What changes will Ethereum 2.0 bring to DeFi after it goes online?

Author: Haseeb Qureshi, Managing Partner of Dragonfly Capital

Translator: Jing Kai

Source: Blockchain Research Society

 

We know that Ethereum is gradually transitioning from the PoW consensus mechanism to the PoS (Proof-of-Stake) consensus mechanism. What does this transition mean for the DeFi industry? What will the development of DeFi look like in the Ethereum 2.0 era? In this article, let's explore it together.

The Future of Ethereum 2.0

If you want to use DeFi protocols on Ethereum today, you will face many restrictions. Currently, Ethereum has only one chain, which means that everyone faces the same transaction fee rate (if you know, Ethereum calls it gas), trading in the same place, all DeFi Legos, are on the same chain.

In other words, today, all of this happens on a shard. (Translator's note: Sharding is a data method used by Ethereum to achieve blockchain expansion)

So what about Ethereum 2.0? According to the plan, there will be 64 shards in Eth2. All shards have the same settlement guarantees, but each shard has different levels of activity, just like there are different cities on the earth. Some are sparsely populated, while others are crowded. And each shard has different costs, you may hear something like this - "Transactions on shard 3 are now 60 gwei... You should come to shard 6, there are only 3gwei!"

What will this mean that there will be a lot of the same economic activities on the same shard? Just like in a city, there will be industrial sectors and residential sectors?

In this article, an interesting psychological model is described to understand the economic load balancing in Eth2.

Ethereum 1.0 and Ethereum 2.0

If Ethereum is an island, then there must be many people on this island who are squeezed to the point where they can't touch the ground: it's too crowded! In fact, it's more crowded now than during the peak of the ICO bubble. Any transaction may cost more than $10 in gas fees before it is slowly processed by miners. This is impressive, but also worrying!

Ethereum 2.0 has not yet arrived, and the island of Ethereum 1.0 is already overcrowded.

Ethereum 2.0 will adopt sharding. In addition to improving the scalability of infrastructure, sharding is also a means for Ethereum 2.0 to meet user needs.

But many people ask - is sharding really useful for DeFi? Many people call DeFi money Lego, and it is the composability of DeFi that they are looking at. After all, sharding destroys composability, and isn't composability the main content of DeFi?

Today, we will explore this topic in this article.

Ethereum 2.0 will create many shards that will work like loosely connected blockchains. But all DeFi will eventually live on a single shard because they all want to condense together.

So, in the end we seem to be back to where we started: a large DeFi shard, with a large number of DeFi applications, and it's still crowded. Just like the crowded island in the picture above, but now it's a little bigger than before.

In a sense, this is a pretty certain inference. But we shouldn't worry about it: it's not a bad thing, in fact, it's completely to be expected!

Let's do a thought experiment.

Ethereum 2.0's urban and rural distribution: cities, suburbs, and countryside

Now, let's assume it's the first day that all the features of Ethereum 2.0 are online. You can run smart contracts on Ethereum, and Ethereum has successfully implemented multiple shards. After a long effort, Ethereum has finally transitioned from PoW to PoS mechanism.

At the beginning of the launch, Ethereum 2.0 was an uncultivated wilderness, and the enthusiastic Ethereum 1.0 natives traveled across mountains and rivers, migrated here, and scattered on different shards.

Will people be evenly distributed on this land? Of course not! The first settlers wanted to unite and build cities. In cities, people live and work together, and mutual coordination and relationships make each other more convenient. In order to improve the productivity of urban life, these immigrants are willing to pay higher rents and are willing to bear higher congestion levels (measured by the price of gas fees on Ethereum).

Despite these inconveniences, it’s worth it! These early cities will become commercial hubs. They may be too expensive for most people, but that’s okay. Those who benefit most from being close to commercial hubs will be more willing to move there.

The first city to appear on Ethereum 2.0 will likely be the DeFi shard.

The DeFi shard will see the major DeFi protocols settle down. These protocols need to be high speed and associated with large liquidity pools, flash loans and other product platforms.

Perhaps there will be a major financial shard, such as London. Or, there will be two shards with their own division of labor, just like the two financial centers of the United States, New York and Chicago. I expect that if there is a second city on Ethereum 2.0, this shard will take on the settlement of centralized exchanges, separate from DeFi and all its messes.

On such a city shard, the cost is high, the transaction volume is large, and it is mainly high-value transactions. After all, the cost of gas will be very high.

