Ethereum’s evolution through proof of stake and economic scaling

The transition to proof of stake

Ethereum launched in July 2015, and the network has run continuously since then without a single second of downtime. Vitalik Buterin and a small team of co-founders designed the network to utilize smart contracts, which are open-source programs that run 24/7. These programs let anyone create digital assets and decentralized applications that function globally without a bank. The network is an alternative where users hold assets directly rather than in a bank database. The network originally relied on a proof of work mechanism where computers solved complex mathematical puzzles to agree on ownership. In 2022, the network upgraded to proof of stake, making it 99% more energy efficient than the previous system. This transition replaced mathematical puzzles with a system where validators lock up ETH as a security deposit to earn the right to process transactions. If validators act correctly, they earn ETH, but they lose part of their stake if they cheat. The transition to proof of stake is easily the best part of the network’s evolution.

Economic security and validator mechanics

The economic security of the network relies on a system of staking where validators process transactions, and you know the fundamentals of validator rewards, so you understand how these incentives maintain the network. In September 2021, 117.5 million ETH coins were in circulation, 72 million of which were issued in the genesis block, while 60 million were allocated to the 2014 crowd sale contributors and 12 million went to the development fund. The remaining amount came from block rewards. Developers adjust the issuance rate via consensus to maintain the minimum amount needed for adequate security. Because the network can adjust issuance, it avoids a fixed security budget. The network consists of thousands of independent computers called nodes that work together to provide financial services and digital applications to anyone, anywhere. These nodes, run by regular people, provide decentralized services to a global user base. Users can participate in the network without a credit check, a minimum balance, or any paperwork. When a user sends money, the wallet signs the payment and broadcasts it to the network, meaning the payment waits in the public queue, known as the mempool, until a block proposer picks it. The block proposer adds it to the next block of transactions, broadcasts it, and earns a fee. High demand can lead to elevated transaction fees, which remains a problem for users.

Transactional efficiency and Layer 2 networks

EIP-1559, which was part of the August 2021 London hard fork, changed how the network handles transaction costs. The update introduced a base fee that adjusts dynamically with activity, and users pay a tip or priority fee to have transactions prioritized. These base fees are burned, which removes ETH from circulation and can make the currency deflationary. Despite these improvements, gas prices remain notoriously high during periods of peak network congestion. Layer 2 networks like Optimism, Arbitrum, ZKSync, and Base run on top of Ethereum to increase capacity, and these express lanes make transactions faster and can cost less than a cent on average. These L2s process millions of transactions worth billions of dollars each year. Users can send stablecoins to anyone in the world for just $0.02, and receivers get the funds almost instantly in about 12 seconds. Because Ethereum uses a system of smart contracts, users can access financial services, trade assets, or use decentralized applications without needing to provide a credit score, personal information, or a bank account. How will the network maintain this balance as issuance continues to change?