Huge Ethereum changes are coming. Developers are preparing to switch the blockchain consensus algorithm from Proof-of-Work (PoW) to Proof-of-Stake (PoS) on September 10-20. Here in our article is the main thing about the Merge for those who missed everything. And for those who are in, we have prepared expert comments and the results of the latest research on trader sentiment at the end.
What is the Merge
The Merge is the main event of the year for the cryptocurrency community. It can compete only with the recent black swan as the collapse of the value of almost all coins, which was probably written about even in coupon magazines. However, it is difficult to say that the impressive volatility of cryptocurrencies is a novelty, because serious drawdowns of their prices with subsequent rapid ups have happened before. But a fundamental change in the principle of operation of a large blockchain network is happening for the first time.
Therefore, the Merge attracts the attention of technology enthusiasts, as well as the one of traders and investors who plan to make money on the transition to Ethereum 2.0.
The Merge is an update of Ethereum: its blockchain will switch to the Proof-of-Stake (PoS) consensus algorithm.
The consensus algorithm is a key mechanism in any blockchain network. It is needed to coordinate the work of nodes and to generate a "consensus" (a situation when all network participants agree with its current condition).
After that, Ether mining will become a thing of the past, and the security and operability of the network will be supported by validators who are the owners of at least 32 ETH and who have blocked their coins (made staking) in order to receive remuneration for conducting operations. There are already 13,330,064 stacked ETH, which belong to 416,568 active validators.
Ethereum developers initially considered Proof-of-Stake as the basis for their blockchain network. But as a result, the less risky option of launching Ether on the basis of the already proven and reliable Proof-of-Work technology won. However, it was decided to abandon PoW back in 2015, so the Merge can naturally be called the finale of more than seven years of the process.
Why did it take so long? Because Ether is not only the second most capitalized cryptocurrency in the world, but also a technological platform. Dozens of second-level (L2) solutions are deployed above the Ethereum network, which use the basic blockchain as the foundation for their work. Here is a chart with the total liquidity of the top 5 second-level solutions based on the Ethereum network, and it exceeds $5 billion.
In such conditions, even a small mistake when switching from PoW to PoS can lead to disastrous consequences and the fork (separation) of the cryptocurrency into two separate branches. Moreover, there has already been one fork in the history of Ether: Ethereum Classic appeared just because of an error.
Then, in 2016, a DAO project was launched, which worked on the basis of the Ethereum network. Due to a bug in its program code, hackers were able to steal about $50 million, which the Ether development team then returned manually. Part of the crypto community did not accept such interference in the work of the blockchain, since it contradicts the very idea of decentralised networks. This is how Ethereum Classic appeared: the same Ether, but working as if there was no return of stolen coins.
With such experience, it is not surprising that the developers have been preparing for the Merge so carefully and for such a long time.
When will the Merge happen
The last announced date from the Ethereum Foundation is September 10-20, 2022. But these are not the final dates. They were announced only on August 24, after the successful transition of the Goerli test network to the PoS algorithm. The Merge may be postponed to October or even November if the development team has even the slightest doubts about the success of the process. The fact that this is only a planned date, and not the final one, is explicitly stated in the announcement.
Anthony Sassano, co-founder of EthHub, announced the date of the Merge on his Twitter account.
Postponements of the Merge have already happened before. For example, until recently, developers planned to switch to a new algorithm on September 19, 2022. And the creator of the Ether Vitalik Buterin at the summit in Shanghai mentioned August. September and October were also given as possible options, but only if "potential risks" would be found.
Therefore, we recommend you to follow the announcements of the Ethereum Foundation. Or you can read our blog as we will definitely inform our readers if something changes.
Everything worked fine, why is the switch to PoS necessary?
Energy efficiency, security and deflation are the three main reasons for the upcoming transition.
🌳 Green trended transition
Unlike the extremely energy-intensive PoW algorithm, PoS can rightfully be considered a "green" technology. Since the mining of ether after the Merge will depend not on the power consumed, but on the number of coins in the stack, a lot of electricity is not needed to maintain the operation of the blockchain. And the drop in energy intensity will be radical: the developers predict that the power consumption of the Ethereum network will fall by about 99.95%.
However, this is only one of the predictions. There is even more optimistic data, according to which, after the Merge, Ethereum will consume 10 thousand times less electricity. The reality may be much more modest, but the energy efficiency of the proof of stake is beyond doubt.
🔫 Not only a carrot, but also a stick
The greater security of PoS is also associated with the method of mining and transaction confirmation. In PoW networks, security is ensured by the number of miners and the random generation of blocks: it is now possible to mine Ether even on a home PC by running a mining program on it. If you're very lucky, of course.
