How the Ethereum Merge Impacts DeFi Industry and the Environment


The huge overhaul of Ethereum from proof-of-work to proof-of-stake has finally happened. The event took place on September 15th as Google tracked the event with a countdown timer with two cute pandas. Let’s understand what it is, why it was a crucial undertaking and the risks and benefits of ETH Merge.

Proof-of-Work and Proof-of-Stake Explained

In order to understand ETH Merge, let’s first get to the root of how decentralized systems function in contrast to centralized systems. The latter depends on a central authority or organization to facilitate transactions, oversee intent and take necessary action in case of malicious activities.

However, in decentralized systems, both control and responsibility are distributed to a network instead of being concentrated with a central entity. Now, in decentralized systems, to ensure that every participant maintains integrity, there are validators who authenticate transactions on the distributed platform.

This leads to another concern- what prevents the validators from acting maliciously? They put up collateral or stake to ensure good intent and consequences for validators. For a job well done, validators are rewarded, and for malicious activities, they pay through their collateral.

A validator approves transactions and paves the way for ‘consensus’ by putting up something of value. Said consensus can be achieved in a variety of ways.

Proof-of-work (PoW) is one of them, where each validator spends significant time and effort verifying each transaction. These validators would set up warehouse-like computing machines that’d run round-the-clock. Why, you ask? So that they can successfully verify transactions and earn rewards (new coins).

When ETH worked through the proof-of-work consensus mechanism, it consumed as much energy as the entire nation of Finland. This brings us to what Ethereum is up to now- Proof of Stake (PoS).

The proof-of-stake consensus mechanism instead requires validators to have skin in the game by ‘staking’ their own coins. For a job done well, they earn more coins. For a screw-up, they pay the penalty in the form of a part of or all of their collateral.

What Is Ethereum Merge?

ETH transitioned to the PoS consensus mechanism through the merging of two blockchains. The ETH blockchain that people widely use is known as ‘mainnet’, different from the many ‘testnet’ blockchains only used by developers. In December 2020, ETH developers built a new network called the ‘beacon chain’, the new Ethereum. Since 2020, validators have been adding blocks to the chain without entering any data or transactions.

On September 15th, when the clock struck 06:42:42 UTC at block 15,537,393, we experienced the merging of the Ethereum mainnet execution layer and the Beacon Chain’s consensus layer at the Terminal Total Difficulty of 58,750,000,000,000,000,000,000, meaning ETH will no longer rely on PoW consensus. Ethereum co-founder Vitalik Buterin tweeted early in the day to confirm the merge.

In a YouTube livestream, the creator of Ethereum said, “This is the first step in Ethereum’s big journey being a very mature system, and there’s still steps to go. We still have to scale, we still have to fix privacy, we still have to make the thing secure for regular users, we all need to work hard and do our part”.

The merge is the network update to ETH, which would allow it to function with the PoS consensus mechanism moving forward. The switch to proof-of-stake had been planned since 2014 but got delayed many times due to technical complexity and the humongous amount of money at risk.

Crypto’s Implications on the Environment

Today more than ever, people are concerned about climate change and its impact on the environment and lives. Carbon emissions from Ethereum were too conspicuous to ignore. Let’s understand the environmental impact of crypto by looking at what miners did.

A miner would set up a powerful computer called a mining rig to execute software that would solve complex cryptography problems. This miner’s rig would be in competition with hundreds of thousands of global miners attempting to solve the same puzzle.

As cryptographic problems would become more complex, all the more energy would need to be expended to solve them. By one estimate, Ethereum consumed close to the total electricity consumed by Switzerland’s 9 million citizens, or 62 million terawatt hours.

Now that ETH has adopted proof-of-stake, miners will instead deposit ether tokens into a pool. Consider each token as a lottery ticket, picked at random to decide who would win the reward.

By shifting to PoS, Ethereum now consumes 99.9% less energy. Moreover, as per one tweet from Vitalik Buterin, the merge reduced worldwide electricity consumption by 0.2%.

Why the Merge Was Crucial

Ethereum blockchain wasn’t secure when using the PoW consensus mechanism. Whoever would be the first to ‘validate’ a block would receive a reward, and everyone else would fail. This means anyone with abundant resources, like electricity, could monopolize the activity. To overtake a proof-of-work blockchain, a malicious actor would need to have 51% of the network’s power under control.

With PoW, a validator would need access to $5 billion to buy enough computers and transformers, connect them to a grid and carry out an attack. With PoS now, Ethereum now has $20 billion in economic security, which will continue to grow.

ETH developers also say that the network of the $60 billion ecosystem of crypto exchanges, lending companies, NFT marketplaces and apps will now be more secure and scalable too. Besides increased security, Ethereum Merge will also impact a wide portfolio of services and tools operating on the network, such as decentralized applications, decentralized finance protocols and millions of non-fungible tokens.

