The Blog

The Node Ahead 64: Ethereum’s Dencun upgrade and the U.S. District Court takes on the SEC

by Brett Munster

Welcome back to The Node Ahead, a cryptocurrency and digital asset resource for financial advisors. Every other week, we discuss the latest crypto news and the potential impacts it may have on you and your clients.

In this edition, we’ll be covering:

  • Ethereum’s Dencun upgrade, proto-danksharding, and blobs (yep, all of that is real)
  • The SEC loses to Debt Box

Dencun goes live on Ethereum

In 2022, Ethereum changed its method for validating transactions from Proof-of-Work to Proof-of-Stake in what became known as “The Merge.” In 2023, the network underwent its “Shapella” upgrade, which enabled users to withdraw their staked funds for the first time. Just two weeks ago, on March 13th, Ethereum successfully completed yet another upgrade to the network known as “Dencun.” We previewed the Dencun upgrade nearly a year ago, but now that it’s live, we thought it would be worth revisiting.

There were several upgrades made to the network, but the main purpose of Dencun was to introduce Proto-Danksharding. Proto-Danksharding is a method of improving the speed and cost of using Layer 2 networks on Ethereum by changing how data is stored on Ethereum’s base chain. If you have no idea what that means, not to worry—that’s the point of this newsletter.

There is a limited number of transactions per block the Ethereum blockchain can handle. During periods of increased usage, there are more transactions to be processed than can fit into a single block. Thus, blocks become full, and any transaction that didn’t make it into the current block has to wait until the next block. Some users or applications may be willing to pay higher transaction costs so their transactions are prioritized ahead of others, which puts upward pressure on fees for using the network. Hence, when demand spikes, transaction times slow down, and fees rise on Ethereum’s blockchain.

In order to alleviate this problem, Layer 2 networks have been built on top of the Ethereum base chain. The basic idea behind Layer 2 networks is that they process a large number of transactions, batch them together, and then settle on the main Ethereum chain as one transaction. This is what is known as “Rollups.” By bundling transactions together, Layer 2 networks are able to amortize the cost of a single Ethereum transaction fee across hundreds or thousands of transactions and drive down costs for end users. Layer 2 networks allow the Ethereum ecosystem to process orders of magnitude more transactions at cheaper costs by removing the computational burden of executing transactions and freeing up the underlying Ethereum base chain to handle the security and data storage functionalities.

The development of Layer 2 networks has made a huge improvement in transaction throughput and reduced fees in the Ethereum ecosystem. Prior to Dencun, fees on Ethereum’s base chain often exceeded $30 per transaction during periods of high demand. In contrast, Layer 2 roll-ups averaged around $0.30 to $2.50 per transaction, depending on network demand. It’s no surprise that over the last couple of years, we have seen usage of Layer 2 networks explode. The two leading Layer 2 networks, Arbitrum and Optimism, are seeing up to 150,000 and 100,000 daily active users, respectively.

However, given Layer 2 networks were not part of the original architecture of Ethereum when it launched back in 2015, the base layer is not optimized to accommodate Layer 2 networks. Layer 2 networks still have to submit a significant amount of data to build consensus on the base chain. That data is generally cumbersome because it lives on-chain forever and places a heavy burden on network validators to download the data. It is estimated that 95% of the transaction fees on Layer 2s are due to costs associated with posting data to the base layer.

The idea behind Proto-Danksharding is to better optimize Ethereum’s base layer to reduce the data burden on Layer 2 networks. Instead of keeping all data directly on the Ethereum base chain, which is expensive and computationally heavy, Proto-Danksharding introduces a new, more efficient way of storing data called “Blobs.” Blobs will store data temporarily for short-term transaction verification and delete the data after a period of time to prevent overloading the network. In other words, Blobs simply enable a more efficient use of blockspace compared to existing methods which will reduce fees when transacting on Layer 2 networks.

Proto-Danksharding doesn’t reduce transaction costs or increase speed on the base layer, rather, it better optimizes the base layer for Layer 2 networks. The fee decrease promised to Layer 2 users will not have any impact on those transacting directly on the Ethereum base chain. However, it should decrease the cost of running a node on the Ethereum network which should lead to a more robust and decentralized network.

