Ethereum is the second-largest blockchain protocol and the first protocol to think about blockchain as a potential world’s computer. Indeed, over the years Ethereum has spurred various applications, from decentralized finance to NFTs, decentralized organizations, and more. Founded by Vitalik Buterin, it launched in 2014 with its ICO, the core development team behind Ethereum helped kick things off, and the crowd sale turned out to be one of the most successful ones in the blockchain ecosystem.
The history of Ethereum is part of the Blockchain Business Models, you find the detailed references in the book:
The beginnings of Ethereum
In a 2014 message from Vitalik Buterin that read “Welcome to the New Beginning,” Buterin explained “When the grand experiment that is bitcoin began, the anonymous wizard desired to test two parameters – a trustless, decentralized database enjoying security enforced by the austere relentlessness of cryptography and a robust transaction system capable of sending value across the world without intermediaries. Yet the past five years have painfully demonstrated a third missing feature: a sufficiently powerful Turing-complete scripting language.”
And Vitalik Buterin continued listing the innovations that Bitcoin had brought but then got to the point of what Ethereum would be for “Ethereum is a modular, stateful, Turing-complete contract scripting system* married to a blockchain and developed with a philosophy of simplicity, universal accessibility, and generalization.”
Vitalik Buterin also highlighted the main goal of such a Blockchain model “to provide a platform for decentralized applications – an android of the cryptocurrency world, where all efforts can share a common set of APIs, trustless interactions and no compromises.”
This message alone well explains the whole foundation of Blockchain. A general-purpose Blockchain, working more like a programming language able to accommodate an infinite number of use cases on top of it. Indeed, as Vitalik Buterin has highlighted in many of his interviews, initially he had thought of a Blockchain that could be used for a few dozens of use cases. But then he realized that the strength of a modular, general-purpose Blockchain would have been unlimited.
This apparently mad project turned into one of the most successful Blockchain protocols, that enabled various use cases (from decentralized applications and finance to decentralized autonomous organizations, non-fungible tokens, and more).
The core developers behind the initial launch of Ethereum were Vitalik Buterin (who would become the leading person for the whole project), Gavin Wood (who later went on to found other successful protocols like Polkadot and Kusama), and Jeffrey Wilcke.
Where did this name come from?
In a forum discussion in 2014, Vitalik Buterin explained the reasoning of Ethereum’s name “I was browsing a list of elements from science fiction on Wikipedia when I came across the name. I immediately realized that I liked it better than all of the other alternatives that I had seen; I suppose it was the fact that sounded nice and it had the word “ether”, referring to the hypothetical invisible medium that permeates the universe and allows light to travel.”
The name choice wasn’t that casual, as it stood for the mission that Ethereum had as a Blockchain protocol. Become the “gas” or the primary element that fueled transactions of any time on top of its modular, general-purpose Blockchain.
*In simple terms that means a general-purpose computer language.
The $18 million-dollar launch
As Ethereum got into the world as a project, it started its journey as a decentralized organization, busy in building up the key components of the protocol that would lay out the foundation of the work to do in the coming years.
By January 2014, as Vitalik Buterin got ready to announce the “Ether Sale” which would officially mark the beginning of Ethereum as a cryptocurrency he reminded the cold day in San Francisco, back in November 2013, when he was drafting the White Paper, after months of reflection on what would determine the evolution of the blockchain.
This phase would be called among the insiders “cryptocurrency 2.0” or the phase in which finally crypto would move beyond the application that Bitcoin had brought around money. In short, it wouldn’t be just about money, as a use case, but rather about applications, decentralized applications, that could potentially be built on top of this new infrastructure.
The journey to get through this realization wasn’t a simple one and as Vitalik Buterin highlighted that was quite frustrating. As Buterin explained in his own words:
“Eventually, I realized that the key to solving the problem once and for all was a simple insight that the field of computer science first conceived in 1935: there is no need to construct a separate infrastructure for each individual feature and implementation; rather, it is possible to create a Turing-complete programming language, and allow everyone to use that language to implement any feature that can be mathematically defined. This is how our computers work, and this is how our web browsers work; and, with Ethereum, this is how our cryptocurrencies can work.”
