Unchained - Ethereum 2.0: What You Need to Know - Ep.201

Episode Date: December 1, 2020

Ryan Watkins and Wilson Withiam, senior research analysts at Messari, explain the nuts and bolts of Ethereum 2.0, including how it will transform ETH as an asset and why they believe it will be Ethereum’s most ambitious upgrade yet. Topics include: the different phases of Ethereum 2.0 and the functions they serve the problems Ethereum hopes to solve with this upgrade the technical requirements needed to ensure the launch can happen the new proof of stake consensus and why Ethereum is leaving proof of work behind the requirements necessary to maintain a validator node on the Ethereum 2.0 network why users won’t be able to use their ETH once it is staked on Ethereum 2.0 the incentives and services that will allow users staking on Ethereum 2.0 to continue using their ETH on Ethereum 1.0 whether the appeal of DeFi is a threat to Ethereum 2.0 staking how Ethereum 2.0 incentivizes client diversity the monetary policy of “minimum necessary issuance” that supports Ethereum 2.0 how Ethereum 2.0 will allow ETH to achieve the unprecedented combination of a store of value, a capital asset, and a commodity what will be done in the short term to help ease the scaling problem while ETH 2.0 is being built whether scalability can be efficiently addressed in time to prevent migrations to other blockchains and the most significant risks Ethereum 2.0 is facing   Thank you to our sponsor! Crypto.com: https://www.crypto.com   Episode links: Ryan Watkins: https://twitter.com/RyanWatkins_ Wilson Withiam: https://twitter.com/wilsonwithiam   Messari Crypto: https://messari.io/   Messari report on Ethereum 2:0: https://messari.io/road-to-eth2     Amount of ETH in the Ethereum 2.0 Deposit Contract: https://etherscan.io/address/0x00000000219ab540356cBB839Cbe05303d7705Fa#analytics https://www.stakingrewards.com/earn/ethereum-2-0   ETH issuance based on amount staked: https://docs.ethhub.io/ethereum-basics/monetary-policy/#proof-of-stake-impact Dan Elitzer article on DETH: https://medium.com/ideo-colab/the-deth-of-ethereum-98553866e81b Learn more about your ad choices. Visit megaphone.fm/adchoices

Hi everyone. Welcome to Unchained, your no-hype resource for all things Crypto. I'm your host, Laura Shin, a journalist with over two decades of experience. I started covering crypto five years ago and as a senior editor at Forbes was the first mainstream media reporter to cover cryptocurrency full-time. Subscribe to Unchained on YouTube, where you can watch the videos of me and my guests. Go to YouTube.com slash C-E slash Unchained podcast and subscribe today. crypto.com, the crypto super app that lets you buy, earn, and spend crypto, all in one place. Earn up to 8.5% per year on your BTC and more than 20 other coins. Download the crypto.com app now to find out how much you could be earning. Today's topic is Ethereum 2.0, which launches seven days after 524,288Eth are claimed in the deposit contract. We will unpack what that means in a moment. Here to discuss are Ryan Watkins and Wilson Withiam, both senior research analysts at Masari. Welcome, Ryan and Wilson. Hey, Lauren. Thanks for having us on. Hi, Laura. Yeah, I'm very excited to talk about this topic. Yeah, so thanks for having us on.

Let's just start with a real basic question. What is Ethereum 2.0? Yeah, so I think Ethereum 2.0 is a couple of things. Most importantly, for Ethereum, it's kind of its most ambitious. upgrade that's been seven years in the making that will scale Ethereum so that it can actually serve as a globally scalable financial infrastructure. And then two, it would also make it more secure. And then as well, it will also transform ETH as an asset. Those kind of like the big picture ideas of what Ethereum 2.0 brings to Ethereum. And what problems does Ethereum hope to resolve with this upgrade? Yeah, so as far as like Ethereum, the blockchain, it's really a couple of things.

And I'll divide this into proof of stake and then sharding, which are kind of the two major components of Ethereum 2 put up. And with proof of stake, it's trying to solve three things. One is making Ethereum more secure. two is ridding it of centralization risk from miners. And then three is making sure that participation in the consensus process is as accessible to users as possible. So that's for proof of stake. And then for my sharding, that's the scaling solution for Ethereum. And basically what that entails is splitting up the Ethereum blockchain into subsets

called Shards and running them in parallel. And the reason why you do this is because you want to keep the requirements to run a node as low as possible so that there's not an excessive burden on people who run these nodes and it is actually accessible to people with basically just like consumer hardware. And the reason why you do that is because it ensures that you can get the scalability while maintaining that core property of being decentralized. And I think I'll add to that as what we've seen since Ethereum launched is that it's run into a couple issues along the line,

specifically during 2017, during the ICO craze. And then most recently this past summer when various defy liquidity mining programs were up and running, that under its current architecture, it can get under a significant amount of, load and that tends to delight transactions and also increase the transaction cost. So it was a recognize, Ethereum 2.0 was Ethereum developers and researchers recognizing that under Ethereum's current architecture that it couldn't scale to meet these characteristics that they were truly desiring out of the platform. So we're going to dive into each of these in greater depth throughout

the episode, but let's do first a quick overview of the different phases of Ethereum 2.0. Can you name them and describe what happens in each? Of course. Yeah, happy to. So the first phase is the one that is eminent. The one where users can actually start staking is called phase zero. And that simply is the launch of something called the beacon chain. And the beacon chain is basically your central core layer of this new network. So it's separate from the existing network. And it will be this coordination layer that gets allows people to stake. It coordinates all the different validators or stakers on the platform. And then it acts as the coordination layer for all the additional upgrades that will be added

later on. So all the additional shards, it will serve as a reference point. to all of those. So it can actually connect information between all those other chains that eventually get added later on. The second phase, phase one, a little bit of a longer timeline. So I think some of the early estimates are maybe late 2021. That will add the scalability component. So phase zero, nothing much more than staking and reaching consensus. The phase one will be adding all these different shard layers, and that will be the base scalability component for Ethereum 2.0. And so really, phase one is just kind of reaching consensus with a whole lot of different things. So you're reaching consensus not only on the beacon chain, but also incorporating all those

other shard chains. So how do you reference the block data that gets added to the entire network across all these, across 65 different chains? The third phase is called 50. phase 1.5. And that is actually the merge of the existing network with the new network Ethereum 2.0. And really, it's just a simple swap of the proof of work consensus layer that Ethereum uses right now over to the proof of stake layer that's on Ethereum 2.0. So how it's going to look like to most users and applications, it's not going to change a whole lot. It's supposed to be pretty seamless. But a lot of it's just going to be the underlying layer where it just kind of switches over and all the blocks are being created through proof of stake instead of by minors.

