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Ethereum prepares itself for the Merge

Sijoitustieto
14 Sep 2022 | 4 min read

Ethereum chain’s billion of dollars worth of cryptocurrencies, millions of users, and thousands of applications are moving to a new, improved blockchain. The latest update to the Ethereum network is the result of years of research and development, culminating in The Merge, which harnesses Ethereum's Proof-of-Stake chain for actual technical use. The Merge is expected to take place on September 15th.

Ethereum, the second largest cryptocurrency by market capitalization, is using The Merge to change its consensus mechanism from Proof-of-Work (PoW) to Proof-of-Stake (PoS). Consensus mechanisms enable cooperation and security of distributed systems.

Ethereum already has an operational PoS network called Beacon Chain (released in 2020), but it is not yet used to process transactions. For now, it's only in use as a staging network for computers using the Ethereum network as they prepare for the PoS upgrade.

Ethereum's full transition to the PoS mechanism requires Beacon Chain to merge with the Ethereum PoW network.

Source: Geekflare

The price of Ether futures, along with the rest of the crypto market, has fallen by more than half from last year's peaks.

Source: Bloomberg. Index in USD. Past performance is not a reliable indicator of future results.

PoW vs PoS

While Bitcoiners believe in the superiority of the PoW mechanism, many other crypto networks work with different consensus mechanisms. Until now, Ethereum, which has been a PoW network is changing to update its mechanism to Proof-of-Stake which many other crypto-networks such as Polkadot, Cardano and Avalanche already use.

PoW and PoS differ in how they decide the right for miner/validator to create the next block in the chain.

In today's PoW system, Ethereum miners compete to mine blocks by solving cryptographic puzzles, just like in the case of Bitcoin. To solve puzzles, PoW consumes a lot of energy.

In the upcoming PoS mechanism, Ethereum validators who stake at least 32 ether (ETH) into the network will be randomly selected to create blocks. The more ether a validator stakes, the more likely it is to be selected to create a block and thus reap the block reward.

In both PoW and PoS mechanisms, the miner/validator who wins a block is rewarded with transaction fees and new ethers. PoS validators also receive rewards for other actions to secure the network.

Transactions After The Merge

When the Ethereum network is congested due to a large number of transactions, it is more expensive to use the network. The more transactions there are online, the higher the costs. During Ethereum's DeFi and NFT booms, expenses often rose high and were widely complained about on social media. Currently, with the crypto market a relatively living a quiet life, transaction costs are at low, as the number of DeFi and NFT transactions online has dropped significantly.

Average transaction cost of the Ethereum network (dollars per transaction)

Source: Y-Charts

Transaction costs are not expected to change with The Merge, even if a new boom appears to increase costs. Future upgrades to the Ethereum network, expected in 2023 at the earliest, are expected to help with the network's transaction costs.

Transactions speed up a bit with The Merge. Currently, in the PoW mechanism, Ethereum blocks are mined approximately every 13-14 seconds. In the PoS mechanism, blocks are generated evenly every 12 seconds.

By comparison, Bitcoin's blocks are generated about every 10 minutes on average, while competing networks Solana and Avalanche generate blocks significantly faster than Ethereum and Bitcoin.

The Merge's potential impact on the price of ETH

The crypto discussion on social media is currently hot regarding the trading of The Merge.

It is naturally impossible to predict the behavior of the ETH price in advance. This is especially true in the case of Ethereum, as a similar change in the consensus mechanism has not been seen before in the crypto world. Due to the number of variables and unknown factors, it is almost impossible to predict what will happen to the price of ETH as a result of The Merge.

For years, those who invested and believed in the Ethereum network have been waiting for the unique update to the network's core technology brought by The Merge. Along with addressing concerns related to the network's environmental impact, PoS brings a new use for ETH tokens in the form of staking.

Although The Merge brings a lot of good things to Ethereum, it does not guarantee an increase in the price of ETH. The Merge brings changes to the amount of ethers mined and how they are distributed. This can be either a positive or a negative factor depending on who you ask. There is also a risk that The Merge will not succeed or that PoS will later be found to be less secure than PoW.

You can also read a lot of speculation in the media that The Merge would have already been priced in at the price of ETH.

Triple Halvening

The price of Ethereum can be affected either positively or negatively by "Triple Halvening", thanks to which Ether can even become a deflationary cryptocurrency. In this case, the amount of ethers in circulation would decrease over time.

The three different factors of Triple Halvening are:

  1. A significant decrease in ETH emissions: The Ethereum network is currently releasing approximately 13,500 ethers daily as block rewards, which on an annual basis corresponds to approximately 4.3 percent of the total amount of ETH. Thanks to the PoS change, annual emissions are expected to drop to around 0.3-0.4 percent.
    The decrease in the amount of block rewards also reduces the selling pressure of ETH miners. A decrease in selling pressure can potentially have a positive effect on the price of ETH.
  2. Burning ETH as a result of the EIP-1559 update: The EIP-1599 update improves the Ethereum user experience and burns some of the rewards for mined Ethereum blocks. Burning reduces the number of ETH tokens in circulation as they disappear into the ether.
  3. ETH staking: In Ethereum staking, the investor deposits his ETH holdings and receives as a staking yield at the time of writing this an annual return of approximately 4.1 percent, which is paid in ETH tokens. In addition to the staking yield, ETH stakers can also enjoy the better security of the network.
    As the number of stakers increases, the security of the Ethereum network improves and makes hostile attacks less feasible. Stakeable ETH tokens are locked for a certain period of time, during which they are out of ETH liquidity at the exchanges.

Triple halving and The Merge affect the Ethereum network in the following ways:

  • ●A more secure and stable network
  • ●An increase in ETH scarcity (i.e. less ETH tokens in circulation) due to decreasing emissions, transaction cost burning and staking.
  • ●Significantly lower energy consumption

The Ethereum community is very optimistic about the changes brought by The Merge to the operation of the network. However, there are numerous unknown factors and it is unclear how the market will react to The Merge.

How are you going to trade The Merge?

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