Etherum Merge - The what and why
In this post, we unpack what exactly is the merge, and why is this important
If you are crypto enthusiast (even a novice one), you have probably heard the term ‘Merge’ being thrown around.
So what’s ‘The Merge’ and why is there so much hubbub around it? Let’s start with the why.
This is part 1 of a two-part post. In part two, we cover the inner mechanics of how this works
The Why?
‘The Merge’ is arguably the most important out of a number of upgrades to the main ethereum blockchain that is intended to make ethereum more sustainable and scalable.
Why the need for more sustainability? - Ethereum protocol, as it operates today, currently has a total annualized power consumption equal to that of the country of Finland. This is because the consensus protocol today (a protocol used to agree on which block of verified transactions gets added to the blockchain) adds a block by getting many ‘miners’ to compete to solve complex and energy consuming mathemetical problems and rewarding the one who solves it first. It’s a lot of work, honestly, hence the name ‘Proof of work’ or ‘PoW’. And yes - ALL that energy used by ALL the other miners who weren’t the first to solve the problem is essentially wasted.
The upgrade solves this by shifting to an entirely new and significantly more energy efficient protocol that can be used to agree on which block of verified transactions to add to the blockchain, known as ‘Proof of Stake’ or PoS.
One analogy to understand consensus mechanism is in the context of elections. Similar to blockchains, one of the tactics employed is addition a cost function, so that you eliminate spam or bad actors.
Most elections have a requirement to eliminate spammy candidates. So there’s a general requirement to demonstrate that certain work is done (e.g. get X number of signatures to become a validated candidate. This is proof-of work. It’s expensive, and generally is fairly wasted effort, but a valid method since it is expensive for non-serious or fraudulent candidates to put the effort
An alternative mechanism is to to demand posting an electoral deposit. Non-serious or fraudulent candidates risk losing their deposits if they do not adhere to the rules or spirit of the election. This is proof-of-stake.
Why the need for scalability? - we’d covered this in an earlier post on the blockchain trilemma. Ethereum’s processing capacity is at 25-30 transactions per second (TPS) today. Just for comparison, Visa today processes about 20-25K TPS (i.e., transactions per second) - i.e., 1000X more transactions that ethereum. And a low TPS equals high transaction fees. A set of upgrades will attempt to solve the issue of scalability through a concept called ‘sharding’ (more on that in a later post).
What is ‘the Merge’?
To become more sustainable, the ethereum network needs to shift to a Proof of Stake protocol. But a change in protocol is not easy as it sounds, especially for a decentralised system such as ethereum. So what do they (they = ethereum community) do? Enter ‘Beacon Chain’.
Beacon Chain is a seperate blockchain that was launched in December of 2020 that introduced Proof of Stake and the concept of ‘staking’ to ethererum. The idea was to test PoS and staking on a seperate blockchain and then eventually merge the Mainnet i.e., the main blockchain that is still running on PoW with the Beacon chain and shift completely to a PoS protocol. This is the event that the community refers to as ‘the Merge’. While initially planned for Q2 2022, the same seems to be have now been pushed further by a few months.
Why all the hubub around it?
There are a couple of reasons that ‘the Merge’ is a much awaited upgrade in the crypto community:
Ethereum’s energy consumption is estimated to drop by more than 99.9% post-Merge, with a shift to the more energy efficient Proof-of-Stake concensus - making it the single largest environmentally sustainable cryptoasset in the market (Bitcoin, the world’s largest cryptoasset still runs on PoW protocol that is energy intensive)
Ether (the currency powering the ethereum network) is projected to become a deflationary asset with total supply contracting under PoS - and as supply reduces, the value of ether strengthens (just as in the real world, the less currency in circulation, the higher the value).
And why is the supply projected to contract? There are two primary reasons -
Till now, the ‘miners’ who worked to add blocks of transactions to the ethereum blockchain were awarded a fixed amount of ether, which is actually ‘created’ (or ‘issued’ per the community terminology) at that point. With PoS, validators (as opposed to ‘miners’ are also issued ether as rewards, but the same is dynamically adjusted to the number of active validators at any point and the quantum of issuance is likely to be much lower than today
EIP 1559 - an ethereum proposal last year introduced the concept of ‘burning’ of ether in base fees (more on this in a later post). So basically not only is the creation or issuance of new ether coming down with PoS, but ether is actively being destroyed by a pre determined process on a daily basis - potentially leading to contracting supply in a short while.
Completion of the Merge will open up developers time to focus on scalability improvements - through a process called ‘sharding’ - that is the next phase of Ethereum 2.0
The Merge is a pivotal upgrade that further differentiates and strengthens the investment case for ethereum’s native currency ether, and sets the stage for a large ecosystem of layer 2 offerings on top of the layer 1 blockchain. Onwards and upwards - literally.
We’ve covered the what and why here. Part 2 of this post covers the how