This week, Ethereum will go through its largest upgrade ever. This event is known as “the Merge” and is the biggest technical event happening in crypto this year. The Merge will complete the migration of Ethereum from “proof-of-work” to “proof-of-stake” consensus, which will reduce the chain’s processing power and energy requirements, making Ethereum more environmentally friendly. Longer term, this transition will bring about a range of scaling and security benefits. This month we will dive into what the Merge is, how it is expected to take place and what the longer-term implications of the Merge are for Ethereum.
When Ethereum launched in 2015, its key innovation was a new execution layer known as the Ethereum Virtual Machine (EVM). In Bitcoin, there is a stripped-down execution environment and limited scripting language that makes it very difficult to do anything other than send Bitcoin between accounts. In Ethereum, the EVM allows developers to write arbitrary code which has led to a flourishing ecosystem of developers and applications running on Ethereum.
While the EVM was novel and unique, the consensus algorithm that Ethereum used was the same proof-of-work consensus algorithm that is used by Bitcoin. As a quick reminder, consensus algorithms are mechanisms that enable nodes in a network to come to agreement as to what the state of the network is. Simply spoken, the proof-of-stake algorithm randomly picks a validator who is then tasked to validate transactions, in contrast, in the proof-of-work consensus algorithm, miners all compete to solve a very complex cryptographic challenge, the winner of this challenge gets rewarded to validate the block. Through this competing process, all proof-of-work miners perform computations in parallel, making it very energy inefficient. As a result, proof-of-work consensus requires a large amount of processing power to guarantee security. Even at the time of Ethereum’s launch, it was clear that this proof-of-work consensus algorithm would need to be updated. As early as 2016, initial designs for Ethereum 2.0 were being presented at Devcon 2 in Shanghai, as the core developers looked for ways to transition to proof-of-stake and improve on Ethereum’s 14 transactions per second.
From 2016 onwards, new smart contract platforms like Solana started releasing their designs and most of these platforms were using proof-of-stake consensus. Proof-of-stake requires validators to post collateral to guarantee security, making it less energy intensive, more environmentally friendly and with potential scalability and security improvements. It was clear that proof-of-stake would be the future underlying engine of smart contract platforms and that Ethereum would need to migrate to remain competitive.
The upgrade to Ethereum 2.0 has been a long time coming. In November 2019, we wrote about the design and phases of this upgrade, which was by that point already two years in the making. There are many intricate parts of this upgrade and some parts have already taken place. In December 2020, the “Beacon Chain” was deployed. This is a proof-of-stake chain that is the beating heart of Ethereum 2.0.
The Beacon Chain has several responsibilities:
While the Beacon Chain has been operational for almost 2 years, it has not been processing transactions. During this time, there have been two Ethereum chains operating in parallel. What is happening this month is that the two chains are being combined, with the current Ethereum main chain merging with the Beacon Chain, hence the term “the Merge”.
The process of the Merge is a complicated one that will (hopefully) only ever happen once. There is not a set date for the Merge, but instead the Merge will take place when the target Terminal Total Difficulty (TTD) reaches 58750000000000. Every block that is mined on Ethereum has a level of difficulty that is going up. Once this specified TTD is reached, the Merge will be activated. As of today, the estimated time of the Merge is 15th September 2022 at 6am UTC. A countdown can be seen here.
Numerous tests have been completed of the Merge on various Ethereum testnets, and the core developers of Ethereum seem confident that the Merge will go through as intended. However, there are several risks and attacks that users will need to watch out for.
From short to longer term, some risks include:
There are risks surrounding the Merge, but the upside of this upgrade far outweighs the risks.
In the immediate term, from a user experience perspective, the Merge will have very little impact. Transaction fees will remain the same and transaction times will decrease only slightly, with block times shortening from about 14 seconds to 12 seconds. Longer term, the Merge sets the course for how Ethereum will scale and has several benefits.
From a technical perspective, the Merge is clearly required and has been a long time coming. At CMCC Global, we are excited by Ethereum’s technical roadmap and look forward to its more environmentally friendly proof-of-stake future. Ethereum is on a path to scalability, although it is not yet clear whether roll-ups on the Ethereum mainchain will be more impactful than sharding. The Merge allows both to co-exist and we will closely monitor developments between Layer-2 solutions and the longer-term deployment of shards.
From a price perspective, we are expecting short term volatility and long-term appreciation for ETH. The Merge has been telegraphed for many months and it has become the primary trading narrative for Ethereum. There is a risk that traders will “sell the news” leading to downward price pressure in the coming weeks. However, longer term, the structural change in ETH issuance, coupled with the incentive for users to stake (and lock up) ETH to earn yield, makes price appreciation likely. There will be 13,000 ETH less a day being created and given to miners, who are net sellers of ETH. We anticipate that this reduced selling pressure will impact market dynamics, pushing the price of ETH higher.
With the Merge (hopefully) completed this week, the natural question will be as to what is next for Ethereum. At a recent conference, Vitalik Buterin laid out further upgrades for Ethereum. He claims that Ethereum will only be 55% complete after the Merge and the target for Ethereum is to get to 100,000 transactions per second. To achieve this, Ethereum will need to go through what he calls the “surge,” “verge,” “purge,” and “splurge.” So fear not. There is still plenty for us to write about going forward!