And then the final phase, the big one, is like phase two. And that will be when you're adding execution to these different charts. So during the first three phases, they actually will not have smart contract execution ability. They won't have smart contract execution ability. so you won't be able to actually port smart contracts onto these individual shards. But there is a bit of a caveat to this whole process, and it's that you might be able to start using some of these shards for scalability means before phase two. And so there is a possibility that you can get the scalability gains

without having to add smart contract execution ability to every single one of these shards. So there is a route as we're going to, down this roadmap for ETH2.0 where phase two may not necessary, it may not be necessary. So even though it might be further out on the timeline, you can start seeing the advancements that E2.0 are bringing far sooner than that. We're going to spend most of the show talking about phase zero, which is the most imminent change, as you mentioned. And listeners should know that we're recording this on Monday, November 23rd, because there's kind of things going on right now. So by the time,

this comes out, we don't really know where things will have landed. However, at this moment, we're about 75% of the way to meeting the minimum threshold. And that would trigger off like a seven-day period before the network could launch. And although also the earliest day it could launch would be on December 1st. So it's kind of like tomorrow, November 24th really is, the first day when people would have the opportunity to stake that minimum amount. So can you just maybe go through the technical details of what is required to make this launch happen? There's really two components to when this chain can launch. And really there's, like you mentioned, a minimum deposit amount and a minimum genesis date.

And so really all you really need to meet is that minimum deposit amount, which is 50024,288E. And as soon as validators deposit that into this contract, which lives on the current Ethereum network, it will go into the deposit contract. People can start running clients on this new Ethereum 2.0 network now. and as a client, they read the contract, they'll recognize it. If it's a valid deposit, they'll then allow, they'll tell the new beacon chain to mint 32Eth for that validator. So they can start staking on the network. So really just kind of a constant contact between the two chains all generated through that single contract.

the other component, the minimum genesis date, is right now listed as December 1st. And it must, all that means is that is the earliest date it can launch. So it can launch any time after that. It just needs to meet that minimum deposit amount. And for that deposit amount, like once that deposit amount is reached, there is a seven-day delay between when it's reached and when it's reached. launched. So yeah, like you mentioned, earliest amount, it could be November 24th. That means that implies a December 1st launch date. It can launch. You can reach that minimum amount any time after that. And then seven days after it reaches that amount, then the chain will officially

launch. And so do you guys want to make a bet? We can all either look really stupid or really dumb by the time this comes out, because everybody will already know by the time this comes out, But we at this moment in time don't. Do you think we're going to get the minimum threshold by tomorrow the November 24th? Yeah, I do. I agree. I would put money on it. Yeah, I have a feeling as well because just even in the time that I was researching for this show, the minimum amount is going up very quickly. And so today, right when I went to write this, you know, make that little change on what amount we're at right now, I was surprised to find where it. 75%. So we were joking before we started recording the show that we think the whales are all back channeling right now. So anyway, all right. So regardless of when the launch actually occurs, let's discuss one of the most fundamental changes that's happening, which is this switch to proof of stake from proof of work. Why is Ethereum moving away from proof of work to proof of stake? So I touched on this a little bit in the overall design of Ethereum 2.0. And it's really three things.

It is for security. It is for energy efficiency, and that it's to reduce the risk of centralization from miners. And it can dive into all three. So on the security front, basically the idea here can be divided into two different categories. One is that you want to make the cost to attack the blockchain very high. And then the other one is that in the extreme case where you do get attacked, like a 50% attack, it's easier to kind of coordinate a new chain that gets rid of the attacker. So the way this works in proof of stake for us proof of work is, well, actually, I'll even remind

to GPU-based proof of work because that's what Ethereum currently operates on. Now, GPUs are ubiquitous. They're like all over the world. They have a ton of different use cases. And if you really wanted to, you could rent out GPUs and use those GPUs to attack a proof war blockchain. And we've seen that with some blockchains that exist that are susceptible to these attacks. Now, proof of work under like with ASICs is a little bit different because AISCs are

specifically designed to mine the cryptocurrency that they, been designed for. So with Bitcoin, their A6 are designed to mine Bitcoin. That's the only thing they can be used for. So it's not just about your ability to be able to rent out this hash power from some bot provider. Proof of work first involves some high initial upfront investment to actually participate in this mining process. Now, the difference between proof of work and proof of stake is that with proof of stake, there's two different things with the upfront investment. It's one. Whereas with an ASIC, an ASIC typically depreciates over, say, about two years, and then you have to buy a new one to stay competitive. Your stake is just an internal accounting

measure in Ethereum and it doesn't depreciate. And then two, your stake also is not like permanently locked. You can actually remove it after. withdrawal period. So really, like, when you go to stake, you only face an opportunity cost. And the reason why those two things are important, you know, not being a depreciating asset and then two only facing an opportunity cost is that it makes the attractiveness of putting up more capital at risk a little bit more attractive. And the reason why is because, you know, if you can just pull out your stake, you know, after withdrawal period, if your state doesn't depreciate, then you're probably more willing to accept the low return for a given amount of

capital you put up. So it raises the cost to attack. So that's one aspect of the proof of state component. The other one is like how it's harder to counter or it's easier to countercordate against the 51% attack. Now, the idea with that is that when you, and granted, like it's very difficult to 51% attack a proof of work blockchain like Bitcoin at this point. you're talking about billions of dollars in investment and much more. But in the case that someone was able to 51% attack Bitcoin, there's basically a couple things you could do. You could basically create a fork and then switch the mining algorithm to something else

so that the attacker can't continue to use their A6 to attack the chain. The problem when you do that is that, well, now you have to bootstrap hash power for this new chain. and probably the way you're going to do that is by switching to an algorithm like B-Mond using say GPUs, right? And then one of the things that I mentioned previously is that you can just write hash power for GPUs on the internet. And then you can kind of just keep, then maybe you can say like, okay, if the person keeps attacking, well, we can just keep on forking.

