Concerns of rising transaction fees have once again rattled the Ethereum community. Adoption will be impossible if fees continue to rise. Will Ethereum 2.0 bring the solution?
Ethereum transaction fees have been stuck above $2 for over a month and the average fee as of September 13th is as high as $3.34. This record-breaking run has increased the cost and time of running smart contracts, raising concerns that Ethereum still isn’t scalable.
Many Ethereum enthusiasts are pinning their hopes on Ethereum 2.0. But should investors or traders consider it viable long-term? How might this situation affect traders seeking out volatility? Can the update really solve ETH’s scalability problem before it’s too late?
How Are Transaction Costs Decided and Why Do They Matter?
In order for Ethereum to work, it runs the Ethereum Virtual Machine on the Ethereum protocol. Currently, Ethereum miners execute the contract code for Ethereum programs or dapps. These miners are rewarded for their effort using Ether and gas.
Gas and Proof of Work (PoW)
Ether (ETH) is the currency of the Ethereum network. It is the reward for miners who use the system. Gas on the other hand is more like a commodity and acts as the “fuel” of the Ethereum network. Instead of implementing gas as a separate token, the Ethereum team ensured that gas was directly pegged to Ethereum, meaning that a direct exchange is unnecessary.
DeFi and Incentives
The problem with this approach is that miners are still required to process transactions using Proof of Work (PoW).
In order to incentivize a miner to process your dapp, you need to offer a larger amount of gas or be forced to wait. This isn’t a problem until there is a lot of demand.
This is exactly what we’ve seen happen in August and September. The explosion in demand from Decentralized Finance (DeFi) apps has put significant strain on the Ethereum blockchain. Ethereum users hope that Ethereum 2.0 will provide a solution.
Eliminating PoW and EIP 1559 Reform Could Bring Scalability
The main reason fees are so expensive is that it is the only way to incentivize miners to bring security to the Ethereum network. The problem with this is that PoW is very expensive, which encourages miners to seek higher fees. This is why one of the landmark advances of Ethereum 2.0 is a shift to Proof of Stake (PoS).
Proof of Stake (PoS)
Proof of Stake consensus will replace miners with validators. Users will have to dedicate a specific amount of Ethereum in order to become a validator, in exchange they will receive a small fee once a smart contract concludes.
Theoretically, this will reduce costs and ensure that gas fees are more stable, preventing the kind of shifts we’ve seen this year.
In case you missed it: recent writing on fee market reform (EIP 1559)
Oh and it seems to be working great on filecoin:https://t.co/sgWLPF1VXg
— vitalik.eth (@VitalikButerin) August 26, 2020
Ethereum Improvement Proposal 1559
Another important change is the Ethereum Improvement Proposal (EIP) 1559. The proposal is currently being tested on Filecoin and appears to be functioning.
The plan uses a base fee system to replace the current auction system. This would increase or decrease dynamically based on network usage and would make it simpler to predict the cost of running a dapp.
Ethereum 2.0 Needs to Solve the Scalability Problem
Anticipation for Ethereum 2.0 is undoubtedly part of the reason behind ETH’s recent price rise and its potential to make the network more scalable.
This is especially important as the DeFi explosion doesn’t look set to stop any time soon.
If Ethereum can push forward with its ambitious plans, it should help to set many of the doubters’ minds at ease.
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