Is Ethereum’s upcoming merger going to be a case of “buy the rumour, sell the news?” Or is it going to change the crypto-landscape forever? We did a little digging to understand what on earth is going on.
Ethereum’s upcoming merger is set to happen on the week of September the 15th, with Ethereum developers currently working to a soft deadline of 19th September 2022 (though this could change). The merge is basically an update of Ethereum.
Ethereum.org describes the merge as “the most significant upgrade in the history of Ethereum,” explaining “the Merge represents the joining of the existing execution layer of Ethereum (the Mainnet we use today) with its new proof-of-stake consensus layer, the Beacon Chain.”
“It eliminates the need for energy-intensive mining and instead secures the network using staked ETH. A truly exciting step in realizing the Ethereum vision – more scalability, security, and sustainability.”Ethereum.org
Fortune describes it another way, writing: “the merge is a long-planned Ethereum upgrade aimed at improving the network. Such upgrades are commonplace, but this is the most important one to date, and its success will pave the way for developers to introduce a host of new features to the network.”
“The merge will, well, merge the current Ethereum mainnet—or the main public Ethereum blockchain used by everyone—with something called the Beacon Chain. Currently, both chains exist in parallel. But only the Ethereum mainnet, which currently uses a mechanism called proof of work, is processing transactions.”Fortune
Proof of stake is a consensus mechanism that is different from the traditional proof-of-work mechanism (the one Bitcoin uses). It’s the way a blockchain governs itself and how Ethereum determines the legitimacy of transactions on its network. Essentially, this new consensus mechanism Ethereum is moving to in the merge is going to use much less energy.
The “work” in a proof of work consensus, which Bitcoin uses, takes the form of mining. In this setup, Bitcoin miners expend energy in the form of computing power. Though proponents of this system say it’s the most secure mechanism, it is notoriously bad for the environment – a key consideration in Ethereum’s shift to proof of stake.
The proof of stake will replace proof of work as a form of reaching consensus. Proof of stake is achieved by the Beacon Chain, which has been waiting in the wings for a while, and was created on December the 1st, 2020. The Beacon Chain has since existed as a separate blockchain to Mainnet, running alongside it in parallel.
As Ethereum.org explains, “The Beacon Chain has not been processing Mainnet transactions. Instead, it has been reaching consensus on its own state by agreeing on active validators and their account balances. After extensive testing, the Beacon Chain’s time to reach consensus on more is rapidly approaching. After The Merge, the Beacon Chain will be the consensus engine for all network data, including execution layer transactions and account balances.”
“The Merge represents the official switch to using the Beacon Chain as the engine of block production. Mining will no longer be the means of producing valid blocks. Instead, the proof-of-stake validators assume this role and will be responsible for processing the validity of all transactions and proposing blocks,” (Ethereum.org).
“No history is lost. As Mainnet gets merged with the Beacon Chain, it will also merge the entire transactional history of Ethereum. You don’t need to do anything. Your funds are safe.”Ethereum.org
Despite the common misconceptions, the merge will not make gas fees cheaper and it won’t make transactions noticeably faster. It is a significant change though, with the AFR reporting that ASX-listed digital asset manager DigitalX has decided to sell Bitcoin and buy ether in wake of the news.
The terminal total difficulty has been set to 58750000000000000000000.— vitalik.eth (@VitalikButerin) August 12, 2022
This means the ethereum PoW network now has a (roughly) fixed number of hashes left to mine.https://t.co/3um744WkxZ predicts the merge will happen around Sep 15, though the exact date depends on hashrate. pic.twitter.com/9YnloTWSi1
“The ‘merge’ of the Ethereum blockchain, expected in mid-September, will allow holders of its native crypto token to earn yield for helping to validate the network, which has prompted DigitalX to sell bitcoin and buy ether,” the AFR reported.
“The ASX-listed digital asset manager said last week it would become a ‘validator’ on the new Ethereum network once its ‘consensus mechanism’, which updates and secures it, shifts from ‘proof of work’ to ‘proof of stake,'” (AFR).
Getting to what most retail investors care about though: is Ethereum about to become more valuable (in terms of price)? Opinion is split, with some predicting a price increase, and others predicting a plunge.
Relating to the reduction in the issuance of new Ether (which will be the consequence of a successful merge) Ether is probably going to become “the largest deflationary currency,” Lucas Outumuro, head of research at blockchain intelligence firm IntoTheBlock, reckons.
This reduction in issuance means Ethereum’s market cap could get bigger than Bitcoin’s over the next 12 months, according to an Aug. 12 report by research company FSInsight.
Richard Fetyko, founder and CEO of altFINS, a crypto analysis platform, recently wrote that (in his personal opinion) higher staking yield, the increasing environmentally friendliness of Ether and the deflationary aspect of a successful merge (despite the fact it will temporarily free up more Ether to be sold) could lead to more people buying Ethereum.
He wrote (as a matter of personal opinion): “Higher staking yield (~8%) should attract new ETH buyers, including institutional investors. Following a successful migration to PoS and removal of risks associated with it, institutions will flock to stake ETH, in my view.”
Katie Talati, the director of research at investment firm Arca, is also bullish on the merge, Coindesk reports.
That said, no-one really knows what will happen until the merge actually occurs. As Bankrate points out: “an increasing price isn’t a given if traders and others still prefer the old protocol.”
Bankrate then goes on to quote Vladislav Ginzburg, CEO of Blockparty, a digital asset marketplace, who has said: “The big question is how will the market receive the fork?”
“Will the original chain be [more highly] valued or the new 2.0 chain be [more highly] valued by users? Naturally, we believe the builders will prefer 2.0, but what about traders? Miners?”Vladislav Ginzburg
Bankrate adds: “The shift from proof of work to proof of stake could cause a big shake-up in graphics cards, which are key to the proof-of-work protocol. Experts see Ethereum miners flooding the market with their graphics processors, leading to a massive decline in prices there.”
Interestingly, Decrypt reports “data collected by Glassnode suggests that options traders are looking ‘extremely bullish’ for September, but leaning bearish again for October, the month after the merge,” possibly due to the “buy the rumour, sell the news” philosophy kicking around.
Further risks of investing before the merge, Coindesk reports, are that it gets delayed or “the prospect that something could go wildly wrong during or after deployment, a risk that’s hard to calculate given all the moving parts that could break (Ethereum upgrades have been delayed before, and several times).”
Another risk Coindesk cites is “all the planned and possible Ethereum forks that will keep the proof-of-work algorithm.” Coindesk reports that some prominent crypto firms have already pledged to support some PoW forks, like ETHPOW, which prominent miner and investor Chandler Guo has backed.
In summary, the merge is significant for the world of crypto. But what will be make or break for Ethereum’s long term valuation – still – is whether Ethereum gets more broadly used for real life purposes and not just as a medium of trade.
At the time of writing, Ethereum is up 0.44% over the past 5 days, and 1.65% over the last month.