But it's just a never-ending cycle of keeping half into fork and someone being able to attack it. Now, the difference with proof of stake is that in the event there's a 51% attack and And Gretnett, like I said, it would be extremely difficult because, you know, where are you going to buy? Let's say like right now there's 10% of participating in proof of stake. And ETH is worth, you know, $60 billion in market cap. That's $6 billion with the Eth. You need to buy.

I mean, I don't know where you're going to buy $6 billion with the Eth. But, you know, if you could do that, the thing is, like if you're watching a 51% attack on ETH, like Ethereum can create a new fork. And granted, you know, forking is definitely hard, but they create a new. fork and just delete your steak. And so basically like the equivalent, you know, that many Ethereum researchers have, you know, create analogy is that it's almost like the equivalent of burning someone's ASIC farm when you can, you know, slash someone's steak for behaving deliciously. And it's a way of kind of permanently ending this person's ability to attack the Pufu steak

blockchain. So that was a long portion on security. The other two are much quicker on, you know, mine centralization and energy efficiency. Energy efficiency, the basic idea is, you know, Bitcoin uses a tremendous amount of energy to secure itself, you know, as much as a small country. And, you know, you can debate up whether that's good or bad. And, you know, like, it's doing something useful, but at the day, it's still you're burning a Norris muscle electricity to make this thing work.

So if you can do it more efficiently, it's probably a good thing. And then the last one on reducing my centralization risk, that's reducing the risk from across a couple different dimensions. I mean, one is just geographical. So if you think about,

and it's not like some conspiracy theory against Bitcoin, but 65% of hash power is in China. So it's kind of like, you know, one risk you can get rid of with proof of stake. There's also the risk that, of like, manufacture centralization. So I want to say like about 90% of all ASICs are manufactured amongst four firms in Asia. So there's kind of that risk there. Another thing with proof for work or A6 is that there's economies of scale.

So the larger you become, the more cheap it comes for you to mine with, Bitcoin because you can negotiate bulk orders for A6 and it's just easier to skill it whereas with proof of stake, in theory, anyone who is 32Eath can quite easily participate in the consensus process

using commodity hardware. So that's the basic idea with mining centralization risk is just kind of getting rid of those risks, although maybe not that likely, just getting rid of the fact that they exist.

Yeah. One thing I want to dive into a little bit is how staking works exactly, because I just wonder, is it going to be one of those situations where, yeah, okay, like, you know, more everyday people can become state validators, but then, you know, I don't know what it takes to be running a validating node and keeping it, keeping the uptime such that you won't get penalized or slashed. So, you know, I just wonder, will a lot of these end up being on centralized services? anyway where they're kind of paying somebody else to do that part for them? Yeah.

So as far as like how can you stake, there's probably three different ways. One would be doing it through a centralized provider like in exchange or staking as a service provider who will just do all the work for you. And the benefit of that is not only convenience, but the fact that you can do it with less than 32 eats. So if you hold one, you can now participate in this. the second way is to do it yourself. And if you're doing it yourself, it's actually not that difficult.

You can do it on a pretty standard laptop. And the way that the incentive systems, kind of rewards and penalties was designed, is that so it's very forgiving. So even if you are, you're down, your computer is down 20% of the year, you'll likely still be able to be profitable. So that's what I mean.

Like it was designed to be forgiving so that, you know, even if you're, you know, just this not good, you know, on a high up time, you can still be profitable. Or at the very least, like not lose your money. And then kind of third would be these kind of like decentralized staking pools that are almost like two-sided marketplaces where on one end you have people who want to stake who submit their east to this. contract, and this contract then goes and allocates that stake to different validators in

this ecosystem. And that's another way of to spitting and staking. All right. And then we're going to talk a little bit about kind of the opportunity cost between staking and doing other things. But let's just make one thing clear. Once people move their Ethereum 2, Ethereum 2.0 in order to stake, they're not able to use it anymore. Why is that? So you kind of, at this point, there are two different chains. And so you don't want to have two different chains that represent the same native asset, having assets that can be tradable and running on each. Because then you start getting some price deviation between the two.

And it can complicate matters in case any issues do pop up as E2.0 starts to evolve. So for instance, a bug runs out. maybe they need to find a way to resolve any differences between the staking amount and what's being read on Ethereum, because they want to make sure the current Ethereum network to make sure, like, those are completely equal because you start running any sort of differences between the two. That's going to make the far more complicated when they do finally merge. Right now, keeping them separate is, and making sure everything on Ethereum, 2.0 isn't transactable can prevent any sort of issues like that running down the road.

But once they do merge, then essentially Ethereum 1.0 and 2.0 become the same network. It's essentially Ethereum at that point. And all the accounts and balances will be transferred onto Ethereum 2.0 and they can be read the same as everything that's on the beacon chain, which would allow everyone to start removing the staked amount that they have as well as any rewards that they may have earned during that time. So it's more of like a safety measure at this point, which makes sense.

Because going forward, you're only going to be able to use it Ethereum 2.0 to a limited extent. So really, you're just looking forward to when that functionality starts to unlock. That's when you'll be able to access everything. So because obviously people realize that or the designers of Ethereum 2 or, 2.0 realized that there's a lot of things people could be doing with their eth. And so they probably need to incentivize them in some way to, you know, move the eth over to Ethereum 2.0 without losing too much opportunity cost. So what are some of the examples out there of new services that have popped up that still enable people to, you know, use eth on eth one once they

have started staking? One of the biggest hesitancies, many people have. is that there's going to be this, you know, kind of like lockup period on your ETH. It will be unlocked by, you know, phase 1.5, but who knows really when that comes? It could be, you know, 12 months from now, it can be 36 months from now. For all practical purposes, it's indefinite. So in the meantime, like, you need to be able to access some liquidity on your, on your Eth. And there's basically, like, two major classes of solutions. It won't be kind of like what steak is doing.

