All you need to know about The Merge
Here we are, roughly a month before one of the most consequential events in crypto history. Tentatively, on the 15th of September (depending on how mining difficulty changes), Ethereum is scheduled to finally begin the transition from its current Proof-of-Work consensus to Proof-of-Stake, in what has become known as “The Merge”. While the update will not affect the way that end-users interact with the blockchain, the new 2.0 version will handle validations differently, be less energy-intensive and, at least in the future, allow for more efficient scaling of the multi-billion dollar Ethereum ecosystem. It’s called The Merge due to the fact that the PoW Ethereum Mainnet will merge with the PoS Beacon Chain that developers have been building and testing on in anticipation of the live launch.
Never in the short but intense history of crypto has an update this big been achieved, or arguably even tried. This is one of the most important events in the history of blockchain technology and there is a lot of misunderstanding around the topic. This article is intended to be a compact guide to solve just that problem.
Why is The Merge happening? Is it necessary?
Ethereum has come a long way since it was launched in 2015 by Vitalik Buterin and seven other co-founders. The project was essentially born out of a World of Warcraft-related incident where Blizzard nerfed Vitalik’s “beloved warlock’s Siphon Life spell”, thus awakening him to the “horrors centralized services can bring”. Ethereum was intended to oppose just this and where Bitcoin was intended to be decentralized money, Ethereum was intended to be the decentralized internet.
This vision has been achieved in no small part, as ETH is the second largest cryptocurrency by market capitalization, behind only BTC. Many projects and industries were born out of it, namely some of the first NFTs, Play-to-Earn games and a very healthy chunk of decentralized finance protocols. The network started to be squished under the weight of its own success. Very quickly gas fees started to rise to ridiculous levels and transactions started to take longer.
Therefore, a solution to upgrade the network had to be found. That solution came in the form of Ethereum transitioning from its current PoW model to PoS, a move that was thought out and researched even before Ethereum launched and was part of the original roadmap. In a nutshell, in the current PoW consensus model the network is secured by miners through hardware. In this system electricity is exchanged for block issuance and the miners receive a portion of the transaction fees for the service provided. In a PoS model, the network is secured by validators, who stake ETH tokens. There is very little electricity consumed in this model and the transition from PoW to PoS is expected to reduce Ethereum’s energy needs by an estimated 99.95%.
How will The Merge actually go through?
The short answer is: normally seamlessly. There has been a lot of research, engineering and testing done, especially in the past 18 months from the Ethereum foundation so that The Merge can happen with no discernable difference to the every day user. Changing a consensus model while the network is still operating and validating transactions worth tens of billions of dollars is no small feat, so the developers have thought out a series of updates in preparation for The Merge.
A very important milestone was the launch of the Beacon Chain in December of 2020. The Beacon Chain ran the new PoS consensus and mirrored the Ethereum Mainnet through shadow forks. By making all updates on the Beacon Chain and then “connecting” it to the Mainnet, the blockchain should keep functioning as normal, validating transactions and keeping the same state with no hiccups.
At the specific moment before the PoS consensus will take over from PoW, the node operators will run one of the existing client implementations. As per ethereum.org, “A client is an implementation of Ethereum that verifies data against the protocol rules and keeps the network secure”. These are essentially implementations that allow users to interact with Ethereum, help keep the network safe and maintain the state. Unlike most other blockchains, Ethereum has four client implementations (execution layer), namely Nethermind, Geth, Erigon and Besu. For reference, Bitcoin only has the one named Core.
Having multiple implementations makes it possible to switch between them whenever a bug is found or a malicious actor tries to attack the network. This makes Ethereum more secure and efficient, due to the fact that it can still function normally where other blockchains might experience issues. Furthermore, having multiple clients will be even more beneficial after The Merge, because bugs or malicious actions impact the network in proportion to the staking share they affect within the PoS consensus. Their source can thus be more easily isolated.
