This is our second post in a series about ethereum. Catch up on Vol. 1 here.
TLDR: This Merge will be the biggest story in crypto for the next three months. It’s estimated to happen sometime this summer. The price of ethereum may go up as a result.
“This is the most significant blockchain network upgrade ever, and probably ever will be. If Ethereum achieves its goals...it would elevate the merge to one of the most historically significant events of the modern age. But for most people, it won’t even register.” [2]
What’s changing? PoS, Issuance, Staking, and Burning
Ethereum is changing its block consensus method to Proof of Stake. Instead of computer chips mining blocks, they will be virtual validators. This reduces energy consumption by ~99.5% and updates Ethereum to operate similarly to most competing Layer 1 blockchains.
Issuance
Issuance refers to the reward for the validators, offered in the form of new coins created by the protocol. You can think of this as inflation since the total supply of tokens slowly increases.
Issuance is expected to drop 90% after ethereum merges. To understand the impact of this reduction, think about what happens with oil prices when supply gets cut. The price typically rises. That is effectively what’s going to happen to ethereum. Holding other variables constant, the current ethereum token price stands to increase.
This is significant because every bitcoin halving has been followed by a massive run-up in price. It seems likely that the same thing could happen with ethereum at an accelerated pace.
The Merge has been nicknamed ‘the triple halving’ because it would take Bitcoin three halvings to produce an equivalent supply reduction. [2]
Staking
Validators who staked early on the Beacon Chain are currently earning 4.8% annually. It’s estimated that once the merge occurs, validators will earn a 7%-12% real yield on staking their coins, a better rate than Solana, Cardano, Cosmos, and Polkadot. This will incentivize more people to lock up ethereum to earn yield, which incentivizes long-term hodling.
Burning
Because of EIP-1559 in 2021 Q3, ethereum already burns fees that previously went to miners. This will continue after issuance reduction goes down 90%. According to ultrasound.money [5], all else remaining the same, the results of this could result in a deflationary currency, meaning ethereum supply could actually shrink over time!
At current stats, Ethereum is estimated to decrease by 0.9% per year post-Merge. [5]
Beyond an investment case, why is Proof of Stake good for the Protocol?
More Secure: Immediately
Blockchain security is a function of decentralization. The higher number of participants agreeing on the truth, the harder that truth is to change. The Merge will allow anyone with 32 ether tokens to become a validator. Additionally, anyone with ether tokens can delegate to one of these validators. This will create more nodes and more decentralization.
Less Carbon Emissions: Immediate 99% reduction in energy usage [6]
More Scalable: Future
Additionally, Proof of Stake will allow for a scaling solution known as sharding. Sharding is like a professor having his 3 TA’s grade exams instead of him doing all of them. Sharding is the future if ethereum achieves mass adoption.
Timeline
The date on most people’s radar is June 2022, but that’s an ambitious target. This is not based on a deadline, but rather an estimation of time for multiple milestones to be achieved by developers.
Some things we know:
Ethereum devs create mechanisms in the code called “difficulty bombs” to help them hit deadlines. One of these is expected to go off in June 2022 [3] to incentivize merge completion.
Part of the plan is to create “testnets” to help debug the code. One of these, “Kiln” was just completed [4] and merged into the main chain. There are four more testnet merges to go before the big dance.
A highly recommended Reddit thread by u/domotheus, who is recommended by people close to the Ethereum Foundation said:
I personally don't set my hopes up for June, but I definitely expect it over the summer, with the asterisk of "unless something went extremely wrong during testing." (e.g. a critical bug requiring weeks to fix, possible exploit in the specification itself require months of fixing and reimplementing.)
Risks
The biggest current risk is something called client supermajority. To set up a validator, you need to run a software package called a client. Client centralization could be a huge problem if there is a bug. The vast majority currently run Prysm. The amount of nodes running Prysm is decreasing, but is still at a troubling number as of today. This technical issue can be explored in more detail here.
Stats (as of 3/27/22)
Resources
Five indicators that the merge will happen in June.
Some Merge stats on ultrasound.money.
A timeline of the ethereum Merge.
A twitter thread simply explaining the Merge.
Vitalik Buterin, ethereum founder, and Lex Fridman and discussing the Merge.
Sources
[2] Bankless, Don't sleep on the merge
[4] What’s New in Eth2 - 25 March 2022
[5] ultrasound.money
➡️ About FirstWatch Crypto ⬅️
FirstWatch Crypto was started by Dan McGlinn (@DigitalDanMcG) and John "Blaize" Hrabrick (@blaizebitcoin) who have been investing in the space for a combined 8 years. FirstWatch Crypto is on a mission to simplify the crypto investment landscape.