Personal data is a highly debated topic in the modern world. Web 2.0 applications are built on internet infrastructure that utilizes users’ information. Applications and websites improve their products by capturing users’ information and opinions. Social media platforms and search engines sell user data to companies seeking to maximize the value of users for their businesses through highly targeted ads and predictive analytics. All major centralized players such as Facebook, Google, Amazon, and Apple rely on their users’ categorical data to make prediction products.

As a consequence, the internet has become a battleground for user attention propelling tech giants to US$ trillions in valuation as the digital space becomes increasingly focused on luring users into unproductive online behaviour rather than value creation. Contextualized data can help companies understand how consumers engage with and respond to their marketing campaigns and adjust accordingly. This highly predictive use case gives businesses an idea of what consumers want based on what they have already done.

Despite our data being monetized everywhere around us by almost every application we interact with on a day-to-day basis, we have zero ownership of it and do not benefit from its sale. Instead, the data brokers have monopolized the data market and benefit greatly from it.

Data brokers (aka information brokers, data providers, and data suppliers) are companies that collect or buy data from other companies, crawl the internet for useful information about users – legally or otherwise – and aggregate that information with data from other sources. Data brokerage involves sourcing and aggregating data and reselling the most valuable categories of users to third parties.

Web3 creates a new premise that enables true ownership of assets and, perhaps even more exciting, true ownership of data, which can also be turned into a lucrative asset. These innovations can help transform this one-sided data economy into a vibrant marketplace, where data producers can decide what information should be accessed, used, traded, and, more importantly, the benefits they receive in return. A web where freedom of data enables permissionless innovation by default will drive a new form of software development. In this Web, developers can quickly construct applications from open state components and power their efforts with new business models enabled from within the software itself, rather than rely on a parasitic relationship with their users.

We see the following problems in the current data economy:

Data Leaks

Over the last few years, data leaks, hacks, and social engineering attacks have increased tremendously. According to an IBM report, the average data breach cost in 2022 is $4.35 mn, a 2.6% rise from 2021. The healthcare industry has the highest data breach costs. In 2022, the healthcare industry is paying an average of US$ 10.10 million for a data breach, 9.4% more than the figure in 2021.

This rapid increase can be attributed to the growth of the data economy. Most Web 2.0 business models focus on monetizing their users via ad revenue, which requires collecting and storing user data, making it a very attractive target for hackers. This harms the end users of these platforms significantly once this data is exposed.

Itheum Solution

Due to a fundamental misalignment between contributors and aggregators, it is extraordinarily difficult to collect a large number of unique data sets. Data contributors are rarely compensated for their contributions (beyond their own care) because they do not have a right to the value created by aggregate data nor a right to regulate how their data is used, which has been repeatedly violated.

Itheum is a decentralized data brokerage platform that transforms personal data into a highly tradable asset class. It creates a bridge between Data creators and Data Consumers and provides them with the tools required to own and trade data on the blockchain.

It aims to be an end-to-end platform required for personal data in the web3 ecosystem to enable real-world and complex use cases using a cross-chain web3 protocol to enable data ownership, data sovereignty, and fair compensation.

The Itheum Platform has three core products:

Data Collection and Analytics Toolkit

Users can be onboarded onto the data collection platform to seamlessly build apps and programs that can collect structured and rich personal data from users and provide visual trends and patterns on the collected data. This product enables the creation of highly structured, outcome-oriented, and normalized personal datasets in the background while users are interacting with a particular application. This provides a seamless experience for the end user and provides structured and highly contextual data for the prospective buyer.

Decentralized Data Exchange (DEX)

This product enables users to own and trade their personal data collected by organizations that build apps on Itheum’s data collection and analytics platform. It unlocks the personal data from these organization silos, and lets users earn a passive income by trading their personal data on the open market with other organizations that can derive value from the datasets.

Using the Itheum DEX, users can sell their data via a peer-to-peer, direct sale method or using their Data Coalition technology and align to a decentralized entity that will trade the data and compensate users after the trade of their data. The Data DEX essentially stores sensitive personal data into secure data vaults and allows users to wrap data as an NFT and earn royalties on the data.

The Data DEX will act as the core protocol layer enabling decentralized data ownership and trade. This protocol can be abstracted with more products built on top of it.

Data Metaverse

Current Web 3.0 data platforms have low adoption and hype. The concepts behind data trading and blockchain-backed data technology are hard for people to grasp. By integrating the metaverse layer, serious and complicated ideas about who owns data are being simplified into easy-to-use consumer products. The metaverse layer intends to normalize the concepts of data trade and ownership.

The key offerings of the Data Metaverse ecosystem are:

N.F.Me: N.F.Me is a digital avatar identity built on NFT technology and backed by personal data. Users can mint an N.F.Me on the Itheum platform. As users provide more data via the Itheum Data DEX, or via Data Coalition DAOs, more accessories are minted and linked to the user N.F.Me.

Data NFTs: N.F.Me’s can choose to take subsets of their data and mint them into separate Data NFTs. These Data NFTs are linked to the base N.F.Me but can be independently traded in the Data NFT marketplace, or secondary marketplaces such as OpenSea.

