Smart contract platforms and solutions for scaling them
Unlike Bitcoin, smart contract platforms allow people to create dApps applications. These applications (dApps) can be accessed globally and around the clock using decentralized blockchains. To use a variety of applications, it is enough for the user to have a device with an Internet connection. According to Coinmarketrate.com, the largest areas of their application currently include the world of decentralized finance (DeFi), and the NFT space.
However, due to the growing demand for these applications, the limitations of existing smart contract platforms have become apparent. The high cost of transactions and long waiting times required alternatives in the form of competing blockchains, or multi-level scaling solutions.
The idea of smart contracts dates back to the invention of Bitcoin. But only with the advent of Ethereum in 2014, and the possibility of programmable blockchain logic, the idea came to life. Now this programmable logic, commonly referred to as a smart contract, allows the use of blockchain technology for a wide range of applications in various industries.
For the first time, smart contracts made it possible to create any type of tokens without the need to create a completely new blockchain. In Ethereum, the token has become part of the code – a smart contract with certain functions that allow, in particular, the “transfer” of digital assets.
You can create escrow agreements or forward contracts that depend on the occurrence of certain conditions in order to be activated.
For example, a smart contract can be programmed to issue money every year on a person’s birthday. Payment can be made after confirmation of receipt of the delivered goods. Or it can be used to enforce certain rights of owners of digital assets, for example, in the field of non-interchangeable tokens (NFT).
At the same time, a new decentralized financial environment has emerged with the DeFi sector having the most important applications that can be found in the traditional financial sector as well.
Adoption of smart contract-based applications
With further implementation, scalability becomes an urgent necessity. Blockchain technology is complex in terms of configuration, programming and operation. However, the transaction speed decreases when the network is loaded, which can affect the user experience for some types of decentralized applications (dApps).
The more congested the network, the higher the transaction fees become, as users try to outbid each other. This can make Ethereum very expensive to use. Here, fees are used not only to pay for transactions, but also to pay for the work of miners.
The scaling trilemma
Despite the fact that blockchain, by all accounts, is superior to traditional networks, no blockchain is perfect. This is due to the difficulty of maximizing components such as scalability, security and decentralization, the so-called blockchain trilemma.
- Scalability is the ability of the blockchain to accept a larger volume of transactions;
- Security is the ability to protect the data stored in the blockchain from various attacks, or the protection of the blockchain from double spending;
- Decentralization is redundancy in the network, which ensures that several entities will not fully control the network.
Not all components are equally important for specific use cases. Processing of weekly payments can be easily carried out on an inert but secure blockchain. However, in other sectors, such as gaming, thousands of transactions per minute are required – an unthinkable task without a scalable solution.
The most popular smart contract platforms
The first-level blockchain is the basis of modern decentralized ecosystems. These projects are designed to handle every transaction on the network. This means that all transaction data is recorded and stored in the blockchain.
An obvious and early scaling method is to increase the number of transactions per minute, combined with low transaction costs. This is usually achieved through a compromise between decentralization and security.
Various first-level blockchains with the capabilities of smart contracts have appeared, which in one form or another seek to compete with Ethereum. Older examples, such as Tron and EOS, used the classic approach of changing the consensus mechanism to Proof-of-Stake (POS), and increasing the number of transactions per minute. Competitor Solana has implemented a new consensus protocol that provides even higher throughput.
Projects such as Polkadot, Cardano and Avalanche also use a multi-level architecture that uses a base layer and attached blockchains similar to Ethereum 2.0.
Multi-level solutions for scaling Ethereum
Second-tier solutions, unlike alternative smart contract platforms, do not try to compete directly with Ethereum. Instead, it is necessary to increase the transaction throughput at several levels. By transferring transactions to the connected blockchain (also known as sidechain), with the final calculation on Ethereum, you can unload the network.
A distinction is usually made between sidechains with their own validators and the so-called optimistic wrapping, which fully utilize the decentralization and security of Ethereum. Bright examples of the first category are Polygon and Fantom. In both cases, a bridge is used to move assets between the Ethereum blockchain and a sidechain based on proof of stake. At the same time, native validators check all transactions, and make calculations on them in Ethereum at a specified interval.
In contrast, Arbitrum and Optimism scaling projects use optimistic wraps. They allow you to combine transactions and perform calculations in Ethereum without external validators. Instead of using a sidechain to prove a stake, Optimistic Rollups relies on the verification of Ethereum miners. Although this leads to slightly higher transaction costs, it allows you to scale the system without compromising security and decentralization.
Has ETH become deflationary due to EIP-1559?
The burning mechanism, introduced as part of the Ethereum London upgrade in early August, burns part of the network’s transaction fees. Meanwhile, the implementation of the update, known as EIP-1559, led to the destruction of one million Ethers worth more than $4 billion.
Since the London update, more than one million Ethers have been burned, according to the Ultrasound tracker.Money. At current prices, this amounts to more than $4 billion. This event was celebrated by Ethereum supporters on Twitter, but those who use the network at the basic level (Layer 1) still suffer from painful transaction fees.
Currently, 11,588 ETH worth about $50 million is burned daily. Over the past 24 hours, the network has been destroying an average of 8 ETH per minute. At this rate, the network will burn about 4.2 million. ETH per year, which corresponds to 18 billion US dollars at current prices.
The rate of combustion means that Ethereum supply inflation has dropped to just 1% per year, as about 5.4 million ETH is mined annually. In recent months, the network has recorded several days of deflationary emissions, when more ETH was burned than mined. As soon as the “merger” takes place sometime in the first half of 2022, it is expected that the issue will become completely deflationary. Currently, the issue of Ethereum will be -3.2% per year, which means a reduction in supply
Transition to Ethereum 2.0
The merger will occur when the current ETH 1.0 chain merges or “joins” with the ETH 2.0 beacon chain, which will mark the end of proof of work (POW) and the transition to proof of stake (POS). Before that happens, the Arrow Glacier update will be rolled out in early December, which will expand the Ethereum complexity bomb.
According to Beaconcha.in, the number of Ethers contributed to the stable fund currently stands at about 8.37 million ETH. This amounts to about 36 billion US dollars, and about 7% of the total supply. Stakers can enjoy an annual return of about 5.2% on an asset that will soon become a deflationary asset.