Ethereum 2.0 FAQ

UPDATED 27 MAY 2022

What is Ethereum 2.0?

Ethereum 2.0, also called Eth2 or “The Beacon Chain”, is the next major change to the Ethereum blockchain, introducing a Proof-of-Stake consensus mechanism, moving the network away from its existing Proof-of-Work architecture.

How will Ethereum 2.0 affect CoinShares and XBT ETP holders?

We continue to monitor developments and timing while reviewing all possible options. The final announcement will be made via our website in due course.

Why can’t I earn staking from my CoinShares and XBT ETPs?

CoinShares is reviewing the staking mechanism, its operational complexity, the length of any lock-ups, and other associated risks. Once we have more clarity, we will make appropriate announcements on our website.

When will Ethereum 2.0 be launched?

The Beacon Chain updates will not take place at a single point in time; instead, they will roll out in several phases over the next few years. We have deliberately not specified dates for the various phases mentioned below as they remain uncertain.

October 12th 2020 = The Beacon Chain Staking Deposit Contract deployed.
November 4th 2020 = Version 1 publicly released.
November 24th 2020 = The Beacon Chain Staking Deposit Contract reached its necessary trigger limit of 524,288 ETH (16384 deposits of 32 staked ETH).
December 1st 2020 = Beacon Chain launched seven days after the threshold was met.
October 27th 2021 = The first Beacon Chain upgrade enabled “light clients”, brought validator inactivity and ‘slashing’ penalties up to their full values.
October 27th 2021 – current date = multiple successful practice Merges and test-net forks.
May 2022 = as of writing, the difficulty bomb has been detonated. This eventually makes the Proof-of-Work chain redundant by making it almost impossible for miners to mine the blocks. Whether it gets delayed for the 6th time, or not, is still in question. But consensus seems to be that the Merge will occur in H2 2022.

What are the phases of Ethereum 2.0?

Ethereum 2.0 is launching in several phases: Phase 0 (The Beacon Chain), Phase 1 (The Merge) and Phase 2 (Shard Chains), (Phase 2.5 - State Execution). The first phase, Phase 0, otherwise known as The Beacon Chain, launched on December 1st 2020. According to the Ethereum Foundation, the next two phases (i.e. Phase 1 and Phase 2) will be released in the following few years after Phase 0. These dates are not yet set. Although, Ethereum’s test-net (a public, beta blockchain used for testing upgrades and decentralised applications), Kiln, upgraded to Proof-of-Stake under a ‘practice Merge’. It is expected to be the last merge test net created before existing public test nets are upgraded. There have also been successful shadow forks which reduce The Merge’s execution risk and flush out any problems that may arise.

Phase 0: the Beacon Chain

The first phase of Ethereum 2.0 is the launch of the Beacon Chain. The Beacon Chain stores and manages the registry of validators and deployed the Proof-of-Stake consensus mechanism. The original Ethereum Proof-of-Work chain will run alongside this, ensuring that there is no break in data continuity.

The launch of the Beacon Chain marked Phase 0. After the Beacon Chain is launched, the Ethereum 1.0 and 2.0 chains will exist in parallel for some time. Ethereum 1.0 will eventually become a shard in the Ethereum 2.0 system, merging the two chains.

Phase 1: The Merge

This phase represents the moment when Ethereum 1.0 merges with Ethereum 2.0. Specifically, the Ethereum 1.0 chain will become one of the shards that make up Ethereum 2.0. This is to ensure that the entire data history will be preserved.

Phase 1.5 - Rollups

This phase is the centre-piece of Ethereum’s long term roadmap, and is another type of scaling mechanism. This is a layer 2 technology that executes transactions off-chain and then submits those transactions on-chain, in order to be validated by the rest of the nodes. This reduces the data needed for a transaction and, in turn, reduces the costs associated with executing such a transaction.

Phase 2: Shard Chains

The next phase includes the implementation of shard chains. Proof-of-Stake is not technically needed but improves the security of shard chains above that of the implementation on top of Proof-of-Work. Shard chains are a scalability mechanism that is designed to spread the data into chunks across the network, making it easier to access. The first version of Shards will only provide data to the Beacon Chain and will not execute transactions or smart contracts. This may come in the second version, but it is not finalised or clear.

What is the difference between Ethereum 1.0 and Ethereum 2.0?

The overall goal of Ethereum 2.0 update is to increase the performance of the network. To achieve this, Ethereum 2.0 introduces:

The transition to Proof-of-Stake; and
Provide the foundations of Shard Chains

Proof-of-Stake is the most significant change in Ethereum 2.0 as it will completely change the economic incentive structure for validating the blockchain. Currently, Ethereum 1.0 runs on a fully trustless consensus mechanism known as Proof-of-Work. Proof-of-Stake hopes to retain Proof-of-Works’s existing benefits while avoiding its main issues – energy consumption. If successful, it would shift the cost of validating the blockchain from energy to total ETH stake. One of its main trade-offs is a change away from the trustless auditing model of Proof-of-Work to the Proof-of-Stake model whereby new entrants must trust some subset of existing network participants to tell them which blockchain is the correct one. The benefit would be a drastically reduced energy expenditure for the whole system.