This would become his approach and strategy in developing the Ethereum protocol. Rather than thinking in simple use cases and potential applications, Vitalik Buterin started to think in terms of a programming language that could accommodate an unlimited number of use cases.
From there lead code developers Gavin Wood (who would later depart to found two major Blockchain protocols like Polkadot and Kusama) and Jeffrey Wilcke (who later went on to found games development studio, Grid Games) but also other lead developers like Charles Hoskinson (who would, later on, support the hard fork of Ethereum, Ethereum Classic, and in 2016 he also found another successful protocol, Cardano), Anthony Di Iorio and Mihai Alisie (who would serve as vice-president of the Ethereum Foundation until 2015).
In short, the founding team that would bring the core Ethereum protocol to life (and that later on would be the protagonist of the first “Ethereum War”) was formed.
Vitalik Buterin at the time described Ethereum as “a next-generation cryptographic ledger that intends to support numerous advanced features, including user-issued currencies, smart contracts, decentralized exchange and even what we think is the first proper implementation of decentralized autonomous organizations (DAOs) or companies (DACs)” (those would stick as some of the core use cases for Ethereum).
Buterin also explained that even though decentralization was the great promise of Ethereum what made it special was “the way that it does this – referring to the various applications. Instead of attempting to specifically support each individual type of functionality as a feature, Ethereum includes a built-in Turing-complete scripting language, which allows you to code the features yourself through a mechanism known as “contracts”.
Indeed, contracts (or smart contracts) would become the killer application for Ethereum. Those contracts represented ‘agents’ running specific pieces of code every time a transaction is sent to it and even more interestingly more advanced versions of these agents would be even able to modify their own code (thus becoming autonomous agents).
Over the course of the months as Ethereum moved from its White Paper to becoming a real-world project, more and more challenges came to be overcome. From the problems related to the proof of stake algorithm to mining and more.
Yet the founding team was focused and capable.
In a post to review the work done on the project just prior to the Ether sale, one of the leaders from the development team, Mihai Alisie, highlighted:
“The project started as an idea in Vitalik’s mind. Ethereum has now expanded into thousands and thousands of other minds around the world, thanks to this interconnected digital mesh called the Internet. A sea of minds brought together by the idea of a Turing complete general-purpose blockchain is creating, as you’re reading these lines, the Minecraft of blockchain tech.”
One of the key discussions that went on in these months, and that indeed represented the foundation of Ethereum from an organizational point of view, was whether to be a for-profit or not-for-profit organization. And the latter was the conclusion, as Mihai Alisie explained:
“After researching a number of models and organizations, we arrived at the conclusion that in order to keep the protocol and the software as pure as possible the only real option was to build a non-profit structure with a declared mission to develop, maintain, nurture and explore the potential of this new technology. Motivated not by money but radiant passion for this crazy idea of a free, open, and decentralized world. That’s what make us happy in the end and most importantly what makes us get up and work on this project, proudly saying today we’re building tomorrow.”
Finally, after months of intense work, the day of the sale came, and in a blog post on July 22, 2014, entitled “Launching the Ether Sale*” Vitalik Buterin announced the sale of what would become the major player in the Blockchain space, only behind Bitcoin (even though at the time very few people expected the success of such a project).
As Vitalik Buterin explained in the same post “First of all, I would like to thank the community, and especially those close to the project who have in many cases abandoned their jobs to dedicate their time to it, for their extreme patience regarding the launch of the ether sale.”
In the blog post Vitalik Buterin laid down the work that had been done in the previous months to get to the sale (that included the development of the first version of the Ethereum protocol). The sale would fix the initial price at “2000 ETH per BTC” until declining to a final rate of 1337 ETH per BTC and it concluded on September 2.
By the first two weeks from the sale over 50 million ETH had been sold pushing Ethereum among the top eight coins for a market cap for a value of the initial sale of $17.3M USD beating out also the initial sale of Dogecoin (at $15.5M).
