The Merge is coming to Ethereum - what it is, and what's all the fuss about.
Everything you need to know about Ethereum's latest upgrade
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It’s been a few months since I wrote about Ethereum, and a lot has happened.
Everyone in this space is getting quite excited as we approach the completion of the famous Merge, so today let’s do a recap about Ethereum and break down what “The Merge” is all about.
Recapping, what is Ethereum?
First and foremost, Ethereum is the OG Smart Contract platform, founded in 2015 by Vitalik Buterin.
Since then, it’s been the main blockchain platform enabling developers in building thousands of applications leveraging its network, from DeFi, to NFTs, DAOs, and more.
With the rise of various competitors eating into its market share, Ethereum still remains strong as the leading platform.
ETH, its native coin, is the second largest cryptocurrency by market cap, being surpassed only by BTC.
For more infromation, here is my article about Ethereum 101.
Now, let’s understand the key challenges Ethereum faces today
There are mainly three problems:
Clogged network: this is caused by the high amount of demand, which translates into high transaction fees for users (aka gas fees).
Disk space: as the network grows, it gets harder and harder for validators to run a node given the amount of data it has to be able to handle.
Too much energy: Ethereum runs on a Proof of Work consensus mechanism, which is a model that receives a lot of criticism due to higher energy consumption compared to other options.
So how do we solve these challenges?
These three problems are the reflection of the classic blockchain scalability trilemma: balancing all three of the cornerstones (Security, Decentralization, and Scalability) is an incredibly difficult task.
Today, Ethereum maintains a secure and decentralized network, but it doesn’t have the scale required to process enough transactions at an affordable rate, hence the network congestion challenge.
The fast but naive solution to this would be to make the network more scalable by sacrificing decentralization (an approach some alternative Layer 1 platforms have taken), but it is too important of a quality to deprioritize. It's decentralization that gives Ethereum censorship resistance, openness, and data privacy, which is the whole point of crypto to begin with.
Here is my article explaining Why decentralization matters.
Therefore, Ethereum’s vision is to be more scalable and secure, but also to remain decentralized.
How does Ethereum plan to achieve this vision?
There is this multi-upgrade roadmap that has been in the work for years and is still ongoing. The Merge is one of these milestones.
Each of these upgrades represents a foundational change to Ethereum:
The Beacon Chain is the foundational piece that will allow Ethereum to run on a Proof of Stake consensus mechanism, and will eventually make Ethereum more secure by coordinating validators across shards.
A Proof of Stake model will be achieved with The Merge, lowering the barrier to participation, and creating a larger, more decentralized network.
Sharding will make Ethereum more scalable by increasing transactions per second while decreasing the power needed to run a node.
So what is the Merge?
Ethereum currently has 2 chains: the Mainnet, and the Beacon Chain.
You may ask why there are 2 chains, and without going too much into technicalities, what you need to know is that blockchains have layers that perform different functions, which is also the case of Ethereum:
the Mainnet
(short for main network), is the core of Ethereum and the platform we’ve known so far since its launch in 2015. It is the execution layer, which means where Smart Contracts are processed, and therefore where transactions are settled.the Beacon Chain
, which was launched in 2020 with the previous upgrade, is the consensus layer, and will be responsible for running staking and coordinating validators.
The Merge simply refers to when these two systems finally come together, merging into one.
This is supposed to be happening during this quarter (Q2 2022).
What is all the hype about? Why is this so relevant?
Well, Ethereum is currently running on a
Proof of Work
consensus mechanism, and it’s trying to transition fully into a
Proof of Stake
protocol
.
This will be achieved with the Merge.
If you are not familiar about what each of these mean, you can read these articles:
- Proof of Work & Mining explained
- Proof of Stake explained
This will effectively be the end of the Proof of Work era for Ethereum and start the era of a more sustainable, eco-friendly Ethereum. At this point, Ethereum will be one step closer to achieving the full scale, security, and sustainability vision.
The key benefits of this transition are:
Proof of Stake requires significantly lesser energy to run a node and validate transactions. Based on a research by Carl Beekuizen, it is estimated that Ethereum’s energy usage can decrease by 99.95%
This doesn’t only help with a more sustainable future, but it also lowers the entry barrier: with more nodes, a more distributed network will help increase its security,
Validators need to stake a fair amount of ETH in the network, so they are positively incentivized to do their jobs right and protect the system to avoid their ETH getting slashed.
Hold on, what happened with ETH 2.0?
Well, it’s a term that has been retired, which is why previously you might have been hearing a lot about ETH 2.0, but nothing at all now.
It’s important to understand that this renaming represents a change in naming only.
