Even with Ethereum 2.0 underway, L2 scaling is still key to DeFi’s future

The Ethereum network has come a long way over the last few years. Everything from the rise of decentralized finance (DeFi) to the recent London upgrade has made the network the most compelling attempt to instill a ‘world computer,’ but there’s still work to be done. 

For global adoption to be the backbone of Web 3.0, the network will need the benefits that the Eth 2.0 upgrade promises to offer. However, to scale for a new wave of decentralized applications (DApps), it’s going to take a lot more, and it’s looking like layer-two solutions may be the only answer.

Related: Want to improve blockchain infrastructure? Work under layer-two solutions

The promises of Eth 2.0

In August, Ethereum saw the implementation of its highly touted London upgrade. This hard fork represents the first stop on the road to Ethereum 2.0, and it implemented multiple important updates to the network to prepare it for the transition. London arrived as Ethereum continued to struggle under the weight of the recent booms in both the DeFi and nonfungible token (NFT) markets. Transaction speeds and costs have, at times, made many DApps completely prohibitive, undermining the benefits that decentralized systems were made to address.

One of the more notable features implemented by London is EIP-1559, which aims to improve inflation rates as well as stabilize transaction fees on the network. To do this, it is implementing a system where base fees on transactions are burned instead of being paid to miners. Miners still receive block rewards, and users can voluntarily add “tips” to their transactions to incentivize priority, but now every block will see a certain amount of Ether (ETH) removed from the network forever.

Unlike Bitcoin, Ethereum doesn’t have a hard cap, so its overall supply increases with every block. This has had many concerned about long-term inflation due to the open-ended growth. While EIP-1559 doesn’t make Ethereum deflationary, it certainly controls how fast the supply can expand.

While a critical first step, London was just the tip of the iceberg when it comes to scaling Ethereum.

The call for 2.0

The majority of Ethereum’s operational issues stem from the fact that the network’s native transaction speeds are throttled by its inherent lack of scalability. To put things into perspective, the Ethereum network can currently process somewhere around 30 transactions per second (tx/s). By comparison, a traditional payment system like Visa is designed to handle 1,700 tx/s.

Ethereum needs to catch up, and that’s what Ethereum 2.0 is all about. For one thing, the network will switch from proof-of-work (PoW) to proof-of-stake (PoS), which means a change from computers competing to solve complex math problems to one where nodes stake assets to validate blocks. While PoS is much more efficient than PoW, improving network speeds to around 50 tx/s, it’s far from what’s required of a global payments system.

This is where another important development of Ethereum 2.0 comes in: sharding. Sharding is a process that takes each block and divides it up into 64 “shards” that can be processed in parallel. In essence, this means that we can take the 50 tx/s estimate and multiply it by 64, which would give us a little over 3,000 tx/s — well ahead of Visa and more than enough to serve as a competing payment network.

Related: Ethereum's 2.0 upgrades aren't the game-changer that could bring more users

Beating Visa isn’t enough

While sharding would enable Ethereum to match or even beat the legacy payment infrastructure, that still might not be good enough. The traditional payment systems are largely concerned with relatively simple transactions. This has been fine for many years, but the internet, and now DeFi, is pushing things beyond what we ever imagined.

Now, we’re looking at 24/7 decentralized exchanges, NFT markets, NFT-powered virtual worlds and blockchain gaming. All of these inherently require a much higher frequency of complex transactions than most traditional payment systems could address. For example, a single player in a blockchain game may be making multiple transactions every minute, and halting gameplay to wait for each transaction to finalize simply won't work. Couple that with DeFi’s ambitious vision of subverting the traditional finance sector, and you start to understand just how much weight the Ethereum network may have to carry.

The point is that even 3,000 tx/s wouldn’t be able to accommodate these services if they managed to reach global adoption numbers.

However, by incorporating additional scaling solutions — such as “rollups” and “sidechains,” — Ethereum has the potential to reach as many as 100,000 transactions per second. This would very much bring it in line with the high-throughput applications that DeFi promises to offer, but what do these answers look like?

Scaling for tomorrow

First off, there are rollups. These come in a variety of forms, including Optimistic, Validium, Plasma, and ZK. Rollups are a scaling solution that shoulder transaction loads by executing them off-chain and writing a cryptographic proof of validity to the chain when complete. This frees up resources on the main chain and can increase overall speed.

Next, there are sidechains, sometimes called “second layer” solutions. These are essentially parallel secondary blockchains that interface with the main chain. These can be deployed multiple times and handle different processes, again, taking considerable pressure off the base layer. The added benefit of sidechains is that they also act as interoperable “bridges” across multiple base networks, providing added liquidity, throughput and cross-compatibility for connected chains.

Imagine a cryptocurrency future where there is an entire ecosystem of primary chains, such as Ethereum, all interacting with each other through a series of side chains. Different networks could be deployed for their specific solutions, but cryptographic techniques would keep data verifiably secure wherever it goes. This may finally provide the level of speed required at sufficiently low cost to finally implement the true vision of DeFi, a financial system that is accessible and affordable for anyone.

This article does not contain investment advice or recommendations. Every investment and trading move involves risk, and readers should conduct their own research when making a decision.