Ethereum Merge and Migrating to Proof-of-Stake: What Happens Next

In this blog, we will cover what The Merge is, what it changes on Ethereum, and will examine the facts and consequences of this technological experiment.

The Ethereum blockchain is the technical infrastructure where countless Web3 applications and crypto and NFT projects exist. At its most basic level, the merge (sometimes called Ethereum 2.0, Eth 2, or ETH 2.0) is an upgrade to the Ethereum blockchain that will reduce its environmental impact, increase security in the network, and enable Ethereum developers to introduce new features and increase the scalability of the chain.

The Merge is an overhaul of Ethereum’s consensus mechanism, shifting the network from Proof-of-Work (PoW) to Proof-of-Stake (PoS) consensus.

The Merge which will be the most significant and substantial upgrade to the Ethereum network to date is already here. Many debates have arisen on the changing dynamics that will come with Ethereum’s Merge. But the truth is that most network participants will notice only minimal changes on Day 1.

Neither gas fees will drop, nor total network throughput will increase. However, the Merge introduces significant changes to the network’s infrastructure and economic incentives that will ultimately be felt by every network participant in the Ethereum ecosystem. This includes new changes to block finality (confirmation times), new MEV-related transactional risks, and new economic incentives that could result in your wallet ultimately paying you to use it.

Ethereum’s switch to Proof-of-Stake (PoS) could be considered a turning point for the blockchain, as well as for the entire crypto universe.

Note that the decision for developers to switch from their original consensus protocol, Proof-of-Work (PoW), to PoS has been several years in the making. Beacon Chain, the Ethereum blockchain branch responsible for using PoS, was initially shipped on December 1, 2020, for development and testing.

Why go From Proof-of-Work (PoW) to Proof-of-Stake (PoS)

Here are the major reasons why Ethereum would switch from a PoW system to a PoS system.

1. PoS Results in a More Secure, Decentralized Network

Most individuals participate in mining pools and only a few participants can validate independently because of the high cost associated with mining. So mining pools build and propose most of the blocks. This results in a highly centralized few that control the network. For example, according to cryptocurrency analytics company Crypto Compare, 5 Ethereum mining pools accounted for 65.4% of all the ETH mined in 2021.

In the case of PoS, Ethereum will include a minimum of 16,384 validators, making the security of the network much more decentralized and, as a result, much more secure.

PoS enables sharding – splitting the network into “shard chains” that share the load of Ethereum, theoretically reducing network congestion and increasing transaction throughput. These shard chains will spread operations across 64 new chains instead of settling all operations on one single blockchain. Sharding is planned to begin in 2023 and should enable giant leaps in scalability for the network.

Danksharding is a newer sharding design that gains traction in the Ethereum community. Danksharding introduces significant simplifications to previous sharding designs and introduces the concept of Proposer/Builder Separation (PBS).

Plus, sharding is expected to increase Ethereum’s transaction throughput up to 100,000 transactions per second – higher throughput than all leading credit card companies.

3. PoS is More Efficient, Using ~99% Less Energy Than PoW

Under PoS there is no need to use massive amounts of energy on proof-of-work computations. As a result, it is estimated that PoS will cut Ethereum’s energy usage by 9.9%.

Here are the key changes that the Merge will bring.

The move to PoS will replace miners with validators. To participate as a validator, one needs 32 ETH to stake and three separate pieces of software: an execution client, a consensus client, and a validator.

Validators propose new blocks, submit attestations (votes), and monitor for any slashable offenses (penalties). A validator will stay active until it voluntarily exits, its balance drops below 16 ETH or it gets SLASHED.

Today, Beacon Chain blocks take 64-95 slots (~15 minutes) to finalize – a significant increase from the less than five minutes it currently takes to wait for 35 block confirmations, at which point it is generally agreed upon that a transaction is likely safe and finalized under PoW.

While the new path to block finality may take longer, it is much more secure than the “longest-chain” rule found in PoW blockchains and is less likely to result in double-spend attacks or hard forks.

