Ethereum (ETH): Blocks lack space for DeFi applications

  • According to the data from Covalent, the use cases for Ethereum, especially DeFi, are steadily gaining in importance and could overtake the ETH value transactions in the long run as the largest use case.
  • Due to the lack of scalability of Ethereum 1.0, the various transaction types are getting more and more cannibalized, driving up gas fees.

The decentralized finance (DeFi) on the Ethereum blockchain has the reputation to become the potential “killer app” for Ethereum and to make the leap into the mainstream. Thus, the Ethereum incubator ConsenSys stated in December 2019 that DeFi applications could reach a billion dollars in value. However, there is still a long way to go, especially after the crash of Ethereum and the resulting problems for DeFi applications such as MakerDAO.

However, the adaptation curve is still pointing steeply upwards. As Camila Russo of “The Defiant” noted in an analysis of Ethereum transactions, DeFi transactions take up an increasing share of the Ethereum block size. However, this reveals a serious problem, the scalability of Ethereum 1.0.

Use cases of Ethereum increase

In her analysis, Russo notes that there are three fundamentally different types of transactions in the Ethereum network. These can be differentiated by gas fees and can be divided into value transfer of Ether (ETH), ERC-20 token transfers and “complex” transactions for smart contracts. Since each transaction type differs in terms of gas fees, the share of network activities can be estimated.

For analysis, Russo used Covalent’s data and summed up and aggregated the gas fees from the Genesis block up to March 25, 2020 for each transaction type on a monthly basis, totaling approximately 665 million transactions. As the following graph shows, the (green) “complex” transactions are taking up more and more space in the blocks of the Ethereum blockchain.

eth gas costs transactions

Source: https://thedefiant.substack.com/p/if-anyone-were-to-question-the-utility-041

According to Russo, the typical “complex” transactions are those produced by DeFi applications, DAOs, games and other applications for non-fungible tokens (NFTs). Russo predicts that the trend will continue and the use of ETH as money will decline in terms of percentage, while complex transactions will dominate the Ethereum blockchain in the long run. Russo expects the trend to flip, with complex transactions overtaking ETH transfers.

As the chart shows, complex transfers have risen from around 5% of network activities at the beginning of 2017 to between 20% and 30% in recent months. The graph also reflects the ICO boom of 2017. Since the burst of the ICO bubble, the use of ERC20 tokens has fallen steadily, with one exception in mid-2018, to currently well below 5%.

Ethereum DeFi transactions ‘cannibalise’ other transactions

As encouraging as the observations are, however, there is currently one major drawback: scalability. As Russo analyzed, there is an upper limit on the amount of gas that all three types of transactions can consume within the Ethereum blockchain.

There seems to be a natural ceiling to the total gas consumed across all types of transactions which points to the intense demand for block space on Ethereum and a lack of scalability. In an ideal scalable world, all types of transactions have room to grow. But on Ethereum today, for one kind of transaction to grow, it has to cannibalize the others.

Ultimately, the growth of the DeFi sector and the increasing demand for block size risks making “normal” ETH transactions, as well as all transactions on Ethereum 1.0 in general, very expensive. It is therefore crucial that the scalability which will be achieved with Ethereum 2.0 increases as quickly as possible. A crucial technology in phase 1 of ETH 2.0 could be the zk-rollups. A date for the launch of phase 0 has not yet been confirmed, however, the five-year anniversary of Ethereum, on 30 July 2020, was set as potential date.

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About Author

Jake Simmons has been a crypto enthusiast since 2016, and since hearing about Bitcoin and blockchain technology, he's been involved with the subject every day. Beyond cryptocurrencies, Jake studied computer science and worked for 2 years for a startup in the blockchain sector. At CNF he is responsible for technical issues. His goal is to make the world aware of cryptocurrencies in a simple and understandable way.

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