The Ethereum Merge: 10 Things You Need to Know (#119 - 12 September 2022)



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The Future of Money with Henri Arslanian
The Ethereum Merge: 10 Things You Need to Know (#119 - 12 September 2022)
By Henri Arslanian • Issue #108 • View online

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The crypto world is now mere days from one of its most anticipated events of this year, if not the recent history of the crypto ecosystem: the Ethereum Merge, in which the entire Ethereum-based blockchain will move from proof-of-work mining to the more energy-efficient and eco-friendly proof-of-stake.
Here are 10 things you need to know about the Merge and what this will mean not only for the Ethereum blockchain but for the crypto ecosystem more broadly. 
1. When will the Merge take place?
The Merge will now go live around September 15, 2022.
This is the culmination of years of work from the Ethereum community, with the project officially kicking off in late 2020 with what was then called Ethereum 2.0
In recent months, intense testing has taken place with numerous testnets, including RopstenSepolia, and Goerli, the last of which successfully wrapped last month. 
Source: Ethereum Foundation
Source: Ethereum Foundation
The size of the Merge is sometimes easy to forget. Let’s not forget that Ethereum has a market cap of over $200 billion. This is as if a company like Toyota, Shell or Cisco (which each have the same market cap as Ethereum) that millions around the world use every day were to suddenly migrate and completely change how it operates overnight.
2. Why does Ethereum need an upgrade in the first place?
Launched in 2015, the Ethereum network quickly became a victim of its own success and began to suffer from a variety of scalability issues as well as from high gas (or transaction) fees. 
For example, there are on average over 1 million transactions per day on the Ethereum network. Whilst this number may be lower than what certain credit card or other centralised players may do, let’s not forget that the Ethereum network is a decentralised network operated by smart contracts.
But the new upgrades should ultimately result in a more scalable, more secure, and more sustainable Ethereum network.
3. The Merge isn’t just a single event; it actually consists of a longer journey
The beginning of the Merge (which was known as Ethereum 2.0 up until late 2021), actually kicked off almost two years ago in December 2020. The first stage of the network rollout saw the introduction of the Beacon Chain, which has since existed as a completely separate blockchain running parallel to the Ethereum mainnet.
Source: Ethereum Foundation
Source: Ethereum Foundation
The Beacon Chain has not been processing mainnet transactions but rather reaching consensus on its own state by agreeing on active validators and their account balances. With the Merge between the two chains rapidly approaching, the Beacon Chain is set to become the consensus engine for all network data, including execution layer transactions and account balances.
And no history will be lost with the switch. For example, once the mainnet merges with the Beacon Chain, the entire transactional history of Ethereum will also merge between the two chains, meaning users’ funds will continue to be safe and secure.  
The conclusion of the Merge doesn’t mean that Ethereum is done trying to improve its blockchain. Far from it. Speaking in July at the Ethereum Community Conference in Paris, Ethereum co-founder Vitalik Buterin revealed that additional upgrades to the network are also on the way, declaring that the end of the Merge will see the beginning of the “surge,” “verge,” “purge,” and “splurge.”
The “surge” refers to the introduction of sharding, a common concept in computer science that provides secure distribution of data storage requirements, enabling rollups to be even cheaper, and making nodes easier to operate.
Not only is this important for scalability reasons, the introduction of “sharding” will continue to make the network as decentralized as it can be. The new network of decentralized validators will only need to store data for the individual chain, or “shard,” that they are validating, rather than the entire network.
Meanwhile, the “verge” will implement Verkle trees (a type of mathematical proof) and “stateless clients.” These technical upgrades will allow users to become network validators without having to store extensive amounts of data on their machines whilst promising to bring 100,000 transactions-per-second (TPS) capability to the blockchain. 
After all, in a proof-of-stake network, validators with locked-up or staked ETH confirm and verify transactions, making a post-verge Ethereum more decentralized than its current iteration. 
The purge will see a mass wipe of old network history, and, as for the splurge, Vitalik merely indicated it was “on to the fun stuff.”
4. A hard fork and accompanying airdrop could coincide with the Merge
Whilst the Merge will see Ethereum transition from a PoW to a PoS consensus mechanism, an anonymous group of developers associated with several large Ethereum miners is still expected to hard fork the Ethereum blockchain after next week’s upgrade, keeping a version of the network running on the current consensus mechanism whilst the Ethereum mainnet transitions to PoS.
The fork, commonly referred to as ETHPoW, will share the same transaction history as the main Ethereum network but start creating its own blocks after the Merge update goes live. 
Because the PoW fork starts from the Ethereum network’s pre-Merge state, all token balances and smart contracts will also be carried over. This means that everyone holding ETH on-chain will end up having an equal balance of ETHW on the forked ETHPoW chain. ETHW will be native only to the PoW fork and represent an entirely different asset than the original ETH on Ethereum post-Merge.
