The Ethereum Merge
TL;DR
- Ethereum operates on a Proof-of-Work consensus mechanism, where miners solve various mathematical problems and receive ETH as a (mining)reward. However, this process consumes a massive amount of energy.
- To combat this issue, the network will transition to the Proof-of-Stake mechanism, which allows for less energy to be utilized and for more efficient processing of transactions.
- ETH issuance will drop to about 0.6 million per year, with a similar 2.7 million ETH burned, essentially making it a deflationary asset which means the total overall supply of ETH will get lowered, but this doesn’t take place right away.
- The Merge won’t be able to drastically reduce transaction times or gas fees, as the upgrade doesn’t increase the network’s capacity.
- However, if the Ethereum team continues to successfully release more upgrades and innovations while maintaining its relevance in the market (via NFTs, DeFi, and other blockchain applications), then we might see more positive price movement, which is even more likely since it will eventually become deflationary.
The week of September 19 2022 ,will be a historic period for the Ethereum blockchain, as its long-awaited move to the proof-of-stake mechanism will finally take place, making Ethereum 2.0 a reality. Vitalik Buterin, the founder of the popular cryptocurrency, has teased us with many promising updates over the last few months and has stated that they’re one step before the transition. Now, all of this may sound foreign to a lot of people, most especially to those who are just starting out in the cryptocurrency space. So, what is the ETH Merge or ETH 2.0 and why does it matter? How will this change ETH transactions? Most importantly, how will this affect ETH prices? As investors, it’s important to understand the potential impacts that this upgrade will have on ETH, so let’s delve deeper.
What is Ethereum 2.0?
This new chapter for Ethereum has been in the works for quite some time now, with the initial roadmap taking shape back in 2017 as a means of combating certain security vulnerabilities and scalability issues discovered in 2016. Since then, there have been a few upgrades, but the most notable ones are the Byzantium and Constantinople upgrades.
The Byzantium upgrade introduced the Ethereum Improvement Protocols (EIP), which established the standards for potential new features on the network, while the Constantinople upgrade laid down the foundation for the transition from Proof-of-Work (PoW) to Proof-of-Stake (PoS), which leads to Ethereum 2.0.
Why is ETH 2.0 needed?
For more context, Ethereum operates on a Proof-of-Work mechanism, which essentially allows its network to come to an agreement on matters such as account balances and order of transactions. At the same time, it lays down the ground rules for mining ETH, where miners solve various mathematical problems and receive ETH as a reward. This act of mining is the “work” in Proof-of-Work.
However, a major disadvantage of mining eth is its heavy energy usage. According to Ethereum.org the process of mining uses a lot of energy which isn't sustainable in the long run.
“To maintain security and decentralization, Ethereum on Proof-of-Work consumes 73.2 TWh annually, the energy equivalent of a medium-sized country like Austria.”
During times when there is a massive influx of transactions (i.e. during a gas war), an exponential amount of energy is consumed, which can be extremely detrimental to the environment. To combat this issue, the Proof-of-Stake mechanism was created, which allows for less energy to be utilized. To have a better understanding of these concepts, check out this Coins Academy blog.
How exactly does The Merge work?
The Ethereum Mainnet is where actual-value transactions take place via the Proof-of-Work mechanism, while the Beacon Chain, which was released in 2020, introduced the Proof-of-Stake to the Ethereum ecosystem. The Beacon chain coordinates a network of stakers, with over 12 million ETH staked, and it also serves as an essential precursor to upcoming upgrades. Once The Merge takes place, the two systems will come together, and the Proof-of-Stake consensus mechanism will be in full effect.
What impacts will The Merge have?
The Merge will allow the Ethereum network to become more efficient at processing a high number of transactions at once and once The Merge is complete, mining rewards will cease, which means that ETH emissions will drop significantly.
The ETH issuance is calculated to drop to about 0.6 million per year, and an estimated 2.7 million ETH burned which means a net 2.1 million ETH will be burnt burned per year, or -7% in yearly ETH supply, making it a deflationary asset. This essentially means the overall supply of ETH is lowered, but this doesn’t take place right away.
What are some misconceptions about The Merge?
Many think that ETH transactions will start to process at lightning-fast speeds with cheaper fees, but the reality is, based on Ethereum.org, The Merge won’t be able to drastically reduce transaction times or gas fees, as the upgrade doesn’t increase the network’s capacity. However, that doesn’t mean that it’s impossible to achieve because this upgrade is still a key step towards realizing that in the near future. Within the next few years, we’ll see the debut of shard chains/sharding and the Shanghai upgrade, which will both take Ethereum’s scalability to a whole new level, but that’s an article for another time.
What can we expect from ETH prices?
As of August 2022, ETH prices have already been reacting to various updates surrounding the upgrade. Once The Merge goes live, we might not expect a mega pump to a new all-time high overnight but if the Ethereum team continues to successfully release these upgrades and innovations while maintaining its relevance in the market (via NFTs, DeFi, and other blockchain applications), then we might see more positive price movement, which is even more likely since it will eventually become a deflationary asset. At the end of the day, it all boils down to supply and demand. How high will the demand be for ETH in 5 years, and how much supply will be left in circulation?
Although these updates may not seem like much on the surface, these will compound over the next few years and contribute to Ethereum’s long-term sustainability. Should you come across websites with “Upgrade to ETH 2.0” prompts, report these right away to prevent potential scams, as this upgrade would not require any action on your end. Keep in mind that all the ETH that you have pre-ETH 2.0 will remain in your wallet even after the transition is finished.
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