You might have heard all over the news that Ethereumis transitioning to the Proof-of-Stake (PoS) consensus algorithm after Ethereum Merge. Why is that, and why now? And what does it mean for your Ethereum holdings? This piece addresses Ethereum’s move to the Proof-of-Stake consensus and why it matters greatly.

What’s This Scalability Issue All About?

Vitalik Buterin once explained a concept called the crypto trilemma.It refers to the choiceblockchain networkdevelopers have to make between security, scalability, and decentralization. According to him, networks can have two of these and have to forego the third. So a quick question: which of these do you think Ethereum let go of?

Introduction to Ethereum

If you chose scalability as the answer to the question above, you are correct. Ethereum is a decentralized blockchain platform that creates a peer-to-peer network for safely executing and validating smart contract application code. As a result, smart contracts enable participants to carry out transactions with each other without the need for a reliable central authority (decentralization). Furthermore, network participants have complete ownership and visibility over transaction data since transaction records are immutable, verifiable, and securely distributed across the network (security).

The cryptocurrency connected to the Ethereum network is called Ether. Users that use computers with a high computational capacity to solve mathematical equations are rewarded in Ether. This process is called mining, and it helps keep the system operating (remember Bitcoin mining?).

Several co-founders created Ethereum, the most popular being Vitalik Buterin, who in 2014 issued a whitepaper introducing it.

Buterin and Joe Lubin, the creator of the blockchain software firm ConsenSys, introduced the Ethereum platform in 2015.

Ethereum Proof-of-Work (PoW) Explained

The first blockchain was the Bitcoin blockchain. Its developer intended to eliminate the influence that states, large banks, or other third parties had on financial systems.

Proof-of-work offers significant benefits, particularly for a relatively straightforward but valuable cryptocurrency like Bitcoin. It is a tested, reliable method of maintaining a safe and decentralized blockchain.

Bitcoin's developers had to figure out a mechanism to prevent anyone from trying to rig the system and spend the same coins more than once in a blockchain where users maintain a shared record. It wasn't an ideal solution, but a clever workaround showed it could work.

This mechanism involves miners competing with one another to solve challenging mathematical puzzles. The first miner to crack the equation has the right to add a new block to the chain, update the ledger, and earn freshly minted coins.

As a cryptocurrency's value rises, more miners are encouraged to join, boosting the network's strength and security. Any person or group attempting to interfere with the blockchain of a valuable cryptocurrency will find it impossible due to the amount of computing power required.

On the other hand, because smart-contract compatible blockchains like Ethereum may need to process many transactions, it is a resource-intensive process that may have difficulties scaling. As a result, alternatives have been created, with proof-of-stake being the most popular.

Ethereum Blockchain Limitations

Resource-Intensive

To ensure that nodes in the network record transactions on the blockchain in a decentralized manner, Ethereum uses a PoW consensus mechanism.

However, there is a high cost to decentralization because the procedure calls for reliable computational power and a lot of energy.

Scalability

One of the main issues with the Ethereum network is that transactions are executed slowly, and the network cannot scale to meet demand without paying hefty transaction fees.

Due to fundamental characteristics of Ethereum mining, block creation is limited to 7–15 transactions per second, creating a scalability issue. In contrast, the Visa network completes about 45,000 transactions each second.

The requirement for each node to handle each transaction on the network is a significant limiting constraint. If this issue isn't fixed, Ethereum users may experience longer wait times due to transaction congestion. The Ethereum network needs to increase the speed at which transactions are processed to be prepared for enterprise-class applications.

Vulnerability to Attack

Since smart contracts are available for public inspection, skilled programmers may find code that contains flaws that can be exploited, resulting in the theft of cash.

Ethereum’s Proof-of-Stake (PoS) Explained

Blockchains use proof-of-stake as a form of consensus mechanism to establish distributed consensus.

Staking in a proof-of-stake systemperforms similarly to mining in a proof-of-work system. It selects a network participant to add the most recent batch of transactions to the blockchain and receive cryptocurrency in return.

The specifics vary depending on the project, but generally speaking, PoS blockchains use a network of validators who donate or stake their cryptocurrency in exchange for the opportunity to potentially validate new transactions, update the blockchain, and earn passive income.

Although Ethereum’s original consensus mechanism is PoW, the network seeks to change to the proof-of-stake for several reasons. In the proposed Ethereum proof-of-stake, validators voluntarily stake money in the form of Ether into an Ethereum smart contract. The validator is in charge of verifying the validity of new blocks produced across the network. The staked Ether then serves as collateral and could be liquidated if the validator refuses to keep up to his side of the agreement.

