Our last article explored Bitcoin, how it works and the Bitcoin halving. Bitcoin was the OG among all cryptocurrencies, but Ethereum, led by Vitalik Buterin, took crypto assets to the next level by integrating smart contract functionality into the blockchain. These smart contracts allowed for many more things that we know today as decentralized finance (DeFi), such as swapping, lending, and staking directly on the blockchain without needing a central exchange. As of today, Ethereum remains the dominant smart contract platform by market capitalization, but Solana is quickly catching up, and it has even surpassed Ethereum when it comes to daily active users and other metrics.

Ethereum - A Historical View 

Ethereum emerged from the mind of Vitalik Buterin in 2013. Buterin, a talented programmer, envisioned a blockchain that could do more than just handle financial transactions. He wanted a platform where developers could easily build decentralized applications (dApps). Smart contract functionality was critical to creating dApps, as this self-executing code could replace the functions executed by centralized exchanges. Alongside Buterin, other key founders included Gavin Wood, Charles Hoskinson, Anthony Di Iorio, and Joseph Lubin. Their collective vision birthed Ethereum, which went live on July 30, 2015.

However, a significant event occurred in 2016. A controversial decision led to a hard fork, resulting in two separate chains: Ethereum (ETH) and Ethereum Classic (ETC). The infamous DAO (Decentralized Autonomous Organization) hack triggered the fork, where millions of dollars were stolen. Disagreement about what to do with the stolen funds split supporters down the middle, with some advocating to roll back the blockchain and return the funds. In contrast, others supported keeping the blockchain decentralized and letting the blockchain exist without any intervention. While ETH rolled back the transaction, returning the stolen funds, ETC remained true to the original blockchain principles.

Ethereum operated on a Proof of Work (PoW) consensus mechanism in the early days, similar to Bitcoin. This involved miners solving complex mathematical puzzles to validate transactions to solve for the next block. However, it consumed immense energy and faced scalability challenges. In September 2022, Ethereum underwent a monumental upgrade known as “the Merge”. It transitioned from PoW to Proof of Stake (PoS). PoS relies on validators who stake their coins to secure the network, significantly reducing energy consumption. This move made Ethereum more sustainable and efficient, cutting its energy usage by a staggering 99%.

Ethereum Improvement Proposals (EIPs) are crucial in shaping Ethereum’s future. These are community-driven proposals for protocol upgrades. Some EIPs enhance security, while others introduce new features. For instance, EIP-1559 improved transaction fees by introducing a base fee and a burn mechanism. As Ethereum continues to evolve, it remains a dynamic ecosystem, fostering innovation, DeFi applications, and the creation of unique non-fungible tokens (NFTs).

Ethereum - Scaling Solutions

Ethereum’s popularity has led to congestion and elevated transaction fees on its Layer 1 (Mainnet). The blockchain trilemma—decentralization, security, and scalability—states that a simple blockchain architecture can achieve only two out of these three properties. Ethereum has chosen to go with decentralization and security, leaving scalability as a major issue. Its Layer 1 processes around 15 transactions per second, which can be limited during peak times.

Ethereum, Bitcoin, and Solana are all Layer 1 blockchains—the foundational layer on which transactions are recorded and settled. Layer 2 refers to solutions that build upon a Layer 1. These solutions aim to increase transaction throughput without compromising decentralization or security. While they operate off-chain or sidechain, they all ultimately settle their transactions back to Ethereum Mainnet. Layer 2 projects, like rollups on Ethereum and the Lightning Network on Bitcoin, inherit its Layer 1 security guarantees.

Different types of Layer 2 solutions aim to solve the scalability issue for Ethereum. Some of the most popular approaches are:

• Ethereum Plasma: a framework for creating child chains that periodically commit to Ethereum Mainnet. 
• Zk-rollups: utilize zero-knowledge proofs to bundle multiple transactions into a single proof, reducing on-chain data. 
• State channels: enable off-chain interactions between participants, settling only the final state on Ethereum. 
• Optimistic rollups: assume validity off-chain and submit proofs to Ethereum Mainnet if disputes arise. 
• Sidechains: operate as independent blockchains that interact with Ethereum Mainnet.

There are many Layer 2 solutions, but one of the prominent ones is MATIC (Polygon). It provides fast and low-cost transactions by aggregating multiple transactions into a single batch. Developers can deploy their dApps on Polygon, benefiting from Ethereum’s security while enjoying scalability.

Conclusion

Cryptocurrency investments can be a great way to diversify your portfolio and potentially earn significant returns. However, understanding the tax implications of your crypto transactions can be complex and overwhelming.

That's where CryptoTaxAudit comes in. We specialize in offering comprehensive support and guidance to navigate the intricacies of crypto taxes. Our team of experts can help you understand the tax implications of your crypto investments and ensure compliance with the latest regulations. We'll assist you every step of the way to ensure that your crypto investments are as rewarding as they are compliant.

No matter what type of crypto investment you're considering, whether it's exploring the vast opportunities in DeFi, staking on Ethereum, or engaging with the latest dApps, CryptoTaxAudit is your trusted partner in managing the tax aspects of your crypto journey.

Contact us today for expert assistance and peace of mind in your crypto investments. Take the first step towards stress-free crypto tax compliance, and let us help you achieve your financial goals.