You may have heard and read a lot about it and you know it’s a significant event in the crypto industry, and perhaps the most important upgrade in the history of Ethereum blockchain. But what is really the Ethereum Merge?
Purpose
We begin our understanding about the Ethereum merge, by first knowing the motivations behind it. Its main purpose is to transition from the blockchain’s proof-of-work to proof-of-stake consensus mechanism. The purpose is to make the blockchain more energy-efficient, secure and enable scalability in the future, including sharding. The proof-of-stake mechanism aims to reduce energy consumption by up to 99.95%
In the proof-of-work mechanism, there are miners that purchase and run the rig. The miners requires computational power to issue a block and earn a portion of the transaction fee. This is how the network is secured. On the other hand, a proof-of-stake mechanism the network is secured by validators that lock up a set amount of ether in exchange for chance to validate transactions and earn rewards through transaction fees. Ethereum is moving off of proof-of-work (POW) to proof-of-stake (POS) because it is more secure, less energy-intensive, and better for implementing new scaling solutions.
How Does the Transition Work?
Instead of a major transition to a new consensus mechanism, researchers and developers for Ethereum decided to break the transition in to two steps. First is shipping the Beacon Chain that runs in parallel with the Main Net. The accounts, balances and smart contracts in the main net using proof-of-work while the Beacon Chain runs in parallel using proof-of-stake. This allows the Beacon chain to be tested for a period of time without having a direct impact to the Main Net and hence minimize the dangers that comes along a major transition. Running the Beacon Chain in parallel also gives enough time for the users to stake ETH to lock a sufficiently huge amount to secure the network.
The second step is merging the beacon chain with the EVM state of the Ethereum Proof-of-work main net.
We can imagine the mechanism of the Ethereum Merge as two spaceships running in parallel, the main Ethereum network being the old spaceship and the Beacon chain being the new. The old space ship will have to undertake a long, demanding voyage but its engine is not made for such journey. On the other hand, a newer spaceship was built with an engine that is robust and more suited for the voyage but has not been field tested.
The aim is to replace the old spaceship’s engine with a new one without requiring the old spaceship to a complete stop. At the same time, the new space ship’s engine has to be tested on the same conditions. So, the new space ship runs in parallel with the old one. After the new spaceship is tested, the space ships will swap engines mid-flight. In this case, the old spaceship will be primed for the difficult voyage without stopping. In the case of Ethereum, “stopping the spaceship’ will cause major disruption in to Ethereum users. Also, in this switch, astronauts in the old space ship or in this case, the Ethereum users, will not have to transfer to another spaceship and will barely notice any change. The rest of the Ethereum state, its transactions, applications, contracts and balances remains unchanged and carried along during the merge.
The Economic Implications
The merge will put an end to the argument that Ethereum, DEFI and NFT’s are bad for the environment. This will make Ethereum an attractive investment for institutions that are regulated with ESG-compliance.
Moreover, the merge will decrease the issuance of ETH tokens. After the merge, the proof-of-work network will stop existing and hence decrease the issuance of ETH. Currently, total ETH supply increases by 4.3% annually which is a way of incentivizing miners for securing the blockchain. After the merge, the validators will have exclusive right to block creation thereby reducing Ethereum’s energy requirement. This decrease in issuance is popularly referred to has the “Triple Halving”.
The Triple Halving is caused by three things:
- Issuance of ETH is dropped from 4.5% to 0.4%. Investors are watching the merge as they expect that the decrease of issuance in ETH will play out with basic Economic law of Supply and Demand and anticipate the price to go up.
- On August 2021, ETH burning was the most significant upgrade in the network, known as the London Hard fork. To confirm transactions on the blockchain, users pay a gas fee. The gas fees are paid for the computing energy required to validate transactions. In the London Hard Fork, the transaction fees are taken from the circulating supply instead of giving all transaction fees to validators. This make ETH become more scarce.
- ETH staking on the Beacon chain is a way of securing the network. Users are compensated with block rewards for staking ETH. Staked ETH will prevent users from withdrawing their staked ETH until six months after the Merge. This too, will reduce the circulating supply
Another important implication of the merge is that users will able to participate in securing the network in their own homes instead of being exclusively participated by institutions and large miners. This will make the network more decentralized and hence more attack-resistant.
What do You need to do before the Merge?
If you own ETH or ERC-20 token wither in a hot wallet or cold wallet you do not need to do anything. Despite the change from proof-of-work to proof-of-stake, Ethereum's entire history since its inception remains intact and unaltered. Any funds in your wallet prior to The Merge will remain accessible following The Merge. You must take no action to upgrade.