Data Coalition DAOs: Personal data generates a lot more value when traded in bulk. Data Coalition DAOs are enterprises or groups that trade bulk datasets on behalf of a large group of individual users. Users are better incentivized to align themselves with a DAO to have their data grouped into a large dataset. These DAOs will in turn make sure that the user’s best interests are taken care of during any trade of data that happens.

Greenroom Protocol: The Greenroom Protocol is Itheum’s initiative for open-standard metaverse interoperability. It defines a set of rules and standards to define NFT metadata that can then be implemented across Metaverse platforms.

Itheum Platform

Itheum is not only ahead of its competitors in terms of its technology, but the product also has been designed by taking a holistic approach focusing on the way they’re used rather than just how they look. The team has done thorough product research by understanding similar products and talking to their users and a few target users for their use cases while prototyping the UX. The website has been developed with tech optimizations, giving them a Google’s Lighthouse performance score greater than 90 and an SEO score of 89. These optimized metrics give users an optimized experience and help Itheum with its marketing.

The aggregation of the above components creates a complete solution that is not intimidating for the end user through gamified via the use of avatars and NFTs. Their integration with Zoidpay shows us the clean and simplified UX for the end user.

— X Day. Paris. 3-5 Nov. Powered by Elrond ⚡️ (@ElrondNetwork) July 7, 2022

Designing a product that appeals to different use cases and users with varied backgrounds and goals is a complicated task. But, the Itheum team has done a great job in designing the Data Marketplace, providing easy navigation and serving a variety of use cases via their platform.

Elrond Advantage

Itheum will be leveraging the Web3 infrastructure of the Elrond network. Elrond focuses on building a robust ecosystem of unique applications to spur innovations and bring a wider user base compared to the same set of DeFi and NFT applications being replicated and launched on other layer-1 platforms. To learn more about Elrond’s state-of-the-art technology and vision for global adoption – read here

Use Cases

Data is ubiquitous, which provides unlimited avenues for Itheum and their use cases.

Itheum’s comprehensive solution allows it to cover a wide range of use cases and applications.

Healthcare

Healthcare data is precious. According to a Trustwave report, a healthcare data record may be valued at up to $250 per record on the black market, compared to $5.40 for the next highest value record (a payment card). Itheum has done multiple campaigns with the OkPulse and the Red heart challenge. These platforms leverage the Data Collection Toolkit to collect valuable patient-generated health and wellness data, emphasising on providing ownership to the end user. Itheum’s base layer allows the user to trade their data securely, and monetise it via platforms that they trust.

They also partnered with SanoPass metaverse, which provides access to traditional healthcare and wellness providers via remote and telemedicine services to empower users and patients to own and operate their health data and discover the infinite opportunities for doing so. Sanopass users will be generating behavioural data, including visits to their gyms, doctors, hospitals, and other health information like age, health status, illnesses, and so on. Every day, Sanopass users will be generating this valuable data and have the opportunity to trade it with data consumers, like insurance companies, medical centres, and apps that are setting up shop in the Metaverse.

Gaming

Itheum has partnered with various guilds and games in the web3 ecosystem with a feature they recently launched; Gamer passports. Gamer Passports are built on top of Itheum’s NFMe ID data-backed avatar technology and provide distinctive new value to gamers, guilds, and the game platform itself, as they seek to unlock valuable gamer insights. Gamers mint and claim an NFMe ID Avatar (a soulbound NFT that’s linked to their identity) which will exist in their cryptocurrency wallets as their unique Gamer Passport. Gamers can now claim and own their on-chain and off-chain player data as they move between guilds and the broader Web3 gaming ecosystem.

eCommerce

Itheum has also partnered with Zoidpay, to improve the user experience for end retail users, and provide them with the right incentives to share their data. Targeted ads, shopping histories, and interests are being exploited by data brokers to re-target users with similar products. The collaboration will enable users to shop freely in the metaverse using their personal data preferences and provide them with discounts or free services on sharing data.

Conclusion

Data is a highly valuable commodity in the modern world, and user data is being misused heavily by technology companies and data brokers. The regulation heavily focuses on securing that data but does not provide a way for users to compensate for the data they generate. Web3 and the business models associated with this innovative technology enable a flourishing ecosystem for proper monetisation and value accrual of user-generated data to the right people. Itheum provides a complete end-to-end solution for the data economies of the world and consists of an extensive set of tools to bridge Web 2.0 data into a Web 3.0 economy. Itheum’s data solutions have won multiple hackathons, including 1st place in the Filecoin global grants vote, Hedera Hashgraph grant, and PlatON Hackathon. Itheum has also secured finalist positions in Harmony, Polygon, and DAOHack hackathons. With the claims portal going live, we will see the first functionality unlocked for the monetization of user data.

