The New Ethereum Engine: The Merge and What it Means for the Crypto Space

By November 24, 2022DeFi
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Author: Mauricio Chandler, Graphics: Osayd Asif Bashir

The BRB Bottomline:

On September 6th, 2022, the Ethereum network transitioned to a “proof of stake” method of transaction verification. Coined “the Merge,” this development in blockchain technology was touted as a monumental advancement with the power to increase the efficiency of blockchain verification and ultimately revolutionize possibilities for Ethereum in the coming years.

For better or worse, cryptocurrencies have consistently been the subject of public spotlight in the last three years. Crypto markets — and in particular, their chaos — have been met with overwhelming controversy and contention as their pros and cons are constantly being weighed against each other. Even as trading platforms like Coinbase and Kraken have made obtaining crypto tokens exceedingly simple, the extreme volatility of crypto has raised important questions about the reliability of decentralized currencies. Nonetheless, by allowing for the implementation of technological applications such as smart contracts, the Ethereum infrastructure has remained at the forefront of efforts to create a thriving Web3 ecosystem and thus continues to support millions of transactions per week. “The Merge” has been announced as the latest iteration of the evolving Ethereum mainnet and is supposed to have drastic implications for the long-term stability and efficacy of the network.

Before delving into the intricacies of Ethereum and the efforts to create a more sustainable token through the Merge, it is important first to understand what cryptocurrency tokens are and the underlying technologies that enable their functioning.

What is the Ethereum Blockchain?

At its core, cryptocurrency is an encrypted, decentralized, and digital form of money based on blockchain technology. Bitcoin and Ethereum are the most well-known cryptocurrencies, but there are thousands of cryptos, all running on distinct blockchain protocols. Cryptocurrencies are referred to as “decentralized” because there is no central governing authority that regulates the value and exchange rates of the currency (like there is for the U.S. dollar or the Euro). Instead, critical processes such as transactions are carried out through a widespread verification system via the Internet.

Outlined in a white paper by the mysterious Satoshi Nakamoto, Bitcoin was the first cryptocurrency to gain widespread usage and notoriety. Since its launch in 2009, Bitcoin has served as a framework for the development of other cryptocurrency assets and acted as a model for the likes of Ethereum, Cardano, and Solana.

Launched in 2013, Ethereum distinguishes itself from Bitcoin and other crypto tokens because of an added feature that allows for the construction of complex transaction systems. This feature results from the implementation of smart contracts, a function that Ethereum founder Vitalik Buterin highlighted in the Ethereum white paper.

So what gives these cryptocurrencies their value? Many say that the intrinsic value of crypto comes from the underlying technology that validates their trade value and exchange rates. This technology is called the blockchain, and it’s what allows for the exchange of crypto tokens through “cryptographic proof” mechanisms.

Blockchain technology allows for decentralized transactions involving cryptocurrencies through the verification and recording of individual crypto transactions on a universal ledger. Essentially, every time a transaction is made using a cryptocurrency token, that transaction is recorded on a “block.” As more transactions occur across the decentralized network, more blocks are added to this ledger, which ultimately creates a chain of blocks, or what we know as the blockchain.

The blockchain is an encrypted record book of all the transactions that have occurred on a particular decentralized network using the cryptocurrencies associated with it. If you were to buy a few dollars worth of Ethereum, that transaction would be recorded on the Ethereum blockchain. Without transaction verification, however, this type of record-keeping is futile. Digital catalogs of information usually have ways to be hacked and taken advantage of. The way many blockchain technologies, including Ethereum once upon a time, mitigate the possibility of fraud and espionage is through a “proof of work” verification system that secures the validity of transactions.

Proof of What?

“Proof of work” was the primary transaction verification method on the Ethereum network before the Merge. The “proof of work” authentication system functioned through a network of computers competing to solve complex mathematical problems provided by an overarching algorithm.