As of late 2021, the community has moved away from the terms “ETH 1 and ETH 2” to “Execution Layer and Consensus Layer”:
Eth1 → execution layer
Eth2 → consensus layer
Execution layer + consensus layer = Ethereum
Or better explained by the pandas…
There are solid reasons why this was done, and I’d like to highlight two points:
Avoid confusion for new users:
they intuitively think that Eth1 comes first and Eth2 comes after. Or that Eth1 ceases to exist once Eth2 exists. Neither of these is true.Scam prevention:
unfortunately, malicious actors have attempted to use the Eth2 misnomer to scam users by telling them to swap their ETH for ‘ETH2’ tokens or that they must somehow migrate their ETH before the Eth2 upgrade.
Dear readers, please be mindful of this scam!
Now let’s talk a bit more about how The Merge affects you as an ETH holder….
How does it impact on gas fee?
As much as people are looking forward to a lower gas fee, The Merge won’t really impact much on it: this is because the current upgrade is focused on the Consensus layer, but the execution of the transactions happens on the Execution layer.
Therefore, it has no impact whatsoever on the throughput capacity of Ethereum, which means that the block size, as well as the number of transactions per second it can manage, will not be changing.
It is, nevertheless, a step closer to a lower gas fee reality, which will happen with the next milestone in the roadmap with the introduction of Sharding: a staking model, combined with the execution capability of the mainnet, are required to be in place first before sharding could happen.
So is there any way to navigate the high gas fees?
Well, this is where
Layer 2 solutions
come in! (and actually, it is precisely because of the rise of Layer 2s that made Ethereum change its roadmap).
Originally, the plan was to work on shard chains before The Merge in order to address scalability. However, with the boom of Layer 2 Scaling Solutions, the priority has shifted to swapping Proof of Work to Proof of Stake via The Merge.
In a nutshell, Layer 2s are separate blockchains rooted in Ethereum (like branches of a tree), designed to help scale applications by moving some of the transactions “off the Ethereum mainnet”, while still taking advantage of its security.
What this means is that instead of everything happening on the main blockchain (Ethereum), most of these transactions are recorded off-chain (on Layer 2 chains) and only the “final” or “ summary” transaction is stored on the main blockchain.
Think of it like when you open a tab at the bar: instead of paying each and everytime you get a drink, you keep a tab and at the end of the night you settle with one single transaction. Voila!
Some of the most well-known examples here are Polygon, Arbitrum, and Optimism.
So to summarize, given that Layer 2s have become as a highly popular and also effective scaling solutions with very affordable transaction fees, Ethereum’s community decided to reshuffle their priorities to The Merge and focus on completing the transition to a Proof of Stake model.
How about the tokenomics… How does it impact ETH pricing?
Well, it is very hard to try to put a potential price on any cryptocurrency.
However, if we stick to pure economics, it is fair to say that the market expectation of seeing ETH price grow post-Merge is pretty justified.
This is mainly due to the fact that ETH will become a deflationary asset:
With the introduction of EIP-1559 at the end of 2021, the built-in fee burn mechanism has effectively gone into function.
Till date, over 2M ETH have been burned, which at current pricing represents more than $7 Billion USD, at a burn rate of almost 6 ETH/min (track the burn here).It is also expected that the amount of ETH being issued will drop considerably.
Additionally, it is believed that by moving to a Proof of Stake mechanism, a lot of the institutional investors will be more eager to get their hands on ETH now that they don’t have to worry about the narrative of high energy consumption no more.
No one needs to be an economics expert to know that
when high demand meets low supply
, we are pretty much hitting the jackpot with this magic formula.
Disclaimer: I’m not a financial advisor, so please always do your own research!
Closing off…
What happens after the Merge?
That would be Sharding, the introduction of shard chains to the Proof of Stake network, scheduled for sometime in 2023.
These "shards" will increase the capacity of the network and improve transaction speed by extending the network to 64 blockchains.
The Beacon Chain is an important first step in introducing shard chains, because they require staking to work securely. Eventually the Beacon Chain will also be responsible for randomly assigning stakers to validate shard chains, which is key to making it difficult for validators to collude and take over a shard.
Are there any risks involved?
Well, there are always risks involved in every upgrade.
The team needs to be able to successfully pull off the merge of 2 chains into one with all the historic data while ensuring the network continues to function.
My personal thoughts…
If I sounded very bullish on Ethereum, is because I am. It is no secret that I’m a huge believer, regardless of the high gas fees.
Ethereum has been leading and driving innovation and trends in this space. A lot of the biggest opportunities flourishing in crypto are thanks to Ethereum, such as NFTs, DeFi, and DAOs.
The clarity of its vision, the refusal to compromise on decentralization, and the non-profit approach (therefore not accepting VC and investors’ money), really channel the beauty of what crypto stands for.
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Appreciate the callout & reference to the Layer 2 post.. I was getting confused between that and Sharding...
nice one! Especially love the usage of Eth's Panda meme.. :)