Resources

Website Medium Telegram Twitter Github

Author – Vokkant Thakkar

In recent times, the usage of layer-2 solutions has been on the rise. Since the start of April 2021, the number of transactions happening on the Polygon Network (a layer-2 solution) has increased from 200k per day to 6mn on a daily average (shown in the chart below), peaking at 9mn in the middle of June. This also signifies a jump from ~5% to ~85% network utilization in nearly 5 months. At the same time, the total number of unique addresses on the Polygon Proof-of-Stake (PoS) chain has grown from 200k to 86mn (a 430x increase!), with the daily active addresses going up from 9k to 360k. This is just one example of a layer-2 solution that has taken off. With the launch of other off-chain scaling solutions, such as Optimism and Arbitrum, on the Ethereum mainnet, the number of users on layer-2 solutions is only going to increase.

Why have layer-2 solutions started burgeoning? The reasons are twofold:

1. Transaction throughput and speed — the throughput on Ethereum, which has been the principal settlement layer for most of DeFi and NFTs’ transactions, has been roughly constant, ranging between 1.3mn and 1.7mn transactions per day. As the number of transaction requests increases at layer-1, user experience decreases due to fixed and slow transaction speeds.

2. Transaction costs — the limited transaction speeds have a cascading effect on costs, resulting in higher transaction fees paid by the user due to the auction-based transaction fees model adopted by layer-1 solutions.

Layer-2 technologies help augment the practicality of the foundational blockchain layer (layer-1). They help tackle the above two issues without much loss of decentralization and security. Thus, the main objective of layer-2 solutions is to improve transaction speed and transaction throughput on the base layer and consequently decrease transaction costs. Furthermore, layer-2 solutions also enable use-cases that require higher transaction speeds, such as blockchain-based gaming, high-frequency trading, etc.

Working of Layer-2 Solutions

Generally speaking, transactions are submitted to layer-2 nodes instead of being submitted directly to layer-1. The layer-2 instance then batches them into groups before anchoring them to layer-1, after which they are secured by layer-1 and cannot be altered. The details of how this is done vary significantly between different layer-2 technologies and implementations. The major implementations include the following:

1. Channels

2. Plasma

3. Sidechains

4. Rollups

Channels

Channels allow participants to transact X number of times off-chain (layer-2) while only submitting two transactions to the network on-chain (layer-1). The first transaction opens the connection for the transaction pipeline, whereas the second transaction closes it, therefore, essentially bundling up all the transactions performed during any session as only two transactions. The advantages of such an approach are 1) load reduction on the layer-1 blockchain, and 2) transaction cost reduction for the user.

Working of Channels Explained

Participants must lock a portion of Ethereum’s state, like an ETH deposit, into a multisig contract. A multisig contract is a type of contract that requires the signatures (and thus, agreement) of multiple private keys to execute.

Locking the state in this way is the first transaction and opens up the channel. The participants can then transact quickly and freely off-chain. Consensus inside the channel is achieved when all the channel participants unanimously agree (majority-based consensus is also possible) to the final state of the channel. When the interaction is finished, a final on-chain transaction is submitted, unlocking the state. The main chain checks the validity of the state update by verifying signatures and final balances, thus making it impossible to try to exit from an invalid state.

Further explanation: since all exchanged transactions are equally valid as far as the blockchain is concerned, state channels need a mechanism to ensure that the latest off-chain state is the one that ultimately gets settled on the main chain. Thus, if a party attempts to unilaterally close a channel, other parties in the channel have a period of time — a “dispute window” — in which they have an opportunity to submit a more recent state, thereby proving that fraud was attempted. Once the fraud is proven, the contract handles the resolution process, which typically involves punishing the guilty party by slashing their deposited funds (though one could also simply update to the valid state and proceed accordingly).

Types of Channels

1. Payment Channels — Payment Channels are simplified channels that only deal with payments. They allow off-chain transfers between two participants, as long as the net sum of their transfers does not exceed the deposited tokens.

2. State Channels **— **State Channels are very similar to the concept of payment channels, but instead of only supporting payments, they also support general ‘state updates’. Thus, State Channels form the superset. State channels allow for potentially arbitrary state transitions to happen off-chain, opening up the possibility of performing scalable, low-latency computations off-chain with similar security to on-chain transactions. State channels also help preserve user privacy. Transactions within a channel are only known by the participants in the channel and get instant finality. Users don’t have to wait for each transaction to confirm onto the blockchain because each signed transaction abides by the network rules.

Evaluation

Advantages

• (Almost) instant withdrawal/settling on mainnet

• Extremely high throughput is possible

• Lowest cost per transaction — good for streaming micropayments

• Transitive channels can be created (if A->B and B->C exist, A->C is possible) using Hashed Time-Locked Contracts (HTLCs), a technique that can allow payments to be securely routed across multiple payment channels

Disadvantages

• Time and cost to set up and settle a channel

• Exit Problem — long exit times if a valid exit state is not reached by members

• Need to periodically watch the network (liveness requirement) or delegate this responsibility to someone else (watchtowers) to ensure the security of your funds

• Lockup of funds in open payment channels

• Closed participation and censorship

• Cannot be used to scale general-purpose smart contracts

• Difficult to set up N-to-N channels (due to Exit Problem)

• Only safe to use when the layer-1 isn’t censored by the block producers

• Need for 100% availability of all the participants involved

Projects using State Channels

Connext Network, Raiden Network

Plasma

Plasma is a construction that enables “non-custodial” child chains (nested blockchains), which borrow the security from the main chain (definition of a child chain). Plasma uses a combination of smart contracts and cryptographic verification (fraud proofs) to achieve higher throughput and low transaction costs in a trustless and secure manner, by offloading these transactions from the main Ethereum blockchain. These Plasma chains (or child chains) periodically report back to the main chain and use it to settle any disputes.

