Since 2014, when Vitalik Buterin helped to create Ethereum ( ETH 0.94% ), he has known there was a problem: scalability. In Ethereum’s white paper (the document that explains how the system is supposed to work), it says, “One common concern about Ethereum is the issue of scalability. Like Bitcoin, Ethereum suffers from the flaw that every transaction needs to be processed by every node in the network.”
Ethereum and more well-known cryptocurrency Bitcoin operate with a challenging system called proof of work (we’ll explore this later). But Ethereum’s founders didn’t want to stay on the proof-of-work (PoW) system. That’s why they created what’s known as the “difficulty bomb.” And this ticking time bomb is set to go off in June. Here’s what this means and why investors can relax (well, at least somewhat).
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This was always the plan
From the beginning, Ethereum developers planned to address the scalability problem by switching from a PoW blockchain to a proof-of-stake (PoS) blockchain. For example, an official Ethereum Foundation blog post in 2015 already laid out the long-term roadmap, including this PoS switch.
The first version of Ethereum was called Frontier. However, at the 200,000th block, Frontier underwent its Thawing upgrade (also called Ice Age). This introduced the so-called difficulty bomb, or more properly, the “difficulty adjustment scheme.” Once reached, it gets exponentially harder for miners to validate Ethereum transactions.
Unaddressed, Ethereum mining would get so difficult that no one would be able to do it efficiently, bringing the network to an almost complete standstill — just like a river flash-freezing into a glacier.
But why, though?
While there is a team of developers behind the scenes with Ethereum, remember that the network is decentralized, and miners are independent parties. Indeed, you could go out today and buy equipment to mine Ethereum right now. There’s no need to get anyone’s permission.
Because Ethereum is decentralized, parties can make their own choices. Hypothetically, miners might not want to move to the PoS network, sometimes referred to as Ethereum 2.0.
For one, the barrier to entry is lower under PoW. One could invest just a few thousand dollars in a mining rig setup and start earning Ethereum today. By contrast, if you want to run an independent validator node in the PoS Ethereum, you’ll need to stake a minimum of 32 Ether tokens — nearly a $100,000 investment at today’s prices.
On the surface, one could argue that incentives for miners are stronger with PoW. However, PoS should be better for users — “gas prices,” or user fees, are expected to decrease, and network speeds are expected to improve. In other words, PoS hopes to solve the scalability problem Buterin outlined from the start. And solving this problem is better for long-term user adoption.
Therefore, Ethereum needs this upgrade. But it also needs all participants to make the jump. To do this, developers built in the difficulty adjustment scheme. If miners keep operating under the Ethereum PoW system, the difficulty bomb goes off and takes away their incentive to keep using it.
Kicking the can (bomb) down the road
Here’s the problem: Ethereum’s difficulty bomb is expected to go off in June, and the new PoS network isn’t ready yet.
Is this the end of Ethereum? Hardly. In fact, Ethereum’s difficulty bomb nearly exploded several times in the past — most recently in December. In each case, the developers simply introduced what’s called a “fork,” changing the code to kick the can further down the road.
The hope was that another fork wouldn’t be needed. However, some developers have shared on social media that they’ve uncovered bugs in their Ethereum 2.0 tests. These bugs need to be fixed before the transition to PoS can happen. And it’s unlikely these issues can be resolved and thoroughly tested before June. This is why many close to the project believe the new Ethereum won’t be ready until the second half of 2022.
Therefore, expect Ethereum developers to create a fork that gets around the upcoming difficulty bomb yet again. So if you’re an Ethereum investor, you can breathe easy — missing the deadline is OK. They can just push the deadline out as they’ve done in the past.
However, before you get too relaxed, there could be another reason for concern. While the difficulty bomb is easily averted, the delay could help other competing blockchains that were built using PoS or similar systems continue to steal market share. Ethereum is in a hard place. It can’t rush the process — any undetected bug could bring the network to its knees. But the longer the conversion is delayed, the more users will struggle to find reasons to remain loyal to a system with high fees and slow speeds.
To be clear, Ethereum is hardly dying. However, the transition to PoS is something investors should be watching intently for the reasons we’ve just looked at.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.