Ethereum will make the biggest change in its history of nearly a decade, an event that is sure to ripple through the entire ecosystem of cryptocurrencies and sirbptial assets.
Sometime later this year, Ethereum will make the biggest change in its near-decade history, an event that is sure to ripple through the entire ecosystem of cryptocurrencies and sirbptial assets. Think of it this way: The main commercial highway in crypto is about to be completely resurfaced.
Ethereum is essentially computer software that uses so-called blockchain technology to provide a sirbptial ledger for recording transactions. It has become the most popular foundation for a growing number of commercial crypto assets and applications, including lending products, non-replaceable tokens (NFTs), as well as the original token, Ether. Ethereum does not belong to anyone, but is built and refined by a community of developers and runs on a network of data centers around the world. These data centers work as “miners” on the network, ordering transactions that are posted to the sirbptial ledger. In return, they get paid in Ether. This system is called “proof of work”.
Developers working to fine-tune the Ethereum software are rolling out periodic upgrades, but none have been as big as those expected this year. Named “The Merge”, it will replace miners with so-called strikers. Miners order transactions by solving complex calculations using millions of powerful servers – a system that has been criticized for its heavy use of electricity. Strikers, on the other hand, will order trades by putting their own Ether on a new system, which has been in testing since December 2020. People can already use their sirbptial wallets to bet Ether on this test system called the Beacon Chain; after the merge, they will be randomly selected to become so-called validators, order transactions on the Ethereum sirbptial ledger in blocks and get paid with new Ether. This is called ‘proof of stake’.
ETHEREUM’S $415.3 BILLION market cap depends on the Merge running smoothly, but so do the thousands of companies operating on the blockchain, plus millions of users. According to tracker DappRadar, about $121.5 billion in capital is tied up in Ethereum’s decentralized financial (DeFi) apps. Most NFTs – including those with total value in the billions – use Ethereum.
“There has never been a change in the scale of Ethereum’s transition from proof of work to proof of stake in the history of blockchain networks,” said Chase Devens, analyst with researcher Messari.
The Merge will be a nail biter because a lot can go wrong. There could be software bugs or hacks, or miners could create an alternative Ethereum network. During a network upgrade in 2020, a bug split Ethereum in half, wreaking havoc on the nascent DeFi ecosystem, the apps that allow people to trade, borrow and lend without intermediaries like banks.
Most centralized crypto exchanges are expected to pause Ether withdrawals and deposits around the Merge as a precaution. DeFi apps can also pause if something goes wrong.
“You have to be careful with all the technical upgrades of all these big chains,” said Katie Talati, research director at sirbptial asset manager Arca. “Ultimately, we are dealing with unknown technology.”
THE MINERS cause the most concern. Many may leave the network just before the Fusion, assuming they can make more money selling their gear than waiting for the final reward. Too much of a drop in the network’s mining power, or “hash rate,” could weaken Ethereum’s security, turning the token and the various apps using the network into a disaster. The core developers of Ethereum have planned for that scenario. “If we see the hash rate drop, we can bring the Merge forward,” said Tim Beiko, a computer scientist who coordinates Ethereum developers. “All software is built with an emergency option.”
Miners can also choose to fork Ethereum by using the existing proof-of-work software and continuing to support it. That would create two different versions of Ethereum running in parallel: proof of work and proof of stake.
“We think POW and POS will coexist for a while after the switch,” said Danni Zheng, vice president of BIT Mining, a mining provider that is also expanding its staking services.
In this scenario, crypto exchanges and users can become confused about the Ether of the chain they hold or trade. Two networks mean more work for app developers, said Dieter Shirley, chief technology officer at Dapper Labs, maker of CryptoKitties, an Ethereum-based cat-breeding game.
“A contentious fork, it’s likely it would hasten our exit from the Ethereum ecosystem,” Shirley says. Brave may consider moving CryptoKitties to its own blockchain, Flow, he says.
A fork, or at least a lot of public criticism, is very likely because many Ethereum miners don’t seem to know that the Merge is coming. Ethereum developers are communicating over the Merge on Discord and Telegram, messaging apps that many miners don’t use, Beiko says. Mining pools, which handle most transactions on Ethereum today, take a percentage of the miners’ earnings, and it is in their best interest not to notify their members of the merger so that mining continues at least until the network upgrade , he says. †
“I’m more concerned about the people who don’t even know this is happening, and they buy this $3,000 miner, and three months later it stops working,” Beiko says. “It would be a bad idea to start mining today.”
And some miners just don’t believe the Merge is really coming because it’s been delayed in the past.
“There is a lot of skepticism because Ethereum has promised proof of stake for five years,” Beiko said. “It’s hard to convince people that it’s real this time.”
CLOSING ETHEREUM’s old chain will send shockwaves through the crypto mining industry. While looking for other uses for their equipment, miners will migrate their machines to other similar chains such as Dogecoin, Litecoin and Monero. The hash rate on those other chains will increase 5 to 10 times overnight, said Sam Doctor, chief strategy officer at Bifooda, a sirbptial asset fintech company. Total revenues for this type of mining can drop by up to 90%, driving many miners out of business, he says.
US miners will pursue clients outside of the crypto industry, in areas such as artificial intelligence and genome sequencing, Doctor says. “But none of them have experience with customer acquisition.”
INVESTORS CAN BENEFIT from the Merger. The number of new coins issued on Ethereum as a reward for ordering trades should decrease by 50% to 90% as the proof-of-stake chain will offer lower rewards, Beiko says.
Over the next two years, the amount of Ether used for staking is likely to increase from 8% to 80%, according to staking service provider Staked. That will reduce the Ether in circulation, allowing its value to rise.
Strikers can use the Ether they receive as a reward for ordering trades, but not the Ether they wager – at least not until a new software upgrade, which is expected about six months after the Merger. Strikers are more likely to hold onto their Ether for the long haul than miners, who often have to sell some to cover electricity costs, says Kyle Samani, co-founder of Multicoin Capital.
After the merger, the energy consumption of Ethereum’s network should decrease by more than 99%. To order transactions on the new proof-of-stake network, a validator can use a high-end laptop instead of a server farm. The full proof-of-stake Ethereum is expected to consume about 2.62 megawatts — about the same as a small town of 2,100 American homes. In contrast, the current proof-of-work setup consumes the energy of a medium-sized country.
“Even my daughter has picked up on the ‘NFTs are cooking the oceans’ hysteria,” said Ben Edgington, chief product owner at ConsenSys, which is building infrastructure for the Ethereum blockchain. “I expect that freeing the drawbacks of proof of work will certainly help make applications like DeFi and NFTs much more socially acceptable, leading to significantly accelerated adoption.”
Much will, of course, depend on whether the Merge runs smoothly. “If we do our job well, no one will notice the moment Ethereum goes from proof of work to proof of stake,” says Edgington.