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BY Eric James Beyer
August 31, 2022
The mythical merge is finally coming to fruition. And, after a rough-and-tumble year for the crypto world, Ethereum’s long-awaited software update could inject some much-needed energy into the Web3 space while scoring a significant win for the environment.
The transition, years in the making, is technically sophisticated, controversial, and likely to be the biggest event in the crypto space for some time to come. So, let’s break down what the merge is, why it’s essential, and what it means for the future of the crypto and NFT space.
The Ethereum blockchain is the technical infrastructure that allows countless Web3 applications and crypto and NFT projects to exist. At its most basic level, the merge (sometimes called Ethereum 2.0, Eth 2, or ETH 2.0) is an upgrade to the Ethereum blockchain that will reduce its environmental impact, increase security in the network, and enable Ethereum developers to introduce new features and increase the scalability of the chain.
So, what’s merging, exactly? The update will combine the Ethereum mainnet (blockchain) with the Beacon Chain, a separate blockchain created in 2020 that has since been running in parallel with Ethereum.
The Ethereum mainnet is what developers call the execution layer in the blockchain network. Execution layers create a place for applications to live and process transactions that relate to those applications. You can think of this as the engineering that allows for data transfers on the blockchain to take place. Execution layers give you the power to conduct a transaction.
The Beacon Chain is the consensus layer in the system. The secret’s in the name — this layer deals with network rule enforcement, validating (or invalidating) transactions that “want” to occur in the execution layer. Because blockchains are essentially decentralized public ledgers, they need a way to verify or invalidate the transactions taking place within them.
To do this while also ensuring that nobody forges a transaction on that public ledger and steals cryptocurrencies or NFTs that don’t belong to them, most computers in the system have to agree on the transaction’s (block’s) validity. This is how a blockchain governs itself without third parties.
Right now, the Ethereum mainnet uses a system called Proof of Work to validate transactions. Merging with the Beach Chain will allow Ethereum to end its PoW consensus system in favor of another system called Proof of Stake. And that’s a huge deal.
Proof of Work is one of the main reasons why blockchain technology has a less-than-stellar environmental reputation. Together, the Bitcoin and Ethereum blockchains use more than 317 TWh hours of energy annually, which places them squarely between Italy and the United Kingdom in terms of electrical energy consumption.
This massive energy consumption comes from the PoW consensus mechanism involving complicated and energy-intensive computation, a process known as “mining.” To perform this mining, nodes in the network — which often take the form of giant servers that can span entire warehouses — solve complex mathematical problems based on cryptographic algorithms.
The process is energy-intensive by design. Requiring resource-heavy computing processes to try to mess around with the ledger disincentivizes people from doing so.
Proof-of-stake consensus, which the Beacon Chain will bring to Ethereum, is orders of magnitude less energy-intensive than PoW — 99.95 percent less intensive. That’s because PoS doesn’t require nodes in the network to solve complex calculations. Instead, it ensures network security by having users stake an amount of their cryptocurrency in hopes that the system will randomly choose them as a block validator.
But is it really possible for the energy consumption to fall by that much?
“The Ethereum Foundation has said it’s going to fall by 99.5 percent,” explained Juan Ignacio Ibanez, a researcher at University College London’s Centre for Blockchain Technologies, in an interview with nft now. “I have been through that claim and reviewed the figures. We are talking about something like 99.9 percent to 99.999 percent energy consumption reduction. [Regardless], the variability in all the possible proof of stake scenarios are dwarfed by the current consumption.”
Along with Bitcoin, Ethereum is one of the most popular blockchains in the world, with a market cap of nearly $190 billion as of writing. Aside from the millions of NFTs the blockchain authenticates, innumerable other decentralized apps and decentralized financial systems depend on the blockchain to function. What happens to the network matters greatly to millions.