Proto-Danksharding is already having a significant impact on fees. Following the upgrade, several users of Starknet were posting images of transaction fees as low as $0.01. Data from Dune Analytics shows median fees on Optimism have fallen to less than a cent and on Coinbase’s Layer 2 network Base, gas fees fell to as low as $0.0012. Other L2 chains also saw fees fall 90% or more.

That reduction in fees is great for end users and also makes Ethereum more attractive for developers. This has the potential to result in a positive feedback loop in which more users attract more developers who make applications that attract more users. Sure enough, following the Dencun upgrade, Layer 2 network Base saw a big surge in transactions and new users. Because of this feedback loop, most applications will likely continue migrating to Layer 2 networks rather than operating directly on the base chain. Instead of end users transacting on Ethereum, it is likely that the Ethereum base chain will transition to serving other blockchains as those applications move to operating on Layer 2 networks.

The Dencun upgrade included a number of other improvements to the Ethereum network, such as improved communication between Ethereum’s consensus and execution layers, an implementation focused on a “transient storage” feature required for Uniswap’s upcoming v4 launch, and introduced a fixed limit for new validators (to manage the growth of the validator set and maintain efficient node communication). But by far the most important part of the Dencun upgrade was the introduction of Proto-Danksharding, which improved the speed and costs of L2 networks and set the stage for Ethereum to make further upgrades in the future.

Ethereum’s end goal is to introduce sharding capability to the network. Sharding splits the Ethereum blockchain network into multiple parallel blockchains, each one responsible for processing transactions of a given type. This should allow Ethereum to scale to more than 100,000 transactions per second. Simply put, sharding is akin to adding additional lanes to a congested highway.

Proto-Danksharding is an incremental step that introduces some of the concepts of sharding without fully implementing it. The fully realized version of sharding is still years away and requires several steps to get there. The Dencun upgrade is the first step toward enabling Ethereum’s rollup-centric roadmap by creating the conditions to make future upgrades to Ethereum’s network much easier.

SEC loses to Debt Box

Under Gary Gensler, the SEC has racked up court losses faster than their NBA counterpart, the Washington Wizards. However, its latest legal misstep might be its most damning, as a federal judge chose to impose sanctions on SEC lawyers for “gross abuse of power” and lying in federal court.

Before we get into the judge’s recent ruling against the agency, we need to start at the beginning. It all starts with a small, Utah-based company called Debt Box. Debt Box is a crypto company that offers investment vehicles in the form of “node software licenses” that allow customers to mine different digital assets across different blockchains. If you haven’t heard of Debt Box before, don’t worry; most of us in the crypto industry hadn’t either until the SEC decided to sue them in July 2023. In the lawsuit, the SEC accused Debt Box of defrauding investors of at least $49 million by selling unregistered securities.

As part of the lawsuit, the SEC requested a Temporary Restraining Order (TRO) against the company in order to freeze Debt Box’s assets. According to the Debt Box founders, this restraining order resulted in their personal and business assets being frozen which led to the inability to pay employees, banks refusing to work with them, and “complete disruption” for around 300,000 users in more than 130 countries. The company was basically forced to shut down as a result of this restraining order.

Just one small, tiny, incy wincy little problem. The basis for obtaining the restraining order was completely fabricated. In requesting the restraining order and asset freeze, the SEC claimed that Debt Box had already sent $720,000 overseas and that the founders would flee to the United Arab Emirates and secretly transfer more assets if the restraining order was not put in place. It was later revealed that the SEC had knowingly and intentionally misrepresented the evidence because the $720,000 transfer was actually sent within the United States in the normal course of business. In a scathing 80-page opinion, the judge said, “The critical evidence the Commission offered to obtain and defend the TRO lacked any basis in fact, yet the Commission nonetheless advanced that evidence in deliberately false and misleading ways.”

