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Understanding The Ethereum Merge : Benefits and Risks

Understanding The Ethereum Merge : Benefits and Risks

The Ethereum network, on which Ether, the second largest cryptocurrency in the world by market capitalization, depends, is about to experience the biggest change in its history: the transition from a Blockchain following a proof-of-work protocol to a Blockchain following a proof-of-stake protocol.

This update of the Ethereum network will have a significant impact on the Blockchain's energy consumption, its transaction management capabilities, as well as the market structure and price of Ether (ETH).

Understanding The Ethereum Merge : Benefits and Risks

The first advance was made on September 6, 2022 with Operation Bellatrix and it will be followed by Operation Paris before the end of the month.

Although the merger could benefit most users and a new category of miners, it also worries some players who could be the big losers of this new Blockchain.

Thus, the miners who had until then ensured the viability of the network find themselves penalized, while many users fear that the security and integrity of the cryptocurrency are threatened.

Decryption of a revolution in the world of crypto currencies.

What is “The Merge” on Ethereum?

In technical terms, "The Merge", or the merger, is the update that allows the Ethereum cryptocurrency to move from a Proof of Work (PoW) Blockchain to a Proof of Stake Blockchain. (Proof of Stake or PoS) – these two systems being two different ways of authenticating and validating transactions on a network.

With the proof-of-work consensus protocol, the transaction is validated by the miner who finds, as quickly as possible, a way to insert a transaction into a new block by solving a complex mathematical problem. Mining power translates into hash, which is the ability of miners to generate transactions in the network.

Proof of stake radically changes the transaction validation mechanism. This protocol makes it possible to validate a transaction more quickly thanks to a staking process (immobilization of tokens to become a validator and obtain rewards). It is important to note that validators are randomly selected.

The Ethereum Foundation will request to have immobilized an amount of 32 ETH to be part of the list of candidates for the validation of a block. This sum represents the equivalent of 54,000$ at the time of writing this article in September 2022.

This shift from proof-of-work to proof-of-stake will significantly increase network efficiency and scalability.

“Staking ETH and becoming a validator is easier than mining (which currently secures the network). And we hope this will help improve the security of Ethereum in the long run. The higher the number of participants on the network, the more it will be decentralized and safe from attacks."

While the crypto community has long talked about Ethereum 2.0, many announcements of network updates have been made since the end of 2020. However, the technical means to evolve the network of a cryptocurrency also important are colossal, which caused some delay in the implementation of the merger.

The stages of “The Ethereum Merge”

The transition from one type of Blockchain to another requires several steps and the implementation of special measures. Thus, on September 6, 2022, the first major step of the merger, named "Bellatrix", was completed. It is followed by the “Paris” stage in the following 10 days.

The Bellatrix stage was made thanks to the beacon chain, a flagship chain in French, specially designed for the occasion. It allows to introduce the proof of stake protocol on the Ethereum network. Also, the beacon chain is responsible for randomly selecting validators to secure the network.

Nevertheless, this step is bad news for ETH miners who have invested in high performance mining hardware. Indeed, if the random selection of validators is now the rule for validating transactions on the Ethereum network, then the remuneration is no longer made according to the “merit” of the minor, but according to chance.

Finally, the Paris operation, which begins in the second half of September, finalizes the complete transition of the Ethereum Blockchain update. As of September 10, 2022, the beacon chain already had nearly 425,000 active validators.

Benefits of “The Ethereum Merge”

The merger was highly anticipated by the community. Indeed, despite some drawbacks and limitations, this update should benefit most market players.

The first benefit is that switching to proof-of-stake helps maintain, or even slightly increase, the speed of the network. Before September 6, 2022 (the date of the first stage of transition to the new Blockchain), the number of transactions per second of the Ethereum network was 13.

After the merger, the number of realizable transactions should be significantly higher. Since the means necessary for the validation of a block will be less important, this should mechanically increase the quantity of transactions processable by the system as a whole.

