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The Merge – What to expect from Ethereum’s long-awaited upgrade?
- The Ethereum Merge is anticipated on or around the 15 September 2022
- ETH will presumably become a deflationary asset after the Merge
- The Merge is expected to reduce Ethereum’s energy consumption by 99.95%
- While the Merge won't reduce transaction costs, many layer 2 solutions are already available to help Ethereum scale
It is the most anticipated event in the digital asset space: the Merge, Ethereum's long-awaited transition from a Proof-of-Work (PoW) to a Proof-of-Stake (PoS) blockchain.
Ethereum is the foundation for most decentralized applications (dApps), such as decentralized finance (DeFi), stablecoins, and non-fungible tokens (NFTs), which all emerged by utilizing Ethereum's smart contract functionality. While Ethereum remains the dominant smart contract platform, it is losing market share as competitors entice users away with cheaper and faster transactions.
Can the notoriously delayed Merge address Ethereum’s shortcomings and what can we expect from the long-awaited upgrade? Let’s take a deep dive into what might be the biggest event in the world of digital assets this year.
Why is Ethereum swapping its consensus mechanism from PoW to PoS?
Ethereum is a public, decentralized blockchain. In order to add new data and transactions to the blockchain, a consensus mechanism is needed to validate these new entries and secure the network. The two major categories of mechanisms are called Proof-of-Work (PoW) or Proof-of-Stake (PoS).
PoW requires miners to solve complex cryptographic functions, a process infamous for being hardware and energy-intensive. On the other hand, PoS requires validators to hold and deploy tokens to secure the network. For the Ethereum network, this is the ETH token.
The transition to a PoS consensus mechanism is expected to reduce network energy consumption by 99.95% while eliminating the need for elite hardware and improving network decentralization and security by lowering the barriers to becoming a validator.
Those who choose to run their own validator client in return for ETH-denominated rewards will need to stake and lock at least 32 ETH (about $40,000 at the time of writing) until the subsequent Shanghai update enables withdrawals from the staking contract.
As of 8 June 2022, validators had locked a total of 12,806,021 ETH to secure the network, accounting for 10.67% of the total supply.
What is the Beacon Chain?
The Beacon Chain is Ethereum's PoS consensus layer. It was launched on 1 December 2020 and runs in parallel to Ethereum's Mainnet. Today, the Beacon Chain already coordinates staked ETH, while transactions and smart contracts are still running on the Mainnet.
It is expected that both blockchains will merge and replace the PoW consensus mechanism of the Mainnet with the PoS consensus layer of the Beacon Chain later this year.
Why the delays?
The Ethereum Merge could be the most difficult upgrade a blockchain has ever undergone, as it replaces the consensus mechanism on a running blockchain that holds $48 billion in DeFi contracts alone.
It was initially planned for 2016, but since developers are highly conscientious about the potential security risks associated with this complex update, it has been delayed several times since then.
Misconceptions about the Merge
- The Merge won't scale the network or reduce transaction costs. While the Merge will lay the foundation for future upgrades such as sharding that will increase network throughput, the Merge itself is not expected to have an impact on network throughput.
- The Merge will not enable withdrawals from the staking contract. Withdrawals are expected to be enabled with the subsequent Shanghai update.
- The Merge will not create any new ETH2 tokens. Users will not have to do anything to keep their assets safe.
In fact, the Merge should have no impact on users. However, since this is the most anticipated event in the digital asset space, users should be wary of scammers, as some bad actors will likely attempt to take advantage of the situation.
What does the Merge mean for investors?
The Merge is expected to reduce Ethereum's energy consumption by 99.95%, which could make it more attractive to those with environmental concerns who have previously shied away from the blockchain due to concerns over its energy consumption.
Additionally, ETH will likely become a deflationary asset once the network no longer relies on PoW mining to reach a consensus. Unlike Bitcoin's hard supply cap of 21 million BTC, Ethereum's supply is dynamic and depends on network usage and newly issued ETH, which serves as rewards for those who secure the network.
While these rewards increase ETH supply, Ethereum base transaction fees are burned (destroyed). Since PoW miners receive the bulk of these rewards, the merge is expected to drastically reduce newly issued ETH.
The website Ultra Sound Money simulates the impact of the Merge on ETH issuance and supply growth. We ran the simulation to calculate annual averages based on network activity over the last 335 days.
Before the Merge (Including PoW rewards)
- Issuance: 5.5 million ETH
- Burned: 2.7 million ETH
- Supply Growth: +2.3%
After the Merge (Excluding PoW rewards)
- Issuance: 0.6 million ETH
- Burned: 2.7 million ETH
- Supply Growth: -1.8%
Since its launch in 2015, Ethereum (PoW) miners received around 49,450,728 ETH, 40.5% of the current supply, as rewards to secure the network.
In contrast, PoS validators only account for 658,315 ETH (0.5%) of newly issued ETH, since the launch of the Beacon Chain on 1 December 2020.
Currently, PoW mining accounts for 89% of newly issued ETH, while PoS validators only account for 11% of new ETH supply.
Outlook: How will Ethereum scale after the Merge
Despite not being officially announced by the Ethereum Foundation, the developers have tentatively suggested 19 September 2022 as a potential date for the Merge, which was later updated to around 15 September 2022. This date should be considered a best-case scenario, as extensive testing must be successfully completed prior to this date.
Once the Merge is successful, validators will start processing transactions and thus receive fee tips (optional fees that users can pay to speed up transactions) to earn additional rewards.
While the Merge will not directly fix Ethereum's current capacity constraints, it opens the gates for Ethereum's upcoming major update, the Surge, which introduces Sharding.
Meanwhile, Ethereum is already scaling via so-called layer 2 solutions, such as Optimism and Arbitrum. These projects specialize in computation and execution of transactions while relying on Ethereum for security and finality.
Since these protocols are able to execute multiple transactions and present these to Ethereum as a single transaction, fees on Optimism and Arbitrum are already reduced by up to 95%. Once the Surge introduces sharding, these efficiency gains are expected to multiply.
Should the team of developers succeed in their mission, Ethereum could not only solidify its place in the digital asset ecosystem but also become the most secure and scalable infrastructure for the evolving Web3 space and the Internet of Value.