What are the opportunities for an Ethereum merger?

KingData ·2022-08-09

Source: David Hoffman

Everything you need to know about merging

Merging is confusing!

Let's start from the beginning, from 0 to 60 years old, and tell one of the most important events in the history of encryption!

1. What is a "merge"?

"Merge" is the name of the event when the Ethereum blockchain changes from using Proof of Work (PoW) to Proof of Stake (PoS).

It's called a "merge" because it's a merger of two separate blockchains currently running in parallel. The main Ethereum blockchain is "merging" with a special-purpose blockchain called the "beacon chain."

Beacon Chain was launched on December 1, 2020. The purpose of the beacon chain is to do one thing, and one thing only: to be a proof-of-stake blockchain.

There are no transactions on the beacon chain. There are no tokens or DeFi applications. It is an empty blockchain that is only used to run a proof-of-stake consensus mechanism.

Because the beacon chain is an 'empty chain', it can be integrated with the Ethereum blockchain to replace the PoW mechanism of Ethereum without caring about any other variables.

Once the two chains are merged, Ethereum's PoW verification will be replaced by a brand new PoS consensus mechanism.

2. Why is Merge so hyped?

The merger is considered one of the biggest events in crypto history since the birth of Bitcoin.

There are several reasons to consider this:

In the history of cryptocurrency, no blockchain has undergone such a major change. Blockchains don't often change such an important part of their operations, nor do they make changes to the vast and powerful economy built on top of them like Ethereum.

ETH assets have a market cap of $203B today (previously $55B 😭), with billions more based on the top of the network. Ethereum is by far the largest and most robust economic ecosystem in crypto, and the security of all these economic activities will move from a PoW-based economy to a PoS-based economy.

Getting it wrong definitely comes with a lot of risk, which is one of the main reasons Merge has taken so long.

There are many, many, many tests and refinements.

3. How does Merge affect ETH?

The merger had a huge impact on the economics of ETH. For investors, this aspect of the merger is the most important.

The merger dramatically changed the economics of ETH in two ways: reducing ETH issuance and instilling ETH as a native yielding asset.

Reduce ETH issuance

The merger will reduce the annual ETH issuance from 4.3% to 0.43%.

This is because the PoS consensus mechanism brings a fundamental improvement in efficiency. PoS is designed to provide the highest level of blockchain security at the lowest cost, and these savings are transferred to ETH by reducing the amount of ETH that needs to be issued to pay for security.

PoW is expensive and requires a lot of resource overhead to compensate for the services of security providers (miners).

In contrast, the cost of PoS security is only the opportunity cost of funds and does not represent any real-world commodity or tangible cost. Unlike PoW, PoS does not require a large amount of currency to be issued to pay for security. Therefore, these lower security costs make the PoS consensus mechanism more efficient.

Ethereum was able to reduce the annual ETH issuance from 4.3% to 0.43% due to the reduced need to pay PoW miners. A reduction in new ETH issuance is generally considered…very bullish.

This is because PoW miners sell most of the rewards they receive immediately, and over time they sell close to 90%+ of the total mining supply.

With PoS, the issuance is reduced by more than 90%, and the management cost of being a PoS verifier is basically reduced to 0.

Proponents of PoW argue that the high cost of PoW blockchains is a feature, not a bug. Costs, they argue, prevent centralization by creating churn in asset holdings, as they force sellers to pay PoW miners. While PoW may indeed create asset decentralization, it also creates security centralization as a secondary effect.

4. Why would Merge deflate ETH?

Almost a year ago, on August 5, 2021, Ethereum introduced EIP-1559, an upgrade that changed the way Ethereum’s transaction fees were managed.

Rather than simply paying miners the full transaction fee, most of the transaction fee is burned.

After the merger, ETH issuance dropped by more than 90%, increasing the proportion of how much ETH is burned per block.

When Ethereum's gas fee is 7 gwei or more, the rate of ETH being burned is higher than the rate of ETH being issued, reducing the supply of ETH.

At the peak of the bull market, gas prices remained at or above 200 gwei for months, making the 7 gwei threshold a very low threshold. Even now in a bear market.

5. Will the merger reduce the gas cost of Ethereum?

Do not.

This is a misunderstanding between "Ethereum 2.0" and "merger".

"ETH 2.0" is the name for the future state of Ethereum that is no longer used in the Ethereum community. "ETH 2.0" refers to a future version of Ethereum that will enable PoS and sharding.

There was a time in Ethereum’s history when the two updates, PoS and Sharding, were thought to come at the same time. As R&D progressed, developers realized they could divide these updates up and release them individually.

 

Sadly, the "ETH 2.0" nomenclature has always been around.

Sharding will reduce Ethereum gas fees on L1, but the real gas fee minimization and elimination for end users will eventually happen on L2s like Optimism, Arbitrum, Polygon, StarkNet, zkSync, or other L2s.