Finally, given how expansive and popular Ethereum is, the transition will kick off positive climate action rippling across the Web3 industry.

Were There Risks to the Merge?

Critics of Ethereum, who often are proponents of bitcoin, compare the merge to changing an airplane engine in the middle of a passenger flight. So, there was a lot at stake- the airplane and the $188 billion worth of ETH in circulation.

The update’s complexity was also compounded by the fact that it may have been one of the biggest open-source software initiatives in history, needing coordinated effort across dozens of teams and many individual researchers, volunteers and developers.

When we look at the technical side, there can be unforeseen bugs within the new blockchain. Critics also question if the new blockchain would be as secure as the older PoW-based one.

However, proponents of ETH argue that slashing (revoking the access of validators and burning their stake) malicious validators might mean more integrity and security on the new Ethereum blockchain.

The Positive Impact of ETH Merge

The successful implementation of the ETH merge informs regulators that the crypto industry can adapt to prioritize the planet and its well-being. Considering the White House Office of Science and Technology’s Policy (OSTP) report on Climate and Energy Implications of Crypto-Assets in the United States, the merge will lead to further research and collaboration the Congress and the crypto industry.

Recommendations in the report included assessing and enforcing energy reliability in the wake of crypto mining projects, setting energy efficiency benchmarks and research and monitoring. This means that the White House acknowledges the potential for the positive contribution crypto-mining has in the nation’s transition to clean energy.

For miners, mining Ethereum used to be costly. As electricity prices surged and crypto prices plummeted, even successful miners started seeing red. To offset their costs, miners typically sell most of their crypto assets earned from mining, which is millions of dollars of selling pressure daily. Now that Ethereum is PoS, validators won’t need to sell the ether they earn, as validating blocks has become significantly cheaper than PoW.

Miners are now replaced with stakers who stake at least 32 ETH by sending them to an address on the ETH network where these assets can’t be bought or sold.

ETH Merge would also invite lucrative financing from ESG-aware investors and business leaders who wish to make green investments. Finally, sustainable crypto-mining would attract regulatory support to amplify and scale the crypto industry to create jobs and be more widely used.

What Next? ETH- Merge, Surge, Verge, Purge, Splurge

It’s critical to note that the Ethereum Merge is not the end all be all of the upgrades to the Ethereum network. It’s only part one in a five-part series of changes that would make the network highly secure, reliable and climate-conscious.

Now, developers will need to crack an existential question. The Merge was only the first step toward a series of upgrades on Ethereum to solve the scalability trilemma. According to the theory of The Blockchain Trilemma, termed by Vitalik Buterin, developers face challenges in creating a blockchain that’s scalable, decentralized and secure without compromising on any of those.

However, blockchain developers often need to make a tradeoff between those aspects, preventing them from achieving all three.

  • Decentralized – A blockchain system must not rely on a central point of control or authority.
  • Scalable – A blockchain system must be able to handle an exponential amount of transactions.
  • Secure – A blockchain system must defend itself against bugs, attacks and other unforeseen issues besides operating as expected.

The theory suggests that after a certain point, a blockchain must compromise on one of the three critical aspects and that it cannot have all three at the same time.

The Ethereum blockchain has successfully completed its first step toward solving this problem with the Merge. Now, it needs to undertake the next four legs of development.

  • The Surge – Implementation of sharding, a scaling solution which The Ethereum Foundation claims will lower the cost of bundled transactions on Ethereum. Once the surge is done, the Ethereum network will process transactions faster, too. While today’s Ethereum can process 15-20 transactions a second, the one with the rollups and sharding will process 100,000 transactions a second, according to Buterin.
  • The Verge – The Verge will implement Verkle trees, a kind of mathematical proof, and stateless clients to allow users to become network validators without needing to store extensive amounts of data on their machines. The Verge will be key for higher decentralization.
  • The Purge – The Purge will purge old network history to drastically reduce the amount of space required on your hard drive, simplifying the Ethereum protocol and not requiring nodes to store history.
  • The Splurge – This update would involve all miscellaneous updates to ensure the Ethereum network functions smoothly.

It is still hard to talk about the timelines of the next four stages of Ethereum development as each is under research and development.

Meanwhile, investors in Ether are expected to lock up their tokens in digital wallets that enable earning tokens under the new PoS format, which they won’t be able to retrieve for at least a while.

Ethereum will need to undergo yet another significant change called Shanghai, which is at least 6 months away. After that, investors may be able to make withdrawals below a capped amount.

Changes and updates to the Ethereum network will pave the way for better blockchain systems that honor the climate and the planet. Stay tuned to learn more about the subsequent updates as they happen.

KiwiTech has established a Web3 Center of Excellence to cater all kinds of blockchain development needs. Get in touch with our seasoned blockchain consultants today.

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