At the same time, attempts to cheat the blockchain during mining are not punished, so hackers can test hypotheses as much as they like and test the system for strength in the hope of finding a loophole that will help them enrich themselves. And there is a chance that they will eventually find such a loophole, because the number of attempts is unlimited.
In Proof-of-Stake, there is a mechanism called "slashing" to protect against fraudulent actions. These are penalties that are imposed on those validators whose actions potentially threaten the network's operability. In fact, this is the protection of the blockchain from malicious interference by those who should ensure its security.
Fined validator:
🔻 cannot receive remuneration;
🔻 loses the ability to dispose of part of the funds stored in the stack.
So staking is a kind of collateral system that motivates the validator to work according to the rules. After all, every attempt to interfere with the operation of the Ethereum network will be extremely expensive. Here is a list of fined validators with a reason specified.
For the first six months after the Merge, the amount of the fine will be greatly reduced in case of bugs. But even such sliced slashing is a good fuse. This is best evidenced by the figures: for the entire time of the test network, only 184 validators were fined.
📈 The further you go, the more expensive it gets
The deflation mechanism was introduced during the update of the Ethereum protocol called London (EIP-1559). Since its introduction, miners do not receive the entire transaction commission: part of it is simply burned. Moreover, the number of coins burned depends on the activity on the network.
Deflation is a condition in which the currency becomes more expensive over time, and not cheaper, as usual. The concept opposite of inflation.
At the current workload, approximately 2.5 million coins are removed from the blockchain per year. But this is not enough for the cryptocurrency to become deflationary: the increase in the number of coins has only slowed down a little, and now the inflation is 2.5%. This is clearly visible on the charts of ultrasound.money project, which tracks the rate of ether burning and allows you to see what will happen to the network after the Merge.
Merging will change everything. After it, the fixed reward for the mined blocks will become a thing of the past as validators will receive dynamic rewards. Its size will be recalculated every 6.4 minutes and will depend on the number of coins in the stack and the activity of validators. Better to say, the more willing to receive a reward is, the smaller the reward is, and vice versa.
And the most interesting thing begins here: even at the current level of activity in the blockchain network, the number of coins in circulation will decrease by 1.5% per year. That is, the flow of new coins will be less than the rate of burning ether during transactions. As a result, Ethereum will switch from an inflationary model to a deflationary one. That automatically turns the cryptocurrency into a good protective asset in the medium and long term: a decrease in supply is very likely to lead to its gradual rise in price.
What else?
Among the advantages of the Merge, three more factors are often mentioned: decentralization, an increase in the speed of transactions and the need of this stage for the further improvement of the blockchain. The first two of them are very controversial.
The transaction speed will not change much — a small increase of about 10% is expected, which is almost unnoticeable for the average user. And what will happen in fact with decentralization is still unknown to anyone. But the theoretical calculations of some experts show that it can turn into its opposite.
What risks does the Merge carry and what are the disadvantages of PoS mining?
Although the Merge is probably the longest-running and well-developed update of the blockchain network, it is very risky. First of all, the transition itself is a very attractive target for intruders. Attacks of varying degrees of complexity from trivial DDoS to attempts to gain control of the developer's computer are not just possible, but extremely likely. After all, the potential jackpot in case the attack succeeds is huge.
Also, instead of the expected decentralization we might get on the contrary a more centralized network. The Lido Finance service is a good example. This is a platform that operates in the Staking-as-a-Service segment. It allows everyone to receive rewards from participating in validation, even those who do not have 32 ETH. You just need to place coins on a platform that will combine individual contributions and create validation nodes itself.
At the moment, Lido controls 31% ETH in staking. In turn, 93.1% all LDO coins (Ado DAO management token) belong to only a hundred people. Same pictures can be seen on other similar platforms. And it is always easier for hundreds to negotiate than for thousands.
Of course, after the Merge everything can change due to the arrival of new players. But in the current situation, a 51% attack for PoS looks even more likely than for PoW. Although in both cases it will be incredibly difficult to carry it out.
The 51% attack is the basic vulnerability of the blockchain network. If one person or a group of people gets control over 51% of nodes in the network, then they get full control over the blockchain. Including the ability to confirm/reject transactions.
Also, the PoS consensus algorithm is a relatively new concept, practically untested on large projects. Theoretically, it should work well. But what will happen in practice when using Proof of Stake for such a large blockchain network as Ethereum, no one will say for sure. Ether has been working on PoW for more than ten years, and during this time the algorithm has proven its reliability.
In addition, there is a risk of a banal error during merging. Minor flaws are not likely to cause serious consequences. But a large-scale failure can lead to another forking of Ethereum. Moreover, the appearance of the ETHW fork, that is the ETH token which after the Merge will continue to work on PoW, has already been announced, and the Poloniex exchange has launched trading with this coin.