In addition to proposing blocks and submitting attestations, validators can also monitor each other for malicious behavior and “slash” other validators for failing to uphold the security of the network. Slashable offenses are acts that are provably against the Ethereum network including double voting (e.g. proposing two blocks in the same slot) or submitting contradictory attestations (e.g. signing two different attestations in one epoch).

“Whistleblowers” or “slashers” are the validators that search for slashible events. After finding a slashable event, they will broadcast it to the network for the next block proposer to add the proof to their block. In turn, the block proposer will receive a reward for slashing the malicious validator. The whistleblower, however, does not receive a reward. This is because being a whistleblower is intended to be an altruistic action and not meant to be profitable.

Note that validators can also be slashed for being lazy and not participating in the network or not having slashing protection up to date on failover servers or using duplicate keys. Slashed validators suffer a gradual loss of ETH, can be barred from further participating in the protocol, and forcibly exited from the network forever.

Under PoW, block building and mining (i.e.proposing and confirming a block) are all handled by the same network actor. Because mining requires specialized tools and knowledge, only a small set of mining pool operators ended up being responsible for the vast majority of block construction – making this both opaque and centralized.

This changes fundamentally with The Merge that creates the conditions for a new class of core network economic actors to emerge: Block Builders. These Block Builders are specialist providers that compete in a real-time marketplace to perform block construction on behalf of validators. Eventually, this separation between Block Builders and Proposers will be codified in the network under what is known as the Proposer/Builder Separation (PBS).

5. Block Reward Subsidy is Reduced by ~90%

Just as miners receive newly minted ETH as a reward for successfully adding a block to the blockchain under PoW, under PoS, the validators that successfully propose new blocks are also issued a block reward. However, under PoS this block reward will be reduced by nearly 90% as validators will not incur the high cost associated with mining and therefore require less of a subsidy from the network.

A significant change to come out of The Merge will be fixed block times. The current PoW model uses variable block times, which means blocks can be confirmed at any moment so every millisecond is equally ‘valuable’ under this system; Miners and MEV searchers cannot predict exactly when the next block will be confirmed.

Risks of The Ethereum Merge

As the Ethereum Merge is the biggest update to any cryptocurrency blockchain network to date, there are a few risks upcoming the Ethereum Merge.

Under PoS, network proposers will be known ahead of time, making them vulnerable to a DoS attack. For example, if a potential attacker is in line to propose one of the next blocks in the blockchain, they can attempt to DoS (a sophisticated networking attack) of the current proposer’s node, causing them to lose their slot, and the transactions in that slot can be picked up by the attacker. There are solutions being worked on to make the proposer selection anonymous, but this is currently still a risk.

Staking pools are becoming more and more popular. The investors who don’t have the required 32 Ether to stake, join a group of others to raise the funds needed to become a validator. This introduces the risk of censorship or governance takeover by concentrating the number of validator nodes under the influence of centralized entities.

As many crypto applications refer to the merged and upgraded network as “ETH 2” there is confusion about whether there will be a newly formed cryptocurrency called ETH 2 (there is not). This makes ETH holders susceptible to scams. Scammers may try to take advantage of this confusion and try to get users to swap out their current ETH for “ETH 2,” but in reality, they would be stealing the user’s Ether.

The merge could cause a drop in Ether price, as well as many of the top cryptocurrencies that have built their platforms on top of the Ethereum blockchain.

In spite of the clear arguments for a bearish ETH and the broader crypto space today, the Merge is arguably the biggest catalyst for a rally that Ethereum has ever seen. As the network cuts its emissions by 90%, ETH will likely become crypto’s first major deflationary asset if the demand to use the network remains constant (Ethereum burns ETH with every transaction as part of an update known as EIP-1559, increasing the asset’s scarcity as more people use the network). According to data, ETH’s supply will peak at 120.5 million and decrease by about 1 million coins a year.

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