For many Ethereum believers, the planned PoW fork is of little interest from a tech perspective. Virtually all DeFi, NFT, and network infrastructure protocols have publicly announced that they will support the PoS chain, leaving the PoW fork in a difficult situation. 
Despite the PoW fork having to start from square one, it is likely that ETHW will hold some value. Similar to the 2016 DAO hack fork that created Ethereum Classic (and that we’ve mentioned in this newsletter in the past), the PoW fork could also have some loyal supporters who continue to develop it, creating demand for its token. 
Whilst the ideological debate around ETHW is not the same as with Ethereum Classic (when the community decided to “go back in time” due to a bad actor exploiting a bug in the smart contract of the DAO - a topic that we have covered here), there is still some interest on ETHW, from those who despise proof-of-work to miners who want to continue benefiting from their mining machines.
In the short term, we should expect some volatility. Many investors have been holding ETH (probably hedging it with Ethereum futures that have been seeing record volumes) with the idea of receiving the “free” airdrop and potentially selling it later on. 
5. The Merge will reduce Ethereum’s electricity consumption by over 99%
The end of PoW mining on Ethereum will result in a tremendously more sustainable blockchain. And that is a very big deal in terms of spurring more adoption of (and better PR) for the crypto ecosystem. The debate around the use of energy required by the Bitcoin network has played a significant role in some of the negative publicity surrounding cryptocurrencies over the past couple of years. 
Ethereum’s shift away from PoW could ease some of that tension, and make life easier not only for traditional financial institutions but also for large investors like pension funds and sovereign wealth funds interested in exploring the crypto space, many of whom have ESG requirements.
6. The switch from PoW to PoS will have no significant impact on lowering transaction fees
Whilst some have cheered the Merge in anticipation of lower gas fees, the truth is that the switch from PoW to PoS will have no significant impact on lowering transaction fees.
That is because gas is determined not by a blockchain’s consensus mechanism but rather by overall network capacity. Whilst this might be disappointing to some, the growing number of layer- 2 scaling solutions in the Ethereum ecosystem as well as future upgrades that the network has in store should eventually bring gas fees down. 
7. The switch from PoW to PoS will have no significant impact on transaction speeds
Transaction speeds will largely remain the same once the Merge has been completed. 
In Ethereum’s current PoW form, the goal is generally to have a new block every 13.3 seconds. On the new Beacon Chain, meanwhile, blocks occur roughly every 12 seconds. Once the mainnet merges with the Beacon Chain, blocks will be generated 10% more frequently than they currently are. However, this change is not radically significant and likely will not be noticed by a majority of users. 
8. The Merge will not require any downtime of the Ethereum network
The transition from PoW to PoS will not require any downtime (i.e. the chain going offline). That’s because the Merge rests on the foundation of a concept known as Terminal Total Difficulty (TTD), which represents a cumulative measure of the total mining power that has gone into building the chain. Once all preconditions are met, blocks will instantly switch consensus mechanisms, in this case from PoW to PoS.
9. The Merge may result in Ethereum becoming a deflationary asset
How ETH gets issued will change after of the Merge. Currently, new ETH is issued from two sources: the execution layer (on the Mainnet with miners validating new blocks using proof-of-work) and the consensus layer (on the Beacon Chain with validators using proof-of-stake).
After the Merge, issuance from the execution layer via proof-of-work will go to zero. To put things in perspective, the approximate current inflation rate of Ethereum is around 4.6% but with almost 90% of that coming from proof-of work. Post-Merge, the annual inflation will go down to around 0.5%.
However, if the level of activity on the Ethereum goes up, there is a chance that ETH becomes deflationary due to a change implemented during the London upgrade in August 2021 called EIP-1559.
We covered the London upgrade in detail here but, in short, EIP-1559 changed how fees on the Ethereum network are paid by separating the fee into two components: the base fee and the priority fee.
The base fee is adjusted up and down by the protocol based on how congested the network is. When the network exceeds a certain target per-block gas usage, the base fee increases slightly. Likewise, when capacity is below the target, it decreases slightly. Then there’s the priority fee, which some have been calling a “tip” to the miners.
But the important aspect of this fee system is that miners only get to keep the priority fee and the base fee is always burned (i.e. it is destroyed by the protocol) and removed out of circulation. This burning mechanism may cause Ethereum to become deflationary.
10. The Merge will not enable staking withdrawals
When it comes to staking and withdrawing assets on the post-Merge Ethereum, users will have to be patient and wait for the upcoming Shanghai upgrade, the next major upgrade following the Merge, before staking withdrawals are enabled. 
Staked ETH, staking rewards, and ETH issued after the Merge will still be locked up on the Beacon Chain without the ability for withdrawals, with all staked assets remaining locked and illiquid for approximately 6-12 months following the Merge. 
Hope this was a useful summary! Now get your popcorn ready for next week!
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Future of Finance and Money - PwC Global Crypto Leader, Best Selling Author, Keynote Speaker, University Professor, Host of Crypto Capsule™ - Views are my own

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