Ethereum and its community has a problem on top of a problem. The first problem is that, by the end of the year, it’ll need to find a solution to the so-called Difficulty Bomb: the level of difficulty of the puzzles miners have to solve in order to be rewarded for mining ether on the Ethereum blockchain is increasing. As the puzzles become more complicated, with miners finding it more difficult to earn ether, a lag grows between the production of blocks on the blockchain. This may prompt the scenario that, in early 2019, mining becomes unprofitable. And this means there are two choices: either to improve Proof of Work for Ethereum (learning from Bitcoin), or to change to Proof of Stake.
The problem on top of this is that there is no guaranteed way forward when it comes to solving the Difficulty Bomb. There are several possible routes and, by the end of this year, some of them will have been implemented. But we won’t know which one is the winning strategy, and that brings instability to the entire Ethereum project. That’s a big deal. The market value of the protocol is $20 billion. Ethereum is the bastion of Initial Coin Offerings (ICOs), which raised over $7 billion in the first half of 2018 alone. There is a lot of cash, and people tied to that cash, in the Ethereum ecosystem.
Let’s look at the options. Proof of Stake is the most talked-about. It is important to remember that this is a first-layer solution, meaning it’s built on the main chain of Ethereum, rather than being built on top of it (“off-chain”), which is known as a second-layer solution. Proof of Stake (scheduled to come into full effect this year) would see Ethereum move from Proof of Work – where miners earn ether by competing against each other to solve puzzles – to a system which distributes rewards based on existing ether ownership. This is the preferred course of action for the individuals who run Ethereum, because it would introduce scarcity into the system, pushing up the price of ether and, therefore, their holdings.
Alternatively, things will be tried that aim to improve Proof of Work. There are several second-layer solutions, like Plasma, which will use smart contracts to process transactions made on child blockchains (Ethereum being the parent blockchain), which means that very large volumes of transactions, on different chains can be computed at once. This should make it easier to scale the network but, because activity shifts off-chain, could push down the value of ether. Moreover, it will likely create an enormous data storage problem, with the size of ethereum blockchain is growing exponentially.
The solution for this problem is so-called “sharding”, which offers a route to scalability while maintaining security. Currently, every transaction that takes place on Ethereum has to be routed through every node in the network. Sharding splits the entire network, at a given point in time, into partitions called shards – a fixed snapshot, if you like. Then, certain nodes process transactions within certain shards, enabling higher transaction throughput across the network. A caveat is that, if you want to have “full” node yourself, you will need to have very sophisticated, enterprise-like hardware – i.e. the role of individuals in a supposedly decentralised system is diminished.
The point of all this is that the essence of Ethereum is going to change, and whichever of these possible ways forward wins out will determine just how drastic a change that is. On the one hand, we could see a protocol controlled by a federation – an elite, likely led by Ethereum co-founder Vitalik Buterin probably – of Proof-of-Stake-driven miners. The more ether you earn, the more influence you will have in the network. And as demand increases for the thing you control, the price will likely go up.
On the other hand, however, we could see decentralization enduring, with child blockchains reproducing and taking much of the work and throughput from the mainchain. The network-based, state-free vision that brought and brings people to the crypto world would remain more intact, but ether could wane in value as new projects and tokens continue to rely on it less.
Buterin has pointed out that, if the Difficulty Bomb is not solved, the value of the Ethereum protocol may fall to zero. We don’t yet know which solution will work, but we do know that as many as possible need to be tried – although the reason for this is not to maintain value in ether or Ethereum. Most people looking at the next wave of the internet – Web 3.0 – agree that there’s a reasonable likelihood that we will see fatter protocols and thinner application layers emerging – the reverse of what has gone before. Whether it’s Proof of Stake or a framework like Plasma that engenders the next wave of innovation on Ethereum, we could well see the reincarnation of ever-more powerful protocols. Investors will put money not into Ethereum via ether but, via numerous tokens, into the layers of infrastructure that enable the next chapter of the digital age to be written.
We are in for exciting times.
I would like to say a brief but big thank you to my team at Coinfirm. They are over 100 people who are really enthusiastic about blockchain in all forms, without whose expertise and assistance writing this would not have been possible.