An Ultimate Guide to The Merge and Ethereum's Proof-of-Stake Transition

An Ultimate Guide to The Merge and Ethereum's Proof-of-Stake Transition

On September 15, an important historical event happened: the Beacon Chain merged into the Ethereum mainnet. The major blockchain has changed its consensus algorithm for the first time ever. This piece will review The Merge and what it means to the community.

Key Points

  • The Ethereum network has gone through a critical upgrade called The Merge, which involved changing the consensus algorithm from Proof-of-Work (PoW) to Proof-of-Stake (PoS). The upgrade is meant to make the blockchain platform more scalable, secure, and decentralized.
  • It started on September 6, 2022 with the successful Bellatrix upgrade on the Beacon Chain. Then, on September 15, as part of the Paris upgrade, The Merge was completed and Ethereum successfully transitioned to a PoS network.
  • After Ethereum's transition to PoS, miners in the network were replaced by validators. Validators are required to hold a certain amount of Ether (ETH) in order to participate in creating and checking new blocks on the network. In exchange for their work, validators receive rewards in a form of newly minted ETH. Currently, a validator can expect to earn a 4-4.5% yield on their holdings in the PoS pool.
  • Ethereum's next major upgrades will include the introduction of sharding and the transition to a new EVM (Ethereum Virtual Machine), which will support multiple programming languages ​​for smart contracts.

When Did The Merge Happen?

First, the Ethereum team launched a network separate from the mainnet called the Beacon Chain. A smart contract for ETH staking was deployed on this chain, allowing users to lock up their funds. As of August 29, 2022, the Beacon Chain had more than 420,000 validators staking over 13.47 million ETH.

The hard fork started off with the Bellatrix upgrade on the Beacon Chain on September 6, and The Merge was activated on September 15.

After the hard fork, the Beacon blockchain became the Ethereum mainnet; the registry data and funds in the deposit contract remained unchanged.

When Can ETH Be Unstaked?

Sending ETH to the staking contract on the Beacon Chain prior to The Merge meant you consent to lock up your funds until The Merge is activated. Currently, the lock up is extended for another 6-12 months until Shanghai upgrade is complete. However, validators started receiving ETH rewards immediately after The Merge.

Why Did Ethereum Switch to Proof-of-Stake?

Prior to The Merge, Ethereum used the Proof-of-Work algorithm to create blocks. The Proof-of-Work algorithm required significant energy costs and imposed scalability limitations on the network. In addition, mining in PoW required miners to invest in expensive hardware, as well as its maintenance, which increased the entry barrier. The Merge, in turn, has addressed those issues and brought Ethereum closer to solving the blockchain trilemma.

As of June 2022, the energy consumption of the Ethereum blockchain was 112 TWh per year, which was comparable to the consumption of a medium-sized country. After replacing mining with staking, this indicator dropped by 99.95%. The developers claim that one node now requires the same amount of electricity as a regular PC.

Another important consequence of the upgrade is increased security: Ethereum can now repel intruders' attacks more effectively. The new consensus algorithm requires a significant amount of funds to be locked up, and validators can lose their funds if they behave dishonestly.

Finally, Ethereum’s planned upgrades related to scalability will not be possible without a change in the algorithm.

Proof-of-Stake and Ethereum

The Proof-of-Stake algorithm assumes that the weight of the validator's vote depends on the number of coins staked. The amount of locked Ether determines the node's reward. Meanwhile, to become a validator, one needs to deposit at least 32 ETH.

In order to optimize calculations, staking participants are divided into separate groups – committees. They typically include from 128 to 2,048 validators and can be combined with each other into blocks.

In the updated Ethereum, the consensus procedure will be divided into so-called epochs, each lasting approximately 6.4 minutes. These intervals are divided into 32 time slots, 12 seconds each. During the specified period, a block is formed. Committee groups are distributed among the time slots and create chain elements.