Therefore, before The Merge will take place, client implementations will group the execution layer (EVM) and the consensus layer (PoW) together via an Engine API, forming a full node. For a smooth transition to PoS, these two layers will be unbundled and can be run separately. Different teams can even develop on either of them until the PoS consensus is dominant. Until then, execution layers will work with consensus layers to make a full node. Popular mainstream consensus implementations are Lighthouse, Teku and Prysm.
As Finematics does a great job explaining, having multiple implementations on both layers will translate into a much more secure network, with 20 pair combinations being possible for the two layers to communicate through. For example, one validator might prefer to run Teku with Nethermind, while another might go for a combination of Prysm and Geth. When The Merge happens, execution clients will listen to blocks coming from the PoS chain.
This will only start happening when the network has had enough PoW to exceed a variable called TERMINAL_TOTAL_DIFFICULTY. This variable simply represents the sum of difficulties of every block in Ethereum that were achieved through PoW. When the variable is surpassed, nodes simply switch to follow the PoS chain. Magic!
What will this mean for users?
After The Merge has taken place, all Ethereum Dapps should run just as before, with an identical state and transaction history. This applies, of course, to ETH locked in Convex or Curve, funds borrowed or lent on Aave, leveraged farms on Homora or assets in Decentraland. If all goes well, for the end user nothing will have changed.
And that is exactly the reason why this update is so important for Blockchain in general. Many companies have had downtime and major errors when it comes to updating their software, some even leading to clients losing money. Imagine the statement that would be made if a distributed network manages to completely switch what is essentially its engine while being operational, with not so much as a blip to the user experience.
Implications for The Merge
So all of this talk about one of the most important things to ever happen in crypto and ultimately nothing will change for the average user? Yes! But also, there are some things that will indeed change if not at the time of the transition, then some time after.
First of all, we will get a slightly faster block time of 12 seconds, down from 13 seconds on the current PoW chain. If a block will be missed in one of the fixed-time slots, then it will be higher than 12 seconds but always shorter than 13. Coupled with this reduced block time variance, in theory Ethereum should have faster transaction times.
The network will also theoretically be more secure due to two factors: First is slashing, meaning the capability of the network to punish bad actors or validators that go offline with no notice. The second is the staking economy. Due to staking being more accessible than mining, the network becomes more decentralized and thus has less concentrated points of failure. While 32 ETH is needed to create a validator node, there are options for users that do not have this much Ethereum, through projects doing distributed validators such as Obol.
Another implication is that the second most popular cryptocurrency will not be “mineable” anymore for crypto mining, an industry that was estimated at roughly $2.2 billion in 2021. Whether professional or amateur, many of these rigs will have to either be sold or made to mine other PoW projects such as Bitcoin, Monero or Zilliqa. GPUs might even see a slight decrease in price. Less mining opportunities could mean less demand.
Lastly, the ETH supply will decrease over time, making it an increasingly deflationary asset. From an estimated peak of just over 120 million ETH, the total supply is calculated to go between 60-100 million within the next decades.
Ways to “play” The Merge?
As is the case with most things in crypto, whenever something, anything happens, people want to try and make a profit from it. In the interest of painting a full picture of The Merge, we will also take a glance over two strategies that are being discussed in various Discord groups and forums to hypothetically make some extra ETH. One is regarding taking advantage of a fork scenario while the other is concerning Lido and stETH. My fellow nerd Stephen the Calculator Guy does a great job going more into detail on both here.
The first strategy is regarding a scenario where, as discussed above, PoS Ethereum and PoW Ethereum will coexist for an instance. While there is virtually no discussion around the fact that the PoS fork will be the surviving one, some people are theorizing that they can sell their PoW ETH for anything, while of course keeping their PoS ETH. The theory essentially treats the PoW fork as an airdrop and there already exists a ETHPoW token on some exchanges, although already down to a double digit price. While it indeed is interesting to see how long the PoW chain will survive and what anomalies it might bring, this strategy seems to be wishful thinking at best. However, I have to admit, I have seen far weirder things in crypto throughout the years.
