The Merge is finally here. While the Ethereum community celebrates the coming of the Merge, some people are still wondering how we got here, what the Merge actually is, and what it all means for the future of Ethereum. Let's jump right in.
How did we get here?
To understand The Merge, we first need to know a bit about how Ethereum works. Ethereum consists of two different layers; a consensus layer and an execution layer, and is made up of a distributed network of computers (or nodes). These nodes come to an agreement about the state of the blockchain, and agree on any new blocks that are proposed. This agreement process is known as a consensus mechanism, and occurs on the consensus layer. The execution layer is responsible for handling the state of the network, including transactions, contracts and balances. In short, the execution layer handles all of the changes that happen on the network, while the consensus layer handles the agreement between nodes about those changes.
Before The Merge, Ethereum was secured using a Proof of Work (PoW) consensus layer, where miners race against each other to perform a computationally expensive problem, with the first miner to solve the problem proposing a new block to the network, and receiving rewards for doing so. The more computing power you have, the better your chances are at completing the work first (hence the term proof of work), however a mining setup requires hardware such as GPUs, and uses a significant amount of electricity.
A different consensus mechanism that can be used to secure a network is known as Proof of Stake (PoS). In a PoS mechanism, the network uses validators instead of miners. Validators effectively perform the same role as miners, but instead of needing to complete a computationally intensive problem, they stake ETH (i.e. put up collateral) against the validity of the transactions they are proposing. This ETH can be slashed/docked from the validator if they behave dishonestly.
What is The Merge?
The transition from PoW to PoS has been planned since Ethereum's launch, with preparation beginning in 2015. After much research, the Ethereum developers launched a PoS chain in parallel to the existing Ethereum chain, with its sole purpose being a PoS layer that can be tested and later used as part of The Merge.
So what is The Merge? In short, it is the point at which Ethereum's execution layer (commonly referred to as the Ethereum Mainnet) will merge with the parallel PoS consensus layer, essentially swapping out Ethereum's existing Proof of Work consensus layer for the new Proof of Stake layer. This will occur while Ethereum is still running, so it can be likened to swapping out a car's engine while it is still driving, or Indiana Jones performing the statue swap from Raider of the Lost Ark (although The Merge will work out better than that did).
It has been a long and difficult road to get to this point, which is why the Ethereum community is excited that The Merge is finally here. This year, the Ethereum developers have performed a series of dress rehearsals to test the transition to PoS. These have been performed on Ethereum testnets (developer networks used to test contracts and apps before deploying on the Ethereum Mainnet), with Ropsten (a testnet) transitioning on June 8, Sepolia (another testnet) on July 6, and more recently Goerli (another testnet) on August 10. All of these testnets successfully transitioned to PoS, and now the time has come for the real deal; the public Ethereum network.
What does this mean for Ethereum?
A greener Ethereum
One of the most notable effects of the change to PoS is the ~99.95% reduction in energy consumption. The majority of the energy consumption in securing the network using PoW comes from the mining process. Therefore, removing this requirement cuts the majority of the chain's energy consumption. With the PoW implementation having an energy consumption per year similar to that of the Netherlands, and carbon emissions per year similar to that of Singapore, the reduction from PoS brings Ethereum's energy consumption per year to below that of Netflix and PayPal. While this cannot be broken down to a per transaction estimate (as blocks are produced regardless of the number of transactions), it is clear that the move to PoS leads to a much greener Ethereum.
A path to becoming deflationary
The Merge also pushes Ether (Ethereum’s native currency) towards becoming deflationary. Under PoW, miners were issued with approximately 13,000 ETH/day as rewards. With the transition to PoS, this miner issuance is removed, and is replaced with approximately 1,600 ETH/day as rewards for stakers, which reduces the ETH issuance by ~90%! But how does this make Ether deflationary? Ethereum's current transaction fee model burns the majority of the transaction fee (ie. removes that portion of ETH from circulation), so if the transaction fees burn more ETH than is issued, it reduces the overall supply of ETH, making it deflationary.1
As mining is an expensive job, miners will often sell the majority of their rewards to cover the cost of their hardware and electricity. This results in a large portion of the ETH that is issued to miners under PoW to be sold each day (known as sell pressure). As rewards are no longer being paid to miners, there will be a large reduction in this sell pressure. As a quick example, assuming miners sell 80% of the 13,000 ETH issued per day under PoW (10,400 ETH) at a price of $1,600 USD/ETH, that is $16.64m USD of sell pressure that is removed from Ethereum per day. This massive reduction in sell pressure indicates a decrease in the supply of ETH that is looking to be sold, without changing the demand for purchasing ETH, lending itself towards an increase in ETH price.
The transition from PoW to PoS also makes Ethereum more secure. If a malicious user wanted to defraud the network, they would need to control either 51% of all nodes in the network under PoW, or own 51% of all staked ETH under PoS. With the USD value of staked ETH currently sitting around $23.45 billion USD, it would take a significant amount of money to buy and stake enough ETH to control 51% of the staked supply, let alone the difficulty to buy that amount. The cost to perform this type of attack under PoS is larger than the cost it would take to own enough hardware and cover the electricity costs to run 51% of the nodes under PoW. Because this cost is higher, it is more difficult to perform this attack under PoS, making it more secure than PoW. Even if a user was somehow able to control 51% of all staked ETH, there are always additional security measures available under PoS, as the Ethereum community can decide to ignore the fork containing the malicious user's blocks, and validators can keep using the minority chain. The community can also decide to remove the malicious actor from the network and destroy their staked ETH. In general, PoS provides a variety of security improvements and leads to a more stable future for Ethereum.
What does this all mean for users?
All of these changes are incredible steps forward for Ethereum, but what does this mean for everyday users? One immediate benefit is that the transition to PoS actually allows users to participate in the PoS validation. Users can stake their own ETH to the network, and in turn receive a share of the staking rewards, effectively providing yield on the staked Ether and turning their ETH into a yield-bearing asset. While it takes 32 ETH to run your own validating node, there are also liquid staking alternatives such as LIDO, Rocket Pool, and even through Coinbase. Liquid staking alternatives often provide a ‘staked ETH’ token to the user when they stake their ETH, which can then be used across many DeFi applications.2
While staking opportunities will be widely available moving forward, The Merge does not provide all of the benefits that users may have been hoping for. For example, The Merge does not result in lower gas fees or noticeably faster transactions, but it does set Ethereum up for future upgrades that will have direct benefits for users. It's a step in the right direction.
The future of Ethereum is bright, and The Merge is just the launching point for Ethereum's plan to address scalability and a ‘Layer 2’ (L2) future. Ethereum.org defines an L2 as a separate blockchain that extends Ethereum and inherits the security guarantees of Ethereum. Some popular L2s today include Optimism and Arbitrum.
While initial Ethereum upgrades will add in the ability to withdraw staked ETH, some of the future big ticket items include danksharding/proto-danksharding, proposer builder separation, and data availability sampling. These future improvements and what they entail are beyond the scope of this post, but will help provide greater transaction throughput and increase the amount of data that can be processed for the same amount of resources. This will help to increase the data space available to L2s, which in turn will allow for more data to be posted to the Ethereal mainnet, decreasing gas fees on L2s.
The team here at Family are incredibly excited about the success of The Merge and the future of Ethereum, and look forward to additional upgrades in the future.