Keeping it open: The first year and the discussion around governance and vision
In a post highlighting the work done in the first year of the Ethereum project, Mihai Alisie, one of the co-founders who would stay on board as vice-president of the Ethereum Foundation until 2015 explained:
“During the last couple of weeks, I started to think about how far we’ve come and how many things we have accomplished since this project started. From idea to implementation and everything in between, it was (and continues to be) the most intense ride of my life.”
Mihai remembered the early days of the Ethereum project when in the autumn of 2013, Vitalik Buterin had drafted the first version of the Ethereum White Paper, which he had addressed to a few selected ones, among these there was Mihai.
As Mihai Alisie recalled “Ethereum felt different from anything else he’d sent me before. The same rush I felt when I first understood the implications of Bitcoin was returning, this time with thousands of new multi-dimensional rabbit holes to explore.”
In fact, Mihai together with Vitalik back in 2011, when Bitcoin was just gaining traction, started Bitcoin Magazine, a project that was meant to narrate all the aspects of the Bitcoin ecosystem. By May 2012 the first issue came out.
From the magazine, Vitalik Buterin started to draft the vision for Ethereum. As the project got set up, along the way, in 2014, the Peter Thiel Foundation awarded $100K fo Vitalik Buterin for his Ehtereum’s project:
This $100K would set the stage for a project worth billions of dollars only a couple of years later and potentially a trillion of dollars in a decade or two.
The early years: $50 million Ether hack, the hard fork and the Web 3.0
In a blog post on January 2016 entitled “The last Blog Post,” Gavin Wood explained how his departure was going to mark the beginning of a few new projects. And in another article on his personal blog, he asked “So Ethereum is released. How come the dream of an open, transparent, jurisdiction-neutral techno-legal system hasn’t arrived?!”
Finally in an article entitled “Why We Need Web 3.0” of September 2018 (over two years from his departure from Ethereum) Gavin Wood emphasized his vision for the future by also announcing Polkadot:
“From a user’s point of view, Web 3.0 will look barely different from Web 2.0, at least initially. We’ll see the same display technologies: HTML5, CSS, and so on. On the back-end, technologies like Polkadot — Parity’s inter-chain blockchain protocol — will connect different technological threads into a single economy and “movement.”
Polkadot and Kusama would all become blockchain protocols springing up from the “Ethereum’s war.”
But how did we get there?
The years from 2014 to 2016 marked the beginning of Ethereum beyond its White Paper. Not just a paper project, but a real-world one, that had shown its capabilities. Yet, the question here still remained on the whole project’s viability.
The development of the Ethereum Blockchain protocol had continued at full speed and the community grew exponentially.
Until one of the greatest heists on the Blockchain took place, and that happened right on the Ethereum Blockchain.
It all happened in the first part of June 2016, when the Ethereum community found a flaw in the DAO’s code. In an article entitled “More Ethereum Attacks: Race-To-Empty is the Real Deal” on June 9, 2016, Peter Vessenes opened by saying “Chriseth at github casually pointed out a terrible, terrible attack on wallet contracts that I had not considered. If there were a responsible disclosure avenue for ethereum contract developers, I would use it, but there doesn’t seem to be. Not only that, this code has been out and published on github for long enough that I wanted to get the news out there quickly.”
In short, a flaw in the smart contract’s code enabled potential hackers to exploit the fact that several withdrawals could be done, before the smart contract eventually records the final balance, thus enabling hackers to potentially steal millions of dollars from these smart contracts. This vulnerability not only was now visible for anyone, and up for grabs by hackers, but that posed a threat to the whole existence of Ethereum as a Blockchain.
Indeed, if one of the core values of Ethereum was security and an “unhackable cryptographed blockchain” how could this be possible in the first place?
The way the community would answer it would determine not only whether Ethereum survived but also if it could thrive going forward.
Initially, the bug in the code was undervalued by the community, but as of June 17th, it became clear this was something serious. In a blog post entitled “CRITICAL UPDATE Re: DAO Vulnerability” Vitalik Buterin explained “An attack has been found and exploited in the DAO, and the attacker is currently in the process of draining the ether contained in the DAO into a child DAO. The attack is a recursive calling vulnerability, where an attacker called the “split” function, and then calls the split function recursively inside of the split, thereby collecting ether many times over in a single transaction.”
