Ethereum 2.0?

Proof-of-ownership (Proof-of-Stake) is the general concept of a fork selection rule.

Preference is given to the chain which is voted for by a majority of coins. The key principles of the voting system for Eth2 are the same as Ethereum’s 2018 offerings and are based on the Casper Friendly Finalty Gadget idea. However, the system has been updated based on a combination of Casper Friendly Finalty Gadget and Latest Message Driven Greedy Heaviest Observed Subtree Fork choice rule (Casper FFG & LMD GHOST Fork Choice Rule).

The voting system mechanism contains the following components. First, a large pool of stakers, each representing up to 32 ETH (32 ETH are necessary to activate a staker; this number can be reduced to 16 ETH, which leads to deactivation). This pool does not vote for blocks directly – it is divided into committees whose members are randomly selected from among the members of the broader pool.

The reason for dividing into committees is that not every stacker can vote for each block – otherwise, the blockchain would contain too much voting data, making scaling impossible.

In addition, committees allow voting data to be collected in controlled chunks of data. Therefore, these committees randomly select sub-groups of stackers to vote on.

According to the Eth2 specifications, the target number of stackers in each committee is 128 (the desired minimum). The developers believe that this is a large enough number of stackers to provide a plausible guarantee of block selection. Vote signatures can be aggregated, which reduces the required block size and allows the network to scale.

Committees are randomly selected, by a system like RanDAO. Random selection is determined by a mnemonic phrase that is added whenever a block is proposed. To resist attacks aimed at fragmenting the block, the proposing block has only two options that can affect the mnemonic phase: to propose the block or not to propose it. Therefore, the possibilities for manipulation are limited.

In addition to the allocation of stackers to committees, there is another subcategory of blocks and block-control points.

One of every 32 blocks is a block control point (checkpoint), and the time interval between control points is called an epoch. Within each epoch there are 32 timeslots (intervals) of 12 seconds in which blocks can be offered.

Thus, each epoch has 32 sets of slots for 32 committees. At the end of each epoch, the committee members change places. Each timeslot has a committee (the “desired minimum” is 128 members). One member has a monopoly right to propose a block within a 12-second interval, and the other members may vote on the block. This voting is also known as grading.

Appointing Stakers to Committees in the Beacon Chain (assuming one committee per slot):

In reality, things can be more complicated than in these charts. For example, in phase zero, there may be up to 64 committees per slot at most, not just one. Therefore, if each committee has 128 members, each epoch can hold up to 262,144 stakers, which corresponds to approximately 8.4 million ETH.

Each staker is assigned to one committee. The more stakers there are, the more committees there are. The maximum committee size is 2048, which roughly corresponds to the entire Ethereum stock used in each epoch (64 committees * 32 ETH * 32 slots * 2048 stakers per committee = 134.2 million ETH).

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The graph below illustrates how the number of committees and the number of committee members varies with the number of ETH in the stacking pool. It shows that as the steaking pool grows, the number of committees increases initially to 64, and then when there is approximately 8.4 million ETH in the steaking pool, the size of the committees begins to increase.

The number of committees and the number of members on a committee:

To determine which blocks have a majority vote, you have to add up all the votes in all the committees. If the voters behave decently, they can be rewarded from the pool of newly released Ethereum coins. If voters break the rules, however, they can be fined and lose a portion of the steak. The penalty is intended to prevent a staker from engaging in behavior such as voting for two conflicting blocks, though it may be allowed within certain scenarios. Steakers may also forfeit rewards for going offline.

8. How will finalization happen in Ethereum 2.0?

When committee members vote on a block, they not only vote on a specific block proposal, but they must also refer to and vote on a specific historical block checkpoint. It is this mechanism that ensures that the voting process is stable. Therefore, there are actually two voting procedures under the Proof of Ownership model, one within the other. The graph below illustrates how the two types of voting occur, and in which blocks these votes can be stored.

Voting and referencing assuming effective communication (assuming there is one committee per slot):

A block can become “confirmed” if a checkpoint block is created on top of it and more than two-thirds of the committee members refer to that checkpoint in their vote in the index (catalog) of all committees within the same epoch.

The earliest a block can become “confirmed” is after two-thirds of an epoch has passed.

The next stage is finalization. A block is finalized when the blockchain contains two confirmed blocks after it. Therefore, in most cases, when the two-thirds voting threshold is reached quickly enough, thanks to efficient communication channels, the user will need to wait one epoch (6.4 minutes) for confirmation, and two epochs (12.8 minutes) for finalization. This process is illustrated by the graph below.

The process of block acknowledgment and finalization in the Beacon Chain within a normal scenario:

9. What will be the sanctions for rule-breakers?

Three scenarios under which voters can be penalized:

  • A block maker makes two conflicting motions within the same slot.
  • Submitting two votes containing conflicting links to checkpoint block transitions at the same height.
  • Filing two voices with overlapping references to checkpoint block transitions. For example, a voice marking a transition from checkpoint block 1 to checkpoint block 4, and a voice referencing a transition from checkpoint block 1 to checkpoint block 4, and a voice referencing a transition from checkpoint block 2 to checkpoint block 3.

It is conceivable that this rule would be replaced by the more logical rule that all references to block transitions must be in sequence, but it is possible that a fair node could skip a checkpoint block, and the result of a sequential vote could be legitimate. A graph illustrating such a scenario:

10. How effective is the proof-of-ownership process in Ethereum 2.0?

The developers claim that once the block is finalized, users will be assured that their transactions cannot be subject to double spending. However, these systems are extremely difficult to evaluate on parameters such as convergence and finalization degrees.

