What Is Ethereum 2.0? Ethereum's Consensus Layer and Merge Explained

The long-planned upgrade to Ethereum aims to improve the network’s scalability and security by switching to a proof of stake consensus mechanism.

The long-awaited Ethereum 2.0 upgrade is nearing its launch.

The multi-phased upgrade aims to address the Ethereum network’s scalability and security through several changes to the network’s infrastructure—most notably, the switch from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) model.

What is Ethereum 2.0?

Ethereum 2.0, also known as Eth2 or “Serenity,” is an upgrade to the Ethereum blockchain. The upgrade aims to enhance the speed, efficiency, and scalability of the Ethereum network so that it can process more transactions and ease bottlenecks.

But Eth2 also doesn't totally exist—in January 2022, the Ethereum Foundation said it would stop referring to the upgrade as Ethereum 2.0. The rebrand is intended to reflect the fact that what's been previously referred to as Ethereum 2.0 is a network upgrade rather than a new network. Accordingly, Eth1 is now known as the "execution layer," where smart contracts and network rules reside, while Eth2 is referred to as the "consensus layer," which ensures that devices contributing to the network are acting in accordance with its rules.

However, the name Ethereum 2.0 has stuck.

When is Ethereum 2.0 happening?

Ethereum 2.0 is launching in several phases, with the first upgrade, called the Beacon Chain, having gone live on December 1, 2020. The Beacon Chain introduces native staking to the Ethereum blockchain, a key feature of the network’s shift to a PoS consensus mechanism. As the name suggests, it is a separate blockchain from the Ethereum mainnet.

The second phase, called "the Merge," is expected in the first or second quarter of 2022 and will merge the Beacon Chain with the Ethereum mainnet.

The final phase is shard chains, which will play a key role in scaling the Ethereum network. Instead of settling all operations on one single blockchain, shard chains spread these operations across 64 new chains.

This also means that it will become much easier from a hardware perspective to run an Ethereum node because there will be far less data that needs to be stored on a machine.

The full upgrade to Ethereum 2.0 is expected to take place by 2023, according to the Ethereum Foundation.

How does Ethereum 2.0 differ from Ethereum?

While Ethereum 1.0 uses a consensus mechanism known as proof-of-work (PoW), Ethereum 2.0 will use a proof-of-stake (PoS) mechanism.

How does proof of stake differ from proof of work?

With blockchains such as Ethereum, there is a need to validate transactions in a decentralized way. Ethereum, like other cryptocurrencies such as Bitcoin, currently uses a proof-of-work consensus mechanism.

In this system, miners use a machine’s processing power to solve complex mathematical puzzles and verify new transactions. The first miner to solve a puzzle adds a new transaction to the record of all transactions that make up the blockchain. They are then rewarded with the network’s native cryptocurrency. However, this process can be hugely energy-intensive.

Proof of stake differs in that instead of miners, users can stake a network’s native cryptocurrency and become validators. Validators are similar to miners in that they verify transactions and ensure the network isn’t processing fraudulent transactions.

These validators are selected to propose a block based on how much crypto they have staked, and how long they’ve staked it for.

Other validators can then attest that they have seen a block. When there are enough attestations, a block can be added to the blockchain. Validators are then rewarded for the successful block proposition. This process is known as “forging” or “minting.”

The main advantage of PoS is that it is far more energy-efficient than PoW, as it decouples energy-intensive computer processing from the consensus algorithm. It also means that you don’t need a lot of computing power to secure the blockchain.

Speaking at Camp Ethereal in March 2022, Lubin said that the impending upgrade will "lay to rest proof-of-work, will lay to rest Ethereum's carbon or energy footprint problem," describing Ethereum 2.0 as being "0rders of magnitude less expensive, energetically."

How will Ethereum 2.0 scale better than Ethereum 1.0?

One of the main reasons for the upgrade is scalability.

The current Ethereum network can only support around 30 transactions per second; this causes delays and congestion. Ethereum 2.0 promises up to 100,000 transactions per second. This increase will be achieved through the implementation of shard chains.

Did you know?

The current Ethereum setup has a blockchain consisting of a single chain with consecutive blocks. This is secure but very slow and inefficient. With the introduction of shard chains, this blockchain is split up, enabling transactions to be handled in parallel chains instead of consecutive ones. This speeds up the network and can scale more easily.

