What does the Merge mean for Ethereum and the crypto markets?
What does the Merge mean for Ethereum and the crypto markets?
août 01 2022
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The Merge is nigh.

Ethereum transition from the Proof-of-Work to the Proof-of-Stake consensus was planned since its conception in 2014.

After many delays, it looks like the Merge of the mainnet Ethereum and the PoS Beacon Chain – the event that will effectively switch consensuses – will really happen this autumn.

With this realisation come many questions.

What will this mean for Ethereum and its ecosystem? Which opportunities and threats will the Merge present to the larger crypto industry?

The markets have already started reacting to the Merge’s imminent approach, and we would like to give you the tools to forge your own opinion on what can happen next.

What is Merge exactly?

Switching consensus for a blockchain like Ethereum is no small task. To ensure it goes smoothly the first step was the launch of the Beacon Chain in December 2020 – a parallel PoS blockchain that allows anyone to become an ETH2.0 validator by staking 32ETH and passing the activation queue.

Over 400k validators collectively staking over 13 million ETH have been registered since then, but the only transactions they have been processing so far concerned their own state: agreeing on validators and their balances.

This will change with the Merge, which will effectively transfer the Mainnet’s transaction history and activity to the Beacon Chain, and validators will take over the miners’ job of processing new transactions, gathering them into blocks and submitting them to the network.

New PoS realities, of course, will change the mechanism of block validation:

–          the network will randomly select one validator and their block to be proposed for every 12-second slot,

–          if the chosen validator does not propose a block, the network progresses to another slot,

–          during each slot, validators take turns voting for the blocks for every 6.4 minutes epoch, which consists of 32 slots,

–          validators will be monitoring each other and can denounce malicious behaviour,

–          every epoch the network issues ETH to reward good-behaving validators for their work, as well as whistleblowers,

–          ill-behaving nodes see a significant part of their stake removed (slashed), and those who fail to stay online and do their share of work see their reward slightly decreased.

However, blockchains are decentralized, and therefore cannot be shut down at a whim. So what will happen with the old PoW chain?

To ensure there’s only one Ethereum even after the Merge, a mechanism called “difficulty bomb” has been programmed into its protocol since 2015. It is set to increase the mining difficulty with time (i.e. blocks), reaching at one moment the stage when it is not profitable anymore, thus discouraging miners from working on the chain. The final difficulty bomb will trigger the so-called “Ice Age”, and the old PoW chain will become de facto useless.

The roadmap

The estimated Merge date has been pushed many times, and the difficulty bomb delayed accordingly. However, we can all agree that it is best that the project of this size is prepared thoroughly, despite the community’s grumbling 😅

 Ethereum’s transition into ETH 2.0 (also known as Serenity stage) has three steps:

Step 0. Beacon Chain

Since the launch of the Beacon Chain, Ethereum developers have been conducting extensive Merge trials on different testnets.

Goerli is the last public testnet to undergo the Merge, and it has recently been scheduled on August 11th. If everything goes well, the final Merge of the execution chain (Mainnet) and the consensus chain (Beacon) will happen on September 19th.

Step 1. Shard Chains

Ethereum will not stop there, though. The transition to PoS does not increase transaction throughput: while the block validation system changes, the blocks are still being created on average every 12 seconds, like in the PoW chain.

The upgrade that will increase Ethereum scalability dramatically is called the sharding, which will mean splitting the blockchain into 64 shard chains, each having its own state.

The sharding is now estimated for the end of 2023, but one of the few things that are certain in the Ethereum timetable are delays…

Step 3. eWASM

The existing mechanism of executing smart contracts – Ethereum Virtual Machine – is to be replaced by the Ethereum WebAssembly, a more fast and efficient solution, designed to be easily readable and debuggable.

How will the Merge impact ETH?

The Merge becoming (almost) reality has contributed to a better market sentiment about ether mainly for two reasons:

Energy consumption

The transition to the PoS consensus will reduce Ethereum energy use by 99%, which will certainly please people and companies who worry about crypto mining’s ecological impact. This is likely to increase the number of projects built on it, and the number of users, creating more demand for ETH.

ETH supply

If today the Mainnet issues approximately 13’000 ETH/day, and the Beacon chain – 1’600 ETH/day, after the Merge it will be only 1’600 ETH/day. At the same time, an average of 1’600 ETH of base fees is burned every day, which will effectively bring net ETH inflation to zero, or even below.

This will reduce ETH supply greatly.

You know what more demand and less supply means for the price 😉

How will the Merge impact crypto markets?

Ethereum has generated a vibrant ecosystem around it, and the Merge will change things dramatically for some of its players.

Ethereum miners are definitely on the losing side. With their services no longer needed after the Merge, a $19 billion industry will have to find itself a new occupation.

While GPU miners can switch to alternative PoW coins, web3 protocols or data center-oriented business, very specific ASIC equipment can only run Ethash-based algorithms, making it useless for anything else. Luckily for both of them, Ethereum had a somewhat forgotten fork called Ethereum Classic ($ETC), which split from Ethereum over The DAO debate in 2016 (or, more precisely, it did not follow the majority’s decision to rewrite the blockchain to retrieve The DAO’s hacked funds). Ethereum Classic does not intend to switch to PoS, and therefore can absorb some of the disenfranchised Ethereum miners.

Ethereum Classic is small: it has $120k of total value locked (from only one dapp) and 35k daily active addresses vs $50 billion of TVL and almost 500k daily active addresses on Ethereum. Some miners, however, decided that a PoW Ethereum is not lost as a concept, and it may be smart to try and develop it as a network, catering to the sceptics of the PoS transition.

AntPool, the mining pool affiliated with mining rig manufacturer Bitmain, has recently invested $10 million into the Ethereum Classic ecosystem, and is reportedly planning to continue. After the news broke on July 26th, $ETC price has gained 80%.

Ethereum liquidity staking protocols are among the clear winners of the impending Merge. Since not everyone has 32ETH to stake, protocols like Lido or Rocket Pool allow users to stake any amount of ETH. What’s more, for every ether staked, they give a sort of IOU token – an stETH, which in itself can be used as collateral in various DeFi protocols. This practice is not without dangers (Celsius’ demise was precipitated exactly by its over-use of stETH), but the business is very promising, and Lido’s token $LDO has soared spectacularly, gaining almost 400% in the last two weeks, while $RPL doubled.

Other Ethereum-based DeFi protocols are also on the rise, with Uniswap and Aave gaining 80% over the last month.

Ethereum layer-2 solutions like Polygon follow the trend (yes, they still believe Ethereum will need scaling even after sharding), with $MATIC doubling its price in the last two weeks. 

It’s not all good for everyone though, especially for the so-called “Ethereum killers” – blockchains that used to define themselves by their differences with Ethereum, notably regarding consensus and transaction throughput. Solana’s price is still at its yearly lows, as is Cardano’s.

It might be too early to celebrate the Merge or dismiss other PoS blockchains. However, it looks like it will be Ethereum that will push the next crypto market growth cycle.

Don’t say you weren’t warned 😉