Perhaps the whole process involving voting committees, indexes of such committees, references to checkpoint block transitions, and the need to wait for block finalization for two epochs is an unnecessary abstraction, an attempt to divide the voting system under the proof-of-ownership model into components in order to complicate it and hide the fact that the security model contains a fundamental flaw in the form of the no asset in the stack problem.

On the other hand, it is possible that such a process actually strengthens network protection.

The multi-component nature of the process – e.g., rounds of steaking within rounds of steaking – ensures that changing the steering clients to encourage rule violations will be technically difficult to implement.

11. How does sharding work in Ethereum 2.0?

Phase 1 adds shards to the system. The original plan was to start with 1024 shards, but that number has now been reduced to 64. The Beacon Chain is still considered the primary or parent chain, but now also contains links to shards. Since there are 64 shards and each Beacon block can be linked to 64 shards, it is assumed that in normal operation each Beacon block can be linked to each shard.

There is a two-way linking mechanism – shard-blockchain blocks link to Beacon blocks (with the hash of those blocks), and Beacon blocks can link to shard-blockchain blocks (cross-referencing). Links to some shards may not be present in Beacon blocks, but each shard-blockchain block must link to a Beacon Chain.

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Graph: Block structure in the Ethereum shard system (shows two shards)

The blue arrows represent the block hash that is necessarily included in each block. The gray arrows represent shard cross-references that may not necessarily be included in a Beacon block, as shown on the right side of the graph.

In Phase 1, the sharding system and the stacking process become interconnected. The validator committees for the slots from phase 0 are displayed in the shards. Each shard is given its own committee of voting stackers, which changes during each “committee period” of the offering block.

Similarly, in Beacon Chain, one committee member is tasked with producing a block in a set time slot, and the other committee members vote on each proposal in the meantime. The key factor is that when a Beacon Chain links to a shard blockchain through a cross-reference system, all of the voting data is included in the Beacon Chain.

The graph below illustrates the possible localization of stackers to shard-blockchains. In Phase 1, steakers are allocated randomly, either to the Beacon Chain or to a specific shard. If a shard has less than 8.4 million ETH in it, there are not enough shakers to fully serve all the shards, so shards can slow down to a certain degree.

Possible distribution of stacker committees across shards:

This leaves Beacon Chain with only one validator committee per slot. However, each blockchain shard contains a hash of the last Beacon block, and each Beacon block may contain all the voting data from the shards (cross-references).

Therefore, all the voting and stacking on the shard-blockchain can also be used in the calculation of the fork selection rules and in the finalization process for the main Beacon Chain. The proof-of-ownership system works as before, except that the Beacon Chain contains voting data not in the committee directory (index), but voting data from each shard.

There are no checkpoint blocks in individual shard blockchains, and there are no confirmation or finalization processes. You must wait for the Beacon Chain to ensure that the transaction within the shards is completed. Once the actual blocks in the Beacon Chain are finalized, users can verify that the transactions within the shards are done.

In this way, cross-links make it possible to:

  • Count stacker votes in shard-blockchain committees as votes on the main Beacon Chain.
  • Finalize and validate shard-blockchain blocks.
  • Perform all other types of shard interactions – for example, move ETH or other types of assets from shard to shard.

The mechanisms needed to do this are still underdeveloped. They may become necessary as Phase 2 arrives.

The sharding structure provides the ability to manage a node endowed with the quality of flexibility – able to handle everything, including the Beacon Chain and every shard. It is possible to manage only the Beacon Chain, which includes headers for individual shard-blockchain blocks.

There is also a third option to manage a node that verifies the Beacon Chain and the selected shard segment. If a user chooses not to manage the node that processes each shard, he is forced to rely on other users to verify the authenticity of the processes in those shards. Nevertheless, it is highly likely that some users will choose to validate these shards, thereby providing assurance.

12. What is the outlook for Ethereum 2.0?

Ethereum holders tend to experiment with new sophisticated systems – DAO, Maker, DeFi.

Some members of the Ethereum community are concerned that Ethereum technology has been around for five years but is still lagging behind, so they believe new technologies are needed.

Ethereum 2.0 satisfies the community’s demand for new ideas, and we can expect to see a significant influx of funds and staking rewards (perhaps billions of dollars in ETH).

13. How will the launch of Ethereum 2.0 affect the price?

In the short term, a significant amount of ETH tokens could be locked into the Beacon Chain, as users will be attracted by the opportunity to earn money by creating new blocks. Thus, the stock of ETH on the market could shrink and the price could rise. On the other hand, ETH may simply be attracted from other contracts where it is considered blocked. In order for Ethereum 2.0 to be a catalyst for token price growth in the long run, not only must the stockpile not be limited, but there must also be generated demand.

For the Ethereum 2.0 network to be successful, the proof of ownership and the sharding system must work and be compelling enough to attract economically significant components of the Ethereum ecosystem.
Smart contracts and DeFi systems will have to choose which shard is right for them and invest in upgrading their technology to become compatible with the limitations of the sharded system.

14. What is the main drawback of Ethereum 2.0?

Ethereum 2.0 is exceptionally complex. In a system with multiple committees, shards, and different types of voting, the risk of failures and delays in implementing updates is high.

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