Shard Chains are separate blockchains that sit within Ethereum and take on a portion of the network's processing work, hence improving its scalability. At present, all nodes (i.e. computers) in the Ethereum network must download, compute, store and read every transaction in the history of Ethereum before processing a new one. In Ethereum 2.0, nodes will be dispersed across a subset of shards. They'll only need to download, compute, store, and read every transaction on that shard – not the whole network. The number of validators on each shard would be limited to whichever validators care for whichever shard.

How will Ethereum 2.0 affect the current Ethereum 1.0 chain?

The current plan is for the Ethereum 1.0 chain to effectively become the first shard on Ethereum 2.0 when Phase 1 takes place. Until then, the Ethereum 1.0 chain will continue as it is now and will undergo improvements to enable it to eventually be an Ethereum 2.0 shard.

How will Ethereum 2.0 affect ETH holders?

ETH holders will not be affected and can continue using their ETH just as they were before. During Phase 1.5, Ethereum 1.0 will become one of the shards that make up Ethereum 2.0. In other words, the ETH holders who are interested only in holding, trading, or using their ETH on Decentralised Applications (DApps) do not have to actively do anything to prepare for Ethereum 2.0.

Can I “buy” Ethereum 2.0 ether?

There will not be a new type of ETH token. For more information, please refer to the FAQ on the Ethereum Foundation website.

What are some main risks of Ethereum 2.0?

A main risk of Ethereum 2.0 is that Proof-of-Stake does not work as hoped. Unlike Proof-of-Work, Proof-of-Stake has not yet been proven to work at significant scale and its vastly increased complexity compared to Proof-of-Work creates a much larger surface area for unintended behaviour (bugs) and attacks.

Proof-of-Stake also has the potential to centralise the holding of ether in the hands of whoever are the currently largest holders. Because Proof-of-Stake rewards validators based on stake held, not work performed, there could emerge a plutocratic tendency in ether distribution whereby current large holders perpetually retain their proportions of ether holdings at the dilution expense of everybody else.

Another major risk is that these code changes are being done on a currently live system, potentially imperilling currently functioning dApps and smart contracts. While this should not be an immediate issue of Phase 0, it will resurface when the Ethereum 1.0 and 2.0 chains must at some point become fully integrated. Although this upgrade has been researched for years and has passed test-net upgrades and implementations such as the most recent one on Kiln, March 15th 2022. This risk is reduced through the difficulty bomb which increases the hash rate high enough to incentivise miners to vote for the hard fork and switch to another chain to circumvent the high fees.

Sources:

Disclosure

The information contained in this document is for general information only. Nothing in this document should be interpreted as constituting an offer of (or any solicitation in connection with) any investment products or services by any member of the CoinShares Group where it may be illegal to do so. Access to any investment products or services of the CoinShares Group is in all cases subject to the applicable laws and regulations relating thereto.

This document is directed at professional and institutional investors. Investments may go up or down in value and you may lose some or all of the amount invested. Past performance is not necessarily a guide to future performance. This document contains historical data. Historical performance is not an indication of future performance and investments may go up and down in value. You cannot invest directly in an index. Fees and expenses have not been included.

Although produced with reasonable care and skill, no representation should be taken as having been given that this document is an exhaustive analysis of all of the considerations which its subject-matter may give rise to.This document fairly represents the opinions and sentiments of CoinShares, as at the date of its issuance but it should be noted that such opinions and sentiments may be revised from time to time, for example in light of experience and further developments, and this document may not necessarily be updated to reflect the same.

The information presented in this document has been developed internally and / or obtained from sources believed to be reliable; however, CoinShares does not guarantee the accuracy, adequacy or completeness of such information. Predictions, opinions and other information contained in this document are subject to change continually and without notice of any kind and may no longer be true after the date indicated. Third party data providers make no warranties or representation of any kind in relation to the use of any of their data in this document. CoinShares does not accept any liability whatsoever for any direct, indirect or consequential loss arising from any use of this document or its contents.

Any forward-looking statements speak only as of the date they are made, and CoinShares assumes no duty to, and does not undertake, to update forward-looking statements. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, which change over time. Nothing within this document constitutes (or should be construed as being) investment, legal, tax or other advice. This document should not be used as the basis for any investment decision(s) which a reader thereof may be considering. Any potential investor in digital assets, even if experienced and affluent, is strongly recommended to seek independent financial advice upon the merits of the same in the context of their own unique circumstances.

CoinShares Capital Markets (UK) Limited is an appointed representative of Strata Global Ltd. which is authorised and regulated by the Financial Conduct Authority (FRN 563834).The address of CoinShares Capital Markets (UK) Limited is Octagon Point, 5 Cheapside, St. Paul’s, London, EC2V 6AA.

The CoinShares Astronaut is a trademark and service mark of CoinShares (Holdings) Limited.