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Ethereum ‘merge’ will change crypto forever: Everything you need to know

August 19, 2022, 1:40 PM UTC
Ethereum-merge
The Ethereum “merge” is poised to change crypto forever.
Illustration by Fortune

The Ethereum community is more giddy than usual. On weekly Zoom calls dedicated to technical matters, Ethereum developers have been celebrating—even singing—as they advance toward the “merge”—an event hailed as the most important technological upgrade in the history of crypto. 

But what exactly is the “merge”? Those who follow crypto news have likely heard about it, and are aware it represents a shift to something called “proof of stake.” But there are few detailed accounts of the technical process, and the merge’s implications for the larger crypto ecosystem.

To that end, Fortune spoke to Ethereum core developers to craft a detailed overview of the merge—currently slated for mid-September—and the controversies that have surrounded it. Here’s all you need to know.

What exactly do people mean by the merge?

Eth2, Ethereum 2.0, ETH 2.0…The project has been called many things in the past, but earlier this year the Ethereum community settled on the “merge.”

Most simply, the merge is a long-planned Ethereum upgrade aimed at improving the network. Such upgrades are commonplace, but this is the most important one to date, and its success will pave the way for developers to introduce a host of new features to the network.

The merge will, well, merge the current Ethereum mainnet—or the main public Ethereum blockchain used by everyone—with something called the Beacon Chain. Currently, both chains exist in parallel. But only the Ethereum mainnet, which currently uses a mechanism called proof of work, is processing transactions. 

Once the merge is complete, the Ethereum mainnet will shift away from proof of work and instead adopt the Beacon Chain’s proof-of-stake mechanism.

What’s proof of stake?

Proof of stake (PoS) is a type of consensus mechanism that differs from the traditional proof-of-work (PoW) one.

A consensus, what?

A consensus mechanism describes the way Ethereum—or other blockchains—determine the legitimacy of transactions posted to its network. It is how a blockchain governs itself.

Ethereum can be seen as a distributed database of nodes—or computers that run software to verify blocks and the transaction data within them. To reach consensus on the network and make a decision, the majority of nodes must be in agreement, and the choice of consensus mechanism determines how they do that.

So, how does proof of stake work? 

Once Ethereum shifts to a proof-of-stake consensus mechanism post-merge, the network will rely on trusted entities known as validators to verify transactions and add new blocks to the blockchain. A validator will be chosen at random each time a new block is to be added, which will occur every 12 seconds or so post-merge.

Anyone can apply to be a validator by depositing 32 Ethereum (about $61,000 at mid-August prices)—a sum intended to ensure that participants have a stake in the success of the network—and run up-to-date software.

As the Ethereum Foundation explains, prospective validators will then be added to an “activation queue that limits the rate of new validators joining the network.” Once a validator is “activated,” it will be eligible to review and approve new blocks the Ethereum network proposes to add to its blockchain. 

In return for securing the network, validators will earn Ether as reward.

While the 32 Ether staked as collateral serves as a major incentive to behave appropriately, there are also punishments for validators that are incompetent or malicious. Namely, they can be penalized with the loss of some or all of their deposit.

The merge hasn’t happened yet, but the Beacon Chain already has over 415,000 validators.

And what’s proof of work?

Proof of work is another consensus mechanism that has been used by the Ethereum mainnet since its genesis. Other older blockchains, most notably Bitcoin, continue to employ it. 

The “work” in proof of work comes in the form of mining, where miners expend energy in the form of computing power. Though its supporters (mostly Bitcoiners) love proof of work, saying it’s the most secure mechanism, the process is notably bad for the environment—which has been a key factor in prompting Ethereum’s shift to proof of stake.

Why is the merge such a big deal?

For one, Ethereum is the most-used blockchain and powers Ether, the second-largest cryptocurrency, with a $202 billion market cap. Ethereum also hosts numerous decentralized applications (dApps) and decentralized finance (DeFi) protocols and establishes the authenticity of millions of non-fungible tokens (NFTs). 

This means the outcome of the merge will affect not just the Ethereum blockchain, but a wide constellation of products and services that rely upon it. And given Ethereum’s size and influence, the fate of the merge is likely to have a ripple effect on the broader crypto industry.

Meanwhile, the switch to proof of stake will affect thousands of people who mine Ether, many of whom have expended significant capital in the endeavor. Most will probably turn to mining other proof-of-work coins, but the merge is still likely to hurt their bottom line.

But while the merge is bad news for miners, the vast majority of the Ethereum community and beyond see the end of mining as a good thing—helping both the planet and Ethereum’s reputation. “The switch from proof of work to proof of stake [will] reduce overall energy consumption of Ethereum by 99.9% or more,” Ethereum core developer Preston Van Loon told Fortune. That’s no joke. 

Another important consequence of a successful merge will be a reduction in the issuance of new Ether. After the merge, Ether is likely to become “the largest deflationary currency,” according to Lucas Outumuro, head of research at blockchain intelligence firm IntoTheBlock. 