The design goals of Plasma include:

1. **World Computation **— data is committed to the root chain (Ethereum) and in the events of Byzantine behavior disputes, frauds are proven and rolled back.

2. Trust Minimization — the primary risk involved in Plasma is around chain halting and blockspace availability, which are mitigated by selecting a good parent chain.

3. Payment and Ledger Scalability — more throughput and faster computation time are achieved due to the nested architecture.

Why Plasma Chains?

Building a two-way peg has been the biggest challenge in designing sidechains (or Plasma chains) with minimal trust assumptions. Creating a peg from parent chain to sidechain is easy to implement: simply lock funds into a contract on the parent chain. The backward peg, which is a sidechain to the parent chain, however, is more difficult to implement as the sidechain is “easier” to attack/manipulate than the parent chain. Various methods have been proposed to resolve this:

1. One-way Peg — This prevents anyone on the sidechain from being malicious and stealing funds on the parent chain. This design is currently being suggested for the beacon chain in Ethereum 2.0, whereby ETH is burned on the parent chain (the PoW Ethereum chain) and simultaneously minted on the sidechain (the PoS beacon chain) as BETH, with no way of doing the reverse.

2. Federated Pegs — This design uses multiple operators to control the reverse peg (centralized, custodial). The operators decide when funds can be unlocked on the parent chain.

3. Plasma — Plasma allows for an almost trustless two-way peg. It accomplishes this through the use of an exit game, which makes use of fraud proofs implicitly or explicitly, relying on variations of challenges that must be issued within a given timeout. The caveat here is the trust assumption that the parent chain has an honest majority of block producers. This is why Plasma isn’t completely trustless or completely non-custodial.

Working of Plasma Explained

1. Plasma chains are initialized by submitting smart contracts to the parent chain. These chains have special rules defined based on the application that they are being used for (can be thought of as dApps on Ethereum).

2. Once smart contracts are deployed, computation takes place in a localized environment.

3. Post a batch of computation processes, periodic commits (Plasma chain block hashes) are submitted to the parent chain.

4. If any of the data/blocks submitted to the parent chain is invalid according to the consensus rules, fraud proofs of state transitions are submitted by the validators to roll back the state of the main chain.

In Plasma, the child chain can’t steal users’ funds or prevent users from claiming their funds back on the main chain, given that no consensus rules have been broken.

Periodic Commits

Periodic Commits work in the following manner:

1. The Plasma chain makes periodic commits to the main chain.

2. Only the block hashes/headers are committed to the main chain (low size). The submission is a commitment to the blockstate as well as ordering on the main chain.

3. The root chain doesn’t perform computation unless any disputes are raised. However, data availability is needed to prove fraud (which is also a problem in non-global computation).

4. A Plasma chain needs to only watch all its parent chains and no other chain, therefore, streamlining the process of blockchain scalability.

Fraud Proofs

The communication between the child chains and the root chain is secured by fraud proofs implemented by the child chain. Fraud proofs are used by Plasma chains to file a complaint to its parent chain.

These proofs use an interactive funds-withdrawal protocol. In order to withdraw a certain amount of funds, an exit time is needed. The exiting party must confirm the outputs via the Unspent Transaction Output (UTXO) model requesting a withdrawal. Network participants can then submit a bonded proof that has to be confirmed and tested if any funds have been spent. If the event appears to be wrong, it is treated as fraudulent, and the confirmation is canceled. With time, another bonded round allows the withdrawal to happen, bonding to state before a committed timestamp. In case of attack, participants can quickly exit and save their costs, ensuring security within the system.

Types of Plasma Chains

1. **Minimum Viable Plasma (MVP) **— MVP is a design for an extremely simple UTXO-based Plasma chain. MVP enables high-throughput payment transactions but does not support more complicated constructions like scripts or smart contracts. In MVP, users need to sign a signature before making a transaction, wait to see the transaction included in a valid block, and then sign another signature. These second signatures must also be included within a plasma block, reducing block space available for more transactions.

2. More Viable Plasma — It is an extension of MVP that removes the need for confirmation signatures by changing the procedure for fund withdrawals. The ordering of each withdrawal becomes based on the position of the youngest input to the transaction that created an output, rather than in the order based on the position of the output being withdrawn (which is the case with MVP). OMG Network is using More VP (1K TPS, 3x cheaper, 99% energy efficient, ETH secure + watchers).

