The Merge: A New Era for Ethereum

Ethereum is, without a doubt, the most successful smart contract platform in operation. Since the platform launched in July 2015, it has gone from strength to strength and has seen a dramatic explosion in the number of decentralized applications (DApps) it hosts.

Today, there are more than 5 million smart contracts running on the Ethereum blockchain, as well as more than 3,000 DApps. Many of these are part of the rapidly expanding decentralized finance (DeFi) sector, which at its peak attracted more than $160 billion in total value locked (TVL) — a measure of the amount of assets held by DeFi smart contracts.

But with close to 800,000 active addresses and 1.7 million transactions processed per day, the Ethereum blockchain is being pushed to its limits. Which, at times, results in extreme congestion, high fees, and an overall poor experience for users and developers.

To help address this concern, as well as make the Ethereum blockchain more futureproof, a range of technical upgrades are planned for integration. Chief among these plans is the upcoming ‘merge’ — which will see Ethereum transition to a new energy-efficient consensus mechanism and prepare it for further performance upgrades.

What is the Merge?

Right now, the Ethereum blockchain is capable of processing somewhere in the order of 10–15 transactions per second (tps). This depends on a variety of factors, including the average block time and the size of the transactions included in the block.

This makes it one of the slowest smart contract platforms operating today, having been leapfrogged by second-and-third generation platforms like Solana, Avalanche, and BNB Chain in recent years. As well as a variety of lesser-known platforms.

Fortunately, Ethereum can be upgraded, and its biggest upgrade yet is now on the horizon. It’s called ‘the merge’. This will see the current Ethereum execution layer merged with a currently separate consensus layer known as the beacon chain to form a new hybrid platform. This new hybrid platform will no longer be secured by tens of thousands of miners, but will instead be backed by a network of hundreds of thousands of validators.

On December 1, 2020, the Ethereum beacon chain launched. As a testnet for the new Proof-of-Stake system, the beacon chain (previously known as Eth2) is designed to demonstrate the stability and viability of Proof-of-Stake for a large already established smart contract platform like Ethereum. It is responsible for storing the details of validators, managing them, assigning blocks, and both distributing inflation rewards to validators and penalizing back actors through slashing.

The consensus and execution layers will work together to maintain operations. Image courtesy: Ethereum

Right now, the beacon chain exists completely independently of the original Ethereum chain (known as the execution layer). The beacon chain is currently being stress tested and its validators are busy processing testnet transactions and maintaining order.

Over the last few months, most Ethereum testnets already moved over to Proof-of-Stake, or are in the process of being phased out. The most recent of these was the Ropsten testnet merge in June 2022, whereas the remaining two testnets — Goerli and Seoplia — are expected to merge in Q3 2022.

Ethereum developers recently proposed September 19, 2022, as the tentative date to complete the merge. However, it should be noted that the merge has been delayed several times in the past — so nothing is set in stone yet.

How Will Ethereum Change After ‘The Merge’

Although the switch to Proof-of-Stake is the biggest upgrade in Ethereum’s history, it isn’t the only thing that will change after the merge.

Ethereum’s rate of inflation is also set to be drastically cut. As it stands, Ethereum inflates at a rate of around 4.3% to just 0.43% — equivalent to a 90% reduction. This inflation will be distributed among validators based on the number of blocks processed, with all validators having an equal chance of being selected for block production.

Following the merge, just 1,280 ETH will be awarded to validators each day as block rewards. It is expected that fees will make up a larger and larger share of validator revenue as the network grows.

Since EIP-1559 was introduced recently, a chunk of all transaction fees is now burned. Because of this, some believe that Ethereum may become a deflationary asset — since the fees burned through EIP-1559 could exceed the rewards distributed to validators. This recently happened for the first timer ever and is set to become more frequent in the future.

The average block time — that is the time for each new block to be processed — will also drop from over 13 seconds today to 12 seconds. As a result, transactions will be included in a block approximately 8% faster.

The merge will set the stage for a variety of further upgrades, each of which will expand on the capabilities of the platform. By far the most important of these is the plan to split the blockchain into 64 separate shards, each of which will be able to process blocks in parallel. This will help to dramatically improve Ethereum’s throughput and allow it to process thousands of transactions per second.

Once sharding has been incorporated, practically anybody will be able to run an Ethereum client, helping to further increase security and ensure network decentralization.

But more than this, it will also bring transaction fees down. As competition for block space is cut, gas prices will inevitably fall, making the platform far more economical to use. This, in turn, will help make Ethereum more attractive to users, businesses, institutions, and even governments — making it the platform of choice for decentralized applications.

