One of the most long-awaited events in the cryptocurrency space appears to finally actually be happening: Ethereum’s transition from Proof-of-Work (PoW) to Proof-of-Stake (PoS).
The transformation of the second largest blockchain has long been shrouded in fear, uncertainty and doubt. The onset of a new crypto winter led many to believe that the change would be postponed yet again or not happen at all, in the face of insurmountable complexity and civil war within the Ethereum community.
That still cannot be ruled out. But with market sentiment recently being at rock bottom, much more attention has been paid to all the possible ways the Merge could derail, rather than the fact that the process has been moving forward.
The third and final rehearsal before the Mainnet Merge is taking place this week, when the Goerli testnet transitions to PoS, expected to be completed by August 12th. Provided that the testnet merge goes according to plan an announcement of the time schedule for the Mainnet Merge is likely to follow.
The Mainnet Merge will see the legacy (PoW) Ethereum blockchain is being merged with a special-purpose (PoS) blockchain called the Beacon Chain, which launched on December 1st, 2020. (Bankless has compiled an informative list of FAQs surrounding the Merge here and another good primer can be read here.)
90% lower ETH issuance
The Merge, provided it succeeds, will lead to a ~90% reduction in ETH issuance. Money supply growth will reduce from ~4% per year to close to zero. The effects of the Merge on ETH money supply can be simulated here. The overall supply of ETH in circulation will peak around the Merge and is predicted to decline going forward as the amount of ETH being burnt outstrips the amount of ETH being issued.
The Merge has been likened to a “Triple halving”, in Bitcoin parlance, because the deflationary impact of the change to PoS is roughly equivalent to the effect of three Bitcoin halvings (which of course only happens once every fourth year, with the next one on track in 2024).
With annual ETH issuance being reduced by approx. 5 million ETH, that translates to approx. $8,5b at current prices (~1.700USD/ETH). Considering that most new ETH issuance have tended to be sold directly in the market by miners, that is a lot of selling pressure that will disappear going forward after the Merge.
~99.95% less energy use
Post-Merge, Ethereum will also use ~99.95% less energy than it currently does.
Whether changing to PoS represents an improvement from PoW is a separate debate. But the change to PoS pre-empts any criticism of Ethereum for heavy energy use. If that will lead to increased adoption/investment from actors that previously have had ESG concerns remains to be seen, but it is definitely a possibility given how sticky (fair or unfair) the energy critique has been.
So will the Merge now actually happen? Or will it be delayed yet again?
In his latest essay where he outlines why he is “max bidding” ETH Arthur Hayes makes a logical deduction why he believes the Merge now is for real. Because the one group that is both the best informed and that stand to lose the most from the Merge, namely the Ethereum miners, is turning increasingly vocal about and mobilising against the Merge.
Just like Bitcoin miners Ethereum miners have been generating revenue by solving computationally difficult puzzles to produce blocks of transactions. With the transition to PoS the miners will be rendered out of business. There are few if any other blockchains with the size and scale of Ethereum that the miners can allocate their resources to instead. Naturally they are not happy. Some have indicated that they will turn to supporting Ethereum Classic, that hard-forked from Ethereum in 2016.
Another very possible scenario is that the Merge will lead to another hard-fork and the creation of a PoW Ethereum blockchain that will continue to run in parallel with the main PoS chain.
On the other hand Ethereum founder Vitalik Buterin has played down the impact of any post-Merge hard forks.
Whereas the miners stand to lose, validators stand to generate attractive returns from staking ETH under the new PoS mechanism. If the Merge happened today, validators could expect to earn a total of ~8–12% APR, although yields are likely to be brought down as the demand for staking ETH increases.
The yield-earning potential from ETH staking (without the type of crazy credit risk that recently got many speculators in various DeFi yield farming schemes severly burnt) is a potential game changer, as it significantly increases the attractiveness of Ethereum as a financial asset.
Price volatility will in all likelihood continue to be a feature, but for investors that in any case would be holding ETH, the ability to pocket yields is a big added advantage.
While Ethereum remains down approximately 2/3 from the November ATH, it has doubled from the June bottoms below $1.000, as the sentiment has tentatively improved.
There is of course still a chance that the Ethereum Merge could turn into an unmitigated disaster, which in case would freeze the whole Cryptosphere in a deep winter like the White Witch of Narnia. But for the moment it does actually look like the Merge will at long last take place and turn Ethereum into an energy efficient, environmentally friendly Blockchain, that will further distinguish it from its big brother Bitcoin.