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Three reasons why Ethereum's 'The Merge' is amazingly exciting

Date: 2022-07-28

The Merge is finally here

In less than a month, we will be witnesses to one of the most important milestones in the short history of Crypto, as Ethereum, the second largest blockchain by market capitalization, with a total value of $180 billion at the time of writing, will undergo a crucial transition that will change completely how this blockchain project evolves, alongside some very probable price action related to $ETH.

The Merge

Photo by Zoltan Tasi on Unsplash

This blog post outlines the basic principles of this transition and answers the main important questions to consider...What are the main misconceptions? Why this event could change the whole concept of crypto investing? Why is this so important?

Ethereum 101

Ethereum was born out of the mind of Vitalik Buterin, a Thiel fellow - a fellowship Peter Thiel gives bright minds to quit college in exchange for $100,000 to start a business - that was passionate about Bitcoin.

With the help of peers like Charles Hoskinson (founder of Cardano), and Gavin Wood (founder of Polkadot), they created the first distributed computer, Ethereum. Using blockchain as the infrastructure layer, they created the Ethereum Virtual Machine (EVM), which enables developers to code and run smart contracts.

Smart contracts are code that, by being stored in a blockchain, are almost impossible to tamper with and are used as the ultimate authority in decentralized applications (an application running in a blockchain).

For instance, you can use a smart contract to simulate a bank; the code is in charge of defining the terms of the borrowing and lending, interest rates, and so on, with little to non-existent human intervention.

Put simply, smart contracts are what enables blockchain to dismiss middlemen, that being banks, lawyers, or whatever. Blockchains enable this by substituting trust systems, systems that require centralized third parties to guarantee the validity of transactions, with cryptographic proofs that validate this automatically with no need of these third parties.

Ethereum is in the process of enduring a radical change to its core

Ethereum, like Bitcoin, was conceived to leverage Proof-of-Work as the main algorithm to define participation (although the Ethereum's whitepaper, the technical paper that defined Ethereum, already considered from the start a future migration to PoS).

Disclaimer: It's pretty common to see people, supposed experts, define PoW and PoS as ‘consensus mechanisms’, which is blatantly wrong. They aren’t used to achieve consensus but to define rules of participation. This is a strikingly common mistake made by even the most knowledgeable experts, but it’s still a reckless way to describe them.

In short, these algorithms define what are the requisites for a node to participate, as well as what it needs to do to gain the right to propose the next block. The block chosen to insert a new block into the chain gains economic rewards for it.

But why does the second largest cryptocurrency need to change the way it works?

Proof-of-work relies on extremely complicated mathematical puzzles that nodes need to solve. The first node to solve it achieves the right to propose the new block. Thus, this algorithm generates a competition to decide who is the next block proposer.

As the problem is a really complex one, nodes need to carry out very computationally-intensive calculations, using very powerful computers. In other words, nodes consume a huge amount of energy during this competition.

To put into perspective, Bitcoin mining (the described competition process) consumed 132,128 TWh of electricity on May 13th, 2021, which accounts for more electricity than entire countries like Denmark, Chile, Finland, Netherlands, and is very close to Sweden's consumption that day.

Vitalik has been very outspoken about the fact that Proof-of-Work blockchains consume too much energy, which is an environmentally serious problem and also a very bad press for the technology as a whole.

Yes, Bitcoin can consume more electricity than entire countries.

Needless to say, electricity consumption is, by far, crypto's most criticized matter.

Also, Ether, Ethereum's cryptocurrency is inflationary at the moment. What this means is that the supply of available $ETH is increasing, which means that the value of the coins dilutes (the more coins are available, the less valuable each coin is).

This is no different from standard currencies like the dollar or the euro, which are, by default, inflationary. In fact, central banks normally assume a 2% inflation rate is ideal, as they consider that low inflation signifies a healthy and growing economy.

As mentioned, inflation decreases the value of each coin. However, in the case of standard currencies, this isn't a problem because they are monitored and controlled by central banks, that have the power to vary the inflation rate of their currencies by using macroeconomic policies like changing interest rates or buying/selling government and corporation bonds (Quantitative easing and tightening).

Sadly, in the case of cryptocurrencies, being inflationary isn't good, as there is no central authority. Thus, almost all cryptocurrencies aspire to become deflationary - besides Bitcoin, which will remain inflationary but its supply is still very scarce.

So what if there's a way to tackle these two great Ethereum problems? Think no more, meet the Merge

The Merge, as you may guess by now, will be moving from a Proof-of-Work (PoW) sybil control mechanism, to Proof-of-Stake (PoS), signifying a landmark transition that, if executed correctly, could change the whole crypto space forever.

This transition entails many different changes, but I'll cut through the noise to give you the three main theoretical improvements it will bring.

The Merge aims to become a landmark event in crypto, a powerful challenge to the deeply embedded status quo that Proof-of-Work is the ultimate and more just way to control blockchains.

In essence, it is a frontal attack on the almost dogmatic faith of Bitcoiners, who worship Bitcoin as the "one and only", and disregard any attempt to challenge their beliefs.

For that reason, The Merge has been met with considerable hate from the Bitcoin community, accusing Ethereum of being centralized, considering that such a transition, which requires ungodly effort, can only be done with a centralized team behind it (referring to the Ethereum foundation).

One way or another, The Merge is finally happening on the 19th of September, and with it, we enter a new era for Crypto.

What are The Merge's foremost important features?

  • It will reduce energy consumption by 99%, according to estimates. But how is this possible? Well, because PoW is far more energy intensive. As discussed earlier, PoW relies on a super-complicated system of maths puzzles competition to decide which node puts the next block. On the other hand, PoS decides this with staking. That is, nodes need to stake their coins to have the chance to propose the next block. The higher your stake the higher the chances to be chosen, according to a weighted probability distribution. On the flip side, if the node behaves the wrong way, its stake could be completely slashed, losing a great deal of money. As this method doesn't require solving complex math problems, the computational requirements and the resources used are much smaller for nodes in PoS networks.

Bottom line, this considerable energy reduction will be widely celebrated outside the crypto community, as a clear step towards more sustainable computer resources use. However, a successful transition will put considerable pressure on Bitcoin to evolve in that same way, although that scenario seems very unlikely.

  • It will drop Ethereum's issuance rate by over 90%, making the cryptocurrency potentially deflationary. Ethereum's PoS blockchain includes a burning mechanism, that burns a percentage of the fees of a block. Instead of all the fees paid to execute various operations on Ethereum going to miners, EIP-1559 essentially split these fees into a base fee and tips (the latter of which would go to miners). It is the base fee that is burned, which is another way of saying that cryptocurrency is destroyed and removed from circulation.

This could create a scenario where more Ether is destroyed than created, reducing the total supply of the cryptocurrency, thus making the existing coins more valuable.

  • It will set the stage for other wildly important improvements, such as sharding for improved scalability while reducing overall GAS fees, one of Ethereum's traditional problems, more efficient storage mechanisms, and an overall much more efficient blockchain. It will also greatly drop the requirements to become a full node in the network (you will be required to own a minimum of 32 ETH, but the computing requirements will be drastically reduced), which should, in the long term, make Ethereum much more decentralized, which I can stress enough to how important decentralization is for blockchains.

The Merge could become a historic event for crypto if successful. Upon succeeding, we could be witnessing the birth of the first blockchain that is widely used while being extremely scalable and truly decentralized, potentially becoming the infrastructure of the future of the Internet, the Metaverse, and many other technology platforms that will be uber-present in our lives.

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