Ethereum Concerns Amid Regulatory Limbo | Image: Bastian Riccardi/Pixabay
Key Takeaways
- Ethereum’s original design was not prepared for the current demand, resulting in network congestion and high gas fees.
- Ethereum’s flexibility in smart contract execution introduces risks of breaches and exploits, as seen in past incidents like the DAO hack.
- While PoS offers benefits like scalability and energy efficiency, Ethereum also raises issues of centralization, particularly with the “rich get richer” dynamic.
- Ethereum’s governance model relies on off-chain mechanisms, leading to debates and conflicts of interest among stakeholders.
What Is Ethereum?
Ethereum network is a Web3 blockchain that powers decentralized applications (dApps). In simple terms, it is a special kind of internet system that runs apps. Ether, which is the native cryptocurrency of the Ethereum blockchain, is the second most valuable digital asset in the world.
Consider Ethereum to be a giant global computer made up of many individual computers connected together. It’s not just a place to send and receive money like Bitcoin; it allows people to build and run applications that can handle complex tasks, such as:
- Automated transactions: Eliminating intermediaries for things like escrow services or trade agreements.
- Decentralized governance: Creating structures for community decision-making within organizations.
- Enforceable agreements: Ensuring terms are followed without the need for legal enforcement.
Ethereum was created as an open-source system to enhance the blockchain capabilities introduced by Bitcoin in 2008, aiming for greater programmability and application potential. It was co-founded by Vitalik Buterin, Gavin Wood, Charles Hoskinson, Anthony Di Iorio, and Joseph Lubin and was first presented publicly in 2013.
Backed by the Ethereum Foundation, the platform can build and operate miniature applications, called “smart contracts.” Smart contracts automatically perform certain actions when specific conditions are met, without needing a person to check or approve them.
This functionality of the network is its USP which doesn’t allow any single company or person to control the entire network. Developers on Ethereum are akin to a community garden where everyone can plant their own plants, but no one person can decide on their own to pave it over.
The real usefulness of Ethereum comes from its ability to handle more than just monetary transactions. For example: artists can use Ethereum to create unique digital art pieces, known as NFTs (non-fungible tokens), and developers can create games or applications offering financial services, like giving loans or earning interest on savings. It is part of what’s called “decentralized finance” or DeFi.
Ethereum’s Consensus Layer Upgrade
Ethereum was running on the proof-of-work (PoW) system which is known to use a lot of energy to verify transactions. The system required a lot of computer power to solve the mathematical equations required to run the blockchain.
In September 2022, Ethereum upgraded to the proof-of-stake (PoS) system that uses less energy and can settle more transactions per second. PoS does not use major computational power to verify transactions, instead, it uses validators to validate transactions.
Despite the consensus layer upgrade via The Merge and being the first smart blockchain, Ethereum is not without flaws. The issues range from scalability and security vulnerabilities to concerns over centralization and governance. Several community members believe that the shortcomings can pose challenges to its long-term viability.
Scalability Challenges Faced By Ethereum
The Ethereum network was born in July 2015. It was originally not built for the high demand of building DApps that it currently handles. Therefore, it can often become congested. The network congestion slows down transactions and drives up the gas fees, or costs associated with performing transactions and executing contracts. Gas fees can fluctuate wildly based on network activity, making Ethereum less attractive for smaller transactions and potentially limiting broader adoption.
One of Ethereum’s most pressing issues has been its scalability. Ethereum is like a busy highway that gets jammed because too many cars (or transactions) are trying to use it at the same time, leading to delays and high costs. To solve this, the developer community is improving the main road with layer-1 upgrades.
Meanwhile, extra roads are being built on top (layer-2 solutions) to handle more traffic. Layer-2 solutions like rollups, which execute transactions off the main chain; and Plasma, which creates a framework for scalable dApps; help reduce congestion and costs. These solutions make Ethereum faster and cheaper to use, with the main road only focusing on ensuring everything runs smoothly. However, criticism has erupted that Ethereum is too focused on layer-2 solutions rather than improving the main layer-1 chain.
As the platform has grown in popularity, it has struggled to handle increased demand. While the switch to PoS was a major step, the Ethereum network still focuses on scalability solutions. Layer-2 solutions and sharding continue to be areas of development for further improving transaction throughput and overall capacity.
Security Vulnerabilities Of Ethereum: Breaches And Exploits
The flexibility of Ethereum’s smart contract layer also introduces a range of security vulnerabilities. Ethereum’s smart contracts are written in Solidity, a programming language designed for creating and deploying such contracts across the Ethereum network. Unfortunately, the network intricacies can lead to unintentional bugs and security loopholes.
A major problem occurred in 2016 with the DAO hack. A hacker found a flaw in the code of an Ethereum-based project, The DAO, and stole a lot of 3.6m Ether (ETH). This event sparked a major debate in the Ethereum community, ultimately leading to a hard fork that created Ethereum – the version that reversed the hack – and Ethereum Classic – which maintained the original blockchain.
According to market reports, Ethereum has been the most vulnerable chain to crypto hacks. As a smart contract platform, Ethereum uses the ERC-20 standard for creating tokens on the blockchain. Think of it like a set of rules for digital assets. Chainalysis found that over half of the ERC-20 tokens available on decentralized exchanges (DEXs) in 2023 were likely scams.
Hackers often exploit vulnerabilities in smart contracts, leading to significant financial losses. The DAO attack and subsequent exploits, especially in the DeFi space, underscore the risks associated with Ethereum. Other DeFi exploits via sidechains and cross-chain platforms include:
- Wormhole Bridge (2022): Hackers exploited a vulnerability, stealing around $320 million worth of Ethereum.