Therefore, this “split function” was used to withdraw ether out of the smart contract many times over in a single transaction. Similar to a broken cash machine where the robber is able to take the same amount of cash many times while the machine records it only once, the hackers started to take advantage of this vulnerability, thus draining millions of dollars worth of Ethereum’s from the DAO’s smart contracts.
Indeed, imagine a cash machine that records only a transaction of $100 but while the drawer is closing the robber is able to take many times over banknotes of $100, while the cash machine only records one transaction of $100. This is the extent to which hackers were draining out money from smart contracts.
From an analysis done by Phil Daian the next day revealed some of these flaws and explained: “this exploit in the DAO is clearly not trivial; the exact programming pattern that made the DAO vulnerable was not only known but fixed by the DAO creators themselves in an earlier intended update to the framework’s code. Ironically, as they were writing their blog posts and claiming victory, the hacker was preparing and deploying an exploit that targeted the same function they had just fixed to drain the DAO of all its funds.”
As it turned out the core bug was part of the language program developed to deal with DAO and smart contracts. In fact, within the language program, Solidity (which was invented by Gavin Wood).
Gavin Wood, interviewed for the Dutch Blockchain Conference, on June 21, 2016, explained in his own words, what was going on and how to fix this next:
“What happened so there are a few things to explain about this. The first thing is that the problem isn’t with the Ethereum itself but the problem is with one of these applications, with one of these smart contracts so the smart contracts are not built into Ethereum. Ethereum exists sort of on a lower level and these software run on the higher level so it’s like saying well these websites are broken and it’s not saying the same thing as the Internet’s broken right. So Ethereum is like the Internet it just sort of works but yes one of the websites as it were that the work that sits on if they’re on the on ethereum and broke this website was called the DAO. Now the Dow was envisioned as some sort of mechanism so that people could pay in ether and this either could be used to sponsor projects and if the project’s ended up becoming profitable people would be able to make some of the new profits back and what happened was due to a technical flaw in this the DAO in this piece of software, this website that sits on top of Ethereum someone was able to attack it and to drain about a third of the money that the DAO had managed to collect into a child DAO. So into a kind of an offspring of the same the same sort of thing but an offspring. Now the reality is that the mayor is still sitting there so we know precisely where as we can see in the system there’s a balance it’s big it’s bigger than it should be but there’s a different owner but a different owner and at the moment the owner is unable to withdraw it. So due to safeguards in the DAO it’s at about thirty nine days before the owner can withdraw it and so we have this time in order to determine whether we’re going to do something about it or whether we’re just going to let it go.”
Further asked by the interviewer, if that was terrible as an attack for the whole system’s trustability, Gavin Wood replied:
“It’s an attack on the DAO. It’s an attack on the on the integrity of the DAO and it’s using the fact that the DAO is a smart contract that nobody can alter how it’s interpreted and if the interpretate if this software is wrong then the interpretation is wrong and people are understandably annoyed and the sound ugly concerned that you know yeah hold on where is this money being going now the question really is what can we do about it “
As the presenter asked “what to do” next, Gavin Wood, made clear to underline he had nothing to do with the DAO and as the interviewer asked Gavin Wood, whether Ethereum would survive that, Gavin Wood remarked an important point about the future of consensus and decision-making underlying Ethereum:
“The community manages this problem hopefully of how to form governments consensus even in the face of a widespread concern that what happened wasn’t the expectation.”
This passage is critical, as would emphasize something the many people getting to know Blockchain protocols for the first time undervalue. The Blockchain protocol is not just a trustless entity that executes orders automatically. But, it’s also (and this is one of the main points of that) a distributed consensus platform, where important decisions can be taken as a group, rather than single individuals. This is a critical difference also between traditional governance (which is also how major tech players’ companies are run) and the new way of managing blockchain-based companies.