3. Plasma Cash — Plasma Cash is a Plasma design primarily built for storing and transferring non-fungible tokens. It is highly scalable because users only ever need to keep track of their own tokens, but at the same time coin proofs are massive. Each block has a ‘slot’ for each coin (unique deposit). When a coin is spent, a transaction proof is recorded in that coin’s respective slot in the block. Coin defragmentation research to support FTs is going on currently. Research is being done in the domain of ‘coin defragmentation’ to support fungible tokens. **Loom Network (2017) **is utilizing principles of Plasma Cash for its scaling solution (CryptoZombies, Axie Infinity).

4. **Plasma Debit **— It is similar to Plasma Cash, except every token is a payment channel between the user and the chain operator. The channels can be transferred just like a Plasma Cash token.

5. **Plasma Prime **— Plasma Prime is a new design that makes use of RSA accumulators to solve the problem of large history proofs in Plasma Cash.

Evaluation

Advantages

• High throughput, low cost per transaction because of elimination of unnecessary data in the main chain (increase in computation power)

• Security of tokens is ensured even in case the Plasma operator proposes invalid state transitions, withholds produced blocks, or stops block production

• Allows (almost) trustless transactions unlike channels

• Compatible with various on-chain scaling solutions such as sharding, varying block sizes, etc.

Disadvantages

• Long waiting period for users who want to withdraw their funds

• The complexity of exit game strategies

• Cannot be used to scale general-purpose smart contracts as it does not support general computation; only basic token transfers, swaps, and a few other transaction types are supported

• Need to periodically watch the network (liveness requirement) or delegate this responsibility to someone else (watchtowers) to ensure the security of your funds

• Relies on one or more operators (centralized) to store data and serve it upon request in case of disputes

• The necessity to provide the full history of the token when it is transferred

Projects using Plasma

Loom Network, OMG Network

Sidechains

Sidechains are “sister chains”, where assets can move between each chain (main and side) but the sidechain has its own consensus mechanism (and thus, a set of validators) which distinguishes how the sidechain achieves decentralization. Sidechains sacrifice some level of decentralization to provide higher throughputs and lower costs at varying levels of security (a well-designed sidechain is even more secure than the main chain!). The image below illustrates sidechains and rollups:

Working of Sidechains Explained

Other than functioning exactly like any blockchain, the sidechains optionally snapshot the block headers to the main chain to prevent forks. The snapshots can provide security against forks even when the validators of the sidechain collude and try to fork out.

If a participant wants to move assets from the main chain to the sidechain, he/she locks the assets on the main chain and provides proof of the lock on the sidechain. To unlock the assets on the main chain, proof of the exit is included in the sidechain block and provided to the main chain.

Evaluation

Advantages

• Established technology, since sidechains are nothing but independent blockchains connected via a two-way bridge

• Support general computation, EVM compatibility

Disadvantages

• Less decentralized, as sidechains have their own validator set

• More prone to fraud, as achieving quorum is easier due to a smaller validator set

• Uses a separate consensus mechanism, which may not be as secure as the main chain’s algorithm

• Invalid state transition problem (assumption taken: 50%+ are honest validators)

• Bridges that connect the parent to the sidechain are often centralized and act as single points of failure

Projects using Sidechains

xDAI, SKALE, Polygon Network (previously Matic)

Rollups

Rollups are a layer-2 solution that perform computation and execution outside the parent chain, bundle together the transactions into batches, and post the data onto the main chain in a compressed and efficient manner. They provide high transaction throughput, low transaction fees, and transparency because of the verifiable batching mechanism used. According to Vitalik Buterin’s article on rollups, “an Ethereum base-layer ERC-20 token transfer costs ~45000 gas, (whereas) an ERC-20 token transfer in a rollup takes up 16 bytes of on-chain space and costs under 300 gas”. This shows that a transfer operation on a rollup takes 150x less fees compared to the fees on the main chain!

Working of Rollups Explained

Rollups publish just enough data on-chain so that any observer can reconstruct the state and detect invalidity. Because of rollups’ inherited security mechanism, users of rollups can transact with security guarantees that their funds will not be lost, double-spent, or misappropriated till the batched data is added on the main chain at some point in the future. This is a defining characteristic of rollups since the smart contracts associated with rollups inherit the security features of the underlying blockchain.

Therefore, to summarize, the key properties of rollups include the following:

• transaction execution occurs outside the parent blockchain

• data or proof of transactions is posted on the parent at the end of the execution cycle

• a roll-up smart contract is deployed on layer-1, which is responsible for enforcing correct transaction execution on layer-2 by using the transaction data on layer-1

Types of Rollups

1. Optimistic Rollups — Optimistic rollups use fraud proofs to verify and ensure that the data submitted to the main chain is not incorrect. These are the same fraud proofs that are being used in Plasma. “Sequencers” are incentivized to publish a batch of state transitions to the main layer-1. This starts a “dispute period” where any party can publish a fraud-proof which shows that the state transitions are invalid. This fraud-proof is stored in an on-chain transaction, and using the proof, the state of the chain can be determined correctly and used to settle disputes. Entities called “verifiers” are incentivized to watch and report fraudulent transactions. Rollups are an effective solution as they scale without adding to the cost, but they introduce new trust assumptions with respect to the “verifier”. However, only one honest verifier is needed for the system to work properly.