Apart from the environmental benefits of switching to proof of stake, there are some advantages in terms of the barrier to entry for those who want to participate in the staking community. Where crypto mining requires expensive equipment to solve cryptographically-rooted problems, staking involves nothing of the sort. Even a dedicated laptop could do the job. This could mean more people could act as validators in Ethereum, making it more decentralized.
Another issue is security. There are reasons to believe the merge will make Ethereum more secure, but there are always two sides to the crypto coin. “It’s a stretch to say something is more secure than something else because it really depends on your threat model, and security is a complex issue,” explained Ibanez. “But proof of stake will change the security configuration of Ethereum a bit, and that could have some advantages, and perhaps some disadvantages, too. For instance, it’s easy to transfer tokens, and if you can use tokens to participate in consensus, it’s much easier to send tokens to a malicious group than it is to send a bunch of GPUs.”
Countering this risk is something called “slashing,” a process where a validator loses its staked tokens. If a group controls the 51% of staked ETH needed to start messing with the ledger, which would be incredibly costly to achieve, the network can slash their tokens, making the whole process an exercise in futility. This good-behavior incentivization mechanism doesn’t exist in proof-of-work systems because you can’t “slash” someone’s GPU crypto mining equipment.
The blockchain also symbolizes the crypto and NFT movement and Web3 in general. A successful merge could be a sorely needed shot in the arm to an ecosystem that is weathering yet another crypto winter. But, while many see the merge as a big win for Ethereum and its environmental impact, not everyone is happy about it. The switch will directly affect the countless ETH miners worldwide who earn cryptocurrency for performing PoW calculations. The merge will essentially eliminate the need for their existence (along with their bottom line).
If those disgruntled Ethereum miners gather enough support to continue operating a proof-of-work version of Ethereum, they could potentially fork the network. A blockchain fork is essentially a split in the network where the (now) two chains share the same ledger history but continue in their own directions after the separation.
When these forks happen, whether via mass dissent or a hacking event, they can result in the duplication of digital assets. This was the case when bad actors hacked DAO in June 2016, the decentralized autonomous organization that launched earlier that year on Ethereum. Prior to the hack, DAO raised $150 million of ETH through a token sale, but due to weaknesses in its code, hackers we able to siphon off roughly $60 million before Ethereum implemented a hard fork, rolling back the blockchain’s history to just before the DAO hack occurred. The network also reallocated the DAO’s ETH, enabling investors to withdraw their funds. It was an extremely centralized move for the supposedly decentralized chain, but one the Ethereum community took in dire circumstances.
Crucially, though, the hackers were able to keep their funds on their version of the forked chain, which became known as Ethereum Classic.
“If there’s a hard fork after the merge, we could see a duplication of the assets out there,” explained Marcos Miranda, Product Lead at Atlendis Labs, a Web3 organization that produces a DeFi credit protocol, in an interview with nft now. “I think that there is a possibility that [a hard fork] could happen because it already happened in the past. But again, with the merge, it’s not only about an investment decision, it’s more of a commitment to the ethos of the whole community. So, you would want to become a validator, not only because you will be getting ETH in return for your services but also because you want to decentralize the network, you want to be a participant. And you also agree with all that Ethereum stands for.”
There is also some ideological controversy surrounding the merge’s effects on the decentralized nature of Ethereum. Several well-known Web3 entities — including Lido, Coinbase, Kraken, and Binance — control large percentages of staked ETH on the Beacon Chain, leading some to fear that they could become targets of censorship attempts by government agencies.
As of last week, @Lido controlled 31.2% of all staked $ETH on the Beacon Chain, followed by @Coinbase (14.7%), @Krakenfx (8.5%), @Binance (6.6%), @staked_us (3.0%), @BitcoinSuisseAG (2.2%), @stakefish (2.1%), and @Rocket_Pool (1.6%). pic.twitter.com/86Iu0qjtpi
Ethereum Founder Vitalik Buterin has indicated that he would support measures to burn the stake of any validators that censor Ethereum’s protocol at the behest of regulatory bodies, but the concern remains.
