The Ethereum blockchain is about to make one of the most crucial technical updates since its inception, going from proof-of-work (PoW) to proof-of-stake (PoS)also called Ethereum 2.0, or Eth2.
Ethereum developers have given September 19 as perpetual date of merger from the current PoW chain to the PoS chain. The merge is expected to roll out to Goerli’s testnet in the second week of August. After the successful integration of the Goerli testnet, the blockchain will launch the Bellatrix update in early August and roll out the merger two weeks later.
The discussion around the transition started with a focus on scalability, so the Ethereum developers came up with a three-phase transformation process. The transition itself has been in the works for almost two years, starting December 1, 2020, with the launch of Beacon Chain, kicking off phase 0 of the three-phase process.
The Beacon chain has begun the move to PoS, allowing users to stake their Ether (ETH) and become validators. However, phase 0 did not affect the main Ethereum blockchain: the Beacon chain exists alongside the main Ethereum network. However, the Beacon chain and mainnet will eventually be tied into the merger.
Phase 1 was supposed to launch in mid-2021, but was delayed to early 2022, with the developers citing unfinished work and code auditing as the main reasons. Starting in phase 1, Eth2 will host all of Ethereum’s transaction history and support smart contracts on the PoS network. Stakeholders and validators will officially spring into action as Eth2 removes mining from the network.
Phase 2, the final phase of the transition, will see the introduction of Ethereum WebAssembly, or eWASM, on the current Ethereum Virtual Machine (EVM). WebAssembly was created by the World Wide Web Consortium and is designed to make Ethereum much more efficient than it currently is. Ethereum WebAssembly is a proposed deterministic subset of WebAssembly for the Ethereum smart contract execution layer. The eWASM was specifically designed to replace the EVM, which would see implementation in Phase 2.
Marius Ciubotariu, co-founder of Hubble Protocol – a decentralized finance (DeFi) lending platform – told Cointelegraph that he is not really worried about the delays because any new technology with such broad implications on the ecosystem would take time:
“PoS is not yet online; however, I don’t see this as a concern. I understand that the merger took longer than some people think. But, with new technologies and the possibility of critical issues, an unhurried approach is best. As this merger goes live, I’m sure other protocols will appear. We will continue to innovate within the Ethereum community; something I have and continue to love to see/experience.
The impact of Merge on the Ethereum ecosystem
The upcoming merger will see the current PoW mainnet merge with the Beacon chain, transferring all of Ethereum’s history to the new chain. A complete change in consensus for an ecosystem as large as Ethereum will have a dramatic impact from a technical and political point of view.
Barney Chambers, co-founder and co-lead developer of cross-chain DeFi platform Umbria Network, told Cointelegraph that the merger will be difficult:
“Ethereum accumulation will centralize in the hands of validators who already hold the majority of the tokens. The Ethereum Foundation says the merger will not impact the price of Ethereum, but the merger will bring about a fundamental change in how new tokens are distributed and this will have a dramatic effect on the price of Ethereum and the entire cryptocurrency ecosystem.”
The difficulty level of proof-of-work mining will skyrocket due to the difficulty bomb, making it unable to take mining to economically viable scales. The Difficulty Bomb is code ingrained in the Ethereum protocol since 2015. It is set to run whenever a specific number of blocks have been mined and added to the blockchain. This makes mining on the existing proof-of-work blockchain much more difficult.
As a result, Ethereum’s proof-of-work chain would be forced to stop generating blocks, as difficulty bombs would make mining a block nearly impossible. This situation is described by its developers as an “ice age”. The simple objective of the bomb is to encourage miners to fully merge, which will increase the adoption of the proof-of-stake chain.
The transition to a new PoS network has become necessary for Ethereum, given its expanding ecosystem leading to several network congestions and very high gas fees. Over the past year, however, the narrative has also shifted towards more environmentally friendly PoS than PoW. While some are lauding Eth2 as paving the way for a more environmentally friendly protocol, Patricia Trompeter, CEO of carbon-neutral crypto mining company Sphere3D, has other thoughts. Trompeter told Cointelegraph:
“PoS only leads to wasteful spending and misallocation of energy resources, as ‘band-aid solutions’ and marketing programs like the ‘Change The Code’ campaign offer no solution to a complete turnaround of industry towards renewable resources.”