2. Zero-Knowledge (ZK) Rollups — In ZK Rollups, “relayers” gather a set of transactions and create a ZK Proof, a validity proof that is stored on-chain. ZK Rollups rely on challenging transactions to tell the smart contract that some data is incorrect, and the block is invalidated as a result. Here, it is impossible for relayers to submit an invalid or incorrect state. The smart contract verifies each state’s transition before it becomes effective. Validation of a block is quicker and cheaper due to the less data that is included.

Optimistic Rollups vs Zero-Knowledge Rollups

Evaluation

Advantages

• Rollups move computation and complete state storage off-chain but keep some data per transaction on-chain

• Optimistic Rollups are EVM compatible

• High throughput and extremely low fees as computation is done off-chain

• More secure as they rely on the main chain’s security

• Research is ongoing to bring smart contract capabilities to ZK Rollups, e.g. Starknet’s ZK language (Cairo)

Disadvantages

• Withdrawal times from layer-2 to layer-1 are high in the case of Optimistic Rollups

• ZK Rollups are not EVM compatible as validity proofs are computation-intensive

• Require additional trust assumptions and economic incentives

• Vulnerable to attacks if the value in a rollup exceeds an operator’s bond

Projects using Rollups

StarkWare, Optimism Labs, Arbitrum, Loopring

Comparison

Conclusion

The world is just starting to adopt distributed ledger technologies, with approximately 1% of the world population interacting with applications built on blockchains and the like. As more and more people recognize and embrace the advantages that Web 3.0 offers, we are going to witness billions of monetary and state transactions on the blockchain every day. To cope up with such a demand, layer-1s would need to deal with the issues related to scalability, such as block size limits, consensus times, and transaction costs. One of the ways this can be achieved is on-chain scaling upgrades such as sharding, but not all chains remain composable post that. The other solution, as mentioned above, is layer-2s and the various customizable flavors that they come in.

Due to the benefits that layer-2 solutions offer with respect to the issues mentioned above, their adoption along with layer-1s is inevitable. As of now, they exist as independent projects aligned with a singular vision of improving the core blockchain that they are being built on. However, we believe in the strong possibility that layer-2s would ultimately merge with layer-1s and exist in a single composable system. The future blockchains would be built with the currently available technology, the on-chain scaling solutions, and the off-chain modular legos, all tightly coupled into fast, secure, cost-effective, and user-friendly worldwide utilities.

Decentralized technology has made great strides in the last decade, slowly gaining wider acceptance in the global consciousness. A big challenge remains in the growth of this sector, the process of staging upgrades. In a centralized company, the decisions are taken by the team internally, and the general public does not have a say in the growth and direction of said company. However, this hurts a decentralized protocol like Ethereum as millions of people are running Ethereum nodes and developing on the network which these changes would significantly impact.

Ethereum Improvement Proposals or EIPs are a great tool to grow and improve the protocol in a decentralized manner. “Ethereum Improvement Proposals (EIPs) are standards specifying potential new features or processes for Ethereum. EIPs contain the technical specifications for the proposed changes and act as the source of truth for the community.”

How does an EIP work?

Any user can submit an EIP by creating a pull request to Ethereum’s EIP Github repository, and highlighting the core changes and the intended effect in a standard predetermined format. Once an EIP is proposed, it goes through a series of iterations and changes proposed by the members of the Ethereum community. It is then reviewed and the core Ethereum developers encode an EIP into the new version of the Ethereum client as part of a future hard fork.

Generally speaking, this process allows for members within the community to contribute to the growth of the protocol, hence allowing for a change in a truly decentralized manner.

However, certain EIPs are disputed after getting approval. One such case is EIP-1559, one of the most controversial EIPs ever introduced. It was heavily contested by the Ethereum miner community.

Current state of Ethereum

Before exploring the improvements planned for the Ethereum network, we must first understand the current state of affairs when it comes to a few important features of the Ethereum network, such as volatility of gas fees, its auction mechanism as well as the transaction fees eclipsing block rewards.

Gas Auction Mechanism

A block has a limited amount of space in it. This cap is decided on the protocol level. Blockchains with bigger blocks can accommodate more transactions, but the cost of running and maintaining the blockchain grows significantly, which requires more sophisticated equipment that in turn hurts the level of decentralization of the network. Due to limited block sizes and a network that supports only 15 transactions every second, the Ethereum network tends to get very congested. To get the valuable real estate of the blocks on the Ethereum network, participants in the network need to incentivize miners to include their transactions in a block.

Each transaction (operation on the Ethereum network) requires a “gas” fee to be paid to ensure that the miners are compensated for the computational effort they put into verifying these transactions. Since the exact amount of gas required differs from time to time based on the amount of transactions taking place and the number of miners available, each transaction is given a “gas limit” stating how much the sender is willing to spend on the transaction being processed.

This mechanism allows miners to reject transactions that have a gas limit below what is necessary to complete the transaction and process those that have been allotted enough.

