What is “the merge” and what does it mean for the future of Ethereum? PoS vs PoW, Myths busted and explainer text and video
What is ETH PoS?
Simply put, it’s ETH PoS blockchain network upgrade. ETH is moving from a Proof of Work (PoW) network to a Proof of Stake (PoS) network.
Given that hundreds of DApps (decentralised applications) are running and being built on existing PoW, thousands of PoW nodes validating the network every second and millions of users on the network, this transition was never going to be easy or quick.
PoW not only consumes a lot of electricity but also becomes expensive after a while when millions of transactions are run on it. Moreover, miners have to work on expensive hardware that needs constant electricity and is always at the mercy of regulators like what we saw in China.
PoS eliminates all that. Validators are staking ETH to verify their transactions. In other words – skin in the game. The node validators are betting that what they have verified is correct, and if they are playing any games – their ETH could be confiscated. In return they earn a transaction fee. The more they stake, the more chances they have of being selected as a validator in that particular block / transaction.
You can read more about PoS & its design philosophy here by Vitalik Buterin or more here
How is ETH going to transition from PoW to PoS?
ETH is going to transition in 3 main phases
1. Beacon Chain: This starts by creating a separate parallel chain. A separate chain from the current Mainnet. This Beacon Chain was launched in December 2020 to mark the start of transition from PoW to PoS.
2. The Merge: As the name suggests, the Mainnet and the Beacon Chain merge so that the Ethereum Mainnet starts using PoS consensus. This is expected to launch by Q2/Q3 2022. This can be delayed, but is surely happening. Ahead of this complete transition, the Kiln Testnet Merge went live on March 15. The Testnet currently has over 300,000 validators, 37% of which are home validators. Also, a strong deflationary model is being implemented – EIP-1559. This will replace user bidding with an automated bidding system and the burning of all transaction fees, thereby reducing the $ETH supply (aka deflation).
I’ve spoken in length about this previously here on the podcast
3. Sharding: Think of this as scalability. From current ~15 txs per second, ETH PoS will be able to handle several thousands of tps post Sharding. Basically, the chain is going to be split into smaller chains called “shards” reporting in to the main chain for verification. This is however expected sometime in 2023. Post Sharding we should see many DApps move to these ETH 2.0 sub chains.
Benefits of the Merge – Deflationary Asset with Low Energy Consumption
1. A daily emissions from 12,000 ETH to 1280 ETH
2. Yearly inflation goes down from 4.3% to 0.43% (also termed as Triple Halving in reference to Bitcoin four yearly halvings – the equivalent of three halvings concurrently on Ether.
3. PoS validator rewards go up from 4.5% to around 10-15% in weeks and months after the Merge
4. Energy consumption drops by 99.5%
5. Hundreds of thousands of people will be able to run PoS validators at home making the network even more secure
6. EIP 1559 will further burn ETH making it net a net burn asset – net deflationary
You can read more on energy consumption here from Ethereum Org
Busting some Merge Myths – What will the Merge NOT Achieve?
- Merge will NOT make ETH gas prices cheaper – Future updates on the Ethereum roadmap such as Sharding should help to improve gas prices.
- Miners fees will NOT go up – rather they will simply be paid to the block proposer of the proof-of-stake block instead of a proof-of-work miner
- There will NOT be a new ETH 2 token. It is not a new network, with a new token or an ICO on Binance. This is just a transition.
- You DO NOT need to do anything with your existing ETH coins. Scammers will be asking you to upgrade to new ETH2 coin. Beware.
You can learn more about ETH 2.0 or ETH Merge in this video by Kris
Summary – The Bullish ETH Narrative
The ETH merge narrative is going to start building in the coming weeks and months. This should probably be the most bullish event for crypto in late 2022. What will push this narrative further? Let’s examine some key points:
1. Fee burn as explained above will remove most liquid supply, making ETH a net deflationary asset
2. Developer activity on ETH is stronger and larger than any other network. Thousands of DeFi, NFT and trading DAapps that continue to build and grow non-stop on ETH
3. Layer 2s, that are flavour of the season, are all verifying on the main chain, thereby adding pressure to base Ethereum layer and in turn price
4. Defi Yields & Staking are locking away further ETH supply
5. Institutions are looking for the next BTC and have found this new love via ETFs, and an ESG thesis
6. EIP1559 expected in Q3 and so is the Merge, act as a triple halving event.
7. ETH/BTC ratio increase will bring more retail onto ETH bandwagon. Imagine ETH four times vs (10K) and BTC only doubling (80K). ETH maxis will go bonkers
8. Ethereum has grown by roughly 1,200 developers in the last 12 months and a total of 4,000 developers whereas all of Solana’s developers combined (~1000) is less than the number of developers that entered the Ethereum ecosystem in the last year
9. While the Merge could extend into Q1 2023, the narrative should start building in Q3. Which means you should be start readying yourself in Q2. In other words, any dips now should be bought below $3000. Ideally given the macro conditions, one should DCA gradually into some ETH