Ethereum's market capitalization peaked at around $569 billion in May 2021. But despite its immense popularity and high value – it is the second largest network after Bitcoin – blockchain could be slow and expensive to use. Transactions took a few minutes.
When the network becomes congested, it can cost up to $100 to execute a single transaction. Ethereum's environmental footprint has made matters worse. Make claims about hydroelectric mining farms and gas flare operations all you want, but proof of work was an energy-intensive process and stopped at nothing in its quest for limitless expansion.
At the same time, people really liked Ethereum; blockchain was the first to support smart contracts and has not been ousted from its top spot by any of its rivals, such as Solana or Avalanche (although several of them have come close, albeit generally briefly).
The Ethereum network supported the DeFi boom of 2020, which introduced the world to an array of decentralized financial protocols, such as Uniswap and Compound, and a booming NFT market that captured the zeitgeist – admittedly, financial excesses.
So rather than moving to a newer, faster model, the community supported Ethereum's biggest change yet. In September 2022, Ethereum transitioned from a proof-of-work chain to a proof-of-stake chain.
The transition is known as “The Merge” and laid the groundwork for fixing the issues slowing down the beleaguered blockchain, while instantly making it 99% more energy efficient. This article explains why this happened and what should follow.
Fusion
On a technical level, The Merge referred to the union of the “Beacon Chain,” a standalone Ethereum proof-of-stake node, with the Ethereum mainnet. The mainnet is the “official” version of the Ethereum blockchain. The Beacon Chain has been active since December 1, 2020 and supported just over 400,000 ETH staking validators at the time of The Merge.
Before the merge, the Beacon Chain was a one-way system. It did not support smart contracts or peer-to-peer transactions. Until (shortly after) The Merge, all that ETH – $13.9 million ($23.5 billion, as of August 2022) – was basically stuck there, earning 4.2% non-refundable interest . (However, it was possible to trade derivative tokens which represent claims on staked ETH).
The main appeal of The Merge was proof of participation. Proof of X refers to the mechanism by which blockchains validate transactions. Because they are decentralized networks, where no single entity takes control, blockchains must find a way to get other people to validate transactions.
The original method, first used by Bitcoin and then by many other networks including Ethereum, was called proof of work. This mechanism convinced people to process transactions by asking anonymous computers, called miners, to brute force their way into a random mathematical transaction.
The first computer to win the race and crack the code would receive a newly minted coin for their efforts, as well as the right to validate transactions in a block and add them to the immutable blockchain. The reason these miners would bother mining bitcoin is somewhat circular – perhaps a decentralized network has value. And hey, look: it is!
Proof of work, often entrusted to PoW, requires a lot of energy because all computers must run calculations until they reach a random magic number. This energy has to come from somewhere, and many energy sources are not environmentally friendly. (Advocates will point you to the plethora of eco-friendly miners, but it's far more sustainable to abstain from PoW chains altogether).
Proof-of-stake chains take the computationally intensive part of mining out of the equation. Instead of letting the most powerful computers mine new coins, those who have locked up the most coins on the network are proportionally more likely to gain the right to mine blocks and earn those newly minted coins. PoS also, arguably, decentralizes the network.
Mining equipment is expensive and so is the high electricity bill one has to pay in most parts of the world to power this miner. On the other hand, anyone can stake coins on Ethereum. You will need 32 ETH to become a validator, but those who don't have the coins can delegate their coins to a validator, who will return a share of the profits to them.
The proof-of-stake mechanism isn't perfect either: while PoS is certainly more environmentally friendly, it means the rich get richer, thus promoting inequality within the chain (and, considering of the value of Ethereum, in society in general). , Also).
However, as the Ethereum Foundation states: “Validator rewards are significantly lower than miner rewards issued on proof of work (2 ETH every ~13.5 seconds), because operating a validator node does not is not an economically intense activity and therefore does not constitute an economically intense activity. demand or guarantee such a high reward.
After The Merge, you can no longer mine Ethereum on the mainnet – you can only continue to mine ETH via an unpopular proof-of-work fork that miners are pushing (it's still not supported by major players in Ethereum, such as the issuers of the popular US dollar stablecoin, USDC). This fork is analogous to Ethereum Classic against ETH.
Merge Timeline
The merger was a long time coming. Vitalik Buterin, inventor of Ethereum said Fortune in 2021, integrating proof-of-stake would only take a year – not the seven it ultimately took.
Things heated up after the launch of Beacon Chain, as well as the introduction of EIP-1559, which destroyed ETH paid in base fees instead of handing them over to miners. The latter discouraged minors and accelerated the transition to proof of participation.
In 2022, Ethereum repeatedly tested the Beacon Chain and mainnet merger, then transitioned multiple testnets – testing environments on which DeFi developers can test their protocols with fake ETH – to proof of participation. The Merger finally took place in September 2022 and went off without a hitch.
Ethereum Merger and Tokenomics
One of the side effects of The Merge is that when combined with EIP-1559, Ethereum could become deflationary. This means that instead of producing more ETH over time (as is currently the case with Ethereum and networks like Bitcoin), Ethereum could slowly reduce its supply over time.
Indeed, The Merge reduced the daily issuance of new ETH by approximately 90%, from approximately 13,000 ETH (from mining) to 1,600 ETH (from staking). However, Ethereum will only become deflationary if it continues to gain popularity.
As The defiant reported, “demand for block space must increase by about a third from current levels for the burn rate to keep pace with post-merge Ether issuance.” But transaction fees – a common indicator of demand – have fallen amid the bear market and are at their lowest level since April 2020, according to data from Ycharts.
Nevertheless, the reduction in new issuance is such that ETH potentially become deflationary. For some traders, this is akin to the Bitcoin halving, whereby the issuance of new BTC is halved every four years – and is usually associated with a price rise (although the cause and effect have not been determined). This has led some traders to be optimistic about The Merge's effect on the price of ETH – even though ETH fell in the weeks following The Merge.
Ethereum upgrades after The Merge
The merge was just the first in a series of Ethereum upgrades. These upgrades were formerly called Ethereum 2.0, but the Ethereum Foundation decided to call them Ethereum upgrades instead. The first major upgrade after The Merge is partitioning.
This divides Ethereum into 64 chains, each capable of processing transactions simultaneously rather than processing each transaction chronologically, as is currently the case. The merge was the necessary prerequisite for all of this to happen, as the Beacon Chain coordinates all of these chains. Commissioning is planned for 2023.
HAS conference in France in July 2022, Buterin, the inventor of Ethereum, described what comes next: the “push”, the “limit”, the “purge” and the “madness”. Surge is the inclusion of sharding, as described above.
The Verge implements stateless clients, as well as a mathematical proof called “Verkle trees”, both of which lower the computational barriers to becoming Ethereum validators. Purging further reduces the barriers to becoming a validator by not requiring nodes to store blockchain history. “Crazy” refers to “all the other fun things,” Buterin said.
Combined, the upgrades will allow the network to evolve. Buterin predicts that Ethereum could one day process more than 100,000 transactions per second and that transaction fees could continue to fall.
Of course, the importance of all these upgrades stems from Ethereum's continued relevance. Many protocols are considering moving to rival blockchains, like Polygon, Solana, and Avalanche.
Yuga Labs used the botched land sale for a Bored Ape Yacht Club metaverse, in which $158 million in ETH transaction fees were burned, to justify the development of a more efficient L1. While The Merge and subsequent upgrades to Ethereum are certainly important to the future of Web3, they may be overshadowed by advancements in other networks.