The Scalability Problem
The scalability problem lies in the fact Ethereum does not scale on the base-layer. This is why even halfway popular decentralized applications (dapps) can cripple the network (e.g. Cryptokitties or past popular ICOs). The scalability problem is a barrier to mainstream adoption. As it stands, Ethereum could not handle even one dapp going mainstream.
The Ethereum blockchain size has also exceeded 1 TB. The problem with this is larger blocks require more powerful machines to verify. The computational power needed exceeds the average user’s hardware and bandwidth. As a result, there are fewer and fewer full nodes that update the network. Fewer nodes mean more centralization. Thus, Ethereum’s growing blocksize is resulting in a more centralized network.
Scaling Solutions and Why They Won’t Work
Three main scaling solutions for the Ethereum Network have been proposed: Proof of Stake (PoS) verification, sharding and Layer2 solutions. Each of these have some serious limitations, which I describe below.
- Proof of Stake (PoS) has no material basis. Unlike Bitcoin’s PoW, PoS verification is not anchored in material value because it does not need an external resource. With PoW, this resource is electricity. The need for electricity ensures it is not economically viable to attack a PoW blockchain. Using energy to back a block also gives its immutability objectivity. Non-energy-based verification ultimately requires a subjective interpretation of immutability. In contrast, attaching energy to a block gives it a material existence in the physical world.
- PoS is centralizing. Increasing blocksize means power is concentrated with those who can afford to have full nodes, which is to say, those with the most money. Currently, the entrance barrier to staking a node on the Ethereum Network is 32 ETH. This is different from PoW where miners compete through the use of energy.
- Sharding is a technique where a blockchain is split in multiple parts (“shards”) with different validating responsibilities. The idea is to lessen the workload on any individual node so there can be more of them. Yet, this solution only prolongs the problem. Sharding takes a single blockchain and turns it into multiple blockchains but does not eliminate growing blocksizes and the increasing the cost of staking. In short, sharding does not fix the underlying problem.
- Layer2 solutions are the only viable scaling option in my view. New projects such as Raiden and the Loom Network are offering such solutions. Loom is especially promising as it enables sidechains on top of the Ethereum base-layer. However, Layer2 solution have security issues. Moreover, if Ethereum adopts PoS it will have an insecure base-layer, and it not possible to build a secure second-layer on top of an insecure base.
Smart Contracts
Smart contracts lack the potential for mass adoption. Here is why.
They are hard to write (see the Parity and the DAO hacks for example) and they are not legally binding (i.e. not real contracts). Securing a smart contract is like proving a computer program doesn’t have bugs. It is very difficult as every computer program in existence has bugs. Moreover, to write traditional contracts takes years of study and passing a bar exam. To have real-world utility, smart contracts need at least that level of competence. Yet, people who write them typically don’t understand the law and how secure a contract must be.
There is also the so-called oracle problem. Smart contracts rely on the accuracy of outside data. But where does this data come from? What guarantees these oracles or not wrong or even corrupt?
Other Issues with Ethereum
There are other issues with Ethereum. One is its issuance policy. The issuance of ETH is not capped. This means there is a constant flow of newly minted Ether, which makes Ethereum an inflationary asset. A second issue is the limited use cases for Ethereum. The number one of which is tokenization, used almost exclusively by ICOs. As the ICO trend declines, the price of ETH will decline. With this, Ethereum’s second use case (a capital raising platform) also dies. Tokenized securities and cryptocollectibles (ERC721) are potential future markets, but they will get nowhere as big as some expect (a topic for another article). Finally, BTC also increasingly cuts into these two use cases with Rootstock (smart contracts) and Drivechain (side chains)
Final Thoughts
Blockchains have advantages in very specific areas, namely censorship-resistance and immutability. Implementing a blockchain makes sense in contexts where immutability and the prevention of centralized control are important. The best use case of this is money. I can’t imagine a future where everyone holds an Ethereum wallet with 345 different tokens for 345 specific services. I also doubt Ethereum’s capability to handle this kind of data load. Ethereum is not leaderless (Vitalik Buterin and dev-team), not entirely immutable (e.g. DAO-hack and subsequent fork), not a good store of value because of an uncapped supply, and does not scale on the base-layer. This is why I am bearish on Ethereum.
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