Cryptocurrencies
16
Sep
crypto-news-review-11

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How The Merge will affect Ethereum

One of the most important events in crypto took place on Thursday 15 September 2022. This is when Ethereum completed The Merge update. The long-awaited event happened without major drama, which made the crypto community sigh in relief. In this article, we will go through the events of The Merge update and its impact on Ethereum and Bitcoin.

The Merge was the result of years-long preparation

Let’s first go through some general points about The Merge. This was arguably the most significant update in the history of Ethereum. Its magnitude is at least on par with Bitcoin halvings. Operations this massive do not even happen every year in the world of crypto.

The Ethereum architecture can be divided into two layers: the consensus layer and the processing layer. The Merge was an update to the consensus layer. It shifted Ethereum from Proof of Work consensus to Proof of Stake consensus. The most visible effect of The Merge was the ending of Ethereum mining.

The idea of scaling Ethereum and moving to a Proof of Stake consensus has been around since Ethereum saw the daylight. Therefore, this upgrade has been more or less in the pipeline for seven years. The original roadmap has been postponed several times and even for several years.

The Merge did not change anything at the processing layer. Transaction fees and block times remain unchanged. The shift to the Proof of Stake consensus sets the stage for future upgrades that will scale Ethereum up to 100,000 transactions per second.

You can read more about the background of The Merge and the Ethereum update process from our in-depth guide.

The Merge took place on Thursday 9-15-22

The Merge was certainly the most followed event in the history of the crypto industry. Millions of people waited for the big moment and watched the final blocks being mined on Thursday 15th of September in the morning European time.

Our office was also awake. We followed the countdown via the popular ultrasound.money site and recorded the most important moment in Ethereum’s history on video. You can check out the last seconds of Proof of Work Ethereum in the tweet below.

Many countdown sites crashed at the last minute, but luckily we didn’t face this issue. We were able to capture a historic moment in real time! The Merge update was completed at around 7:40 am CET. But, what happened after that?

Amazingly, not really anything at all. The biggest update in history was pushed through without the slightest problem. All Ethereum applications continued to run normally and the new Proof of Stake consensus started generating blocks from the first second.

The Merge was often compared to changing the engine of a jet in mid-air. The analogy may be a little exaggerated, but it was in any case the culmination of huge expectations and years of work in a single moment.

The end result was the best possible for the Ethereum community and the crypto industry. At stake was not only Ethereum but also the fate of the thousands of different applications built on top of it. The potential losses from direct and indirect (futures) investments as well. We were talking about hundreds of billions of dollars here.

PoW vs. PoS debate on social media

There has been a huge debate on social media since The Merge. It seems to focus on PoW mining pools vs PoS mining pools. The war of words between Ethereum and Bitcoin maximalists has escalated since the update.

Ethereum is criticized because only four pools hold around 68% of the validators on its Proof of Stake blockchain. At the time of writing, the figures are Lido 30.1%, Coinbase 13.8%, Kraken 8.4%, and Binance 6.3%.

In reality, however, the situation is not so simple. The tweet below shows the contents of the largest pool, Lido, in a very clear format. In reality, it consists of dozens of validators that are not controlled by the Lido protocol.

 

Centralized exchanges such as Coinbase and Kraken could theoretically be a problem if the US administration required them to censor certain addresses. Brian Armstrong, CEO of Coinbase, has previously said that in this case, Coinbase would rather shut down its staking service than choose the path of censorship.

Exchanges make it possible for retail investors to participate in staking without the minimum restrictions of the protocol. Many wallet software now also offer a staking option. This is not only true for Ethereum, but also for other popular Proof of Stake platforms such as Cardano.

The Bitcoin camp has also criticized the fact that it is possible to leave the mining pools at any time, but Ethereum stakers funds are locked up for another six months. This is partly true. The staking will be unlocked after an update titled Shanghai. The ETA is 6 to 12 months.

It depends on the staking service how the Ether lock is defined. For example, a liquid staking service such as Lido will give you stETH tokens instead of staked ETH tokens, which can be traded normally.

It is also worth remembering that the Ether staking lock-up has been known since the launch of the Beacon Chain in 2020. It is a feature that will be updated next. After that, it will be easy to stop staking. Each PoS currency has its own limitations when it comes to staking.

Ethereum inflation vs. deflation

One of the biggest effects of The Merge is the deflation it brings to Ethereum’s ETH token. You can follow the Ether issuance in real time via the ultrasound.money website The photo below was taken on 16 September at around 14:15 CET time, the day after The Merge.

eth supply

The date of The Merge is shown with a vertical line. Ethereum’s inflation stopped at The Merge and turned to deflation. However, the situation has changed since the early hours and the supply of Ether has started to grow again. Why is this happening?

Ether will become a deflationary currency after The Merge under “normal circumstances”. This means that the activity in the blockchain must be sufficiently high in relation to the amount of Ether being staked.

New ETH tokens are distributed in the PoS through staking rewards. The deflationary pressure comes from the EIP-1559 update, which was activated a year ago. It burns the so-called base fee for every transaction in the Ethereum blockchain.

If the base fees are higher than the staking rewards paid over the same period, the amount of Ether in circulation is reduced. If the blockchain activity is low, less Ether is burned than is generated in staking fees.