The chosen validator proposes the block, and the others vote for it. After receiving the majority of the votes, it is included in the blockchain. Each epoch, committee members are shuffled. The maximum number of groups and their members depends on Ethereum's maximum emission, equal to 134.2 million ETH.

Staking Profitability

The validator’s commission in the Ethereum network consists of two parts: premium and basic. After switching to Proof-of-Stake (PoS), a fixed block reward became a relic of the past. Now, the income of the validators is based on the additional emission of ETH, which changes dynamically every epoch. The size of the new coins' annual emission will be calculated according to the total sum of funds locked in staking.

Staking Rewards reports that at the end of August 2022, Beacon Chain validators were receiving 4.5% per annum, and holders delegating funds were getting about 4%. As Nanse analysts found out, over 60% of all staked Ethereum coins are controlled by four platforms: Binance, Coinbase, Kraken, and Lido Finance.

Messari analyst Tom Dunleavy suggests that The Merge will increase ETH staking yield, which will range from 7% to 13% per year but will decline over time.

ETH Price After The Merge

Most experts agree that The Merge will affect the cryptocurrency market. According to Glassnode, Ethereum-based derivatives traders are positive about the price of ETH in September 2022. Based on the ratio of calls and puts, as well as OI indicators, investors are betting on the price from $2,200 to $5,000. Former BitMEX CEO Arthur Hayes believes ETH will rise to $3,000.

Chainalysys researchers point out that after The Merge, the price of Ethereum may show a dynamics different from the rest of the cryptocurrency market.

Ethereum will still have a deflationary burn mechanism, which should also contribute to the growth of ETH. And the growing adoption of Ether by institutional investors is yet another positive factor. Besides, the number of whales holding ETH has grown, too.

Ethereum Miners and PoW Fork

The Merge made further Ethereum mining impossible due to the so-called difficulty bomb. Consequently, some miners may migrate to Ethereum Classic (ETC), an old fork of Ethereum extremely close to its "parent" in terms of architecture. However, it does have a much lower hashrate and overall activity.

Ravencoin (RVN) is another possibility for former ETH miners. The coin demonstrated a price surge of more than 100% in the first two weeks of September.

A small part of the Ethereum community – miners and equipment manufacturers – intends to launch a fork to save the PoW algorithm. According to Chandler Goh's proposal, the project could be called Ethereum PoW (ETHW). The launch of the mainnet fork should take place within 24 hours after the activation of The Merge.

Meanwhile, investors do not bet on the project. By mid-September, the ETHW futures price had already dropped to $30. Several large projects, like Uniswap, Chainlink, Ethermine, and OpenSea, have already refused to support the Ethereum PoW fork.

Chances are that ETH holders will receive an airdrop of the ETHW fork cryptocurrency, and Binance and Bybit have already announced their intent to distribute free coins. The same thing happened in 2017 with Bitcoin Cash, which separated from Bitcoin after a hard fork.

After The Merge, ETHW price declined to levels below $15 and the new network experienced difficulties. At the time of writing, the future of ETHW is still uncertain and major centralized exchanges have not announced their final decision on whether they will support it.

Further Updates

The Ethereum roadmap includes implementing sharding, a technology used to increase the scalability of the blockchain. Sharding is a process of dividing a common database into fragments. This update will allow the Ethereum network to grow with the load, despite a significant increase in the size of the ledger.

The Beacon Chain made it possible to coordinate the work of validators and their distribution among shards. The algorithm implements segment synchronization and opens access to information about the current state of the network. The nodes of the updated mainnet will store part of the blockchain, and special algorithms will verify the validity of the data.

Sharding will reduce hardware requirements and allow the node to run on laptops and smartphones. The update is scheduled for 2023, but the final date depends on the effectiveness of the PoS transition.

The next step after sharding is the deployment of a new Ethereum WebAssembly virtual machine (ewasm) that will support various programming languages ​​for creating smart contracts. Ewasm aims to make Ethereum more efficient and should eventually replace the Ethereum Virtual Machine (EVM).

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