The Ethereum Merge Explained

Within the last few weeks, a lot has been said about the ethereum merge. Many people have called it the most important event in the history of crypto and would change crypto forever.

Despite all the hype and talks, it’s obvious that a lot of people don’t understand what it’s all about & the implications on the blockchain and the economy. The thread is aimed at bridging the knowledge gap & simplifying the concept of Ethereum merge for even a layman to grasp.

The Purpose of the Merge

The ethereum merge is the joining of the existing layer of the ethereum blockchain (the mainnet we're currently using) with the new proof of stake consensus layer, the Beacon chain.

Presently, ethereum mainnet operates on a proof of work (POW) consensus mechanism. The network is secured by miners who consume electricity to validate transactions and add them to a block in the blockchain.

In the proof of stake (POS) mechanism, there is no need for miners. The network is secured by validators. These validators have to stake ethereum to validate the network. Instead of having many miners competing in an energy-intensive fashion to solve the puzzle and create the same block, validators are chosen based on a selection algorithm that takes the size of their stake into account.

Once a validator is selected, they have the exclusive right to create a block. This mechanism consumes less electricity and has higher transactions per second(tps).

The purpose of the transition to POS is to make the Ethereum blockchain more energy efficient, secured and scalable. The merge fixes its massive carbon footprint reducing 99% of its power usage making Ethereum a more environmental friendly solution

Due to the risks involved in transitioning to POS from POW, the Ethereum researchers decided to split it into two steps. The first step was to launch the “Beacon chain”. This was successfully executed in December 2020.

This created a parallel POS chain that could be tested for some time without having any impact on the existing POW chain. This also gave enough time to stakers to stake more ETH so that the amount of staked ETH would be sufficient when the POS chain fully launches.

The Beacon chain currently has over four hundred thousand (400,000) validators and over thirteen million ETH actively staked. The Merge is the second step of the launch. This phase merges the POS Beacon chain with the already existing POW mainnet.

Why is this merge necessary and what is the motivation behind the merge?

1- It will make ethereum ESG (Environmental, Social, Governance) compliant. The POS mechanism uses less energy so would have little or no importance on the environment.

2- It will lead to a reduction in the Ethereum issuance. Since both the POW and POS chains are funded by Ethereum issuance, after the merge, the POW network would cease to exist, thus dramatically reducing ETH issuance. This concept is called “Triple halving”.

3-It makes the network more decentralized. Ethereum enthusiasts can be more involved in the network by becoming validators.

This would make the network more decentralized as more people can become validators/ consensus participants as opposed to mining which was mainly for institutions and sophisticated miners.

What are the positive implications of the merge?

1- The block time on the merged POS chain would be lower than what is obtainable in the existing POW chain. There will also be a reduction in the block time variance which should cause a faster confirmation of transactions.

2- It would further cement the distinction between Bitcoin and Ethereum as Bitcoin would be known for its POW mechanism and Ethereum for its energy efficient POS mechanism.

3- The merge could become a deflationary asset as it would likely decrease the ETH supply over time.

Are there really risks involved in the Merge?

The Ethereum merge promised to be one of the biggest events in the history of cryptocurrency but it comes with a few risks.

Some of the risks include:

1-Threat to stablecoins: There are concerns that the ethereum merge may pose a threat to the stability of stable coins.

Most stablecoins on the Ethereum blockchain are locked in smart contracts on the blockchain.

MakerDAO made a video stating their fears that major stablecoins such as USDT and USDC may lose their pegs due to negative funding.

2- There is also the possibility of network outages or downtime during the transition from Proof of Work (PoW) to Proof of Stake (PoS). The Ethereum team has been working for the past one and a half years to prevent this from happening, but there's a growing possibility.

3- The merge could lead to perpetual backwardness in the contract as future may trade below the market spot price.

4- Risk to DeFi: The merger poses a risk to Decentralized Finanace (DeFi). DeFi platforms like Aave are already putting cautionary measures in place to mitigate the effect of the merger on them, in case it takes a negative toll.

Aave recently started a governance vote to temporarily pause ETH borrowing

The risk in the DeFi market is users can potentially benefit from ETH POW by borrowing ETH before the merge. Returning the borrowed ETH after the merge would make the Blockchain interpret it as staked ETH.

Some of the Misconceptions about the Ethereum Merge.

1- Ethereum gas fee will reduce after the merge. This isn't true! At least the merge doesn't do this directly. Reducing gas fees would involve working on the network capacity and throughput.

The merge doesn't do this but can lay the groundwork for this procedure later on.

2- Ethereum transactions would become faster after the merge. There's some truth to this rumour but Ethereum transactions would not be “noticeably” faster.

The beacon chain allows validators to publish a block every 12 seconds as opposed to 13.3 seconds in the mainnet. Ethereum developers believe that transitioning to PoS will enable a 10% increase in block production, the slight improvement will go unnoticed by users.

3- Investors would be able to withdraw staked ETH after the merge. Staked ETH (stETH) is a cryptocurrency backed by Ether and it currently lies locked on the Beacon chain.

Most users are euphoric and expecting to withdraw their staked ETH after the merge but the developer community has debunked the rumours confirming that the upgrade doesn't facilitate this change. Withdrawal of staked ETH would be made available during the Shanghai upgrade.

4- Validators will not be able to withdraw ETH rewards till the Shanghai upgrade. This is another huge misconception. Validators would have immediate access to their rewards immediately after the merge is completed.

Sources: Twitter: @symphonyfinance, @spacepalsdao

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