Yet the Reddit user by the screen name of ydtm explained back at the time “Yes, I realize the OP is a bit harsh. I do think Vitalik is a smart guy. But I also think that tens of millions of dollars almost evaporated here, and I would like to provide a perspective based on language design – which might be somewhat different from what we’ve already heard from Emin Gün Sirer in his post mortem which also appeared recently.”
Things got very bad when the flaw was found to be draining dozens of millions and it could get even worse. In the meantime, the developer’s community was frantically trying to find various solutions to the problem. Yet, whichever solution was potentially threatening for the network.
At this point, it’s critical to understand that Blockchain-based business models living on these protocols are made of rules expressed in the form of code that can’t be changed so easily. A change in the code could mean either a soft or hard fork.
And none of these options was a simple one. Forking the blockchain is something that needs to be done carefully and only to reach critical decisions, and this indeed was a survival threat. However, that also opened up the discussion of how blockchain protocols were really immutable. They are not. Indeed, forking enables the underlying rules of a blockchain to be changed. Even though extremely difficult and still based on the consensus of the majority that could be done.
Among the Ethereum community, the leader, Vitalik Buterin also was extremely preoccupied. In a chat between Vitalik Buterin and Exchanges, recorded on Steemit we can feel Vitalik’s concerns:
[3:09:03 AM] George Hallam [ETH] : Ping
[3:09:19 AM] Bill Shihara: Pong
[3:09:57 AM] Bill Shihara: Is the reported issue with the DAO real?
[3:10:17 AM] Vitalik Buterin: as far as we can tell yes
[3:10:33 AM] Mike Li: Where can I find the report?
[3:10:54 AM] Vitalik Buterin: https://www.reddit.com/r/ethereum/comments/4oi2ta/i_think_thedao_is_getting_drained_right_now/
[3:10:55 AM] Vitalik Buterin: active thread
[3:11:06 AM] Alex Hanin: https://thedao.slack.com/messages/general/
[3:11:07 AM] Mike Li: Thank you VB
[3:11:19 AM] Vitalik Buterin: possible mitigation strategies are:
[3:11:21 AM] Bill Shihara: Thanks. There is a lot of panic so a clear statement from the DAO and ETH team’s would be extremely helpful. At this point, people are speculating that griff’s account was hacked.
[3:11:29 AM] Vitalik Buterin: 1. seizing any stolen either that goes through exchanges
[3:11:38 AM] Vitalik Buterin: 2. there is one person who will split within 2 hours
A few minutes later in the conversation, Vitalik Buterin said:
[3:43:01 AM] Vitalik Buterin: ok can you guys stop trading
Asking exchanges to stop trading was a huge deal, as it also meant other legitimate people couldn’t freely trade Ethereum. Thus, this signals perfectly the concern Vitalik Buterin had at the time.
To make things even worse, on June 18th 2016, on “An Open Letter” a guest claimed to be the attacker (this might have only been an attempt to distract the Ethereum’s community), and explained:
“I have carefully examined the code of The DAO and decided to participate after finding the feature where splitting is rewarded with additional ether. I have made use of this feature and have rightfully claimed 3,641,694 ether, and would like to thank the DAO for this reward. It is my understanding that the DAO code contains this feature to promote decentralization and encourage the creation of “child DAOs”.
And at the end of it he went on:
“A soft or hard fork would amount to seizure of my legitimate and rightful ether, claimed legally through the terms of a smart contract. Such fork would permanently and irrevocably ruin all confidence in not only Ethereum but also the in the field of smart contracts and blockchain technology. Many large Ethereum holders will dump their ether, and developers, researchers, and companies will leave Ethereum. Make no mistake: any fork, soft or hard, will further damage Ethereum and destroy its reputation and appeal.
I reserve all rights to take any and all legal action against any accomplices of illegitimate theft, freezing, or seizure of my legitimate ether, and am actively working with my law firm. Those accomplices will be receiving Cease and Desist notices in the mail shortly.
I hope this event becomes an valuable learning experience for the Ethereum community and wish you all the best of luck.
