Emergent Order: Ethereum and The Merge

On September 15, Ethereum, the world’s second-largest cryptocurrency by market capitalization, underwent a significant shift from proof-of-work consensus to proof-of-stake dubbed The Merge. Ethereum users had no need to make any adjustments; the transition, as far as we can tell, occurred quickly and painlessly. So what does this development mean, why is it happening and what are its potential ramifications?

A Little History

In the wake of the devastating Great Recession, the white paper outlining the oldest and most famous cryptocurrency, Bitcoin, was introduced on October 31, 2008 by one Satoshi Nakamoto, whose true identity has never been verified. Bitcoin was an idea to make a new, decentralized currency that would avoid banks and have transactions be verified by the community. This verification would be accomplished by every user maintaining a record of transactions on their computer in a record known as the blockchain. 

In order to make this system viable, several pitfalls had to be navigated. One of them was the Sybil attack, in which a malicious actor created multiple online personas and voted more than once to influence the blockchain in their favor. Nakamoto’s solution was to create a system of one CPU (computer processing unit), one vote. Put very simply, computers must solve a complex problem called a cryptographic hash in order to make changes to confirm a change to the blockchain; the people who perform this task are called miners, and for their services they receive rewards in Bitcoin.

The process of solving these cryptographic hashes involves massive amounts of computing power, especially when miners want to beat each other to the prize. This competition between miners has resulted in the production and purchase of computers dedicated to maximum computing power; entire facilities full of Bitcoin-mining machines in the United States, China, and Europe are not uncommon. This entire enterprise has created a new problem for cryptocurrencies: environmental impacts from the massive amounts of energy spent by mining facilities.

Proof of Work vs Proof of Stake

In the wake of Bitcoin’s success, other cryptocurrencies have joined the fray, from Dogecoin to Litecoin to Ethereum. The vast majority also use a proof-of-work model to verify transactions. But several cryptocurrencies began using the proof-of-stake model, which they claim is more environmentally friendly than proof-of-work. In proof-of-stake, several users are randomly selected to verify the blockchain and are required to put up an amount of their cryptocurrency as their stake, which can be decreased for misconduct on the validators’ part. This process consumes much less energy than proof-of-work, allowing for the blockchain to be scaled up more easily.

In Ethereum’s case, the cryptocurrency began with a proof-of-work system. However, the plan from the beginning was to shift Ethereum to proof-of-stake. Not only will such a move allow Ethereum to avoid criticism for environmental damage–Ethereum’s estimated energy consumption can be reduced by 99.95% by the Merge–the proof-of-stake network is reported to bring lower transaction costs and the potential for sharding, the splitting up of a blockchain into several independent parts for efficiency. 

While the proof-of-work Mainnet chain was operative, Ethereum underwent a series of incremental upgrades to prepare for the transition to proof-of-stake. The goal was for a quick and efficient transition; no transaction records would be lost, and no downtime on the network would be necessary. The biggest step, short of the Merge itself, was the creation of the proof-of-stake Beacon chain. During the Merge, the Mainnet and Beacon chain were fused into one proof-of-stake network, as had always been the plan.

Merge Effects

So now that the Merge is complete, what does it mean for cryptocurrency investors, Ethereum users, and everyone else? As mentioned above, Ethereum is assuring its clients that there is no action needed on their part; all transaction records have been preserved in the Merge. Now that the proof-of-work chain is officially done away with, the predicted reduction in energy consumption will finally have a chance to come to be. And the shift to proof-of-stake could set the stage for cryptocurrency transactions on a larger scale, due to the reduction in transaction costs. 

It is worth noting that there are currently no plans for Bitcoin, the world’s largest cryptocurrency, to similarly change from proof-of-work to proof-of-stake. Additionally, cryptocurrencies in general are a volatile store of value; over the past six months, Bitcoin’s price in USD has dramatically crashed several times since its release. In essence, the Merge is a further attempt to achieve Nakamoto’s goal of secure decentralized finance; Ethereum’s performance over the coming months will determine how much further cryptocurrencies have to go.