When Ethereum L1 gas fees are reduced, L2 fees will be reduced by an order of magnitude. Ethereum’s solution to gas fees was never to lower them on L1, but to move users to L2 and let them enjoy the fast and cheap transaction experience found there.

6. Will the merger increase the transaction speed of Ethereum?

This is actually the same question as above (does Merge reduce gas costs), but formulated differently.

Transaction volume and transaction costs provide the same supply and demand dynamics in crypto networks.

After the merger, Ethereum’s block time (how often a block is added to the Ethereum blockchain) did get slightly faster, going from an average block time of 13.6 seconds to 12 seconds.

This translates to a 12% increase in transaction capacity and therefore a 12% reduction in gas costs.

But this is an insignificant amount and should not be considered a "gas fee reduction".

7. Will Merge reduce Ethereum’s energy consumption?

Yes. important moment. This is one of the main results of The Merge and PoS.

After the merger, Ethereum will consume about 99.95% less energy than current usage.

PoS secures the blockchain with capital, not energy. So the remaining energy required to maintain Ethereum is comparable to basic computer usage; things you are doing right now, like reading this article, sending a tweet, downloading a movie to your hard drive, etc.

With PoS enabled, the energy cost of Ethereum is just running 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 be the greenest financial system in the world.

The banking and finance industries still require people to move around in internal combustion engine cars and turn on lights in physical buildings that would otherwise consume energy that is no longer needed in a crypto-enabled world.

Maybe Wall Street should go green by using Ethereum ;)

8. Will ETH Stakers dump their ETH after the merger?

No! They can't.

Withdrawing ETH from ETH staking nodes will not be enabled immediately after the merge. This is because of simply keeping things as simple as possible, while Ethereum has gone through the biggest and most complex upgrade the industry has ever seen.

Withdrawals are expected to be unlocked 6-12 months after the merger.

So will stakers give up their ETH once withdrawals are enabled?

Maybe, but there are still limitations in that regard. There is a withdrawal/deposit queue that limits how fast people can stake and unstake. This is again a mechanism to keep the chain stable, and will not let the rapid fluctuations of the Ethereum application layer affect the security of the chain.

The deposit/withdrawal bottleneck is limited to X/ETH per day, where X is equal to:

#validators/65536, round down to the nearest integer.

The number 65536 is derived from 2^16. For some reason, Ethereum developers love these square numbers. It's apparently called the "churn limiter" and you can read about it here and here.

Currently, there are 433,916 Ethereum validators on the Beacon Chain. To find how many validators per epoch, divide it by 65,536 and round down to the nearest integer.

433,916 (total validators) / 65,536 ≈ 6 validators per epoch

So the activation/deactivation count is 6 validators per epoch. An Ethereum epoch is 6.4 minutes, 225 epochs in 24 hours.

Therefore, the current rate of validator activation/deactivation is 1,350 validators per day.

225 epochs * 6 validators per epoch = 1350 validators per day

Each validator has 32 ETH, so a maximum of 43,200 ETH is unlocked per day.

32 ETH * 1350 validators = 43,200 ETH

Also, APY as an ETH staker increases after the merger, as ETH stakes also charge transaction fees.

This is expected to boost ETH yields from 4.2% to 5%+, but also higher at times of high gas consumption.

9. Why 32 ETH?

Why does it take 32 ETH to run a node and not 31, 33 or any other number?

The answer is that the more nodes, the more total message passing between nodes. If the amount of ETH is low, more nodes can come online. While this is good for decentralization (🙂), it is a limitation of scale (☹️).

32 ETH was chosen as the best balance between the two ends of the spectrum, also because it is a square number: 2^5.

Since node messaging is exponential, reducing the ETH validator requirement from 32 to 16 will increase the amount of messaging for all nodes by a factor of 4. 32 was chosen as the minimum amount of ETH stake that can also yield "finality" in 768 seconds or "2 epochs".

Is 32 ETH permanent?

unnecessary! It can of course be modified to 16 or lower with improved consumer hardware, message compression, and better signature aggregation.

10. Proof of stake is not on-chain governance

A common criticism (mainly from the Bitcoin camp) is that PoS equates to the "fiat system" we are trying to get rid of.

What they mean is that whoever has the capital has the power.

This is a frustratingly false position, and many of those who often support it may be spreading it maliciously to discredit any consensus mechanism other than Bitcoin.

It's surprising how some PoW proponents keep repeating the blatant lie that PoS includes voting on protocol parameters (which it doesn't, just like PoW doesn't), and this is often unchallenged. In PoS and PoW, nodes reject invalid blocks. It's not difficult.

The role of an ETH validator is exactly the same as that of a PoW miner. This is a 1:1 comparison.

ETH holders have no governance rights over Ethereum. As in Bitcoin, this power is held by non-validating node operators, the "community".

Ironically, these camps advertise PoS as a “get richer” scheme, while PoW mining facilities provide richer and more capitalized entities with greater returns on investment than smaller, less capitalized entities. The big return on investment is an indisputable fact.

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