Ethereum Testnets

A network of nodes called an Ethereum testnet is used to evaluate the Ethereum protocol. In addition, the testnets are used for testing to make sure it is functioning as intended.

Before deploying to the Mainnet, these networks are used by authors of smart contracts or protocols to test potential smart contracts in an Ethereum-like setting.

Any contract code you write should be tested on a testnet before being released to the mainnet. Most Projects among dApps that connect with current smart contracts have testnet deployments.

The majority of testnets employ a proof-of-authority consensus algorithm. A few nodes are chosen to validate transactions and build new blocks, staking their identities in the process.

However, the cost of creating tests and delivering them on the testnet is substantially lower than that of creating smart contracts and deploying them on the mainnet. This is because we must pay gas fees before deploying our smart contracts on the mainnet, and these gas payments are actual financial obligations.

Typically when testing your smart contracts, you don't want to use real money. Testnets can help you with this. You can use the free cryptocurrency offered by testnets to pay for gas. We cannot use this free cryptocurrency on the mainnet because it has no value.

In essence, before releasing your smart contracts on the mainnet, you should test them on a testnet first.

Types of Ethereum Testnets

Rinkeby

Rinkeby is a proof-of-authority testnet for Ethereum employed to test developments and how they’ll come out on the Ethereum protocol. It is Ethereum's main network fork. Before launching your dApps on the actual Ethereum mainnet, you can test them in a test environment using Rinkeby.

The Ethereum Foundation developed Rinkeby in April 2017, and the Geth developer team is responsible for its upkeep. It employs the proof-of-authority consensus mechanism.

This testnet shows the network statistics, including several nodes, transactions, and blocks. Additionally, it displays the number of peers, the total number of nodes connected to Rinkeby, the number of blocks per second, and the number of transactions per second.

Kovan

Another testnet for the Ethereum protocol is called Kovan. Kovan is a fork of the mainnet, just like Rinkeby.

Kovan was developed by the Ethereum Foundation in June 2017 and is now under maintenance by the Geth development team. It also makes use of the proof of authority consensus mechanism until it was moved to a proof-of-stake.

Kovan generally supports the same functions as Rinkeby does. On this Kovan testnet, you can also obtain free Ethereum by using the official faucet.

On the Kovan testnet, you can write ERC-20, ERC-721, and ERC-1155 tokens. It displays ERC-20, -721, and 1155 tokens in addition to the most recent blocks and transactions. You may also look for addresses, transactions, blocks, and other information.

Goerli

The Parity team invented Goerli in November 2018. It employs the proof-of-authority consensus mechanism, like both testnets mentioned above, but is the latest testnet to migrate to the proof-of-stake.

The ERC-20, -721, and -1155 coins are all shown on the Goerli website, along with the most recent blocks and transactions. Goerli allows you to search for addresses, transactions, blocks, and other data, just like the other testnets we've seen, but still ranks as Ethereum’s largest testnet.

Differences Between Ethereum’s Proof-of-Work and Proposed Proof-of-Stake

Proof-of-work involves miners competing to validate transactions and solve cryptographic puzzles to receive block rewards. Proof-of-stake, on the other hand, uses randomly selected validators to ensure the transaction is reliable and pays them with cryptocurrency in exchange. Although one offers a better solution, both options have a different set of benefits and drawbacks.

Compared to the proof-of-work consensus, proof-of-stake offers the following improvements:

- Proof-of-stake lower energy consumption encourages more nodes to secure the network, reducing the risk of centralization.

- Lower entry hurdles and fewer hardware requirements mean that sophisticated hardware is not necessary to have a chance of producing new blocks.

- Generally, it has been theoretically proven that proof-of-stake, as will be used for Ethereum, is more economically secure than proof-of-work.

Drawbacks of Proof-of-Work

Proof-of-work is an energy-efficient method for confirming transactions. The blockchain is less environmentally friendly than other systems since the network's computers must use a lot of energy and operate often.

Drawbacks of Proof-of-Stake

The fundamental problem with proof-of-stake is that it requires a substantial upfront payment. To become a validator, which depends on the size of the entire network, you must buy a sufficient amount of the cryptocurrency's native token.

This could inevitably lead to decentralization problems, as large players would create centralized ways of co-funding a node, thus holding all the validating power to themselves.

Conclusion

No consensus mechanism is perfect, so it's crucial to recognize that both proof-of-stake and proof-of-work have advantages and disadvantages. Despite this, Ethereum's move to the proof-of-stake is believed to bring more good than bad to the system. Challenges will definitely arise, and it is clear from the Ethereum developers' delay in the launch that they are ensuring everything is in perfect order before it launches.