“The Merge”: What Is It, Why Does It Matter, and What Are the Implications?

Introduction

On August 24th, Tim Beiko of the Ethereum Foundation released an official timeline for the Ethereum Merge. “The Merge”, a term used to represent the Ethereum Network’s complete transition away from a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) consensus mechanism, represents a long awaited overhaul to the network’s underlying technology. The Goerli testnet — the last testnet to undergo the protocol upgrade — successfully merged on the 11th of August. Now all sights are on Bellatrix, the first stage of the merge taking place September 6th, and the completion of the merge on September 15th. There are many expected improvements to come as a result of this highly anticipated technological shift, ranging from an immense increase in the network’s transactional capacity, to a significant reduction in the network’s carbon footprint. In the following paper we will highlight what’s changing, what’s misunderstood, and what you ultimately will need to know as we approach “The Merge”.

The Basics

To understand the functionality behind this monumental event, we first must have an adequate understanding of a fundamental aspect of blockchain technology: data validation & consensus mechanisms.

In its simplest form, blockchain technology is an efficient, auditable and secure form of data storage. The data structure consistent with blockchain technology is unique relative to other forms of databases, primarily in the sense that data is stored in interconnected, time-stamped “blocks” which form the blockchain. In practice, this data can be essentially any transaction that occurs within a specific blockchain.

To make this concept easier to understand, let us consider a simple example which involves two parties; Party A & Party B. In this example, each block within a blockchain serves as a historical record which logs money being moved between these two parties. Now assume Party A decides to send Party B one Ether. This would be an example of a transaction which is submitted and recorded within an individual block on the Ethereum Network. As additional transactions occur between the two parties, each block is filled with a record of the transactions, logging them in chronological order.

Eventually, after a certain amount of transactions, the block reaches its data storage capacity and another block must be created to record future transactions. This is the sequence of events that results in a blockchain expanding.

Some logical questions to ask would be “who records these transactions?”, and furthermore “what ensures the validity & therefore the security of these transactions?”.

This is where data validation comes into play. In order to ensure the legitimacy of all transactions, blockchains rely on what is called a “consensus mechanism”. A consensus mechanism can be described as a methodology of verifying transactions and determining true asset ownership. This form of data validation is carried out by external parties referred to as “data validators”. As a data validator, you are given a statistical chance at being granted a bounty for providing a verified record of transactions. To further incentivize accurate recordings and to disincentivize inaccurate recordings, the bounty is scaled by design to provide a larger potential reward for accuracy, and a smaller potential reward for inaccuracy.

Proof-of-Work

The first widely implemented consensus mechanism within blockchain technology is referred to as a Proof-of-Work (PoW) consensus mechanism. PoW is a system reliant on mining nodes utilizing their processing power and algorithmic software to generate a hash value beneath a certain threshold. Miners on a PoW network compete with each other to create the next block; the validity of the blockchain’s transaction record is thereby protected by the entire network’s processing power. In the case of PoW, the bounty is dependent on the speed in which a miner is able to generate an adequate hash value, ultimately implying that higher computational power equates to greater potential financial gain. The large fixed expenses associated with being a miner on a PoW network results in a high barrier to entry, as the average individual cannot afford the hardware necessary to be competitive.

There are also a few potentially high variable costs associated with the PoW consensus mechanism, such as energy consumption and equipment cooling. These expenses and their consequential environmental impacts are effectively a “double-headed beast,” as they not only compound the barrier to entry issues, but are also major points of public and governmental criticism when it comes to blockchain technology.

Proof-of-Stake

In an attempt to remedy the issues described above, an alternative consensus mechanism known as Proof-of-Stake (PoS) was engineered. PoS is a consensus mechanism that is reliant on a blockchain ecosystem’s stakeholders “staking” their assets. This mechanism replaces the “first come first serve” aspect of PoW validation, as block “proposers” are now selected at random rather than by speed.

While it is expected that this change will result in a lower barrier to entry and therefore increased decentralization, it is important to note that a validator’s odds are directly correlated to the amount of Etherum staked. In other words, the more Ethereum a validator has staked, the higher chance they have at earning a bounty. This will be an interesting mechanic to observe, as we will now be able to compare which model proves to be more truly decentralized.

