Written by: David Hoffman, Co-Founder, Bankless
Edit: 0x711, 0x214, BlockBeats
Mergers are confusing, so let’s start from the beginning and explain one of the most important events in cryptocurrency history in simple terms.
1. What is "the Merge"?
"Merge" is the name of the event when the Ethereum blockchain transitions from using a Proof-of-Work (PoW) consensus mechanism to a Proof-of-Stake (PoS) consensus mechanism .
It’s called a “merger” because it’s the merging of two independent blockchains that are currently running in parallel. The Ethereum mainnet is “merging” with a special-purpose blockchain called the “Beacon Chain.”
The Beacon Chain was launched on December 1, 2020, with the sole purpose of " becoming a Proof of Stake (PoS) blockchain ."
There are no transactions on the Beacon Chain, and there are no Token or DeFi applications. It is an "empty chain", just to become a blockchain running the PoS consensus mechanism.
Because the beacon chain is an "empty chain", it can be merged with the Ethereum blockchain and replace Ethereum's PoW consensus mechanism without having to worry about any other variables.
Once the two chains merge, Ethereum's PoW verification will be replaced by a new PoS consensus mechanism.
2. Why is “merger” so popular?
The merger is considered one of the most important events in the history of cryptocurrency since the birth of Bitcoin’s “genesis block.” There are many reasons for this.
First, no blockchain in the history of cryptocurrencies has experienced such significant changes.
It is very rare to change the operating mechanism of a blockchain, not to mention that except for Ethereum, no blockchain has made such a major change after establishing a huge on-chain economy.
Today the market value of ETH assets is US$203 billion (previously reaching US$550 billion), and the value based on its network is hundreds of millions. Ethereum has by far the most powerful and active economic ecosystem among cryptocurrencies, and the security of all economic activities will shift from being based on PoW to being based on PoS.
So when things go wrong, the risks are huge. This is one of the main reasons why the merger takes so long. There is a lot of testing and improvement work involved.
3. What impact will the merger have on ETH?
The merger will have a huge impact on the ETH economy, especially for investors.
The merger dramatically changes the ETH economics in two ways: reducing the issuance of ETH and making ETH a native yielding asset .
Reduce the issuance of ETH
The merger will reduce the annual ETH inflation rate from 4.3% to 0.43% .
This is because the PoS consensus mechanism will fundamentally improve efficiency. PoS is designed to provide the highest level of blockchain security at the lowest cost. These cost savings will benefit ETH by reducing the amount of ETH issued to maintain security.
PoW is very expensive and requires significant resource overhead to reward miners for their services.
In contrast, the cost of ensuring PoS security is simply the opportunity cost of capital and does not represent any commodity or tangible cost in the real world. Unlike PoW, PoS does not require the issuance of a large number of Tokens to pay for security fees. Therefore, these lower security costs make PoS's consensus mechanism more effective.
Due to the reduced need to pay PoW miners, Ethereum was able to reduce the annual ETH issuance rate from 4.3% to 0.43%. Reducing the issuance of new ETH is generally considered bullish.
This is because PoW miners sell most of the rewards they receive immediately, and over time, the portion that is sold accounts for nearly 90+% of the total mined volume.
By adopting PoS, ETH production will be reduced by more than 90% , and the overhead cost of being a PoS validator will basically be reduced to 0 .
Supporters of PoW believe that the high cost of maintaining the PoW blockchain is just a feature of the PoW consensus mechanism, not a flaw. They argue that these costs prevent centralization by creating churn in asset holdings, as this forces sellers to pay fees for PoW miners. While PoW may indeed ensure asset decentralization, it also creates security centralization.
4. Why will the merged ETH experience deflation?
Almost exactly one year ago, on August 5, 2021, Ethereum launched EIP-1559, an upgrade that changed the way Ethereum’s transaction fees are managed. Rather than simply paying the entire transaction fee to miners, most of it is burned.
There are many reasons for this.
After the merger, ETH production will be reduced by at least 90%, and the proportion of ETH destroyed in each block will also increase accordingly.
When Ethereum's Gas fee is greater than or equal to 7gwei, the rate at which ETH is destroyed will be greater than the rate at which ETH is issued, reducing the total supply of ETH.
At the peak of the bull market, gas prices remained at 200gwei or higher, and this situation lasted for many months. Even in the current bear market, it can be achieved.
Click here to review the historical prices of Gas fees:
https://dune.com/hildobby/Gas
Click here to simulate the post-merger issuance of ETH:
https://ultrasound.money/
5. Will the “merger” reduce Ethereum’s Gas fees?
Won't.
This is a misunderstanding caused by confusing the two concepts of "Ethereum 2.0" (ETH 2.0) and "merger".
ETH 2.0 is a name for the future state of Ethereum that is no longer used by the Ethereum community. ETH 2.0 refers to the future version of Ethereum that will enable PoS and sharding technology.
There was a time in Ethereum's history when it was thought that these two updates would happen at the same time, namely PoS and sharding. As development progressed, the developers realized they could separate these updates.
However, the term "ETH 2.0" has always existed.
Sharding will reduce Ethereum’s Gas fee on L1, but for end users, the realization of truly low Gas fee or even zero Gas fee will eventually occur on L2, such as Optimism, Arbitrum, Polygon, StarkNet, zkSync or others L2.
When the Ethereum L1 gas fee is reduced, the L2 gas fee will be reduced by a larger order of magnitude. The solution to Ethereum gas fees has never been to reduce fees on L1, but to migrate users to L2 where they can enjoy a performance-efficient and low-price transaction experience.