So basically what they allow you to do is if you stake through them, they will allow you to borrow USDC on your, on your ETH. So it's like going to kind of collateralize loan. And it's kind of this larger class solution called like mistaking derivatives. These class solutions are kind of a little bit, you know, less developed at this time than I would say the former. But the basic idea is that you have either a centralized service provider, like an exchange, or you'll have a decentralized protocol, say like Rockpool or Sapphire. And you will be able to deposit your ETH with them to stake. And then in exchange, you'll give you kind of like an ETH derivative,

which was called like Deth for now instead of death. And the idea is that you can use this like Deith on Ethereum to access, I mean, everything in Ethereum. So, you know, in theory you could send it to compound and borrow, die against it. You could mint die against it in Maker or, you know, whatever opportunities you want to do in Ethereum. In theory, you'll be able to do with this kind of derivative beef. Bet mode activated. The scorebed app here with trusted stats and real-time sports news. Yeah, hey, who should I take in the Boston game?

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Choose news, not noise. CBC News. Well, one thing, despite, you know, all these developments and, you know, allowing people to both stake and do other things with their Ethereum, there is this concern that because there's a lot of financially appealing opportunities in DFI on Ethereum that people won't be super interested in staking. How much of a threat or concern do you think the appeal of DFI is to staking on Ethereum 2.0? I actually don't think it's a major concern.

I think the biggest thing between staking and DFI just boils down to how validator returns. our design. So if there was this event where, say, you know, yields in D5 were very high, and then some people who are staking, and granted, like, this is actually significantly more important in phase 1.5 beyond when you can actually withdraw your ETH and, you know, use it in D5. Although I will touch on phase zero kind of after this thought, but, you know, if there was a case where, you know, Heath was being withdrawn from staking to go for use in D5.

Well, the way that the returns are validators of design is that if there's less people staking, the rewards will be higher. And if there's more people staking, there will be, the rewards will be lower. So at a certain point, the rewards would become, like, more attractive again

so that there's kind of like a minimum amount that, on, you know, how much people would want to, like, leave for D5 for staking. And then another related point is that staking and

kind of defire are just two different products. Staking is you're just getting kind of like a native yield on your ETH for providing Ethereum security. And basically the two main risks that you assume are

one, the Ethereum blockchain failing, which is just systemic risk that you get from holding any asset on Ethereum. And then two is, like validator risk. The risk that your validator just doesn't perform or, like, you behave maliciously. And even that can actually be diversified a way if you were to go through kind of like a decentralized staking protocol that kind of diversifies their validator risk across multiple validators.

But can you just lay out what those penalties or, you know, what happens if you get slashed, just so people know? High level idea is that if you behave maliciously, let's say like you double sign of blocks, you can lose some of, if not all of your steak for doing so. And basically, what that means is that like, you know, that 32E that you posted as, you know, basically collateral with the steak gets deleted. Okay. Yeah. That's, that's a little bit harsh, but I guess there have been plenty of people in Defi this summer who got totally wiped out by various things that happens. 100%.

And so one other thing that I want to talk about is this incident that happened on the test net where one particular client for Ethereum 2.0 had a design flaw and that caused participation on the network to go from 80% down to 5% because pretty much all those validators got wiped out. So how is client diversity, which is like a principle really that is important to Ethereum and weirdly not at all to Bitcoin, or rather, they just have like completely different perspectives on it, which is super interesting to watch. But client diversity is something that Ethereum really values. And yet here we have like certain clients that are really just becoming the most popular

out of the gate. How is Ethereum working to mitigate the risks around that? Abby brought that up. It's kind of very interesting to look at the two different philosophies. So right now you have Bitcoin where over 98% of clients run on Bitcoin run Bitcoin core. On the other side, you have Ethereum where about 80% are running Geph at the moment. But there is a bit of a diversity into that 20% of what clients are people running there. And so there's definitely a push to move towards a more diverse client base so that you don't have one client that's overreaching or having too much control over the network. Yeah, but actually, one thing I'd say is that they've been trying to do this since the time that they launched and it's always been that there's been one dominant one, which is also very interesting.

But anyway, keep going. I completely agree. And I think they blame a lot of, or they, I don't want to say blame, but I think a lot of the reason behind that was they didn't really have too many clients to start with when they first launched the chain. So you have this first mover advantage where Geth becomes the popular client to use. It gains a lot of traction, gains a lot of trust, and all of a sudden it's kind of hard to eat into that market share. So that's why for Ethereum 2.0, the Ethereum Foundation put a lot of money into via grants into building out this a variety of clients.

And I know they at one point we're working on eight to 10 different clients. And at the moment right now, you have four viable ones going into the beacon chain. Even with that said, there has been one client named Prism that has become the thing. amongst most validators. And like you said, on the test net, it had a bug and that issue reared its ugly head. That one bug caused the entire network, not to go down, but to drop to a very low percentage of validators actually working on the client. So that means they couldn't finalize blocks.

They could keep building and adding blocks to the network, but they couldn't finalize them, which just means that at some point, it's possible that those could be reverted. So how do you prevent that? So there's a pretty unique design within Ethereum that if more than 33%, if you can't finalize, so you need 66% of validators actively working and voting on blocks to finalize the chain. If you can't do that, then Ethereum will automatically start penalizing validators that are not online. And so it's called an inactivity leak. And if you're inactive, it'll start gradually and then actually exponentially

reducing your staked amount, either to get you to a point where you're dropped off the network or to actually incentivize people to come back and join the network and do what they're supposed to do. And so eventually it gets back to that 66% minimum. What that means in the terms of client diversity is if you're running a majority client and say that is somewhere between 40, 60% of the network and it has a bug, you are automatically under risk if all of a sudden those clients go under it. So you are in some sense incentivized to run a minority client and run one that may not make

up 33% or more of the network because then you're not at risk for those types of those bugs. Yeah, it's almost like surge pricing or something, but applied. completely different context. Exactly. Yeah. All right. So in a moment, we're going to talk about how ETH the asset will change, but first a quick word from the sponsors who make this show possible. Crypto.com, the crypto super app that lets you buy, earn, and spend crypto, all in one place. Earn up to 8.5% per year on your BTC. Download the crypto.com app now to see the interest rates you could be earning on BTC and more than 20 other coins. Once in the app, you can apply for the Crypto.com metal card, which pays you up to 8% cash back instantly.