Finally, the security of a network using proof of stake is ensured as the number of validators increases.

In its presentation of the beacon chain, Ethereum specifies that the risk of collusion between the actors and the takeover of a fragment (corruption of transactions) has "less than a billion chances" of occurring.

A large number of actors on the network indeed decreases the probability of simultaneously encountering dishonest validators who can, so to speak, corrupt the network.

Towards a greener Ethereum network?

Crypto currencies are often criticized for their energy consumption, at least for some of them. The first two cryptocurrencies in the world, Bitcoin (BTC) and Ethereum (ETH), in fact alone share almost 60% of all the energy consumption of the market, that is to say about as much than their market share.

According to Polygon (MATIC), “The Merge” update could significantly reduce carbon emissions from the Ethereum network. Not to mention that “The Merge” does not only benefit Ethereum, but all projects, tokens and Blockchains connected to the Ethereum network.

In its tweet, Polygon states, “The merger is estimated to offset 99.91% of the carbon emissions from the Polygon network, reducing the annual total to just 56.22 tCO2e.”

Several specialists have looked into the question of reducing the energy consumption of the network.

According to researcher Carl Beekhuizen of the Ethereum Foundation, Ethereum consumption could be reduced by more than 99% thanks to the network update. This would represent a saving in energy consumption equivalent to that of 2.7 million French people (considering a carbon emission per French person of 4.6 tonnes per year).

On this aspect alone, “The Merge” is a revolution as such.

The criticisms often addressed concerning the polluting nature of crypto currencies should therefore be significantly less important in the future, which could constitute an additional means of democratizing crypto currencies.

What are the risks for Ethereum users?

Ethereum is not just Ethereum. It is also one of the references of an entire market!

Indeed, the Ethereum network serves both Decentralized Finance (DeFi) applications, stablecoins, as well as NFTs and many other market projects. This update may therefore lead to certain risks that affect much more than the Ethereum network.

In a tweet critical of Ethereum, Maggie love recalls that more than half of the nodes of the Ethereum network are hosted by Amazon, 15% by Hetzner and 4.1% by OVH.

As a reminder, the nodes designate the computer resources that ensure the storage and validation of the data. Updating Ethereum based on a random selection of minors also increases the risk that the network will find itself very centralized with certain hosts.

The risk of centralization is not only IT, it is also legal.

Among the players in the beacon chain, we find the staking specialist Lido (30%), followed by Coinbase (14.6%) or even Kraken and Binance (15%). By category, network players are whales (big players) for 11.5%, exchange platforms for almost a third of contributors (31%), as well as staking platforms for more than 40%!

According to some estimates, nearly two-thirds of beacon chain players would agree with the American authority Office of Foreign Assets Control (OFAC). In other words, the presence of stronger regulations among the actors of the Ethereum network would be enough to tip the latter.

Finally, there is the question of cost.

Since “The Merge” update will not (or slightly) increase the transaction throughput on the network, it should not massively decrease the cost of transactions on the network.

Until now, the cost of Blockchain transactions has been a major drawback of Ethereum – and should remain so. Despite the reduction in energy consumption, the fees to be paid to validate a transaction will probably remain similar to those currently applied.

Ethereum: a major update that does not fix everything

We have seen that the Ethereum update “The Merge” will mark the history of the world of crypto currencies in addition to that of Ethereum.

This event will have consequences on several levels, since the transition from a Blockchain of proof of work to a Blockchain of proof of stake will increase the transaction volumes achievable on the Ethereum network, reduce its energy cost by almost 99% and maintain globally the throughput of transactions validated at the same level.

However, some limitations of the Ethereum network might remain.

First, transaction costs are likely to remain quite high. In addition, several specialists and critics of the network point to the risks of legal or IT centralization of the Blockchain. This represents an important argument weighing on the security of the network – although the management of Ethereum ensures the maintenance of the latter with the new Blockchain.