The Merge of Ethereum

TLDR

Ethereum will switch consensus mechanism to Proof of Stake
Will be 99,95% more energy efficient
Issuance rate will be zero to less

Explanation:

The Merge is upon us, and the last test net is finally live and working, this means that we now have a date for The Merge. The launch date is set up to be around 15-16:th of September this year.

The Merge of the main chain with the beacon chain, or the upgrade from Ethereum 1.0 to Ethereum 2.0 if you will, is one of the biggest things that have ever happen to Ethereum. For some people this could be a bit confusing, why is It called The Merge and what will happen to Ethereum? I will try to explain in short what The Merge means, a couple of misconceptions and why this is positive thing for Ethereum.

To start, why is it called The Merge? The reason that this upgrade is called “The Merge” is that this event contains a merger of two blockchains, the execution chain and the consensus chain. Ethereum today consist of the execution chain with a built-in consensus mechanism Proof of Work.

The Merge will change Ethereum’s consensus mechanism to Proof of stake, of you struggle to understand the difference between these two learn more here.

The proof of stake chain is already live and is called the consensus chain or (Beacon chain). The Ethereum upgrade will actively merge the mainchain of Ethereum that we now today, with all the applications built upon (Execution chain), with the new consensus chain. In this way will Ethereum switch consensus mechanism from Proof of Work to Proof of Stake.

So, now you hopefully have a better understanding of why it is called The Merge, it will in short upgrade the consensus mechanism from Proof of Work to Proof of Stake.

So, how will this effect Ethereum? First, I will write down some misconceptions of what this upgrade will not do to set your expectations right.

Misconceptions:

“We need Ethereum to upgrade since it will lower the gas fees”

This is unfortunately false, the change to proof of stake will not effect the gas fees. To lower the gas fees, we need to scale the blockchain via a layer 2 scaling solution or scaling the base layer via sharding.

-“All the staked ETH will be available and sold at once which will crash the network as well as the market”

This is not true, when The Merge happens, you will not be able to withdraw your staked Ether, you will have to wait until the Shanghai upgrade goes live. Even then all the validators cannot withdraw their stake at once. The protocol is set so that only six validators can withdraw every 6.4 minutes which gives it a maximum of 1350 validator nodes each day.

If the maximum is reach it will effectively only be around 43,200 ether of 10 million ETH staked, so it will not crash the network. 43,200 ETH in sell pressure will not crash the market since the total circulation of Ethereum are around 120 million.

-“After The Merge all the transactions conducted on Ethereum will be much faster.”

In the Proof of Work system Ethereum issued a new block every 13,3 seconds. After The Merge in the Proof of Stake system new blocks will be issued exactly every 12 seconds. Sure, this is faster, around 10% faster, but it is highly unlikely that it will be noticed by the users. To increase transaction throughput (transaction speed) we will have to do the same efforts as we must do in order to lower gas fees, using blockchain scaling solutions.

How will switch to Proof of Stake really effect Ethereum?

More sustainable

First and foremost, after the switch from Proof of Work to Proof of Stake, Ethereum will be way more energy efficient. No matter your view on the energy consumed via Proof of Work, Proof of Stake are objectively more energy efficient. Ethereum’s energy consumption will be reduced by ¬~ 99,95%, so Ethereum will use much less carbon to maintain its security.

Issuance rate

One big change that will happen to Ethereum after the Merge is the issuance rate of new ETH. The reason for new issuance of the ETH token is to keep miners incentivized to validate new transactions, they need to be paid. This is done by issuing new ETH. In a proof of Stake system, you still need to pay stakers for creating an incentive for them to validate transactions. However, these rewards differ between a Proof of Work system to a Proof of Stake system, especially when it comes to issuance. Note, this is in the context of Ethereum, other Proof of Stake system or Proof of Work system could differ.

I have outlined below how much issuance that are made pre-merge compared to post-merge.

Mining rewards ~13,000 ETH/day pre-merge Staking rewards ~1,600 ETH/day pre-merge Issuance of new Ethereum pre merge are ~ 14,600 ETH/day.

After The Merge all the mining rewards will be eliminated which leads to an issuance rate of:

Staking rewards ~1,600 ETH/day post-merge.

This will effectively drop new ETH issuance by approximately 90%.

Okay, but how is this happening and why do you not need to issue as much ETH to keep the network secure in a Proof of Stake system? Mining in a Proof of Work system is an economically intensive activity, to participate you need to pay a big chunk of energy cost, you also need to purchase expensive mining equipment to be able to participate in this activity.

Due to these economically intensive actions, to keep incentivize miners to secure the system the network needs to pay them a certain percentage that exceeds the money they have invested in the mining activity. In a Proof of Stake system, you still need to pay the validators (stakers) “salary” for their work of securing the network and running the nodes. However, in a Proof of Stake system, the operational cost is dramatically lower, which lower the demand for issuance,

In addition to the lower issuance that will come with The Merge, Ethereum implemented a new upgrade in the London hard fork or (EIP-1559) in August last year. This upgrade was implemented to enable more predictability when it comes to gas fees. However, this upgrade also enables “the burn” of ETH, so for every transaction that is conducted in the Ethereum network a certain percentage of the transaction fees are getting burned. So, what has this to do with The Merge, why is this important to know?

After The Merge, with an average gas price of at least 16 gwei (which is not an extreme number of activity), at least 1,600 ETH is burned every day, which effectively brings net ETH inflation to zero or less.

Take aways:

New consensus mechanism: Proof of Stake
99,95% more energy efficient
Zero inflation (could even be deflationary)

So, mark September 15/16:th in your calendar and wait for The Merge!