In his latest newsletter, Outumuro predicts that because the cryptocurrency will no longer be awarded to miners, the amount of new Ether issued will drop by approximately 87%. “ETH’s net issuance is now projected to range between –1.5% to 0.5% based on the last three months of data, compared to –4.5% to –0.5% using Q1 to Q2 numbers,” he wrote on Aug. 19.

This decline in issuance, in turn, means Ethereum could eclipse Bitcoin in market cap over the next 12 months, according to an Aug. 12 report by research firm FSInsight.

Finally, the merge is viewed as a critical step for Ethereum’s overall development. According to Ethereum creator Vitalik Buterin, the network is now about 40% complete, and after the merge, “Ethereum can go up to being 55% complete,” he said.

Also on Ethereum’s road map are four other phases happening in parallel that developers are calling the “surge, verge, purge, and splurge”—all of which aim to make Ethereum much faster, safer, and more decentralized. “At the end of this road map, Ethereum will be a much more scalable system…By the end, Ethereum will be able to process 100,000 transactions per second,” Buterin said. 

Why is the merge controversial?

While most of the Ethereum community strongly supports the merge, a vocal minority is denouncing it as a colossal mistake. While some of this criticism is rooted in self-interest—namely, miners concerned about lost income—there are also ideological concerns.

Namely, critics say proof of stake will make Ethereum more centralized and less secure, and point to the dominance of a few entities holding staked Ether (Ether deposited on the Beacon Chain). As data firm Messari has pointed out, Lido Finance controls a whopping 31.2% of all staked Ether on the Beacon Chain, while Coinbase controls 14.7% and Kraken 8.5%. 

The large positions of Lido and others reflect the fact they are custodians for thousands of smaller Ether holders—and don’t actually own most of what they hold—but the centralization fears persist nonetheless.

These concerns include fear that law enforcement may treat validators as a target for censorship or surveillance. Buterin himself addressed this on Twitter. He signaled his support in burning the stake of any validators that censor the Ethereum protocol if asked by U.S. regulators. 

“I believe the Ethereum community is strong enough to fight off base-layer censorship,” EthHub cofounder Anthony Sassano tweeted on Aug. 16. “Bitcoin is prone to the same censorship risks as Ethereum is—it doesn’t matter if it’s PoS or PoW.”

Even Coinbase CEO Brian Armstrong suggested on Aug. 17 he’d rather stop the cryptocurrency exchange’s staking business than comply with any potential censorship sanctions.

Another concern surrounds “MEV”—Maximal Extractable Value (formerly Miner Extractable Value)—and potential MEV-Boost issues post-merge. 

MEV is the profit a miner or validator can make by picking, excluding, or reordering transactions within blocks. MEV-Boost is an optional software built for proof-of-stake Ethereum. It allows validators to sell blockspace to so-called block builders and outsource block production to maximize their reward—effectively subcontracting some of their validating duties.

Though there are upsides to MEV and MEV-Boost, both can also be used by bad actors in a malicious way. Specifically, some within the Ethereum community are worried about censorship of MEV-Boost “relay operators,” or entities that connect validators to block builders, among other things. 

Questions surrounding MEV and MEV-Boost post-merge have increasingly consumed the attention of countless users on crypto Twitter, to the point where it was even addressed during the most recent Ethereum Core Developers meeting. Though developers understand the concern, they’re hopeful that MEV-related issues, especially involving censorship, will not be prevalent threats, and remain focused on building Ethereum as a censorship-free protocol. 

Finally, there are other fears over proof of stake, notably the risk of a 51% attack—where bad actors conspire to take over more than half the computing power of the network, and tamper with the blockchain record to steal tokens. But with proof of stake, an attacker would need majority ownership of staked Ether to pull this off—and that would be incredibly expensive to obtain. 

Buterin himself doesn’t see a 51% attack as “fatal,” and the Ethereum community has likewise downplayed the concern, reminding others of the ability to slash a validator’s stake, among other things

Will the merge lower the gas fees everyone complains about?

No. 

Gas fees refer to the cost of carrying out a transaction on the Ethereum blockchain. Gas fees are paid in Ether (denominated in the smallest unit of Ether called gwei), and have frequently spiked during busy periods because of higher demand for transactions to be processed.

Gas fees are considered a big pain point for Ethereum users. This is unsurprising since, during the busiest periods on Ethereum, gas fees can reach hundreds of dollars, making the network unviable for many. 

The merge will shift Ethereum to proof of stake, but it will not expand network capacity. Therefore, it will not impact the price of gas fees.   

Buterin predicts gas fees will drop in the future, though. He estimates that in time, after the merge, gas fees could be as low as $0.002 to $0.05 owing to roll-ups—a so-called Layer 2 technology that “rolls-up” a multitude of transactions off-chain, processes it, and then records a compressed version on the main Ethereum blockchain. And as the Ethereum Foundation says, “The transition to proof of stake is a critical precursor to realizing this.”

Any other big misconceptions about the merge?

Yes, there are many.

For one, the merge won’t speed up the time it takes for Ethereum to process transactions. Though timing for new block creation and settlement (or finality) will change slightly post-merge, it won’t be substantial enough for Ethereum users to notice, the Ethereum Foundation says. 