Ethereum follows a “First price” auction mechanism wherein each sender enters a bid of the amount of gas that they are willing to pay for a transaction, and miners pick transactions that are desirable to be entered into the next block. Since there is not much transparency as to how much other users are paying in the form of gas per transaction, the sender often ends up paying more than what is necessary. A lot of this is considered a side-effect of the unpredictable nature of the gas fees on Ethereum.

Volatility of Gas Fees

The volatility in gas fees creates a bad user experience, and transactions sometimes get stuck for multiple hours and sometimes even days, especially at times when the network is congested. On the 1st of September 2020, Ethereum miners ended up earning over $500,000 USD in just one hour, which was an all-time high as far as gas fees were concerned. While this meant that miners earned handsomely for their efforts, it also meant that users had to pay ridiculously high fees for their transactions, which led to longer wait times, congestion on the network, and an increased number of unconfirmed transactions. During this month in 2020, for the first time, miners earned more from transactions (gas) fees at $172 million in comparison to the $150 million they earned from block rewards.

A blockchain that relies primarily on transaction fees and not block rewards leads to instability in the market and incentivizes the creation of “sister blocks” and opens the network up to other mining attacks. With only transaction fees, the variance of the block reward is very high due to the variable transaction fees in a given block, and it becomes attractive to fork a “wealthy” block to “steal” the rewards therein. This not only raised concerns about the stability, and scalability of the network but also became a potential obstacle to the DeFi boom which was putting more transactions on the network than ever before.

Here’s a look at the average transaction fees on Ethereum over the last year, expressed in USD

(Source: Ycharts; Ethereum Average Transaction Fee)

What is EIP 1559?

EIP-1559 would replace the auction system of the gas price with a new transaction price mechanism based on gas rates. This would introduce a concept of base fee — a dynamic rate of conversion from gas to gwei — into the Ethereum protocol, which would vary according to the activity on the network.

EIP-1559 introduced three new changes to Ethereum in order to combat these problems -

1. The gas limit will be increased to 15M gas from 30M gas. The size of blocks will be adjusted dynamically based on the utilization of the network, and allow block sizes to float from 0M to 30M gas without any disruption or lag. The gas limit pre-EIP-1559 will serve as the target block size. The target block size will serve as the equilibrium point that the network wants to maintain. If block sizes are below the target block size, the network is underutilized, and the base fees are decreased. Similarly, if the network is congested, the block size will be higher than the target block size, and the base fees will be increased.

2. The structure of the transaction fees will be changed and will include two components, a base fee, and a tip (optional). The base fees will be calculated based on the gas cost of the previous block and the target block size, as explained later.

3. The base fees collected every block will be burnt, and the tip fees (optional) will be awarded to the miners, to incentivize the miners for including a particular transaction in a given block.

Impact of EIP 1559

EIP-1559 will make Ethereum’s fee market more efficient and improve the user experience. It will help in having supply pressure, gas price stability, and optimized block sizes. EIP-1559 makes Ethereum & web3.0 more usable and frictionless. Here are a few reasons why:

Simpler gas fee estimation

Most interactions on any web3.0 application are transactions. And every transaction involves paying a gas fee. Thus, the gas fee experience is a major factor for the whole web3.0 experience. And currently, the gas fee experience is frustrating and painful. The crux of the problem is that gas fee estimation is really hard. Users need to constantly predict the gas fees, set it on their wallets, and hope the transaction goes through. Many of them end up failing altogether but still cost valuable ETH. And if the transaction is successful, the user may end up overpaying for gas.

EIP-1559’s pièce de résistance is it’s easier gas fee estimation. Users no longer need to constantly estimate their gas fees. And suffer from pending & failed transactions. Post EIP-1559, the user simply needs to set the maximum they are willing to pay for a transaction. And they can be reliably certain that their transaction will go through. They can also be assured that they won’t overpay for gas. This improved mechanism will make the gas fee experience far less daunting for crypto newbies as well.

Moreover, DApps & wallets can also provide a better transaction experience to their users by being able to easily estimate the gas price to recommend to the user.

Faster Transaction time

From the point of view of the user, everything from clicking the ‘submit transaction’ to getting the confirmation counts as ‘transaction time’. One factor is of course the TPS (transaction per second) of the Ethereum network. But the other contributing factor is the time taken for the transaction to get included in the next block. Currently, if the gas price estimate is low, a ton of transactions stay pending for a long time. This is really frustrating, especially for new crypto users, who have no idea why this is happening. To them, Ethereum transactions take painfully long and are a terrible experience.

While EIP-1559 won’t affect the TPS, it will make it easier and faster to get your transaction included in the next block. As mentioned above, the user can easily estimate the max gas they need to pay to be certain their transactions will go through. The DApp, or relayer networks such as Biconomy, can also perform the gas estimation for the user more reliably and ensure all transactions are included in the next block.

Moreover, post EIP-1559 blocks will be kept half full on average. This is to ensure that during higher congested periods, blocks can effectively double their capacity. Thus, there would be a lower number of pending transactions as they would get included even in times of high traffic. And in theory, even if a transaction is pending, it will eventually go through quickly. Both these points will over time ensure faster successful transactions that will improve the UX.