6. Will the merger increase Ethereum’s transaction speed?
This is actually similar to the previous question, just expressed in a different way.
In the Crypto network, transaction volume and transaction costs will affect its supply and demand changes.
After the merger, Ethereum's block time (how often blocks are added to the Ethereum network) did become slightly faster, improving from an average block time of 13.6 seconds to 12 seconds .
This means that the transaction capacity is increased by 12%, and the gas cost will be reduced by 12%.
But this is a negligible amount and should not be considered a "gas fee reduction."
7. Will the merger reduce Ethereum’s energy consumption?
Will do. will be greatly reduced. This is one of the main results of The Merge and PoS.
After the merger, Ethereum’s energy consumption will be reduced by approximately 99.95% compared to the current level .
PoS secures the blockchain with capital rather than energy. Therefore, the energy required to keep Ethereum running after the merger is comparable to basic computer usage: like what you are doing now, such as reading this article, sending a tweet, downloading a movie to your hard drive, etc.
With PoS enabled, Ethereum's energy cost is just to run a node - about 2.6 MWh per year. That's about 1,300 times less than the entire U.S. gaming industry consumes.
Ethereum will actually become the greenest financial system in the world.
Banking and finance still require people to drive gas-powered cars around and turn on lights in buildings, whereas these energy sources are no longer needed in a crypto-driven world.
Maybe Wall Street should go green by using Ethereum ;).
8. Will Ethereum stakers sell their ETH after the merger?
No, they can't.
After the merger of Ethereum, the pledged ETH cannot be withdrawn immediately. This is to keep things as simple as possible, after all this is the largest and most complex upgrade Ethereum has ever experienced in the industry.
Withdrawal of staked ETH is expected to be unlocked within 6-12 months after the merger .
So will stakers sell ETH immediately after unlocking?
Maybe, but there are still limitations. There is a withdrawal/deposit queue that limits how quickly people can stake and unstake. This is another mechanism to keep the chain stable and will not allow rapid fluctuations in the Ethereum application layer to affect the security of the chain.
The ETH deposit/withdrawal bottleneck limit is X/ETH per day, where X is equal to:
Total number of validators / 65536, rounded to the nearest whole number.
The number 65536 is 2 raised to the 16th power. For some reason, Ethereum developers love these square numbers. It’s called the Churn Limit Quotient, and you can read about it at the two links below:
https://ultrasound.money/
https://benjaminion.xyz/eth2-annotated-spec/phase0/beacon-chain/
At the time of writing, there are 433,916 Ethereum validators on the Beacon Chain. To find how many validators can be activated/deactivated (exited) per epoch, divide it by 65,536 and round to the nearest whole number.
433,916 (total number of validators) / 65,536 ≈ 6 validators can be activated/deactivated per epoch
So 6 validators can be activated/deactivated during each epoch . An Ethereum epoch is 6.4 minutes, 225 epochs in 24 hours.
Therefore, the current validator activation/deactivation (exit) rate is 1,350 per day .
225 epoch*6=1350 epochs/day
Each validator has 32 ETH, so up to 43,200 ETH (32*1350) can be unlocked per day.
In addition, the APY (annual yield) as an ETH staker will increase after the merger because ETH staking will also charge transaction fees.
This is expected to increase the ETH yield from 4.2% to 5%+ , and even higher when gas consumption is high.
9. Why 32ETH?
Why does it cost 32 ETH to run a node and not 31, 33 or any other number? The answer is that the more nodes there are, the more total messaging between nodes . If a node requires a smaller amount of ETH, more nodes can come online. While this is good for decentralization, it limits Ethereum scalability.
Choosing 32ETH is a compromise, which also comes from a square number, 2 to the 5th power.
Since node messaging is exponential, lowering the validator requirement from 32 ETH to 16 ETH will increase message delivery by 4x for all nodes. 32 was selected as the minimum amount of ETH pledged to achieve block "finality" within 768 seconds (i.e. 2 epochs).
Is the staking amount requirement of 32 ETH permanent?
uncertain! It can certainly be modified to 16 ETH or lower with improved consumer hardware, message compression, and better signature aggregation.
10. PoS is not on-chain governance
A common skepticism (mainly from the Bitcoin camp) is that PoS is equivalent to the "fiat system" we were originally trying to get rid of.
What they mean is that whoever controls capital controls power.
This is a frustratingly false position, and many of the people who often espouse this view may be spreading it maliciously to discredit any consensus mechanism other than Bitcoin.
The role of an ETH validator is exactly the same as that of a PoW miner. This is a 1:1 comparison.
ETH holders do not have governance rights in Ethereum. Just like Bitcoin, this power is held by non-validating node operators, the “community.”
Ironically, these camps promote PoS as a scheme to “make the rich richer” when the indisputable fact is that PoW mining facilities deliver higher returns on investment to wealthier capital.
TL；DR
PoS Ethereum with native ETH returns is the most democratized consensus mechanism as it provides returns in the same proportion as 32, 320, 3200 or 32,000 ETH.
They will all receive the same yield of around 5%.
This is in stark contrast to PoW miners, where a $100 million investment in a mining facility will generate well over 10 times the hashrate of a $10 million investment due to the economies of scale that PoW hardware and energy costs can bring.
**This article only represents the views of the original author and does not constitute any investment opinions or recommendations.
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