The second strategy is regarding Lido and its interest accruing stETH. Lido is a staking service that bundles user’s ETH together in batches of 32 ETH to be turned into validators for the upcoming PoS consensus. Users receive a digital receipt under the form of stETH. After the relatively recent Celsius and Three Arrows contagion episode that cascaded depegs left and right, Lido’s stETH was not spared and depegged as much as 13% from ETH. Read more on the contagion in a previous piece of mine here. While at the time of writing this article stETH sits at a 2.9% discount from ETH, the main ETHstETH Curve pool is still suffering from a significant imbalance, with a ratio of 27/73.
The main idea here is that after The Merge, stETH will regain its full peg. Therefore, it would in theory make more sense to buy up stETH because of an almost 3% discount. Not to mention that it’s an interest accruing token, meaning users get more of it in their wallet. Once the PoS chain is dominant, stETH can be exchanged for ETH. While this strategy is more down to earth than the previous one, it has been said repeatedly that the staked ETH can only be redeemed after the Shanghai upgrade, due to go live 6-12 months after The Merge. By that time, the peg might be restored due to other market factors or it might be lost again.
Potential risks
No good deed goes unpunished and no major shake up of a $200 million+ market cap project can be without risk. Some things might go fully or in part wrong during The Merge.
For example, validators proposing the next block will be known ahead of time, thus making them vulnerable to Denial-of-Service (DOS) attacks. While measures are implemented to prevent this, such as the selection process happening through a highly encrypted method called a Single Secret Leader Election (SSLE), in theory a malicious actor could DOS the next validator thus making them lose their slot. This would make any transaction vulnerable to being picked up by the attacker.
Another risk is one that many other PoS Layer 1s experience, namely centralization. There is some concern over how much staking power the likes of Coinbase and Lido have in deciding the state of Ethereum and over its consensus. More so, Lido also has potential governance takeover risks, which would effectively allow bad actors to do a lot of damage to the Ethereum network if they so choose. One solution to the Lido problem proposed by the community would be to allow stETH holders to veto dangerous proposals.
Combating Misconceptions
The Ethereum Foundation has a pretty cool list of misconceptions around The Merge accessible here. Some of them are pretty widespread and it only helps to calm the waters before such an important step. Here are some of them and their rebuttals:
“The Merge will reduce gas fees”: While this isn’t outright false, there is no direct correlation between a consensus upgrade and the relation between the number of transactions on the network and how much validating volume there is. Of course, Ethereum should be a more scalable and efficient network some time after the transition, which in turn should translate into among other things, cheaper gas fees.
“Staked ETH can be withdrawn after The Merge”: Staking withdrawals will only be redeemable after the Shanghai upgrade, which is scheduled to happen 6-12 months after The Merge. Fee tips/MEV will be credited to the respective validator’s Mainnet account normally.
"Staking APR is expected to triple after The Merge": The Ethereum Foundation also states that estimates suspect a 50% change in APR, not 200%.
“Stakers will all exit at once when the Shanghai update launches”: False, withdrawals will be rate limited to prevent just such a scenario.
See you on the other side!
It’s extremely interesting and exciting to see history in the making to such an extent in a new industry. Crypto is still very young and is just showing signs of maturing here and there. If The Merge goes as planned without any major hiccups, it will be a testament to how powerful and game-changing blockchain technology really is. This upgrade will pave the way for future ones that will implement features such as Sharding, all with the purpose of making Ethereum faster, more efficient, secure and more scalable. I have finished this article in the (very) early hours of Friday, August the 19th 2022, less than a month before Ethereum transitions and I can’t wait for the real thing. Here’s to a seamless upgrade and to justice being brought to the Siphon Life spell of a very unfortunate Warlock.