Crypto Global

Ethereum's Merge is just around the corner!

The Ethereum merge date has been set. On August 18th, the ETH developer community agreed on the final deadline for the historic upgrade. The developers chose September 15th.

Essentially, Ethereum is changing the method it uses to settle transactions. This is known as the merge. Similar to Bitcoin, Ethereum so far uses a consensus mechanism called Proof of Work (PoW), which requires users to solve complex math problems to validate transactions and secure the network. People who solve these problems are called miners and have to invest enormous amounts of energy and equipment to have a chance to mine the blocks of transactions and earn rewards. This makes it difficult for new miners looking to validate transactions to earn block rewards.

Ethereum features a transition to another consensus mechanism called Proof of Stake (PoS), which replaces the process of block mining with validation. It works as follows: users stake their Ethereum to win the right to create a block. Based on their engagement, one of these users is pseudo-randomly selected as a validator. Validators can create new blocks and send them to the network for validation. When a block is added to the chain, its verifiers receive a reward proportional to the amount of Ethereum they staked. On the other hand, if someone sends a malicious block, they risk losing their entire bet through a process known as "slashing." To be selected as a validator, users must either stake at least 32 Ethereum or join a staking pool with a smaller amount.

The developers estimate that Ethereum's power consumption as a network could drop by around 99.9% after the merge. The merge is an important part of upgrading Ethereum. However, the overall upgrade plan consists of three main phases:

  • First is the start of the Beacon Chain. This is a proof-of-stake blockchain that the Ethereum network will switch to when it runs out of proof-of-work. The Beacon Chain went live in December 2020 and runs parallel to Ethereum's main chain called Mainnet.
  • The second phase is called a Merge. Here the Ethereum mainnet and the Beacon Chain will be combined and the Ethereum network will go live with the Proof of Stake.
  • The last phase of the upgrade is called "Sharding". With Sharding, a database is divided into several parts. The main Ethereum blockchain is split into multiple smaller chains for parts of different datasets. With Sharding, Ethereum will be able to process thousands of transactions per second, solving the scalability problem.

How will Ethereum change after the Merge?

As for the downsides, proof-of-stake cryptocurrencies aren't nearly as battle-hardened as proof-of-work cryptos, nor are they backed with nearly the same amount of capital. Another downside is one that is unfortunately quite common with proof-of-stake cryptocurrencies, and that is that the initial distribution of the crypto coins can lead to a concentration of the staking among a handful of participants. The third disadvantage relates to the previously mentioned crypto consensus procedures, namely that many proof-of-stake cryptocurrencies do not use a PoW mechanism and therefore can be corrupted when malicious validators control a third of the total stake - a much lower threshold than 50 percent in Proof of Work (PoW). The fourth disadvantage relates to the second, namely that proof-of-stake cryptocurrencies are more prone to centralization as those with large amounts of coins can overwhelmingly influence the rules of the network. The fifth downside is that staking requirements can still be prohibitively high. The sixth disadvantage is that the opportunity cost for validators can be high since their money is locked up and cannot be used. The final downside is that proof-of-stake does not protect against blockchain forks as well and cryptocurrencies that use this consensus mechanism without lowering the risks are again vulnerable.

For the above reasons, we, along with other blockchain industry players, believe that PoW generally offers better security and decentralization guarantees while sacrificing some degree of scalability. PoS typically offers better scalability while sacrificing some level of security and decentralization. Ultimately, the best choice depends on numerous factors, including the primary use case of a particular blockchain, such as hard money resilience or smart contract functionality.

Still, moving from proof-of-work to proof-of-stake will significantly reduce the computing power and power consumption required to validate transactions. The Merge is arguably one of the most important events in the cryptocurrency at the moment. The expectations are therefore extremely high and if these expectations are not met for whatever reason, Ethereum could develop negatively very quickly.