The Ethereum Merge Happened - So What?
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On September 15th around 6:40 AM UTC, Ethereum successfully pulled off the largest software update in blockchain history. This update known as “The Merge” marks Ethereum’s mainnet upgrade to a proof-of-stake consensus model, a feat considered impossible by many in the Web3 Community.
After switching to proof-of-stake, or PoS, Ethereum decreased its energy consumption by 99.95% as well as decreased global energy use by 0.02% (Ethereum Foundation). Despite incredible developers accomplishing this historic feat, the Ethereum community remains divided on the issue.
PoW to PoS
Before the Merge, Ethereum’s mainnet ran on a proof-of-work consensus model, similar to the one Bitcoin uses. Proof-of-work relies on miners to secure and validate the network. Ethereum miners would use massive amounts of energy to run computers to solve complex cryptographic puzzles, with the fastest computers winning the ETH rewards for that block.
It was estimated that the ETH miners used the same amount of electricity as the entire country of New Zealand (Bloomberg). Even though mining is incredibly energy intensive, supporters preferred mining instead of staking due to concerns over centralization.
The aforementioned concerns stem from the fear of validator centralization, when a small group of validators control a large majority of the network. Before the Merge, mining centralization was rampant as the top 3 mining pools controlled over 50% of the network resources (Consensys).
This figure has not improved much since The Merge, as on September 15, 2022, 420 blocks of a 1,000-block run were validated by Coinbase and LIDO alone, both of which are either based out of the US or largely funded by US venture capital firms. This fact has caused the two largest validators on the Ethereum network to be potentially subject to US and SEC regulations.
Prior to the Merge, miners had to run their own mining farms to compete in validating each block. By successfully validating a block, miners were in turn rewarded with Ethereum tokens, or Ether. With proof-of-stake, users can now deposit a minimum of 32 ETH into a node validator which is used to verify the transactions on the blockchain. By running node validators, investors who stake their Ethereum can earn anywhere from 4-6% interest on their ETH.
Despite the high entry cost of obtaining 32 ETH, the hardware needed to run a node validator is significantly lower from the cost of GPU power required for mining ETH. This change in hardware is the main factor for why Ethereum is using 99.95% less power than it was before the Merge. There are staking options available for investors who do not have access to 32 ETH.
Validator requirements democratize and further decentralize block verification, as even small nodes can verify transactions. In contrast, a small scale ETH mining system could never compete with the largest mining farms. Anyone with any amount of ETH can now lock up their tokens on a centralized exchange to receive staking rewards. A payment structure such as this was not available to retail investors pre-Merge.
For users with 32 or more ETH, the hardware required to run a node validator for staking is significantly cheaper than the GPU hardware and energy costs associated with mining. If you do not have access to 32 ETH but still would like to participate in staking, then please check out the full list of Ethereum staking options here.
Network Fees and Scalability
Anyone who has used Ethereum in the past to purchase an NFT can attest to the high gas/network fees. A single ETH transaction could easily cost more in gas fees than a typical US household’s monthly electricity bill (Reuters). Terms like “Gas Wars” were commonly used in the NFT community, as the networks would get so congested that the fee to mint a single NFT would cost the user hundreds of dollars.
During the 2021 bull run, it was common for a single token swap on a decentralized exchange to cost north of $100 USD in ETH for gas fees. The same swaps would only cost fractions of a penny on proof-of-stake blockchains like Binance Smart Chain or Solana.
Despite Ethereum’s historic transition to proof-of-stake, gas fees remain high. The first NFT minted after Ethereum's Merge cost the user over $60,000 in gas fees (Bloomberg). This is because the Merge did not address scalability or throughput, meaning the network is not faster nor cheaper than it was before.
The Ethereum Foundation is addressing these issues in future updates, such as the Surge, which will introduce sharding to Ethereum, a practice already in use by Solana. Sharding is when a blockchain divides the transactions into smaller blockchains, which are then confirmed on the “main” L1 later, significantly reducing the amount of time needed to complete a block.
The Ethereum community helped pull off the most historic software update in blockchain history. For years many considered it to be impossible for Ethereum to switch to proof-of-stake. Had the developers left even the slightest exploits, billions could have been lost. Instead, Ethereum remains as the 2nd largest cryptocurrency by market cap.
Ethereum is still years behind other L1 blockchains in terms of throughput and scalability, however, The Merge needed to be successful in order for Ethereum to ever have a chance at catching up. We are eager to see the future of the world’s second largest cryptocurrency, and maybe one day, the largest cryptocurrency in history by utility and market cap.
What is Ethereum 2.0?
Ethereum 2.0 is a term formally used by the Ethereum Foundation to name its upgrade to a Proof of Stake Consensus Protocol.
What is the Merge?
The merge is a term coined to describe Ethereum’s update from a Proof of Work to a Proof of Stake consensus protocol.
What does this upgrade mean for the future of DeFi?
While gas fees remain high, this upgrade will lay the foundation to improve Ethereum’s scalability and throughput to make the network faster, and cheaper to use, making DeFi more accessible for retail investors.
What is the value of ETH going to be moving forward?
Many factors such as the overall health of the macro economy, BTC’s Price, among other factors play a role into the pricing of Ethereum. It is hard to say what Ethereum’s future price will be, however, if the Ethereum Foundation continues to deliver, I see no reason for adoption to slow down.
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Author: Ken Melendez
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Information in the article does not, nor does it purport to, constitute any form of professional investment advice, recommendation, or independent analysis.