Will The Ethereum Upgrade Affect DeFi Projects?

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The Ethereum network currently goes through a lengthy upgrade period, ultimately culminating in Ethereum 2.0. This upgrade affects many different aspects of the Ethereum ecosystem. It will also make an impact on DeFi projects and services, either for better or worse.

Adjusting the Gas Fees For DeFi

Whenever a new concept gains traction on the Ethereum blockchain, there are always transaction-related concerns. Similar to Bitcoin, Ethereum’s blockchain can only accommodate so many transactions per block. This number is relatively limited, even though Ethereum’s network processes many more blocks per hour. 

Source: Etherscan

To be more specific, Ethereum generates a new block nearly every 20 seconds. For Bitcoin, that process takes 10 minutes. With 30 times more blocks generated on the network, transaction congestion on Ethereum should be less of an issue. That is far from the case, as DeFi projects experienced first-hand earlier this year. 

Rising gas fees – the unit to measure transaction costs on Ethereum – have been a topic of debate and dissatisfaction for many years now.  As the chart below confirms, the fees have spiked to an average of $15 earlier this year. Over the past 365 days, users pay $2.16 per transaction on average. That is an acceptable amount when transferring hundreds of thousands of dollars. Unfortunately, that fee also applies to much smaller transactions. 

Source: BitInfoCharts

Ethereum 2.0 Is designed to address this situation. With its chain sharding approach, it is possible to process more transactions in parallel at a lower cost. It will take time until sharding goes live and is running at its full potential. Depending on how the development goes, this may not even occur in 2021. However, when it happens, users of DeFi projects will benefit from lower gas fees for both deposits and withdrawals. 

Ethereum Staking and DeFi

Whereas the chain sharding concept will positively impact DeFi projects, staking may do the exact opposite. Through the ability to stake Ether, users have a more “reliable” way to increase their portfolios. Staking Ethereum does not require investing in riskier projects or dabbling in new tokens that tend to fluctuate in value every day. 

Instead, users stake their ETH balance to earn more ETH. Staking is possible through one’s computer or by using various staking pools. Over 1% of the total ETH supply is currently locked ins taking through the Phase 0 deposit contract. Users need to contribute 32 ETH or a multitude of this amount to begin staking. As more enthusiasts engage in staking, there will be fewer ETH to contribute to DeFi projects. 

In a way, one can draw a parallel between DeFi lending and staking ETH. Both options require committing [part of] one’s ETH portfolio to earn a return in Ether. Only time will tell if these two concepts will coexist or if one of them will dominate the market. For now, the impact of staking on decentralized finance seems minimal, but that situation may change over time. 

Tokenizing Ethereum 2.0 Deposits

It has already become apparent that staking 32 ETH or more will not allow users to spend that money for a while. The funds remain inaccessible until phase 1.5 of Ethereum 2.0 goes live. That can take months, or even more than a year. 

In the DeFi space, however, there are some crafty developers. One option is to tokenize one’s funds used for ETH2 staking and use this new token to explore different decentralized finance projects. While this is a cumbersome approach, it highlights different ways to approach this current upgrade process. There is no immediate need to choose either staking or DeFi, as users can simultaneously explore both options. 

Building More Complex DeFi Contracts

To the average onlooker, an Ethereum smart contract may seem like wizardry. It takes some time to begin understanding the intricate features and aspects. Even so, the current DeFi smart contracts are relatively limited in what they can achieve. There isn’t enough network capacity to support a multi-layer complex code right now. 

Thanks to chain sharding, many different processes on the Ethereum blockchain will be executed in parallel. That allows, in theory, for building incredibly complex decentralized finance products and services. What kind of constructions the community will get to experience is difficult to predict. Overall, the implementation of Ethereum 2.0 should prove beneficial to DeFi across the board. It is up to developers and coders to maximize the technology’s potential. 

Potential Impact on DAI

One last factor to consider is what Ethereum 2.0 will mean for DAI. As the Ethereum-based stablecoin of choice, DAI plays a crucial role in the DeFi segment. However, the currency is hampered by Ethereum’s current constraints, preventing it from being embraced on a much larger scale. 

Thanks to the changes Ethereum 2.0 will bring, it becomes cheaper to use DAI than before. Moreover, it may yield to more merchants accepting this stablecoin as a payment method. Other options to explore include DAI being more prevalent in the DeFi ecosystem as a whole.  It remains unclear if Ethereum 2.0 will impact this Ethereum-based currency, yet it is a potential outcome to keep in mind. 

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