Released in January 2009, bitcoin has been used for approximately a decade now to transfer money in a peer-to-peer blockchain network. We know that there is no central or world bank entity that controls the flow or functionality of Bitcoin as a result of its decentralized nature. Ethereum, on the other hand, when compared to bitcoin differs primarily in its added functionality of the smart contracts to its base cryptocurrency — also known as ether. However, despite its striking similarities, Ethereum was created to serve as a platform for building blockchain-based/decentralized applications and was made well positioned for applications that need to be built quickly and that interact efficiently and securely in a blockchain ecosystem.
But what is Ethereum and why should you bother?
Ethereum uses blockchain technology, which is a transaction record that is independently verified by others and held on a distributed ledger. It is the same technology that underpins bitcoin, but differs in the fact that while bitcoin blockchain merely facilitates bitcoin transactions, Ethereum on the other hand has been designed to act as a programmable infrastructure. This makes Ethereum more flexible and adaptable as a development platform than the bitcoin blockchain.
The Ethereum platform is often referred to as a Turing-complete virtual machine built upon the foundational functionality of blockchain. It allows one to construct smart contracts and applications with their own arbitrary rules for ownership, transaction formats and state transition logic. A basic version of an application on Ethereum can be written in just two lines and protocols such as currencies and reputation systems can be built in under twenty.
Ethereum functions on its own token called ‘ether’ allowing for exchange of value across the network and providing for a primary form of liquidity. One of the most prominent tokens on Ethereum is ERC20 which is widely regarded as the standard used for all smart contracts on the Ethereum blockchain. Ether also provides the mechanism for paying and earning transaction fees that arise from supporting and using the network. Like bitcoin, ether has been the subject of immense speculation and has witnessed wide fluctuations in its prices. It is worth noting that ether is the financial incentive that pushes and fosters decentralization (and attracting miners), which makes the platform more secure.
Given these characteristics, Ethereum is likely the future of DLT systems. Let us explore some crucial technical challenges and solutions that Ethereum and ERC 20 tokens face today.
Challenges and Solutions
1. Scalability: Scalability is a crucial cause of concern for Ethereum platform. After all, since it is based on blockchain and the design is such that it has to replicate transactions and blocks to every node in the network, so just how scalable can it be?
Currently, the Bitcoin blockchain size is around 159 GB and can grow by 1 MB approximately every 10 minutes. Each node would need to have some serious resource capabilities in order to process that amount of data necessary to handle the number of transactions as is handled by a major credit card company like Visa or Mastercard, at the speed necessary to handle the requests. The Ethereum blockchain size is 57 GB and would also suffer from the same growth pattern. It would be even more complicated by the fact that Ethereum is an application platform containing applications and code and not solely a cryptocurrency.
Aside from the spinoff of Bitcoin Cash (BCC), there have been a few suggestions on how to alleviate the future scaling issue for Bitcoin. For the Ethereum platform, there are two strategies in place to help deal with the issue of scaling. First, because of the mining algorithm every miner is forced to be a full node. Second, after processing each transaction, an intermediate state tree root is saved to the blockchain. In the event of a centralization event, as long as there is a single honest miner on the network the issue can be addressed via a verification process. So, if a malicious miner publishes an invalid block, the verifying node would run the same computation and see that the state generated does not match the state provided and reject the transaction.
The switch to Casper, a proof-of-stake (PoS) consensus algorithm, is also said to improve, among other things, the scalability issues that are associated with the current proof-of-work (PoW) consensus approach. In a proof-of-work based blockchain, the consensus algorithm rewards nodes that solve cryptographic puzzles. The winning miners validate transactions and create new blocks. A set of validators then take turns proposing and voting on the next block, the weight of validator’s vote depending on the size of their stake/deposit. This PoS approach is said to be advantageous over PoW in terms of security, a reduced risk of centralization and energy efficiency.
2. Interoperability: Collaboration with other platforms still remains a major issue for Ethereum. A fully interoperable blockchain environment means the user from another blockchain may be able to read, interpret, interact and comprehend with data from Ethereum without much efforts. Interoperability functions at various levels and with distinct characteristics — ranging from mere data exchange to its usage on other platforms. There have been some efforts taken towards this but realistically speaking, full interoperability still remains a distant dream.
3. Transaction processing speed (TPS): While in comparison to a bitcoin transaction where an average blocktime is approximately 10 minutes, Ethereum has a much faster rate at around 12 seconds. However, other established payment platforms like visa can process around 24000 transactions per second. Given the slow rate, there have been various solutions proposed to make Ethereum blockchain faster. These solutions include sharding and ‘layer-2’ protocols that work by sending most transactions off chain and only interact with underlying blockchain only to enter and exit from the layer 2 system. Off-chain computations not only decrease transaction processing and verification costs but also takes a huge load off the Ethereum blockchain. Further, a decentralized storage mechanism which allows only that data which is frequently used will make the transaction speed much faster.
With its state transition function, Ethereum provides an open-ended platform by design, and is well suited to serve as a framework for financial and nonfinancial decentralized applications. Regulation is still up in the air on this. How it may even apply to a global decentralized platform is unclear. Current laws and regulations will catch up and apply to these platforms. However, it is still important to work through any legal and regulatory impacts of particular applications. Businesses operating in regulated industries should seek guidance from their regulators before integrating critical, customer-facing, or data-handling processes with platforms like Ethereum.