Isn’t this the situation we are in now? Isn’t this exactly what we are trying to avoid? Now normal users can’t use the DeFi shard at all!

Wait, don’t rush. The other shards are not sitting there unused. Most people live in the suburbs of the city, but you might occasionally go to the shopping mall in the city to join in the fun if you want to buy something new. Most of the time, living on another shard, you only do it when you really need to go into the city: after all, it’s not that troublesome, and it only takes a few minutes of cross-chain transactions from your shard to the DeFi shard to complete.

Where will most users be?

I think there will be two types of shards: suburban and rural. Most people will live in these two types of places.

Suburban life

Suburban life is affordable for a lot of people, and they have access to decent services - not a lot, but enough to meet most of their needs. If you want to do something fancy, like get a flash loan to refinance a multi-million dollar Maker vault into a recursive leveraged compound position, you might have to ride your beloved donkey or take the subway to the DeFi shard to do it.

But if you just want to do something simple, the shops on the corner can meet your needs. For example, exchanging ETH for some DAI or buying some WBTC can be easily done. Almost all ERC20 tokens have achieved cross-shard circulation and can be used in the suburbs. And some of the most popular tokens and use cases provide services for local shards. Just like suburbs in the real world, most suburban-type shards on Ethereum look similar.

In suburban shards, medium transaction volume and medium transaction value are common. For most people, it is also quite leisurely to keep their assets here and live a peaceful blockchain middle-class life.

Ethereum 2.0 Pastoral Shard

Finally, let's take a look at another type of shard that will appear: Pastoral. This is a sparsely populated rural area. Suppose you have made a blockchain game application, and users can just play by themselves. Most of the time, they don't need to interact with other assets. Then you can directly put all game operations on a pastoral type shard.

If some economic activities are not suitable and cannot be accounted for in cities or suburbs, go to the Tianyuan shard. There, there are no DeFi services or frequent token transactions. No one will bother you there. The Tianyuan shard allows high-frequency but low-value transactions to be carried out conveniently.

Blockchain City Construction Plan

If the vision of DeFi in Ethereum 2.0 is true, then we can know two things.

First, on Ethereum 2.0, there will also be congested shards! The most congested shards will come from the highest value part provided by DeFi, and composability allows these currency Legos to benefit from it. Nonetheless, DeFi will also expand to enable cross-shard functionality so that it can provide some ancillary services in suburban shards, similar to the local branches created by national banks.

But the emergence of sharding does not mean that user activity will be evenly distributed across shards. This is not only impossible, but also economically stupid.

Let high-value companies move to cities, let idle families move to the suburbs, and let the countryside stay away from the hustle and bustle of the real estate market, work when the sun rises and rest when the sun sets.

Is load balancing necessary?

This analogy should also make it clear to the reader why it is not a smart thing to programmatically load balance smart contracts across shards! We should assume that the deployers of protocols and contracts are adults and can make reasonable choices about where to live. Forcibly moving a business from the city center to the countryside in order to "balance the city's load" will have disastrous consequences.

Similar to Cosmos and Polkadot, sharding can be seen as providing a similar interoperability vision. There are many different blockchains, each with their own economic activities, and there is a highway connecting these blockchains. In addition to Ethereum 2.0, these shards will all use the same language, share the same tools, and benefit from Ethereum's huge community.

Ethereum: Wall Street of the Crypto World

Ethereum 2.0 has a huge and challenging vision, and its realization will also encounter various risks. But despite these current situations, I believe that Ethereum's position as the TOP1 DeFi city will not be challenged.

Ethereum is already the Wall Street of the crypto world. Although there are many competitors who want to challenge its dominance, at least for now, no one can beat it.

So do we have to pin our hopes for scalability on layer 2 networks for now? These layer 2 networks, in my opinion, are shopping malls built on top of Ethereum. This is an improvement, but it may not be enough.

Developers who run out of patience will build temporary suburbs and pastoral areas around Ethereum 1.0, using other blockchains as bridges to Ethereum. In other words, if Ethereum 2.0 takes too long, outsource your small city to other blockchains, which is what Serum is doing. Otherwise, wait for the Cosmos/Polkadot interoperability story to come to fruition.

Will DeFi wait for Ethereum 2.0 to appear? Or will the DeFi craze continue to spread? We don't know. But we can understand that for the current Ethereum, the vision of DeFi is huge, and the current Ethereum cannot bear it.

Where will the future go? Perhaps only time can tell us the answer. Original text: https://bankless.substack.com/p/defi-in-eth2-cities-suburbs-farms

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