Eliminate overpaying for gas

While EIP-1559 isn’t designed specifically to reduce gas costs, it will definitely ensure users don’t overpay for gas. Currently, during periods when blocks are full and the network is clogged, users may end up paying very high gas prices to get their transactions in the next block. Moreover, as discussed, gas prices are currently hard to estimate during highly congested times. Thus, a user may overestimate by a huge margin in fear of a failed transaction. And end up paying way more for gas than what was required.

Post EIP-1559, even if you overestimate by an enormous margin, you will only pay the fee required to get included in the block. The difference will be refunded back to you! Thus, if the user sets the max acceptable gas as 500 gwei and their transaction gets included in a block with a base fee of 10 gwei, they will only pay 10 gwei. Currently, if they estimate as 500 gwei and the transaction could have been included at 10 gwei, they would still pay the full 500 gwei. Thus, users will never overpay for gas. They can set a high gas estimate to ensure a quick transaction while being relaxed that they won’t be penalized for over-estimation and still just pay the base fee + miner’s tip.

Lower Issuance

To combat the instability of blockchains with transaction fees greater than issuance, the base fees are burnt. Even though miner revenue is greatly decreased, it is necessary for the long term to combat the issues of forking and creating sister blocks. This is also one of the strongest changes to the tokenomics of Ethereum. The burning mechanism removes ETH from the circulating supply and the value flows back to the Ethereum holders.

Economic Analysis

Let us analyze the changes in the token model of ETH post-EIP-1559 -

Base fee will vary in accordance with the utilization of the block that is being generated. Each block will have the capacity to incorporate 15 million gas. In times of high volume, this can increase up to a maximum of 30 million gas. The base fee formula depends on the utilization of the network and the fee of the previous block.

We can clearly see that even if the network is being utilized at a hundred percent, i.e. all the blocks are at full capacity ( previous-block-size = 2 * target-block-size), the max change in base fees with each block will only be 12.5%. This improves user experience as the transaction fees can be reliably predicted, and a user can provide the right amount of gas for a given transaction. Pre EIP-1559, the gas fees would have rocketed suddenly, and user transactions with insufficient gas fees would have been stuck for a few hours/days.

Despite adding the base fee and tip parameters, the new transactions are still backward compatible and will work with the legacy transaction functions.

Will ETH become deflationary?

The fact of the matter is that no one can predict whether ETH supply will deflate, but we can take estimates. We get a deflationary asset when burning outgrows the minting of the asset. Let’s dive into both these mechanisms:

Minting

We are currently minting 13,600 ETH daily from block rewards to miners. These figures are unlikely to change after EIP-1599.

Burning

As the base fee is burned, the amount of ETH burned is highly dependent on the network congestion or rather block utilization of ETH.

So the questions remain — How much can we truly burn? *Would it be enough to make it deflationary? *The two primary variables to calculate the burn are Network transaction fees and Base to total fee ratio.

While we can estimate the network tx fees based on historical data, the base fee to total fee ratio is anyone’s guess until EIP-1559 goes live and generates substantial data. As of the time of writing this article, Ethereum network participants are spending 3k ETH daily on gas.

If we assume daily transactions to be around 3k/day and the base fee to be 40% of the total transaction fee then 40% of 3k = 1.2k ETH will be burned daily. While this is indeed a high amount, it is nowhere close to the ETH supply that is minted on block rewards. Hence, it is unlikely that ETH will be deflationary as more ETH can be minted than burned. Further, in the event that the network is extremely burdened for a long period of time, and the base fees are extremely high, users are economically incentivized to wait for the network to cool down.

Moreover, as Ethereum scaling solutions have started to gain traction, we anticipate activity to move towards the scaling solutions while the protocols derive security from Ethereum and maintain regular checkpoints. We witnessed a similar decline in network congestion and transaction fee as Polygon started gaining traction as a sidechain.

Can ETH 2.0 change the game?

As we have established the unlikely scenario that ETH will deflate post-EIP-1559 because of PoW (Proof of Work) rewards outpacing the burning of the base fee, the scenario will definitely be different as Ethereum transitions to a PoS (Proof of Stake) consensus with the merge of Beacon chain and Ethereum mainnet that is scheduled in 2022.

Monthly Net Issuance — Projections

PoS rewards, unlike PoW, are lesser and hence, have limited inflationary pressure on ETH. As shown by the beacon chain staking rewards page, ETH 2.0 is estimated to generate ~1.3k ETH daily. If the total transaction fees remain the same as the current system, then we can expect very low inflation and even deflation on ETH!

ETH 2.0 Staking APR Projections

Conclusion

The EIP-1559 Upgrade is likely to go live on 4th August 2021 between 13:00 UTC and 17:00 UTC, with block 12,965,000. The base fee mechanism hints at the protocol’s direction in trying to take some of the power away from the miners. The EIP-1559 update is paving the way for future progress regardless of whether it turns out to be bullish or bearish for the price in the short term. Ethereum continues to be the most talked about blockchain among its peers and with the recent London Upgrade and ETH 2.0 also under the works, it is likely to be the undisputed Layer 1 blockchain in the near future.