Reserve years now in the Crypto.com app. Back to my conversation with Ryan Watkins and Wilson Withiam. Yields for staking start at 30% if the number of ETH staked is around the $524,000 necessary to launch the beacon chain. But if it ever reaches 16 million, ETH state, the max yield would be about 4% a year. and if it goes higher, like, to $100 million, then it would drop below 2%. So in general, when you look at this, does it feel like this is a good monetary policy that would keep the chain secure, et cetera, or are there any concerns that you have about it? I think this is like a good opportunity to talk about, like, kind of the philosophy of Ethereum's

monetary policy. So Ethereum's monetary policy can be defined as minimum necessary issuance. And the basic idea is that Ethereum will always issue an amount of ETH that will keep the network secure over time. And the difference between this philosophy and, say, Bitcoin's, which is deterministic issuance in fixed supply, is that whereas with Bitcoin, it's kind of optimizing for kind of like monetary idealism in a sense that, You had people that created this that wanted to create this extremely scarce, you know, fixed supply of currency that was resistant to debasement. Whereas Ethereum says, hey, well, yes, we want our currency to be scarce, but what's more important is that Ethereum blockchain stays secure. So that's kind of like the monetary policy for Ethereum versus Bitcoin,

optimize for security over kind of like, you know, this market. monetary idealism. And each has it on tradeoffs. For Bitcoin, the tradeoff is that in a sense, you kind of set your security budget arbitrarily in the beginning because you just said, hey, we're just going to have halvings every four years in the rent of a fixed supply. And this fee market for block space is supposed to pick up. And that's what's supposed to secure Bitcoin in the long term. And then the trade off for Ethereum is that, well, Ethereum monetary policy, I mean, sure, you can say that it's minimum necessary issuance, but who determines that? And then what does it actually mean, practically speaking?

Because with Bitcoin, it's very easy to understand. Yeah, like, every year, there's going to be X amount issued. This is going to this is, this is, this is, this is going to be a total supply in 2056. It's just all deterministic. It's easy to understand. But whereas with the theory, which is like, Okay, I get that. It's supposed to be to minimum necessary to be secure, but it's a little bit hard to wrap your head around, you know, what that means and how it works. So there's, there's downsides to both, but, you know, I think there's room for experimentation. And, you know, they each have their own benefits that each community believes are important. One of the most interesting parts of your analysis around Ethereum 2.0 was about ETH the asset and how that will change.

You said that under Ethereum 2.0, ETH will become a store of value, a capital asset, and a commodity, and that this is an unprecedented combination. So how does it fit the definition of all three? And how do you know that this is the first time in history that this is? Chris Berniske, I think back in 2017, introduced this paper from an academic called, I think he was like Robert Greer, about the three superclasses of assets. The idea is that every asset in the world that has ever existed can be classified into these three different categories. One being stores of value with the idea being that these are assets that maintain their purchasing. power throughout time. Two being capital asset, with the idea being that these are assets that produce and are generated income. And then three being commodities, which are assets that can be consumed or are they're transformable into something else. So examples of those that be,

you know, for a capital asset would be, you know, a stock or a bond in Apple. This is kind of this income-producing asset. An example of commodity would be like oil. You can use oil for a ton of different things to power your car. You can turn it to different end products. And then for a store of value, you know, it could be debatably the US dollar, although some people would kind of scoff at that in the space or gold, which actually is both a commodity and a store value.

So that's kind of like the high level idea of like these asset classes. Now Ethereum and Ethereum 1.0 is a commodity and a store value. It's a commodity because it's used as gas to pay for transactions. And I think this relationship will be, or this analogy will be especially powerful when a new EIP is introduced called EIP-1559, where the majority of transaction fees will actually be burned instead of being paid for miners. So it'll quite literally be consumed

by Ethereum blockchain. For store of value, that's Ethereum's use as an asset in defy to store value, to send transactions. Like, that's the idea. So that's Ethereum as a statisticist today. Now, if Ethereum 2.0, it introduces staking.

And what staking allows you to do is you can post your eth as collateral to become a validator on Ethereum 2 put out. And now you can actually start generating yield on your, on your eath. And the amount of yield you will get varies on the amount of eith that's being staked. So at, you know, 524,288, you know, that kind of like you said before, like the rate that you'll be getting, is very high, it'll be about, say, like, 23, 24%. And then at about like 10 million or 16 million each state, it'll be somewhere between like 4% and 6%. But the idea is that now you're getting a yield on,

like a native yield on ETH. So when you combine those three things, it's like, well, you have all these different sources of demand for ETH the asset and ETH is being used for all these different things. And then, you know, I'm like a little bit hesitant to say that it's unprecedented. So I've not literally explored every asset in history. But from what I have seen, there's nothing really like this. You know, something that is a non-sovereign store of value, you know, just like Bitcoin,

that is also used to, you know, power this, you know, globally scalable computer. and also offers a native yields almost similar to a kind of like sovereign bond in a sense. And the combination of the three just makes ETH super interesting as an asset. And when you mentioned EIP 1559 and about how the fees will be burned, so how do you think that will affect the issuance of ETH or the net issuance, I should say, and what it will look like in terms of a store of value? Yeah. So I think some helpful context as well is that when the beacon chain launches, hopefully, you know,

eight days from now on December 1st, all the issuance from the beacon chain will actually be incremental to the issuance on Ethereum 1.0. So over the next year and a half, say, Ethereum will issue about, you know, 3.8% worth, or it's like, it's an annual inflationary, it will be about, 3.8, 3.9%. And then on the beacon chain, you'll get incremental issuance, depending on how much ether staked, of anywhere from 0.10% to 0.8% in the most aggressive scenarios where there's, like, you know, 30,000, 30 million eastaking. So in total, like, Ethereum and Monster policy likely between, you know, 4 and 5% over the next, you know, 1 to 2 years. Now, where this changes is that

