The Next Big Step in the Ethereum Roadmap
The Ethereum Merge is one of the most anticipated events of 2022. This will be the time when the Ethereum protocol moves from proof-of-work to proof-of-stake. What will this mean for investors? Read here as we examine the future of one of the most talked about protocols in the crypto asset class.
What is the Blockchain?
The blockchain is exactly that- a chain of blocks. Each block contains a number of the most recent transactions. If Alice wants to send Bob $5, this transaction is recorded on the blockchain and their wallets are updated with the new balance.
If Alice used a centralized company like Venmo or Western Union, she would have to submit the transaction to the company, who serves as a middleman. This centralized company then approves if the transaction goes through and updates their wallets.
This company will then take a fee for performing the service of transacting money. This fee can be substantial when transferring money internationally or to areas without significant financial infrastructure.
With the Blockchain, it does not matter where in the world Alice or Bob are located. They are able to make their transaction without permission from any centralized actor.
Blockchain transactions are stored in blocks and validated by other computers (also called nodes) that are connected to the blockchain. These nodes ensure that transactions are honest and no one can forge a transaction.
Blocks are created one at a time, and only one computer is able to make each block. To choose which computer is able to make the block, blockchains use a method called a consensus mechanism.
The two most common consensus mechanisms are proof-of-work and proof-of-stake.
The Merge is the migration of the Ethereum protocol from proof-of-work to proof-of-stake.
Proof of Work
Proof of work is the consensus mechanism of Bitcoin and Ethereum before the Merge.
In the example of Bitcoin, computers are used to solve complex math equations in order to create a block to house transactions.
All other nodes on the network are able to verify these transactions are honest.
The computer to solve the equation first and create the block is rewarded with the native coin, Bitcoin.
Proof of Stake
Proof of stake is another option as a consensus mechanism. As an example, we will take Ethereum after the Merge has occurred.
Instead of choosing a computer to make a block based on solving an algorithm, blocks are made by computers that hold the Ethereum coin.
These computers holding Ethereum are called ‘stake pools’ and are rewarded with more Ethereum for creating blocks and validating the network.
Why does any of this matter?
This has been a lot of computer science so far. Why does any of this actually matter? What will the merge from proof-of-work to proof-of-stake do to Ethereum?
Ethereum holders will now be able to delegate their ETH to a stakepool and earn up to 12% APY on their ETH. With all this ETH in stakepools, there will be less sell pressure as liquidity will be tied up in staking.
The Merge will also decrease the inflation of ETH. There will be a significant decrease in ETH issuance after the merge.
The issuance of ETH under proof-of-stake will be 10% of the issuance under proof-of-work. That’s a 90% decrease by moving to this new system.
Gas fees are the fees to complete a transaction. To relate to the previous example where Alice sends Bob $5, Alice will have to pay this fee to complete the transaction. The ETH spent in gas fees is burned.
Once a gas fee has been paid, the ETH spent in gas is gone forever. There is no way for any user to access burned ETH.
Considering the ETH being spent in gas fees is burned, and with this decrease in issuance, ETH could become a deflationary asset.
What about the gas fees?
A transaction on Ethereum costs too much in gas fees for it to be a possibility for most average users. When will we get cheaper fees?
A common misconception is that the Merge will lower gas fees. It will not. This means that protocol transactions will not be cheaper because of the Merge.
There are Ethereum Improvement Proposals (EIP) that are scheduled to lower gas fees on the main chain in the future.
In the meantime, check out this article on how to navigate layer two solutions for affordable transactions.
What needs to happen first?
Ethereum is currently practicing the Merge on different testnets. A testnet is an environment that is similar to the main blockchain where developers can practice their code before official deployment.
This is allowing the developers working on the Merge and developers running nodes to practice the transition so that when the main protocol is migrated, all bugs and issues would have already been solved.
During the Merge, the entire transition will be handled by the computers running nodes and there will be no change to the user. All on-chain assets, like your favorite meme-coin or DeFi liquidity pool will remain unaffected.
Once the Merge is initiated, all developers and protocols will switch to the proof-of-stake chain and will be unable to mine on the proof-of-work chain. Miners will no longer be able to mine ethereum and will have to use proof-of-stake.
We will then begin the next era of the Ethereum roadmap, moving forward towards a more decentralized financial system, not controlled by any one group, but open to all.
Final Thoughts
The Merge is an exciting time for investors and the crypto ecosystem as a whole.
ETH holders will soon receive lucrative dividends on their investment. Coupled with the decreased sell pressure from staked ETH, there is a supply-shock coming that will have unfathomable effects on trading price.
Despite current macro market conditions, now is an exciting time for adventurous investors to accumulate a key asset in the crypto market class. The fundamentals of crypto have never been stronger.