The computers competing to solve these problems (referred to as miners) would work towards authenticating groups of transactions. The first computer to successfully validate a transaction from a database of random information received a reward for its efforts. These rewards were quite sizable, and incentivized more computers to work towards Ethereum mining.

While effective in validating transactions, the best way for Ethereum miners to profit was through using as much computing power as possible to authenticate the largest amount of transactions. This strategy ultimately culminated in the creation of a power-intensive system with negative environmental implications.

One of the main selling points of the Merge has been Ethereum’s transition from proof of work to proof of stake. According to the Ethereum website, The Merge decreased the Ethereum miannet’s energy consumption by around 99.95% and created a cleaner, more efficient network for future development.

The proof of stake method allows for such drastic changes in sustainability by cutting back on the amount of computing power being put into Ethereum mining. The staking method allows verification priority to people who “stake,” or temporarily lock up, their cryptocurrencies in a communal safe.

Similar to how bank collateral works, the chances of having the opportunity to participate in the Ethereum staking/verification process increase with the amount of cryptocurrency staked. This system encourages more entities to stake their coins and create a more stable token economy. With less power going toward mining Ethereum, the system gained significant advantages in overall cost and efficiency.

Why Merge?

Alongside decreased energy costs, the Ethereum network had several incentives to execute the Merge. One is the introduction of new validators. In the old proof of work system, miners were using natural resources to convert energy into crypto; in proof of stake, prospective validators can use financial resources to produce these securities.

Essentially, validating cryptocurrencies is no longer as reliant on computing power, which ultimately creates an environment where individual entities with more investment in the Ethereum network have more say in transaction verification outcomes. This change could be beneficial as individuals who care more about the future of Ethereum have increased influence over the direction that Ethereum takes.

Another aspect of the Merge that has garnered approval is the possibility of less token issuance. With less mining infrastructure, Ethereum is being rewarded in smaller amounts for the verification of new blocks. The decreased issuance of Ethereum could potentially bolster the value of tokens in the long run and work toward stabilizing the system as a whole.

Although the Merge has been received by the crypto community with general positivity, there are some critiques that have recently gained traction in the discourse surrounding decentralized finance.

Problems With the Merge

While the consensus is that the Merge will have positive implications for Ethereum in the long run, critics argue that the transition to proof of stake could potentially take away from Ethereum’s claim to decentralization. Corporations like Lido, Binance, and Kraken have massive sums of cryptocurrencies that they are able to stake freely. The number of cryptocurrencies that these DeFi organizations are capable of staking may ultimately work to place a lot of power in the hands of just a few corporate entities.

A report from J.P. Morgan last month expressed concerns over the possible centralization of the Ethereum blockchain. With a few entities commanding a majority of the stake in Ethereum, J.P. Morgan believes that the Merge could polarize the Ethereum network between classes of smaller users and large corporations.

Berkeley DeFi

Coming from a university with one of the leading computer science programs in the nation, many U.C. Berkeley students actively invest in Ethereum through easy-access trading platforms. As the Merge stirs up even more excitement surrounding crypto investment, it is important to remain educated when making high-risk trades. Ethereum and its affiliated cryptocurrencies continue to be exceedingly volatile securities. Do research before buying.

A good way to stay up to date about the latest crypto news is through platforms like Coindesk and the Financial Times. Students can also follow organizations like Blockchain at Berkeley or Berkeley Xcelerator on Instagram and other social media platforms. Staying informed about the events surrounding the decentralized finance space is a fundamental part of investing smartly.

Take-Home Points

  • Ethereum is one of the thousands of cryptocurrencies operating on blockchain technology.
  • The Ethereum network was extremely inefficient and environmentally unsustainable under the “proof of work” verification method.
  • Ethereum has transitioned to a more efficient network using a new “proof of stake” transaction verification system.
  • There continue to be some concerns surrounding the decentralization of Ethereum on the proof of stake method.

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