if EIP 15599 gets implemented on ETH1, where the majority of transaction will be taking place until the ETH1, E2 merger, is that you actually be able to reduce the issuance in the meantime. So I'll actually back up again. So that's kind of like what the monetary policy looks like for the next year and a half. And I think where it's particularly interesting is once the ETH1 merger happens and ETH1 is now merge into E2 as a shard, well, that once incremental issuance from the beacon chain, like I said,

of 0.1% to 0.8% is now the only issuance for Ethereum. And this is actually where it gets interesting because I believe it's a 20 million estate per day. Ethereum, and this is in Ethereum 2.0, at 20 million estate per day, Ethereum will be issuing about 2,000,

eth per day to pay to validators. And if you look at like how much each per day people were paying over the summer in D5 on average, it was about 5,000 Eath. Right. So if like Ethereum 2.0 was launched day and people are playing the same amount of transaction fees, like net issuance would be like way negative. Now of course

there's like there's some nuance here and the big nuance is that Ethereum 2.0 is going to increase transaction scalability. So in theory, it will actually alleviate the fee pressure, so that is not where you have to pay, like, $40 to go in, send your friends some money or exchange an asset on uniswap. But according to some of the analysis that we did, that we based off the economic models that consensus put together, it looks like the likely issuance rate for Ethereum 2.0,

will probably be, like, and I say net issuance rates, like net of the burns will be, you know, anywhere, you know, from, say, like, negative 0.5% to, like, zero point five percent. It really depends on, like, how many validators are participating in and then, you know, ultimately how much heat is being burned. But, you know, the big idea here is that issuance for the impetrethian to Pinoa will be extremely low, if not negative. And one other thing I wanted to ask about was the deeth that we mentioned earlier, these eith derivatives that will be minted so that people can stake, but also then continue to play around in the Ethereum 1 ecosystem. So let's say I stake my eith and I get back some dith,

and then I use that to mint dye on MakerDAO, but then my vault gets liquidated. So hopefully people understood that. I think most of my listeners have been following my D5 posts or my posts podcasts. But essentially that's like the money that you put up as collateral. Now you've lost it. But supposedly you own this ETH on Ethereum 2.0. So if that happens, then who can claim the ETH that I've staked on Ethereum 2.0? Yeah.

So I guess this is like in basically before phase 1.5 when, you know, ETH1 version of E2 and you have these derivatives where you can, can't actually claim the underlying ETH. So, yeah, in this scenario where the MakerDAO system votes in kind of D-Eath, like this derivative that is collateral, and then people are mined and die against this collateral, the liquidation process would be the same. You know, the collateralization ratio falls below the target amount. The DEEth gets liquidated, and then, you know, who it's liquidator now has this DEA.

it depends on the like the staking solution that created this deeth but let's say it was like one of these decentralized protocols that you know met to this deeth yes like eventually you will be able to claim the underlying eith by having this deeth derivative and basically what it is it's just like you know for these decentralized staking protocols is that this deeth is a right to redeem a certain amount of underlying ETH. So if you hold, say, 32D.Eth and the exchange rate is one to one, you'll be able to redeem the 32Eth, you know, once it is redeemable. So this is, I guess the important concept here is that, yes, like all these ETH derivatives

are fungible when they're issued from the same provider. All right. So now let's talk about the fact that this whole process, to moving to Ethereum 2.0, it's going to take years. And meanwhile, you know, Ethereum, as we've been talking about, has kind of been bumping up against its max capacity in particular because of DFI, which is a pretty active ecosystem. And one of the issues with DFI is that the different protocols in Difer are composable, which is the way that people describe the fact that you can, you know, do a transaction that involves multiple of these protocols within one point.

block. And that's why they call DeFi Money Legos. So because that would kind of want, you know, like all the Defy protocols would then sort of want to, you know, stay with each other to keep in the same ecosystem, what do you think is most likely to happen in the meantime to solve this fairly urgent problem that we already have around scaling? Yeah. Yeah, absolutely right. And a lot of the Ethereum researchers recognize this. Scalability is a need now. And frankly, what Ethereum 2.0 can bring from a scalability perspective is years away. Maybe a year, maybe a little bit over than that. So in the short term, the solution that a lot like Battalic and some of the other teams

I've been working on for years is transitioning over to a layer two solution. And specifically the one everyone is talking about is called brolops. There are various flavors of them, but in general you can kind of look at them as as roll up contracts. And essentially all it is is taking a lot of the transactions that we, that in Defi is handling today, moving them to a layer that's above Ethereum right now. So kind of taking them off chain, but having security ties back into the chain. So they would periodically actually transfer these transactions, batch them together and submit them to the base chain. So in a way, it's providing similar security guarantees. So I,

I think the perspective is that even if you, if any issues happen on these chains, on these other layer two solutions, you would still at any chance be able to claim your assets on the main chain. So right now it's kind of moving towards that layer two solution. And like you brought up that the issue is like as application moves from the base chain up to one of those layers, it removes those composability bonds. No longer will I be able to run a transaction that calls different applications in the same block. It would have to be done in an asynchronous manner or it would have to take multiple blocks.

So that one issue with roll-ups is that. And one of the reasons why it has to be asynchronous is to ensure security there is a lengthy withdrawal period. So I go up into a layer two protocol. I can start using an application that deployed a contract there. I want to get back out and use some of the other contracts. It's about, I've heard anywhere between three to four days to a week to get out. So there is this issue of one, getting liquidity out to trying to call transactions between two different applications across these two chains. There aren't any limitations. to compose ability within a single roll-up.

So that might mean a lot of applications go and build on the same roll-up. And eventually, one of the issues is if that everyone moves onto the same roll-up, you start running to the same scalability issues that are present today. So that's why you kind of have like this relationship where you're trying to figure out what is the best way to scale Ethereum, but not. lose what really makes it special, which are some of these composability bonds. There are some solutions in place to try and help out on the liquidity side to minimize the issues of getting out. So one could potentially be a cross-chain liquidity solution,

like Thor chain, for example, where you'd be able to actually move between chains without waiting for that lengthy withdrawal time. That's a decentralized option. You can also go through a centralized market maker to accomplish that. There isn't a great solution to completely fix the composability issues at this moment. There are some solutions out there. One

in particular called, from Connects network called Spacefolds, which would allow two different layer two networks to communicate and transact. But right now it's still working towards what is that going to be solution that would allow cross-chain

composability. And that's definitely going to be one of those issues going forward. What's your sense? Do you think that they're going to address the scalability issues quickly enough? Or do you think that we're going to start to see significant migration over to some other blockchains? Like, I've heard some people saying, you know, they're looking at polka dots, Solana, near, like, what's your sense?