Hard-forking the protocol to win the war
It had become clear by that point that this was a war, a “DAO War.” On June 24, 2016, on a blog post entitled “DAO Wars: Your voice on the soft-fork dilemma” Péter Szilágyi, from Ethereum’s core development team (that had been frantically trying to solve this major flaw in the last weeks), explained:
“The last week was quite hectic for all of us in the Ethereum ecosystem. The DAO has shown us that it takes much more effort to write smart contracts than we originally anticipated; but also that it takes a surprising amount of debate to reach a consensus on issues of this scale.”
One thing that strikes quickly from this event, is now going through this survival threat, there was no single person in charge. Sure, the community still relied a lot on Vitalik Buterin’s ability to respond to this. Yet the decision on how to end this over was in the hands of the developer’s community and even there, the developer’s community alone wasn’t the only stakeholder. In order to align the whole ecosystem, any decision needed to be debated over and made publicly available, to enable people using, exchanging, or building applications on top of Ethereum to understand what was happening there.
This event is at the heart of what it means to do business on a Blockchain.
As Vitalik Buterin went on aligning the community around the two courses of actions possible (soft-fork which would have been less invasive of the protocol, and hard-fork) as he emphasized in the same “as there is no clear, best course of action that will satisfy all community members equally, we’ve decided to give the power to the people running Ethereum to decide whether they support this decision or not.”
Vitalik Buterin also explained the consequences going forward, “miners who do not update by definition vote against the soft-fork as they will continue the current logic of keeping the gas limit above the vote threshold. If the soft-fork is accepted by the majority, non-updating miners will still accept blocked transactions. In that case, non-updating miners will either fork off their own Ethereum network, diverging from the majority, or will forfeit any blocks they mined (since it’s not accepted by the majority, overruling the minority blocks)”
And as an epilogue “This release implements a soft-fork. A soft-fork is perfectly compatible with all protocol rules and requires only the consensus of the majority of miners to enact. It is temporary and can be removed/amended at any point in time upon miner consensus. It does not break protocol rules; it does not roll back any executed transactions/blocks; and it does change not any blockchain state outside of the original protocol capabilities.”
As time went by, the dilemma on how to permanently fix the issue was highlighted in the blog post “To fork or not to fork” on July 15, 2016, Ethereum’s core developer Jeffrey Wilcke explained “The DAO, though not a product developed by the Ethereum Foundation, has been a hot topic as of late, both internally in the organisation as well as within our community. The Hard Fork is a delicate topic and the way we see it, no decision is the right one. As this is not a decision that can be made by the foundation or any other single entity, we again turn towards the community to assess its wishes in order to provide the most appropriate protocol change.”
By July 20, 2016, the hard fork had been completed. This time Vitalik Buterin took the lead in explaining the process. As Ethereum’s blockchain moved toward block 1920000 (the one that would execute the hard fork) we can only imagine Buterin’s state of mind. As the process completed Buterin acclaimed “we would like to congratulate the Ethereum community on a successfully completed hard fork. Block 1920000 contained the execution of an irregular state change which transferred ~12 million ETH from the “Dark DAO” and “Whitehat DAO” contracts into the WithdrawDAO recovery contract. The fork itself took place smoothly, with roughly 85% of miners mining on the fork.”
This is what the hard fork looked like in practice. This simple move in codes determined hundreds of millions to move to the new fork in a few seconds.
Vitalik Buterin closed the post by highlighting “we thank our developers and the community for working together to make the transition as smooth as it has been, and look forward to working together to continue to make the Ethereum ecosystem and protocol a success.”
In a final post “Onward from the Hard Fork” Vitalik Buterin explained “The foundation has committed to support the community consensus on the admittedly difficult hard fork decision. Seeing the results of various metrics, including carbonvote, dapp and ecosystem infrastructure adoption, this means that we will focus our resources and attention on the chain which is now called ETH (ie. the fork chain). That said, we recognize that the Ethereum code can be used to instantiate other blockchains with the same consensus rules, including testnets, consortium and private chains, clones and spinoffs, and have never been opposed to such instantiations.”
Therefore, going forward two Ethereum protocols would come out from this hard fork. The new ETH, which would be rebranded as the “official” Ethereum protocol, contained the altered history (by removing the hacked tokens) and the old Ethereum protocol, named now ETC, or Ethereum Classic that contained the unaltered history (together with the theft of millions of dollars).