These upgrades are expected to help Ethereum leapfrog competing smart contract platforms in terms of energy efficiency, scalability, security, and environmental friendliness. It may also lead to the deprecation of a variety of layer 2 platforms, which aim to extend Ethereum’s capabilities through the use of sidechains. Since these mainly aim to boost its scalability and reduce fees, there is a reasonable chance that platforms like Optimism, Arbitrum, Immutable-X, and more may be rendered redundant.

Ethereum’s supply growth is set to level off after the merge. Image courtesy: Etherscan

To operate as a validator and assist with the block production process, users will need to stake at least 32 ETH. This ETH will remain locked until the Shanghai upgrade is completed. This will occur approximately 6–12 months after the merge, after which users will be able to withdraw their staked ETH.

Regular users will be able to continue interacting with Ethereum through their favorite Web3 wallets and there will be almost no change when it comes to interacting with DApps. Whereas users that currently operate a node will need to run a separate client for both the execution layer and consensus layer. A list of some of the most popular clients can be found here.

Looking further out, Ethereum is also set to incorporate ZK-SNARKS into its stack, allowing for truly private transactions and smart contract operations. This will be combined with the introduction of rollups at the protocol level, allowing Ethereum to scale further by executing transactions off-chain, before finalizing them with a rollup on-chain. These two potential upgrades are currently in the research stage — with no fixed date for integration.

Why the Move to Proof of Stake?

As we previously touched on, Ethereum is currently secured by a Proof-of-Work (POW) consensus system — which sees a large network of power-hungry SHA-256 miners compete to discover the next block, fill it with transactions, add it to the blockchain, and then broadcast the updated state to the rest of the network.

According to recent estimates by Digiconomist, this mining network uses somewhere in the order of 79 terawatt-hours of electricity per year. This is slightly more than the entire energy consumption of Austria (~66.8 TWh/yr) and leads to the release of around 34 million metric tons of CO2 into the atmosphere each year.

This has, understandably, led to Ethereum (and other POW cryptocurrencies) receiving a great deal of backlash among critics — who say that its environmental burden isn’t justifiable.

By switching to Proof-of-Stake with the upcoming merge, Ethereum will cut its energy burden by more than 99.95%. This will not only make it one of the most energy-efficient smart contract platforms in operation but will also reduce its energy burden to just a sliver of what it is currently. Indeed, a POS-based Ethereum would have roughly the same CO2 burden as around 3,681 gas-powered passenger vehicles.

Since Ethereum’s environmental concerns have attracted significant regulatory pushback and is a major point of contention among potential users, investors, builders, and institutions, the new upgrade is expected to help change the perception surrounding Ethereum and other blockchain technologies.

According to recent data from Statistica, this will bring the average energy consumption of a single Ethereum transaction down to around 0.1 KWh — which is still 80 times higher than that of the Visa payment system. However, given that Ethereum is also set to undergo a significant performance upgrade when it is split into 64 sharded chains, the energy cost per transaction will be brought roughly in line with Visa.

According to a 2020 thought piece by Ethereum Co-Founder Vitalik Buterin, Proof-of-Stake will allow Ethereum to retain its industry-leading security by ensuring that the cost to attack remains the same. But it also allows the network to recover faster from attacks thanks to the “slashing” mechanism, which would be used to penalize validators that participate in attacks, without requiring a network re-org or fork.

“Attacking the chain the first time will cost the attacker many millions of dollars, and the community will be back on their feet within days. Attacking the chain the second time will still cost the attacker many millions of dollars, as they would need to buy new coins to replace the old coins that were burned. And the third time will… cost even more millions of dollars. The game is very asymmetric, and not in the attacker’s favor.” — Vitalik Buterin.

The merge is a crucial next step in the evolution of Ethereum and could be set to demonstrate its potential applications in dozens of new sectors. Nonetheless, time will tell if it manages to deliver on expectations and we have yet to see how the competition will react to the potential technical superiority of an upgraded Ethereum.

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About Master Ventures

Master Ventures is a blockchain-focused venture studio helping to build the next generation of blockchain-based Web 3.0 system innovations within the crypto industry. Launched in 2018 by Founder and CEO Kyle Chassé, the company’s ethos can best be summarized in the acronym #BeBOLD: Benevolent, Open, Love, Decentralized.

Master Ventures co-creates with entrepreneurs and businesses worldwide to turn the best ideas into innovative and disruptive products. They do this by investing as strategic partners through offering advisory services to the projects they believe in. To date, Master Ventures has invested in over 40 crypto projects, including the likes of Kraken, Coinbase, Bitfinex, Reef, DAO Maker, Mantra DAO, Thorchain, and Elrond.

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