It gets even worse because the SEC then tried to cover it up. According to the U.S. District Court Judge Robert Shelby, SEC attorney Michael Welsh “knew his statement from the TRO hearing was incorrect. Rather than correcting the misstatement, he and the SEC attempted to subtly shift the language to gloss over and perpetuate the misconduct. It was not just a single imprecise statement or inadvertent misstatement. Each piece of support the Commission offered in seeking the TRO—and then later reiterated in defending the TRO—proved to be some combination of false, mischaracterized, and misleading.” The judge made it crystal clear that the SEC lawyers did not make an error. They lied intentionally.

Can we just take a moment to appreciate the hypocrisy of what happened? The SEC exists to ensure market participants do not make materially false or misleading statements in the securities market. And yet, the SEC knowingly made materially false and misleading statements in federal court. Apparently, the SEC thinks it should be treated differently than those it regulates.

Once it was revealed that the SEC had fabricated evidence and lied in court, Judge Robert Shelby ordered SEC attorneys to explain why they shouldn’t be sanctioned by the court after presenting what he regarded as false and misleading evidence. At that point, the SEC had no choice but to officially admit that its lawyers made inaccurate statements, pledged to train its enforcement staff on the matter (apparently, lying under oath isn’t covered in SEC training), and filed to dismiss the case. And here is where the case took another twist. Debt Box asked the judge to deny the motion.

When have you ever heard of a scenario in which the party who is being sued is offered to dismiss the case and says, “nah, we would rather continue being sued?” That’s what Debt Box did.

The reason Debt Box wanted to continue with the lawsuit was because the SEC asked the judge to dismiss the case without prejudice, which would leave the door open for the agency to refile charges against Debt Box in the future. The SEC conducted itself in an illegal manner and then had the audacity to ask the judge for a do-over as if nothing happened.

Fortunately, Judge Shelby denied the SEC’s motion meaning the SEC will not be able to refile the same charges at a later date. “The SEC’s conduct constitutes a gross abuse of the power entrusted to it by Congress and substantially undermined the integrity of these proceedings and the judicial process,” Judge Shelby said in the filing.

But Judge Shelby didn’t stop there. Instead, he took the almost-unheard-of step of sanctioning the SEC and ordering it to pay Debt Box’s attorneys’ fees and all expenses resulting from the SEC’s misconduct. To recap what happened; the SEC sued a company, and the result was the SEC being hit with enforcement action by the courts.

Fabricating evidence and knowingly lying in court is not the type of behavior we should have from a federal agency. And yet, this isn’t the first time the judges have exposed abuses of power by the SEC under Gary Gensler’s leadership. Time and again, Gensler has shown a willingness to put his political and career ambitions ahead of upholding the mission and purpose of the SEC. Whereas in previous lawsuits it was determined the SEC acted “arbitrarily and capriciously,” at least the SEC wasn’t blatantly breaking the law. This latest court loss is the most alarming example yet of Gensler’s long list of abuses of power.

In Other News

A fifth of US voters have bought crypto, Paradigm survey finds.

Bitcoin miner revenues hit all-time highs amid the recent price surge.

Coinbase has filed a lawsuit against the SEC, accusing it of arbitrarily and capriciously refusing to answer the exchange’s formal petition for clear crypto regulation. 

Spot bitcoin ETFs have been an “absurd” success.

Robinhood’s crypto trade volume rose 10% in February.

Court rules that Craig Wright is not Satoshi Nakamoto, ending long-standing drama.

Paradigm, the Crypto Council for Innovation, and others weighed in to support Coinbase’s effort to push the U.S. securities regulator for crypto rules.

Fidelity amends spot Ethereum ETF to include staking.

BlackRock tokenized investment fund. Financial giant BlackRock is teaming up with Securitize to launch a tokenized private equity fund, according to regulatory filings.

Disclaimer:  This is not investment advice. The content is for informational purposes only, you should not construe any such information or other material as legal, tax, investment, financial, or other advice. Nothing contained constitutes a solicitation, recommendation, endorsement, or offer to buy or sell any securities or other financial instruments in this or in any other jurisdiction in which such solicitation or offer would be unlawful under the securities laws of such jurisdiction. All Content is information of a general nature and does not address the circumstances of any particular individual or entity. Opinions expressed are solely my own and do not express the views or opinions of Blockforce Capital or Onramp Invest.