Thus, the hard-forked Ethereum protocol would continue its existence afresh, with a very hard-learned lesson, dozens of million dollars missing, and yet a community that had responded with maximum support.
And all of this paradoxically highlighted one of blockchain’s most important promises, the unknowability of the holder.
Everyone knows the address:
Misplaced millions of ethers, and yet none knows who that is (having passed on the Ethereum Classic blockchain we don’t know for sure whether these tokens were eventually sold and to whom). Just like Satoshi Nakamoto remained a mystery after years from the Bitcoin’s White Paper (together with a pool of 1.1 million Bitcoins worth billions). So Ethereum’s stolen token was never traced back.
Solving for Scale: Making Ethereum from 100x to 1000x more efficient
When Ethereum was first created as a project, the first question that popped to mind to investors was whether it would become a viable project. However, as it showed it was viable (and it survived the “DAO War”), the next question was about scalability. Indeed, as more and more applications (dApps) got built on top of the Ethereum blockchain, its fees to execute transactions got higher and higher.
In part, these “gas fees” have helped as a disincentive to the system to execute transactions or applications that might be less relevant to the whole ecosystem. Yet, in the long run, the Ethereum ecosystem depends upon its ability to accommodate as many use cases as possible.
This poses a major challenge, which is scalability. How does Ethereum tackle that? In two main ways.
Layer 1 Scaling: Getting 100x Better
Core examples of Layer 1 scaling comprise proof of stake and sharding. Indeed, as Ethereum rolls out what’s now called Eth2 (the upgrades that will make the whole protocol more scalable), eventually, as and if the roll-out comes out successfully, Eth2 will merge into Ethereum, thus becoming a more effective whole.
It’s important to highlight that Ethereum started primarily as a proof of work-based protocol (like Bitcoin). While this delivered the project’s viability; as Ethereum grew to support new use cases like decentralized finance and decentralized applications a new consensus algorithm needed to be introduced. That is why Ethereum started to move toward proof of stake and sharding (these changes will be coordinated by the Beacon Chain).
As Vitalik Buterin highlighted in “Why sharding is great: demystifying the technical properties” “sharding is the future of Ethereum scalability, and it will be key to helping the ecosystem support many thousands of transactions per second and allowing large portions of the world to regularly use the platform at an affordable cost. However, it is also one of the more misunderstood concepts in the Ethereum ecosystem and in blockchain ecosystems more broadly. It refers to a very specific set of ideas with very specific properties, but it often gets conflated with techniques that have very different and often much weaker security properties. The purpose of this post will be to explain exactly what specific properties sharding provides, how it differs from other technologies that are not sharding, and what sacrifices a sharded system has to make to achieve these properties.”
He also explained that when it comes to Blockchain protocols the Scalability Trilemma (or the ability to keep the public blockchain scalable, decentralized, and secure) can be achieved via more complex mechanisms like sharding*.
As Vitalik Buterin highlighted “a sharded blockchain is:
- Scalable: it can process far more transactions than a single node
- Decentralized: it can survive entirely on consumer laptops, with no dependency on “supernodes” whatsoever
- Secure: an attacker can’t target a small part of the system with a small amount of resources; they can only try to dominate and attack the whole thing”
Blockchain companies use sharding to partition databases and increase scalability, allowing them to process more transactions per second. Sharding is a key mechanism underneath the Ethereum Blockchain and one of its critical components. Indeed, sharding enables Blockchain protocols to overcome the Scalability Trilemma (as a Blockchain grows, it stays scalable, secure, and decentralized).
Layer 2 Scaling: Getting 1000x Better
When it comes to layer 2 scaling, this has the potential to make the whole ecosystem much more effective. This consists of enabling smarter protocols on top of the main Ethereum protocol. Thus expanding exponentially the capabilities and use cases available on the main protocol. A very basic example of layer 2 scaling are payment channels which “allow for practically unlimited, bidirectional transfers between two participants, as long as the net sum of their transfers does not exceed the deposited tokens.”
