Ethereum roadmap and risks

Written: July 2022

Note that since this article was written, Ethereum successfully completed the transition to proof-of-stake consensus on September 15, 2022.

This article is Part 5 of a five-part series that aims to provide an overview of the Ethereum network from an investment perspective. The first part provides some background on the mechanics of Ethereum, and then outlines its general value proposition and competition positioning. The second, third and fourth parts each focus on a key aspect of the ecosystem of applications that may be built on Ethereum, and aim to provide insight with regard to use cases, growth metrics and considerations. The fifth part examines the future of Ethereum from a broader perspective, and includes a discussion of its development roadmap, as well as different types of risks that may be associated with an investment in ether.

Ethereum roadmap

This article aims to provide an overview of some of the key aspects of Ethereum development. It should be noted that what follows is by no means a comprehensive list, and there are several other development projects underway or planned for the future.

The Merge

The Ethereum network is transitioning from PoW consensus to PoS consensus, which is estimated to reduce energy consumption by about 99.95%, and helps prepare the network for future development plans.¹ PoS validators will replace the role of PoW miners, and will be responsible for proposing and validating blocks, earning associated rewards. The reward amount generally depends on the proportion of ether staked in the network. A deposit, or “stake,” of 32 ETH is required to become a validator. Validators who behave dishonestly can have their deposit slashed, meaning that they lose some of their staked ether. Sabotaging the network via something called a “51% attack,” which would allow the saboteur to double spend their tokens and violate the integrity of the blockchain, would require the accumulation of more than half of all staked ether.

Progress

The transition process to PoS began with the launch of the Beacon Chain in December 2020. The Beacon Chain refers to the PoS consensus layer that currently runs in parallel with the main Ethereum blockchain. Staking is already live, with about 10% of total ether supply currently staked.² “The Merge,” which refers to the event that would complete the PoS transition, would join the existing execution layer of Ethereum with the Beacon Chain, such that Ethereum will continue as a PoS blockchain.

Ethereum’s transition to PoS is a complex process, and would be the first transition of this type on such a large scale. Therefore, extensive testing needs to be performed to ensure that everything works correctly, which is why the Merge has taken so long to implement. Over the past few months, significant progress has been made, with public test networks having successfully made the transition to PoS (e.g., Ropsten in June, and Sepolia in July). These test network transitions serve as “dress rehearsals” for the actual Merge event. The third and final public testnet to undergo the transition before the main network does so will be the Goerli testnet.

Becoming a validator

As discussed, 32 ETH is required to become a validator, which may be prohibitively expensive to acquire for some people. In addition, running a validator node requires sufficient hardware and connectivity, as well as a certain degree of technical expertise. Finally, locking up ether as stake would prevent the use of that ether elsewhere.

To address these issues, there are staking service providers available for those who do not wish to run a validator node themselves. There are also pooled staking services for users who do not have or feel comfortable staking 32 ETH. Many pooling solutions also offer “liquid staking,” which involves the issuance of tokens representing staked ETH that users can then use elsewhere. One such liquid staking solution, Lido, currently accounts for about a third of total ether deposited as stake,³ which may lead to risks associated with centralization (see Risks section below).

Effect on monetary policy

After the Merge, the amount of new ETH issued per day is expected to decrease by about 90%, which is expected to bring the net issuance rate to zero or less.⁴ This is because rewards for PoS validators are much less than the rewards currently issued to PoW miners, since operating a validator node is not as economically intense as being a miner.

Rollups

Ethereum can currently handle only around 15 transactions per second, which is far below some other blockchains, such as Solana and Tezos. During periods of high traffic, Ethereum transaction fees can become prohibitively high (see Part 1 – Introduction to Ethereum ). Scaling solutions are ways to make transactions on a blockchain network faster and cheaper. The Lightning Network, for example, is a scaling solution for the Bitcoin network that facilitates faster and cheaper payments. For Ethereum, there are several types of scaling solutions with various pros and cons. “Sidechains” operate in parallel with the base layer (Ethereum), but are independent blockchains with their own consensus mechanism and security properties. “Layer 2” solutions have the advantage of deriving their security from the base layer.

There are several types of layer 2 scaling solutions (e.g., state channels, rollups, plasma, validum), but “rollups” are particularly relevant for Ethereum. Rollups involve operators who bundle together many transactions and process them off-chain, and then post the result of and the relevant data associated with those transactions back to the base layer. There are two main types of rollups, with different approaches to security.

The zk rollup technology is still developing. Historically, the use of zk rollups in practice has largely been restricted to certain simpler use cases, while optimistic rollups have supported more general-purpose computations. Advances such as zkEVM, which aims to allow developers to move virtually any Ethereum smart contract over to a zk rollup without needing to alter its underlying code, may expand the use of zk rollups for more general applications.

The total value locked in layer 2 protocols on Ethereum has grown from less than $50 million at the beginning of 2021 to more than $3.5 billion as at the end of June 2022.⁵ Although rollups may be a promising way to scale transaction capacity while deriving security from the Ethereum base layer, there remain concerns pertaining to issues such as operator centralization, as well as implementation errors and other potential technical vulnerabilities.

Danksharding

Sharding is another element on the Ethereum roadmap that aims to improve scalability. The original plan was to distribute the load of the network by introducing 64 smaller blockchains, called “shard chains.” The Beacon Chain would be used to coordinate validators and shards and enable information to be relayed between shards. However, the plans for sharding have been evolving, and currently seem to be oriented toward a new rollup-centric approach called “danksharding.” Danksharding does not use the idea of shard chains, but instead aims to split the burden of handling the large amount of data associated with layer 2 rollups over the network as a whole. This approach will decrease the amount of data that individual nodes will be required download and store, aiming to increase scalability as well as improve decentralization.

Risks

Blockchain is still an emerging technology, and the Ethereum network is still evolving. The historical price volatility of ether is very high – many times the volatility typically seen in equity markets. There are many factors affecting the future development of Ethereum and that may affect the price of ether going forward.

Risks related to an investment in ether may include the following:⁶

Conclusion

When Ethereum launched in 2015, it was the first blockchain network with a very different vision from Bitcoin, aiming to provide a decentralized infrastructure for a diverse range of applications. Over the past seven years, the network has grown in size and has demonstrated use cases in various sectors, including finance, gaming and the metaverse. Ethereum’s potential value proposition with regard to aspects such as security, transparency, accessibility and self-custody may continue to drive growth and adoption of the network in the long run. Blockchain is an emerging and evolving technology, and the result of its future development and its impact on traditional systems remain to be seen.

For more background on the history of Ethereum, please visit: https://www.fidelitydigitalassets.com/research-and-insights/about-ethereum.