- Poly Network (2021): In one of the largest DeFi hacks, over $600 million worth of cryptocurrency was stolen. Interestingly, most of the funds were later returned.
- Ronin Network (2022): Connected to the popular game Axie Infinity, attackers stole roughly $620 million in cryptocurrency.
Despite the Ethereum community’s efforts to improve security practices, the potential for breaches remains a serious concern.
Ethereum’s Centralization Concerns
Ethereum moved to PoS in an effort to increase scalability and energy efficiency, but it also raised new issues with centralization. In contrast to PoW, in which miners fight for processing power, PoS demands validators to contribute to network security by staking their Ether (ETH).
The “Rich Get Richer” Dynamic
Imagine a world in which one’s wealth determines one’s capacity to influence a system. In PoS, your chances of being selected as a validator and receiving rewards increase with the amount of ETH you stake. A concentration of power among significant stakeholders or staking pools may result from this.
Through staking pools, users can pool lesser amounts of ETH to take part in validation. Despite being meant to improve accessibility, the network may become dominated by big, popular pools. Centralized decision-making could result from a few large pools owning a considerable amount of staked Ethereum.
A small group with disproportionate authority may have an impact on transaction processing, network governance, and even upgrades. This undermines Ethereum’s fundamental tenet of decentralization.
By promoting distributed staking pools and smaller validators, the Ethereum community is actively attempting to allay worries about centralization. The aim is to achieve a balance between maintaining a genuinely decentralized system and ensuring network security.
Governance Issues Of Ethereum
Ethereum governance is the system for deciding how to modify the Ethereum protocol, a process that directly impacts all dApps built on the network.
Unlike the permissionless activities on the chain, where anyone can participate freely, protocol changes involve a high level of coordination and consensus due to the impact on the entire network’s stability and security.
Ethereum’s governance does not rely on direct on-chain mechanisms such as stakeholder votes for protocol changes. Instead, it employs an off-chain governance model. This means changes are discussed, debated, and refined through community forums, development meetings, and other informal communication channels before any code is written.
But Ethereum’s governance is an ongoing experiment in decentralized community management. Ideally, it aims to involve a broad spectrum of stakeholders in the decision-making process.
The stakeholders include:
- EIP authors: Individuals who propose changes via Ethereum Improvement Proposals (EIPs).
- Developers: Those who implement changes in Ethereum’s code.
- Node operators: Participants who run the software that powers Ethereum and validate transactions.
- Users and developers: Those who use and build on Ethereum, providing feedback and suggestions.
However, in practice, governance can often be swayed by those with substantial financial or developmental stakes in the network. Some community members have often accused the backing entity, the Ethereum Foundation, of having governance concentration.
A notable instance is the divisive DAO hard fork discussion in 2016, in which participants struggled to preserve blockchain immutability or undo a significant hack. The 2021 controversy over transaction fee reform in EIP-1559 brought to light possible conflicts of interest between miners and the network as a whole.
A major governance concern at the moment is striking the correct balance between various scaling methods, which raises concerns about security, decentralization, and the ideal future structure for Ethereum. To avoid potential hotspots of failure, it is also imperative to concentrate on the diversity of clients. These examples show how Ethereum governance is a continuous process that tackles difficult technical issues, competing agendas, and the fundamental principles of decentralization.
Debates around upgrades and changes to the protocol can be contentious, exposing rifts within the community. For example, the decision to move from PoW to PoS was not universally accepted and led to significant discussion about the future direction of Ethereum.
Efforts To Address Ethereum Flaws
The quest for scalability remains a top priority for Ethereum, even after its consensus layer upgrade (the Merge). A crucial step was sharding, where the network is divided into “shard chains” to process transactions in parallel. This boosted capacity, potentially lowering gas fees by reducing congestion.
However, Ethereum’s ambition doesn’t stop there. Proto-danksharding takes sharding a step further, dividing data within each shard into smaller, more manageable chunks. This optimizes storage and transmission efficiency, leading to faster transaction times and a more robust network.
Moreover, improvements in Ethereum’s protocol and the adoption of scaling solutions such as rollups are in progress. Ethereum Improvement Proposals (EIPs) are regularly submitted for review, offering solutions from across the community to enhance the platform’s robustness.
Conclusion
While Ethereum continues its role as the biggest smart contracts-powered blockchain, its sustainability depends on addressing fundamental flaws. The network’s ability to scale effectively, maintain high security, decentralize power, and manage its governance will determine its future position in the blockchain hierarchy.
As the platform evolves, the community’s response to these challenges will not only impact Ethereum’s trajectory but also offer valuable lessons for the broader blockchain community. The ongoing developments and improvements in Ethereum’s consensus layer will be critical to watch, as they will likely influence the network’s ability to overcome its current limitations and shape its future.
FAQs
What are smart contracts on Ethereum?
Smart contracts are self-executing contracts with the terms of the agreement directly written into code. They automatically perform transactions and other actions when predefined conditions are met, without human intervention.
What is Ethereum’s consensus layer upgrade?
Ethereum transitioned from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism to increase efficiency and reduce energy consumption. This upgrade, known as The Merge, aimed to handle more transactions per second and reduce computational power.
What are the main security concerns with Ethereum?
Ethereum faces security risks primarily from vulnerabilities in smart contracts that can be exploited for hacks or financial theft. The flexibility of its coding language, and Solidity, although powerful, can lead to bugs and security loopholes.
How does Ethereum address scalability and congestion?
Ethereum addresses scalability with layer-2 solutions such as roll-ups and sidechains that process transactions off the main chain, reducing congestion and gas fees. Additionally, shard chains, introduced in one of its biggest updates, partition data to further increase network capacity and lower costs.