Patricia believes that PoS instead dismantles the crypto’s decentralized infrastructure, “pushing power to the wealthiest holders with unimpeachable control over users.”
After the merger, ETH issuance will drop to around 0.6 million per year, with a similar amount of 2.7 million ETH burned, meaning a net 2.1 million ETH burned per year , or -7% in one year. Supply of ETH, making it a deflationary asset. ETH miners will be officially out of business once the difficulty bomb hits, being forced to mine other PoW coins with the same hashing algorithm for their existing gear or exit the market altogether.
Ethereum co-founder Vitalik Buterin predicted that the transition would not only help scale the network, but also reduce energy consumption by 95%. Transaction processing speed should be comparable to centralized payment processors. However, none of these features would arrive with the merge on September 19.
The main scalability solution called sharding that enables parallel processing of transactions will only arrive after the completion of phase 2, which is expected to take place in the second half of 2023.
Daniel Dizon, co-founder and CEO of non-custodial and liquid ETH staking protocol, the Swell Network, told Cointelegraph:
“The merger represents a significant change to Ethereum’s underlying business model and hardware requirements, resulting in a massive reduction in power generation. It is expected that there will be a significant demand for ETH, as the rewards for participating in ETH staking will increase significantly through priority fees and MEV capture. The implication of the merger is not fully taken into account. The increased demand and reduced issuance of ETH will lead to structural upward pressure on prices compared to the current state of Ethereum today.
Does the merger make Ethereum a stock?
Aside from the technical and financial impact of the merger, the biggest discussion seems to be whether Ether would qualify as secure once the network transitions to PoS. The discussion has gained a lot of momentum online in recent days and the answer to the question depends on who you ask.
Debate around the security status of Ethereum was prevalent long before the transition to PoS came into play. The debate escalated significantly after the U.S. Securities and Exchange Commission filed a lawsuit against Ripple, deeming its sale of XRP tokens as security.
Many XRP proponents have since pointed to ETH’s “pre-mine” and often blamed the SEC for giving Ethereum a free pass. The confusion and dilemma around security status stems from a lack of clear regulation for the crypto market. While lawmakers agree that Bitcoin (BTC) can be considered an independent asset class, the status of Ethereum has been the subject of debate.
Adam Levitin, research professor at Georgetown University Law Center, explained what could make the PoS-based Ethereum network safe in the eyes of regulators:
I’ve had negative reactions here, so let me elaborate. “Security” includes an “investment contract”. “Investment contract” is defined by SCOTUS in Howey as a K for investment in a joint venture where profits are expected “solely from the efforts” of a third party. 2/
— Adam Levitin (@AdamLevitin) July 24, 2022
He added that “Howey speaks of an investment of ‘money’, but that has always been interpreted to mean simply an investment of value. Placing a stake easily satisfies this element.
Coin Metrics co-founder Jacob Franek countered Levitin’s argument, suggesting that Ethereum is one of the most decentralized platforms with open source support.
3/ Is there a problem with the disclosures today?
Ethereum is an open-source distributed project.
It has arguably the most transparent, real-time disclosures of any distributed project and certainly more than a traditional, centralized company.
— Jacob Franek (hiring) (@panekkkk) July 24, 2022
Another major concern with the PoS transition has been the centralization of the decision-making process. Konstantin Boyko-Romanovsky, CEO of reward monitoring and block transaction validation platform Allnodes, told Cointelegraph:
“While the risk of centralization with Ethereum’s new PoS consensus mechanism exists, it is far from realized. So far, the strong community behind the Ethereum network has met all the challenges, and there is no reason to assume that the problem of centralization will not be solved either.
The Ethereum blockchain has become the backbone of DeFi, non-fungible tokens, and decentralized autonomous organizations. While the ecosystem will continue to support these nascent use cases, the true transition to PoS with sharding and high scalability features will not be available until after 2023. The success of Eth2 will depend heavily on the execution of the final phase, but many market experts are still skeptical on this subject, in view of past delays.