It's realistic that some applications, there's going to be some leakage. I think a lot of what's going on on defy right now is Ethereum-centric and moving off. is not part of their near-term plan. And if it's going to be, they're going to move up to a roll-up solution. Also, a lot of these other networks aren't necessarily production-ready. They're really on kind of like the same timeline as roll-ups. So the roll-up solutions that we're talking about, some of the bigger name ones like optimism and off-chain labs's solution,

they might be coming out sometime within the next four to five months. And you might see the same sort of maturity trajectory timelines for, these other chains to allow applications actually start building on some of these. So I think some use cases, particularly maybe non-financial use cases, might move over to some these other chains. But I think when it comes to defy applications, Ethereum is where the action is. And that's where a lot of these platforms that are building off of uniswap, building off compound, they're not going to want to move away from that.

And those base layer platforms aren't going to want to move from Ethereum because a lot of what they are doing is based on that. It's tied into what Ethereum has been building. And so if you want to really get the advantages of what Ethereum 2.0 can bring down the line, staying within that ecosystem is really going to be a part of their roadmaps going forward. All right. Well, we'll have to see what happens. So we're running out of time a little bit, but I do still want to dive a little bit more

into phase one, phase one point. and at least phase 1.5, we can discuss whether or not, how deeply to go into 2.0. But one thing I wanted to understand about phase one was, so this is where we, well, actually, so no, I should do this question all at once because, as you know, Vitolic wrote a post where he said, because the movement toward roll-ups is kind of happening at a pretty quick pace, and there seems to be some consensus around that is like a good way to scale. And frankly, that if they make it work, then that will actually provide more transactions per second than the originally planned Ethereum 2.0. So he said that there's a scenario where

like Ethereum would move to Ethereum 1.5 and then be done. I wanted to know, you know, what your thoughts were in terms of like whether or not or how likely you thought that would be to happen. But then also one thing, when I was researching for the show that confused me a little bit is I read that. So in phase one, and that's where they introduced the different shards. But then, yeah, I didn't really know how the shards work with the roll-ups. Like, are we still going to have all these little mini-blockchains and then also the roll-ups? Or, yeah, if you could help me in our sand and the listeners, that would be great.

One of the benefits that can happen when phase one launches is that you have all these various shard chains. They're acting as they call them data availability layers. And really, they can just act as kind of storage layers, storage chains. And at the moment, on their own, somewhat useless, mainly just trying to get the network to come to consensus. But there is an option for roll-ups to actually use these networks that they can plug into these networks and use them as data storage layers. So that would actually get, if the roll-up plan works and you see applications moving up to another layer, they can actually plug into one of these various 64 shard chains and use them as kind of this data storage layer. And that would actually give you the opportunity to get used Ethereum 2.0 scalability earlier than phase 1.5 or phase 2.

Okay. So in a way, it's it's not that different from Ethereum 2.0's final vision in the sense that there would be kind of like a layer to or there would be a layer for execution. There would be a layer for storage. It's just that in Ethereum 1.5 and done, what would happen is that the execution would happen on roll-ups and then the storage would still be in the shards at who that are introduced in phase one. Is that, is that it? That's precisely correct. Exactly. So yeah, The scalability, everything that's happening on the base layer, that would all be taken care of by shard chains that plug into the beacon chain. All the execution, where the applications live, where users actually interact with, that's going to all happen on a roll-up layer. Okay. So what do you think the odds are that we end up with Ethereum 1.5 and done versus Ethereum 2.0 as originally planned?

So I'm pretty, I think a lot of applications are going to move off to roll-ups. This is all dependent on how much adoption roll-ups get. And right now you're starting to see synthetics be very bullish on the fact that roll-ups are going to lead are really going to be the near-term, near-to-mid-term scaling solution for Ethereum. There's a good chance. Uniswap has done some integrations with optimism as well, which is a roll-up solution. And as soon as you start to see some of these big D-5 players move up, I just suspect that a lot of other applications will move up as well. because they're very reliant on those. They plug into them and they, like we said, are composed with each other.

If this roll-up solution works out and pans out, which I think it will, I think there's a very good chance that you'll either see no phase two or very limited phase two. So maybe instead of putting execution layers on every shard chain, maybe it's like four to eight of the shard chains, a very small percentage, which kind of limits the complexity and limits development time. so you can actually get there sooner. But I think there is a very strong chance that either phase two gets dialed back

or there's really very little need to go that far. So you'll be able to actually use a theorem 2.0 for its scalability needs a lot sooner than initially projected. Yeah. And then I was going to say, I said one thing I would add is that with sharding, like phase one sharding, like using these charts of data availability layers,

in roll-ups, you can probably get about 100,000 transactions per a second. And the benefit of this is that this can potentially come in the next 12 to 24 months. And then you have an Ethereum 2.0, which can scale Ethereum, like, orders of magnitude. So if, you know, the ecosystem adapts to this world, then we get scalability like way sooner than we would if we were to wait for phase two. And then at that point, like the prospect of doing phase two become less attractive because you don't actually get any incremental scalability from enabling computation on these charts. Yeah. I already know we made a bet in this episode, but I think if I were to make another bed, I would also bet on this, assuming that everything

continues going as it's been going. All right. So we're going to do two last quick questions. One is just like a general question, but one is like for people who might be interested in staking. What do you think is the biggest risk that Ethereum 2.0 faces? Like if you were an Ethereum researcher or developer or whatever, what would you be thinking about most right now or working on most right now? You know, where do you see like potentially the biggest pitfalls in the game plan moving forward? What is around like E-derivatives? So there is this idea that it may be just,

to kind of zoom out a little bit higher level is that there's always this trade-off between, like in cryptocurrency specifically, that people care about between like decentralization and convenience. And people oftentimes are comfortable cussetting their cryptocurrencies and centralized exchanges or custodians or in the case of staking, this comfortable staking through a service provider rather than doing it themselves. And the reason why it's important is because there could be a scenario, although I don't think this is unlikely, because of the existence of decentralized staking options

and the fact that validating is very accessible to the average user. But there is a scenario where a lot of people end up staking with, say, like a Coinbase or a Binance of the world, and Coinbase of Binance issues their own ETH derivative. and then that E-derivative becomes extremely liquid in secondary markets. It starts to get a lot of integrations in D-Fi, maybe even C-Fi as well, so now you can borrow and lend against it. And, you know, this kind of liquidity creates a network effect.