This is what post-The Merge inflation is all about. This Twitter thread explains it with an illustrative graphic. Ethereum activity is now exceptionally low due to the ongoing bear market. Once the number of transactions returns to normal levels, Ether will become deflationary.

Ethereum roadmap

While The Merge was a massive update and arguably the most important in Ethereum’s history, it is by no means the end of the line for Ethereum. Far from it. According to Vitalik Buterin, Ethereum was about 40% complete before The Merge. Therefore, there are many updates ahead.

Buterin thinks Ethereum is about 55% ready after The Merge. Next up are stages called The Surge, The Verge, The Purge, and The Splurge. You can read more about what they contain in this article, which also has a good diagram.

In short, the Ethereum roadmap is as follows:

  • The Merge: moving to a Proof of Stake consensus
  • The Surge: massive scaling update (sharding and rollups)
  • The Verge: Verkle trees and stateless clients bring improvements to validation
  • The Purge: removing old transaction data, reducing node hardware requirements
  • The Splurge: Different kinds of updates

The entity above is called the Ethereum endgame. If you want to take a deep dive into the subject check out Vitalik Buterin’s interview on the Bankless channel.

This article was written on 16 September, the day after The Merge update. The next step is to wait for the dust to settle and ensure that the Ethereum blockchain is running smoothly. Once everything is in order, we will move on to waiting for The Surge update, meaning Ethereum scaling. Before this, we’ll also see the previously mentioned Shanghai update which will unlock Ethereum’s staking.

The fate of Ethereum miners

As mentioned at the beginning of this article, the most visible impact of The Merge is the end of Ethereum mining. This is no small thing, as tens (hundreds) of thousands of miners went out of business overnight. Admittedly, there has been time to prepare, as The Merge has been known to come for years.

What will Ethereum miners do next? It seems that miners have three options.

  1. Start mining other PoW coins
  2. Sell the mining equipment
  3. Support the Ethereum PoW project

The first option has been the choice of many miners since The Merge. This can be clearly seen, for example, in the hash rate of Ethereum Classic. However, it is not particularly sustainable in the long term. Smaller coins provide so small mining rewards in dollar terms that they can’t cover more than just a small portion of Ethereum miners.

If a large number of miners move to a new cryptocurrency, the same cake will be shared by a much larger number of participants. At the same time, the difficulty of mining will also increase significantly, making the mining process unprofitable for most.

In addition to ASICs, a lot of Ethereum mining has been done using GPU rigs. This means a computer where 6 to 12 graphic cards are connected to a single motherboard.

mining rig

Ethereum mining has been very profitable in recent years. This has driven up the price of graphics cards and caused supply chain issues. The mining trend has therefore been a pain for ordinary computer enthusiasts. Many people will thank The Merge for the fact that graphics card prices have already started to fall.

The third option is to support the Ethereum PoW project. The idea is to continue the Proof of Work based Ethereum, which means keeping the Ethereum blockchain as it was before The Merge.

It is hard to believe that Ethereum PoW would achieve significant popularity. There is already a PoW version of Ethereum, Ethereum Classic, and even that has not been particularly popular after all these years.

The impact of The Merge in the coming years

Let’s look at the impact of The Merge in the big picture. Could this Ethereum update also affect the price of Bitcoin? It is possible. Some believe that Ethereum’s move to PoS consensus will put further pressure on Bitcoin’s power consumption.

A good example of this is the renewed advertising campaign by the environmental organization Greenpeace, which attacks Bitcoin’s Proof of Work.

New cryptocurrency regulation is currently being prepared in both the EU and the US. So far, Bitcoin’s electricity consumption is seen on both sides of the Atlantic in a negative light. Bitcoin will continue to be an increasingly hot target for PoW criticism.

Some critics believe that the Proof of Stake shift will make ETH an easier victim for the SEC, which wants to classify most cryptocurrencies as securities. Jake Chervinsky, who knows the US regulation, rejects the idea.

It’s impossible to know what SEC boss Gensler will ultimately think, but it’s certainly not worth jumping to early conclusions.

What about big-money investors? Is Ethereum now “kosher” for the world’s richest people? Many Ethereum investors expect The Merge to bring more institutional investors to the currency. There are two good reasons for this:

  • Staking yield
  • The ESG

Macro analyst Raoul Pal believes that Ethereum’s yield could become the industry standard to which other yields are compared, similar to the US Treasury bonds. This is very possible. Achieving a return of 4% per annum is certainly of interest to many institutions.

It is likely that Ethereum’s staking will start to increase during 2023 when the Shanghai update is completed. Some institutions will certainly jump on board earlier. Many have also waited for The Merge to be completed before making an investment decision.

ESG, on the other hand, is related to mining and electricity consumption. Even if the critique of mining is largely wrong, its drawbacks drive institutional decisions. Ethereum’s energy consumption decreased by 99.99% after The Merge, making it an ESG-compliant investment for institutions.

We are unlikely to see a massive influx of investors into Ethereum until the overall market sentiment starts to improve. The biggest impacts of The Merge will be seen in the coming years. We are not talking about weeks or necessarily even months.

Image by Лечение Наркомании from Pixabay

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