September 28, 2022

Understanding and Navigating the Ethereum Merge

By Mathis Biton

Ethereum’s long-awaited technology “merge” happened a few weeks ago, sparking responses from stakeholders in the space and beyond. What does the merge entail, why does it matter, and what are the implications for web3? What follows is a synthetic answer to each of these questions.

What the merge entails

Let us begin with the basics. Cryptocurrencies are decentralized and, as such, need to be verified by computers to make transactions visible. The merge refers to the upgrade from a “proof-of-work” verification mechanism to a “proof-of-stake” model.

Proof-of-work and proof-of-stake help users perform secure transactions by making it difficult and expensive for bad actors to commit fraud. Those mechanisms force participants to prove that they have supplied a resource to the blockchain, be it computing power or money. The critical difference between proof-of-work and proof-of-stake is how the algorithm qualifies and chooses users for adding transactions to the blockchain.

We don’t need to get into technical details, but the financial implications of each model are substantial. A proof-of-work system requires fast computers that use large amounts of resources; as the network grows, the transaction time often slows down. With the merge, Ethereum replaced its proof-of-work model with proof-of-stake, making transactions faster, cheaper, and less energy-intensive.

But all of these changes will not happen overnight; while energy consumption will decrease immediately, the cost and speed of translation are unlikely to be affected. As Ethereum’s core developer Danno Ferrin said, “to most ordinary users, the merge means mostly nothing.”

Still, energy consumption matters. Crypto’s environmental impact has become a significant point of criticism against the space, with the Biden administration floating the idea of limiting mining and usage if the process does not become more efficient. Before the merge, it was estimated that  Ethereum was using approximately 72 Terawatt- hours per year, about as much as the country of Austria. The merge is excellent news for socially conscious users or investors who simply want to avoid regulations. According to the Ethereum Foundation, the transition reduced Ethereum’s energy consumption by 99.95%. Coupled with an eventual decrease in transaction costs, this change could impact the space positively.

After all, Ethereum is the second largest cryptocurrency based on market cap, trailing only Bitcoin.  When something happens to Ethereum, it reshapes the entire crypto universe.

What are the implications

First, the process by which the merge happened reveals the importance of web3 governance. The Ethereum foundation first talked about the merge over four years ago, and the fact that it took so long to execute has to do with the conflicting incentives of stakeholders. On the one hand, users demand better environmental performance – and some socially conscious users may join the ecosystem now that performance has improved. Conversely, the move from proof-of-work to proof-of-stake ostracizes miners, who broadly represent another key constituency for Ethereum and crypto.

More than open-source software, Ethereum is akin to a nation-state with different constituencies, institutions, and problems that mirror those of real-life political entities. We can draw parallels between President Biden’s recent student loan cancellation and the merge. In the former case, those who put tremendous effort into paying their student loans wonder why others should have it any other way – even if the policy did improve the lives of others. In the latter case, miners who put tremendous effort into the proof-of-work model wonder why others should have it any other way – even if the transition improves the whole ecosystem. For those who think of web3 as the next layer of human coordination, putting these socio-political dynamics at the center of the space – as opposed to treating them as an afterthought or a technical malfunction–represents a key challenge for the crypto world. Most crypto enthusiasts are engineers and computer scientists, not sociologists and philosophers. But the question of governance is no longer avoidable.

Second, and more broadly, the merge marks an occasion to reflect on the place of “layer 1” ecosystems like Ethereum, on top of which the entire web3 space is built. Will the future bring more centralization, with Ethereum and Bitcoin capturing almost all of the value? After all, many layer 1s justify their existence by pointing to their cheaper, more environmentally friendly transactions. If the two giants improve their infrastructure, will those smaller ecosystems remain? Perhaps we will also see more specialized ecosystems emerge. Klaytn, for example, distinguishes itself by its regional specialization (Asia) and its focus on the intersection between the metaverse and web3. This sort of strategic positioning might become the norm in a world where technicals are no longer the distinguishing feature.

Final Words

We are still too early to evaluate the merge and its consequences. While the process went smoothly, and no crisis has emerged in the aftermath, the long-term ramifications remain. Nevertheless, the merge already represents an important movement in the rise of crypto because it symbolizes a moment of reform – one during which the ecosystem came together, despite conflicting incentives, to make its infrastructure more secure and sustainable. In this respect, the Ethereum Foundation has much to be proud of.

Mathis Biton is a graduate student at Yale University, a start-up founder, and the NYU SPS Metaverse Collaborative team’s governance expert.

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