The Merge is an upcoming upgrade to the Ethereum network that many people are hailing as one of the most significant events in the history of cryptocurrency. The initial stages of the Merge began on September 6, 2022, and it’s scheduled to complete sometime around September 15, 2022. If all goes to plan, it will see the Ethereum blockchain transition to an alternate way of validating its network known as proof of stake (or “staking”) .
Like Bitcoin, Ethereum currently validates its blockchain by using something called proof of work. We’ve gone over proof of stake and proof and work, so you can get caught up to speed here, or here, if you aren’t already. The important takeaway is that this move to proof of stake is being viewed by many as an instrumental step towards the goal of the Ethereum network being more broadly adopted and going truly mainstream.
What the Merge could mean for crypto users
The transition to Ethereum 2.0 is expected to be a critical catalyst in the crypto community that will result in a more sustainable, faster, scalable, and secure blockchain.
More environmentally friendly—The Ethereum Foundation estimates that the move to proof of stake will reduce the energy consumption of the Ethereum blockchain by as much as 99.95%. (1) This will be one of the most obvious changes for users and one of the most predictable outcomes of the Merge.
Faster transactions—The Merge will lay the foundational architecture for something called “sharding.” In layman’s terms, sharding will enable the partitioning of the Ethereum blockchain into smaller, more easily managed parts. Over time, this will greatly improve the throughput and transactions per second of the network
Lower network fees—Though this will not happen immediately, the increase in scalability that sharding will bring should reduce network congestion and the corresponding high fees currently needed to do business on Ethereum’s overcrowded blockchain.
More security and decentralization—After the Merge, the Ethereum network will require a minimum of 16, 384 validators to maintain the network. (2) The more validators spread out over a larger part of the globe, the less likely the blockchain can be abused by bad actors or suffer from power shortages or natural disasters.
What the Merge could mean for investors
With all the promises of a better blockchain, it begs the question: will this affect the price or long-term value of ETH? Although no one can see the future, there are a few key points to consider.
Lower supply—An integral part of the transition to ETH 2.0 has been the introduction of a “burning” mechanism that has taken Ether out of circulation. As of September 7, 2022, there have been 2,612,762 ETH burned. This has reduced the inflationary pressure on the asset and has allowed Ethereum to more directly compete with the digital gold/sound money/store of value narrative that is currently being dominated by Bitcoin.
What’s more, ETH 2.0 will continue to incentivize the holding of Ether through its staking rewards, whose potential for returns can be as high 4-12% Annual Percentage Rate. (3) The reduction in supply, coupled with appealing incentives to hold on to the asset, should have a positive impact on Ether’s price over time. If you want to learn more about the tokenomics of ETH 2.0, please check out this recent blog post.
Green crypto—The lower environmental impact could open the doors to many investors—whether they be endowments, family offices, pension funds or a small retail investor—who are interested in crypto, but cannot, on moral grounds, reconcile the high energy usage needed to maintain networks like Bitcoin.
Web3—Non-fungible tokens (NFTs), decentralized finance (DeFi), and decentralized apps (Dapps) are the three pillars on which Web3 is currently being built around. All three have seen tremendous growth in interest. However, for Web3 to go mainstream, it needs energy-efficient, secure, and decentralized blockchains. And it needs to be able to recruit talent to build out the ecosystem. With the Merge, possibilities for scaling will go up, efficiency will increase, fees will likely go down over time. As the blockchain becomes more accessible and cost-effective, it will draw in more projects and developers that will increase the value of the network.
Potential areas of concern
We will get a clearer picture over the next few weeks if the Merge is successful. However, there are a few potential stress points that are worth keeping an eye on.
Hard forks—One of the contentious issues of the upcoming Merge is the fact that proof of stake will effectively render the thousands of “miners” who currently validate Ethereum’s proof-of-work network obsolete. Miners will have no role in the new Ethereum and no way to make money. It’s possible that disgruntled miners will push for the continuation of a separate proof-of-work Ethereum that will run independently. This hard fork could draw value out from ETH 2.0.
However, most institutions, exchanges, service providers, and developers have been firmly backing Ethereum’s upcoming transition to proof-of-stake. If a proof-of-work hard fork does occur, current trading related to potential forked assets suggest its token would trade at 1-2% the current price of Ether. (4)
As a reference, Ethereum Classic, the breakaway chain that was the result of the previous Ethereum hard fork is only worth 2-2.5% of the current market capitalization of Ethereum.
Sell pressure—The Merge will also bring a partial end to the lockup period for those that have been staking their Ether since the launch of the Beacon chain in 2020. It’s possible that these long-term holders will sell as soon as it is possible for them to do so, flooding the market with Ether and hurting the price.
However, since many institutional-level staking operations only ramped up in 2021, they are still in the red when it comes to their investments. Because of this, they are likely to hold until the market turns to the upside. Further, even if there is a desire to sell, the 13.3m ETH currently being staked will only gradually be unlocked over the course of a year. So it is impossible for a full blown dump to occur. (5)
Censorship and/or centralization—While the long-term trajectory of the Ethereum network looks to be increasingly decentralized, we cannot ignore the fact that the majority of validating done on Ethereum is by institutions. There is a worry by some in the crypto community that large players could have a disproportionately influential say on the future of the network.
Looking forward
There are many unknowns with Ethereum’s upcoming Merge. However, if it goes off largely as promised, it will see massive reduction in energy expenditure, better efficiency, and higher throughput which should combine to have favourable outcomes for the Ethereum ecosystem and the price of its native coin, Ether.
--Haan Palcu-Chang, Crypto Specialist
Sources
(1) “The Merge,” Ethereum Foundation: https://ethereum.org/en/upgrades/merge/
(2) "What Is Ethereum 2.0? Ethereum's Consensus Layer and Merge Explained,” Decrypt: https://decrypt.co/resources/what-is-ethereum-2-0
(3) “ETH staking post merge: yield estimates and risk,” Coinbase: https://www.coinbase.com/institutional/research-insights/research/market-intelligence/eth-staking-post-merge-yield-estimates-and-risk
(4) “Potential Ethereum Hard Fork Token ETHPOW May Trade at 1.5% of Ether's Price, Futures Suggest,” CoinDesk: https://www.coindesk.com/markets/2022/09/01/potential-ethereum-hard-fork-token-ethpow-could-trade-at-18-ether-futures-suggest/
(5) “What Will Happen To Ethereum's Price After The Merge?” Seeking Alpha: https://seekingalpha.com/article/4536238-what-will-happen-ethereum-price-after-merge?
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