Another misunderstanding about the merge involves the time frame during which investors can cash out their staked Ether after the upgrade. 

Investors won’t be able to withdraw their staked Ether immediately after the merge occurs, and will have to wait until the Shanghai upgrade, which is “the next major upgrade following the merge,” the Ethereum Foundation says. “This means that newly issued ETH, though accumulating on the Beacon Chain, will remain locked and illiquid for at least six to 12 months following the merge.”

To Ethereum core developer Tim Beiko, the biggest misconception about the merge is that you need 32 Ether to run a node, he told Fortune. “You don’t. Running a node is free,” he said. “Thirty-two Ether is only needed to run a validator,” as mentioned earlier.

Validators also can’t change protocol rules, Beiko said. “All the nodes validate protocol rules, hence validators can’t single-handedly change them.”

Okay, so what technically happens to pull this off? 

A lot. 

To prepare for the merge—and any other Ethereum upgrade for that matter—developers rely on Ethereum test networks (testnets) to practice running code before they deploy it on a mainnet. Testnets are similar enough to the Ethereum mainnet that developers can run tests and check for bugs or security holes to prevent such shortcomings from impacting the main blockchain.

Prior to the upcoming merge, testnets Kiln, Ropsten, Sepolia, and, most recently, Goerli all underwent the transition to proof of stake as dress rehearsals for the real event.   

Additionally, Ethereum developers introduced a handful of changes to the blockchain known as hard forks to pave the way for the merge, including the so-called London hard fork in 2021. London had a few purposes: It aimed to stabilize transaction fees by permanently destroying (“burning”) a portion of such fees, removing that Ether from circulation. The London hard fork also delayed the so-called difficulty bomb, a mechanism intended to incentivize the network to move away from proof of work by exponentially increasing the difficulty level of puzzles required for mining—making continued mining unviable. 

Following London, other forks like Arrow Glacier and Gray Glacier pushed the difficulty bomb off further and changed its parameters. There was also Altair, which upgraded the Beacon Chain.

Developers have conducted as well 10 mainnet “shadow forks” where they ran through the merge using a small number of nodes. This proved helpful since the shadow fork process is minimal enough to not disrupt the mainnet, but useful enough to assess any potential issues prior to the big mainnet merge. As developers continue to prepare for the merge, they’re planning still more shadow forks.

The process of the mainnet merge activation itself is intricate and involves three big steps, as Christine Kim, research associate at Galaxy Digital, explains

Starting it all, an upgrade called Bellatrix—named after a star and not the villain from Harry Potterhappened on Sept. 6 and set things into motion. It will prepare the Beacon Chain for the merge. Next, the network will need to reach a final Terminal Total Difficulty (TTD) value, which represents the potential difficulty level for mining, once the Bellatrix upgrade is complete. Nodes will watch for it, and once reached, it will prompt the final step, called the Paris upgrade. Paris will remove dependence on proof of work mining and mining difficulty, among other things, readying the network for the Beacon Chain and proof of stake. 

Given the complexity of all this, the process will definitely not happen overnight. Ethereum developers predict that there will be a 14-day period between Bellatrix and the mainnet merge.

How could things go wrong? 

Many things can go wrong, and it’s difficult to predict—despite years of tests and preparation. 

Ultimately, the merge is far from a slam dunk, and various issues may arise—like hiccups with clients or software verifying transactions, and application breakdown, among others—that are so complex they can be difficult to plan for. Bad actors might also try to sabotage the process as well. 

But Ethereum developers and engineers are working to be ready for any potential problems, and contend that they’re prepared.

Do I need to do anything with my Ether?

No. Be very wary of anyone telling you otherwise.

As the Ethereum Foundation says:

“As a user or holder of ETH or any other digital asset on Ethereum, as well as non–node-operating stakers, you do not need to do anything with your funds or wallet before the merge.

“Any funds held in your wallet before the merge will still be accessible after the merge. No action is required to upgrade on your part.

“As we approach the merge of Ethereum mainnet, you should be on high alert for scams trying to take advantage of users during this transition.”

Some people unhappy with the merge may try to branch off and create their own projects and variations of Ethereum—but anything of the sort will never be Ethereum. 

For example, a cohort of miners are planning an Ethereum hard fork post-merge to create what they call “ETHPoW,” in an attempt to continue a proof-of-work chain and retain their income. But even though this project sounds like ETH, and somewhat includes Ethereum in its name, it is not correlated with Ethereum, and will have its own token and applications if it succeeds. 

Wen merge? 

Ethereum developers are targeting the week of Sept. 15 for the merge, with TTD set to 58750000000000000000000. 

Nonetheless, many factors may change that time frame. The Ethereum developers made clear that the timing is an estimate and nothing is finalized yet.

But, it’s safe to say that Ethereum is closer than ever before to proof of stake. As artist Jonathan Mann sings after every successful merge test on each developer call, Ethereum won’t be resisting the “urge, the urge to merge.”

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