Finally, validation in PoS may simply not attract enough participants due to its disadvantages:
💰The high entry threshold is 32 ETH. On PoW, you can already mine on one graphic card.
🤖 The skew of the probability of getting a block towards the holders of large stacks. On PoW, blocks are distributed randomly.
⛔️ The possibility of losing your contribution due to slashing caused by a bug or the actions of third parties. The example is mentioned above Staking-as-a-Service platforms. This has already happened to Staked customers and is likely to happen more than once as the market grows.
In one word, the Merge is a truly extraordinary event that will divide the world of blockchain into before and after, no matter what it ends with.
How will the Merge happen?
The developers began preparing for the transition of Ethereum to PoS on December 1, 2020. Then the Beacon Chain (signal chain) blockchain was launched, the only function of which was to reach consensus on the Proof-of-Stake algorithm.
Since there have been no transactions in the Beacon Chain all this time, the blockchain turned out to be empty. This will allow it to merge with Ethereum and to replace the consensus mechanism from PoW to PoS without losing history and with the safe transfer of funds to the unified network. In theory.
In practice, difficulties may appear. In order for the Merge to pass without surprises, the Ethereum developers decided to first work it out on test networks. One of the last such workouts was the merger of the Goerli testnet with the Beacon Chain, which was successfully completed on August 11. Although the developers complained about «some confusion» during the test, its results were even better than expected. This made it possible for the first time not to postpone, but to bring the date of the Merge closer.
The last step before the Merge is the upgrade of Bellatrix, which is planned to be held on September 6.
«Ether will beat Bitcoin». What do experts think about the Merge?
Taking into account the uniqueness of the event, the Merge could not leave the experts of the cryptocurrency market indifferent. To complete the picture, here are the most interesting opinions.
Lucas Outumuro, head of research at IntoTheBlock
Lucas believes that one of the reasons for the Merge of Ethereum is the reduction of cryptocurrency generation after switching to the PoS algorithm. Although inflation in the global economy still remains at a high level, ETH is likely to become the largest deflationary currency in the world.
Also, the expected profitability of 6-7% will make stacking attractive to coin holders, which, in turn, will increase the security of the blockchain, since obtaining 51% will become a more expensive enterprise. In general, the Merge offers great economic benefits for Ether holders, which determine its current dynamics.
FSInsight
FSInsight analysts have prepared a report in which they made an optimistic prediction about a significant increase in the capitalization of ETH. Up to the point that it could surpass BTC in terms of market capitalization over the next 12 months. They also believe that after the Merge is completed, the supply inflation rate will decrease, and the bearish pressure from the miners will be reset.
Huobi Research
Huobi Research analysts are confident that the impact of the Merge on the market will be complex and profound not only in relation to the Ethereum ecosystem. It will also bring uncertainty and new opportunities to other ecosystems.
Traders bet on the Merge
The long and meticulous preparation for the Merge seems to have done its job. Despite a significant amount of uncertainty, both the market as a whole and individual traders react positively to the upcoming merger.
In particular, according to GlassNode, open interest in Ethereum-based options at the end of July exceeded the same indicator for bitcoin-based securities. In August, this indicator continued to grow and reached record values close to $8 billion.
It is noticeable that investors are betting on a serious increase in the value of the cryptocurrency at the end of September — up to $2.2, $2.8 and even $5 thousand.
At the same time, traders are preparing to close positions and go short immediately after the Merge. Most likely, they expect a drawdown, which will be a consequence of the exit from Ether that players who buy coins for the sake of a potential fork. In the case of a «split», they will receive free ETHW coins from the fork, which even now are more promising than most existing altcoins.
In addition, the exit of a large number of miners from Ether will also create strong bearish pressure on the cryptocurrency as they will sell at least part of their ETHs. In the short term, this can lead to a significant excess of supply over demand and, consequently, to a drop in the value of the coin.
In short
🧬 The Merge is an extremely important event for the entire crypto world. This is the first fundamental change in the blockchain of this magnitude.
⚖️ During the Merge, Ethereum's consensus algorithm will change from Proof-of-Work to Proof-of-Stake. As a result, Ether will become radically more energy efficient, safer and a little faster. And also it will become deflationary, that is, every year the supply of ETH coins will decrease. But we will have to pay for these advantages with the riskiness of the transition: PoS, unlike PoW, is a new technology. Therefore, in theory it is better than PoW, but what will happen in practice with decentralisation and validation is unknown.
⚡️ The Merge is planned for September 10-20. For the transition, the Ethereum network will be merged with the Beacon Chain, while the transaction history and the contents of the wallets will be preserved.
This article is not an investment recommendation. The financial transactions mentioned in the article are not a guide to action. Itez is not responsible for possible risks. The user should independently conduct an analysis on the basis of which it will be possible to draw conclusions and make decisions about making any operations with cryptocurrency.