Another issue is what’s known as the 51 percent attack scenario, a hypothetical situation in which malicious actors collude to take over more than half of the validators in the network to forge the blockchain record and steal crypto or NFTs. Doing this would be incredibly difficult, since a hacker would need to own the majority of staked ETH in the system to do so, which would be prohibitively expensive to acquire.
There’s also the possibility that switching to proof-of-stake validation could mean that ETH is easier to classify as a security. The Securities and Exchange Commission (SEC) and Web3 entities in the U.S. have a tenuous relationship, to say the least. The prospect of the second-largest cryptocurrency in existence attracting the SEC’s ire isn’t something about which anyone should be particularly excited. Still, it’s a possibility that nobody can say for certain what will happen.
In a nutshell, it won’t.
Gas fees are the cost of conducting a transaction on Ethereum, and they can skyrocket during busy periods (like when an NFT project is minting), potentially adding hundreds of dollars to transaction costs. Unsurprisingly, Ethereum users aren’t so fond of this. However, the merge doesn’t affect the network’s capacity, so users won’t see a change in this dynamic after the merge is complete.
In April, Cooper Kunz, CTO at Calaxy, a Web3 social marketplace, described the merge as “one of the most difficult, novel, and impressive feats of engineering I think the world has ever seen,” in an interview with nft now.
He’s not exaggerating. Ethereum developers have been hard at work at the merge for years, delaying it multiple times in the process. To pull off a switch of this magnitude, engineers have been conducting dress rehearsals for the merge in recent months involving several Ethereum test networks (testnets) to look for bugs or hiccups in the transition process. The most recent of these tests, which took place on the Goerli testnet, successfully merged earlier this month.
Two significant upgrades must also take place before the merge happens. First is the Bellatrix upgrade, which activates the merge on the Beacon Chain, followed by the Paris upgrade, which removes any dependency on proof-of-work mining.
“It requires a huge amount of collective effort,” said Jiahua Xu, a researcher at UCL’s Centre for Blockchain Technologies to nft now. “[Developers] have been talking about moving from proof of work to proof of stake for five years or so. [Ethereum] has probably the best brains in the blockchain community, and still it [took this long].”
“They’re doing all of this without pausing the network,” added Ibanez. “I think that’s just impressive.”
If all goes smoothly, Ethereum developers expect the merge to take place during the week of September 15, 2022. That’s not a guarantee, however, and given how long it has taken for the merge to come this far, it wouldn’t be a big surprise if the Ethereum team delayed it even more.
Still, it’s an exciting time to be in the crypto and NFT space. With any luck, the merge will go off without a hitch, and the Web3 community will have all the more reason to celebrate and promote a positive environmental message within and without its ranks.
Significant changes in blockchain systems are a kind of pressure test for the communities that support them, and Ethereum is no different. Vitalik Buterin and the majority of the Ethereum community faced just such a test when DAO was hacked, and they decided to commit to the ideals of fair play in Web3 and left Ethereum Classic in the dust.
The merge represents a similar kind of value test, just under different circumstances. For example, the 32 ETH needed to independently stake as a validator is a high barrier to entry for most of the community. But that number isn’t set in stone.
“They can raise the bar, they can lower the bar, they can do whatever they want,” explained Miranda. “They might lower it in the future. This is something that Vitalik [has talked about] a lot. He would love to have people running [and validating] nodes on their cell phones someday. And with the merge, you could, in theory, do that if you have a flagship smartphone.”
Likewise, Ibanez believes that the merge and its aftermath, both immediate and long-term, will reveal a great deal about what the Ethereum community wants Web3 to look like as it moves forward.
“Whether they raise the amount of ETH required to stake or lower it, or even stay passive, it’s going to be a test for the community and its ethos,” Ibanez underlined.
And that’s what makes the merge exciting — it could be the start of an entirely new era in Web3 as we know it.