How will Ethereum 2.0 be more secure?

Ethereum 2.0 has been devised with security in mind. Most PoS networks have a small set of validators, which makes for a more centralized system and decreased network security. Ethereum 2.0 requires a minimum of 16,384 validators, making it much more decentralized—and hence, secure.

How could Ethereum 2.0 affect Ethereum’s price?

More scalability means more usage, which, in turn, means more demand. Which—at least in theory—should propel the price of Ethereum to new heights.

“By the time ETH 2.0 and rollups work together there will be 100,000 transactions per second capacity. That’ll mean a completely seamless experience for the next billion people,” Jamie Anson, founder of Nifty Orchard and organizer of Ethereum London, told Decrypt.

Matt Cutler, CEO of Blocknative, is equally optimistic, particularly as gas fees are expected to decrease with the launch of Ethereum 2.0.

“Our customer base sees reducing transaction fees and increasing network throughput as big opportunity areas moving forward,” he told Decrypt.

Moreover, the ecosystem taking notice of major milestones will reinforce Ethereum developer momentum. “This will have a long-term bullish impact on the price of ETH—notwithstanding the short-term volatility, which is part-and-parcel of crypto-asset valuations,” Cutler added.

Fast Facts:

• Ethereum 2.0 represents Ethereum's switch to a new "proof-of-stake" consensus model.

• Proof-of-stake allows for faster transactions and lower fees compared to its previous proof-of-work model.

• The proof-of-stake model allows Ethereum holders to "stake" their holdings to "stake pools" that will earn rewards and grow their holdings over time.

• Ethereum holders can stake their holdings right now on a number of popular exchanges like Kraken, Coinbase and Binance.

• Ethereum 2.0 will implement a method known as sharding that will greatly increase transaction speeds, potentially scaling its ability to 100,000 transactions per second or more.

• The current cost for transactions on Ethereum's network is very high and prevents many from using it. If this update is successful, the reduced fees it will bring will make the network more practical for average users.

• Ethereum's upgrade could have a profound effect on its price as its lower fees and faster transactions open the network up to a broader demographic of users. 

Where Can I Stake My Ethereum?

Ethereum 2.0 is obviously not out quite yet, but some services do allow Ethereum holders to stake their holdings on the testnet now. It's important to first understand that staking your ETH will lock them in place until the full release of Ethereum 2.0. Your Ether will of course earn staking rewards while it is locked, but stakers can not remove their ETH from the stake pool.

Staking to Ethereum's testnet through a stake pool is a bit tricky and comes with a good deal of risk. For that reason, it's best left for the more technically advanced. For those that wish to take an easier more hands-off approach, staking on an exchange is probably best. Some of the exchanges that allow Ethereum holders to stake right now include Kraken, Coinbase, Binance and more. Staking on an exchange does include higher fees, with most exchanges charging 15% of staking rewards or more.

What Does This Mean For DeFi?

Should ETH 2.0 prove successful, it will have a drastic effect on the current bottlenecks that slow it down now. Ethereum has a massive decentralized financial ecosystem, but most of it is nearly unusable as it is too slow and congested. This congestion can cause transaction fees to be larger than the amount of money the user is trying to move in the first place.

In Ethereum's current state, only those with larger holdings can make use of the benefits of its ecosystem. At the time of writing, swapping cryptos on Uniswap, a decentralized exchange and liquidity provider on Ethereum's network, costs nearly $150. This makes sending a few dollars or trading small amounts of money impossible.

The fees to make transactions are so high because they are controlled by miners, creating a rather large conflict of interest. With PoS, these issues will essentially no longer exist. 

Right now, Ethereum can only handle around 30 transactions per second. Vitalik Buterin, one of the founders of Ethereum, has alleged that 2.0 may eventually scale to as many as 100,000 transactions per second using sharding and other tactics. 

"ETH2 scaling for data will be available *before* ETH2 scaling for general computation. This implies that rollups will be the dominant scaling paradigm for at least a couple of years: first 2-3k TPS with eth1 as data layer, then 100k TPS with eth2 (phase 1). Adjust accordingly," Buterin said in a 2020 tweet.