“The Merge”

As previously stated, Ethereum’s transition from a Proof-of-Work to a Proof-of-Stake consensus mechanism is known as “The Merge”. There are many technical implications and details related to “The Merge” that are outside the scope of this paper, but we will highlight three key anticipated benefits: reduced energy costs, improved scalability, & enhanced security.

1) Reduced Energy Costs

The Merge is forecasted to reduce Ethereum’s energy consumption by approximately 99.95% since data validators will no longer need to use high powered computers and exorbitant amounts of energy to complete their job. This drastically reduces the overall carbon footprint of the entire network.

Why does this matter? This has the potential to eliminate a core concern and bitter stigma associated with blockchain technology: the negative environmental impact that comes with powering the network. As we see the carbon footprint for the Ethereum Network decrease, public sentiment will likely improve and we may see a change in tone from a regulatory standpoint. This has the potential to encourage more individuals — who previously had concerns about the environmental impact of cryptocurrencies — to consider using blockchain technology in the future. A foot forward on the path to mass adoption.

2) Improved Scalability

PoS provides greater scalability potential for two mutually inclusive reasons: an increased number of data validators & improved transactional capacity. Since the barrier to entry as a PoS data validator becomes significantly lower, the network will naturally attract more data validators. As the network adds more data validators, the network’s capacity will continue to increase, which contributes to achieving a faster consensus and a more decentralized network.

In addition to opening the door for more data validators, this technological shift will also lay the groundwork for further innovations in scaling technology (such as sharding) which is expected to have a significant impact on the network’s transactional capability. This had been foreshadowed by the network’s Co-founder and lead developer Vitalik Buterin, as he previously projected the change could result in the network being able to eventually maintain 100,000 transactions per second (TPS), an astonishing 769,000% growth in transactional capacity. It is worth noting that as Visa & Amex have provided a range of numbers for their system’s performance throughout the years, and there seems to be no general consensus on what their maximum transactional capacity is. However, all reported values come in lower than ETH’s target throughput of 100k TPS.

3) Enhanced security

A network that is powered by a PoS consensus mechanism is characterized as having a higher degree of security relative to a network powered by PoW. One of the key security concerns with a PoW network is a “51% attack”: when a malicious entity acquires control of the network by having more than 50% of the network’s mining capabilities and is able to reorganize the transactions to better favor their interests. The 51% attack is not entirely eliminated by PoS, but it makes it much more costly to acquire this power as the bad actor would need to have possession of 51% of all the ETH staked.

Another way that PoS improves the overall security of the network and integrity of the data validators is via potential financial penalty for dishonest behavior. Since a node is required to stake ETH in order to participate as a validator, that ETH is at risk of being destroyed by the network if there is an attack or failure to participate linked to that particular node. The amount of staked ETH at risk of being destroyed depends on the degree of attack or dishonest behavior, and can also vary depending on how many other attacks are happening on the network at the same time (also known as “correlation penalty”).

If penalized, a data validator has the potential to lose 100% of their staked ETH. This disincentivizes attackers and promotes overall integrity across data validators, ultimately making the network more secure relative to PoW.

Common Misconceptions

“The Merge will result in a reduction in gas prices”

Short answer: Yes, but in the future.

Long answer: The Merge will not result in an immediate reduction in gas prices. The “Merge” sets the stage for L1 & L2 scaling mechanisms such as Sharding & zkRollups, which will decrease gas prices in the future.

“You must have 32 ETH to act as a data validator”

Staking pools allow users who have less than 32 ETH to combine their assets in “staking pools” in order to serve as a data validator.

“There will be a new token (i.e. ETH2)”

No new asset or token will be released. 1 ETH before the merge = 1 ETH post-merge.

“There will be a network outage when the Merge takes place”.
There will be no downtime or network outage once The Merge occurs, it should be essentially unnoticeable.

Conclusion

The Ethereum merge will be a historically significant event in the history of blockchain systems. For individuals that currently hold Ethereum it is important to note that there is no immediate action that must be taken and according to the Ethereum Foundation, the transition should be seamless and essentially unnoticeable. If you are an acting node or developer on the Ethereum network there are preparation considerations that can be found on the Ethereum Foundation’s website. Individuals should also expect an influx of Ethereum mining equipment to flood the market/get repurposed for other PoW chains and it is similarly anticipated that there will be lower expected yields when mining Ethereum on an institutional level.

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