Actually, Dan Alitzer wrote like a great piece on this, where it almost becomes like a USDT, like, you know, Tether kind of thing where, you know, if people want to go in state, they're probably going to go do it with the centralized service provider, because, I mean, yes, it's convenient, but most importantly, they get liquidity and utility from this E-derivative that's not available with these other options. So there's a scenario where staking could end up centralized for this reason. But like I said, I don't think this risk is likely, but, you know, it is a possibility. I was going to echo that.

I think staking centralization is one of the biggest issues that, as some people present as a problem with. staking because it is a very real it's very real people like convenient they usually pick convenience over sovereignty um so you could see a lot of people staking with uh exchanges very easily um but i will preface this with the design around e2.0 uh somewhat disincentivizes that because like we said if a lot of the same if the validators are running the same clients and they all happen to go down at once, those ones will be more likely to be the ones that get slashed. Because another one of the designs around, we didn't mention this, is there are slashing penalties, but the slashing penalties get ramped up if more validators are offline or behaving

maliciously at the same time. So if you're running all these validators on the same services and they're kind of doing the same thing, they all fall offline at the same time, they'll all get slashed a much higher amount. So if you're staking with a single service, you're at a much higher risk unless they're using some sort of decentralized validated service on the back end. Yeah. And I was going to say, like, that also like that kind of brings up of what that's kind of related to the e-derivatives as well, is that if like a centralized service provider, say, Coinbase were to issue their own e-derivative, the risk of that e-derivative are not the same as the risk of a decentralized

taking pool issuing its own derivative. And the key difference is that with Coinbase, the risk is that beyond the custodial risk, but the risk is that the, for the derivative is that Coinbase's validators just don't perform or they behave maliciously. Whereas with you, with like the E-derivative that centralized taking protocol issues, the validator risk that spread across this entire kind of network of validators in this protocol. So, I mean, actually, I think one good analogy, you know, hopefully, you know, it doesn't bring, you know, memories of the financial crisis when you think about this, but it's a difference between like an individual mortgage and a mortgage-backed security that kind of pulls all these individual mortgages into,

into what security to diversify the risk. Yeah, yeah, it's like a reverse analogy, but anyway. Okay, so then this is the questioner for people who are potentially interested in participating. What do you think is riskier, putting your money in defy or trying to stake on Ethereum 2.0 at this point? So I think it depends on what you're doing in defy if you are putting your, if so if you're putting your money basically like anytime you put your money into defy there are a bunch of different risks that you assume there is smart contract risk there is composability risk because of all these different protocols interacting and then there's also like

the the risk of just you know the theory unless it's a blockchain failing which kind of like I think of it as like the systemic risk of defy whereas with staking there's really just two risk one being validated risk, which you can derisify away with these decentralized taking solutions. And then just kind of systemic risk of Ethereum. So those are the kind of differences in risk. Now, within D5, there's a bunch of different things you can do. I mean, you could deposit your funds into Compad,

which has been heavily audited and, you know, a known and reputable team. Or you could go in, go put your money into like a new yield farm that popped up yesterday that some pseudonymous developers created and you risk getting like Rockpool. So there's a lot of

differences here. So yeah, so I would say like yes, like they are competitive, but like but it's just there's kind of different things. This is really. Yeah. And I, you know, I don't know every last person who listens to my show, but I'm pretty

sure if they're listening to my show, then a lot of them wouldn't be going into an unaudited defy contract by an anonymous developer and getting wet pulled. So hopefully, hopefully. I'm sure people will write in now and be like, that happened to me.

But anyway, and Wilson, do you have a take? Yeah. I think, obviously, it comes down. Its different personas are attracted to the various forms of risk. So there's going to just going to be a different user type that is willing to dive into these unaudited contracts that are proposing high yield returns.

But it's going to depend on what applications you're going to use and what is your investment horizon. If you're looking at on a long term, staking is going to be relatively safe as long as as you're doing your research on what validator provider that you end up using and what service you're going to go forward with that. Because like we said, it is, it's very difficult to not make money on the staking part. So you can, it, you, you, you're really going to have to work hard to not be have a good uptime or use a validating service

that may not be as trustworthy to not make some sort of return or lose your money on it. Whereas with defied, of course, there are some applications that are very well audited that have done a lot of work on that service and are trustworthy within the, in the whole ecosystem that would be a lot, would be just as safe to work with. And then obviously there's a whole other part to it that, where the madness comes in, where these flash alone attacks are very relevant. So it's just something to keep an eye out for that there are just more risks involved with Defi at this point.

All right. Well, this has been super fascinating to dive into this huge momentous change happening on one of the biggest blockchains. where can people learn more about each of you and Masari? Yeah, so you can check out both Wilson and I's work on Masari.com. And then you can follow me on Twitter at Ryan Lockins underscore. And you can find me on Twitter at Wilson Whiffiam. Not as active as the other guys, but feel free to jump on.

I retweet them constantly. All right, great. Well, thank you both so much for coming on Unchained. Yeah, thanks, Laura. Thank you for having us. This is a lot of fun. Thanks so much for joining us today. To learn more about Ryan, Wilson, and Ethereum 2.0, check out the show notes for this episode.

Don't forget, you can now watch video recordings of the show on the Unchained YouTube channel. Go to YouTube.com slash C slash Unchained podcast and subscribe today. Unchained is produced by me, Laura Shin, with help from Anthony Yoon, Daniel Ness, Bossie Baker, Shashonk, and the team at CLK transcription. Thanks for listening. Thank you.