As Vitalik Buterin explained “This technique – referring to payment channels – is powerful: it can be adjusted to handle bidirectional payments, smart contract relationships (eg. Alice and Bob making a financial contract inside the channel), and composition (if Alice and Bob have an open channel and so do Bob and Charlie, Alice can trustlessly interact with Charlie). But there are limits to what channels can do. Channels cannot be used to send funds off-chain to people who are not yet participants. Channels cannot be used to represent objects that do not have a clear logical owner (eg. Uniswap). And channels, especially if used to do things more complex than simple recurring payments, require a large amount of capital to be locked up.”
However, the main problem with these schemes is the fact that transactions are pushed off-chain (where the value is moved outside the blockchain), which can pose security risks, thus comprising the whole purpose of the blockchain.
However, for Vitalik Buterin, one of the most exciting examples of layer 2 scaling are the so-called “roll-ups.” As an example, let’s consider the case of optimistic rollups, which “use a side chain that sits in parallel to the main Ethereum chain. They can offer improvements in scalability because they don’t do any computation by default. Instead, after a transaction they propose the new state to mainnet. Or “notarise” the transaction.”
This is critical because roll-ups will reduce the congestion on top of the main blockchain, as they take place on a “sidechain” thus potentially reaching a transaction speed of 2,000-3000 per second.
Therefore, all these transactions would be processed through the rollups on the sidechain and the reports on top of layer 1, or the main Ethereum’s blockchain, de facto increasing speed, and reducing gas fees.
And the key advantage is that these transactions would still be on-chain. This passage is critical to understand as Vitalik Buterin himself highlights:
“The fact that data is on-chain is key. Putting data on-chain and having consensus on that fact allows anyone to locally process all the operations in the rollup if they wish to, allowing them to detect fraud, initiate withdrawals, or personally start producing transaction batches. The lack of data availability issues means that a malicious or offline operator can do even less harm (eg. they cannot cause a 1 week delay), opening up a much larger design space for who has the right to publish batches and making rollups vastly easier to reason about. And most importantly, the lack of data availability issues means that there is no longer any need to map assets to owners, leading to the key reason why the Ethereum community is so much more excited about rollups than previous forms of layer 2 scaling: rollups are fully general-purpose, and one can even run an EVM inside a rollup, allowing existing Ethereum applications to migrate to rollups with almost no need to write any new code.”
Toward Ethereum 2.0, Staking, Sharding, Proof of Stake* and Scaling
As a quick recap so far, Ethereum was born in 2014 out of Vitalik Buterin’s White Paper, and the core development team has been extremely successful since the start. By 2016 a critical flaw in the DAO smart contract made it possible for hackers to steal millions of dollars worth of Ethereum, thus posing a serious threat to its survival. The solution to it was a hard-fork, to which most of the Ethereum community joined in and that determined the split of the protocol. From there two protocols were formed, Ethereum Classic (ETC) Containing the unaltered history of the protocol (comprising the stolen tokens) and ETH, which would be rebranded as Ethereum, which contained the altered history (the protocol from which the stolen tokens had been removed).
As Ethereum showed its viability, it started to scale quickly and by 2017 it also showed its potential. However, a problem of scalability arose, especially in light of massive “gas fees” (the fees to process transactions on top of Ethereum’s Blockchain). To solve this problem, Ethereum started to move toward Eth2 – scheduled between 2022-2024 – which once successfully rolled out would be rebranded as Ethereum. This upgraded protocol will primarily address scaling through two layers. With Layer 1 Scaling, the main protocol might get potentially 100x more efficient.
This will consist of integrating new mechanisms such as proof of stake, and sharding. In the process, Ethereum holders can also stake their coins (those would be locked into the blockchain until the transition to Eth2 has been completed) and earn interest as a result of that. Layer 2 Scaling instead will consist of integrating mechanisms such as roll-ups that might make the whole blockchain 1000x more efficient, by enabling transactions to be processed at scale on sidechains, that can be reconducted back to the main protocol (thus still be on-chain and therefore secure).
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