The Ethereum Merge is one of the most important events in crypto history. If successful, it will arguably be the most crucial step toward mass adoption by providing the infrastructure to build blockchain projects on a large scale.
This article will firstly discuss what the Merge is. Secondly, we will understand the difference between the Proof of Work consensus algorithm and Proof of Stake. Thirdly we will discuss the main criticism against Proof of Stake. And lastly, we will go a little bit deeper into the Merge.
What is the Ethereum Merge?
The Merge is a change in how the Ethereum blockchain processes transactions. This change occurs at the base protocol level and fundamentally changes how the blockchain operates.
In simple terms, it’s the transition from validating transactions through mining to validating through staking. In more technical terms, it’s a change in the consensus algorithm by transitioning from Proof of Work (PoW) to Proof of Stake (PoS).
Don’t worry if things seem a little complicated. We will take each term in part and explain it thoroughly.
What is a Consensus Algorithm?
A blockchain is a type of digital storage infrastructure that has some very unique functions.
Firstly, new transactions are verified and added in a decentralized way. Secondly, every node in the network agrees upon a single history of transactions. And thirdly, every participant in the network is bound by the same rules.
This combination of functions creates a few unique properties. Anyone can participate in a blockchain network if they follow the rules, and no one can censor transactions.
A consensus algorithm is a mechanism by which the blockchain enforces these rules in a decentralized way. Therefore, it effectively replaces any central authority and ensures the blockchain is autonomous. In simpler terms, a consensus algorithm is the ruler of the network.
This state of decentralization and autonomy is achieved by carefully aligning incentives and punishments to keep most network participants honest. In simple terms, it creates a situation where network participants have much to gain if they follow the rules. And on the other hand, they have much to lose if they try to cheat.
What is Proof of Work?
PoW is commonly known as mining. This consensus algorithm makes use of specialized hardware to validate new transactions. First, let’s understand how transactions are processed and how incentives and punishments are aligned.
As the name states, in blockchains, transactions are processed in blocks of transactions. In PoW, miners compete for the chance to process a block of transactions and receive the reward associated with this work. Let’s see how this works.
Nodes create blocks of transactions that need to be processed and send to miners to be solved. Each block comes with a cipher, and miners must guess this unique number. Thus a miner wins the right to process transactions and get the reward.
Once a miner solves a block, it broadcasts the solution to the entire network. Every node verifies that the work is done correctly and adds it to their copy of the blockchain. If everything is in order, the miner receives the block reward. This reward usually consists of new tokens created by the network and transaction costs paid by users.
The process of mining requires considerable upfront costs. Operators must purchase expensive hardware and pay for operations, including electricity. In this situation, miners can only be profitable if they follow the rules and mine valid blocks.
However, if miners try to cheat the network, they thus run the risk of being excluded. Leaving them with a significant upfront investment and no way of monetizing it.
PoW has served both Bitcoin and Ethereum very well and guaranteed their decentralization. But this consensus algorithm is costly to run and does not scale well. Thus the need for a transition to a more efficient mechanism.
What is Proof of Stake?
PoS is also most commonly known as staking. It represents the process by which users stake tokens to become validators in the network.
The goal is the same as in PoW, to validate transactions in a decentralized way and ensure censorship resistance. We’ll also see how this process works and how incentives and punishments are aligned.
A validator node is randomly selected to propose a block of transactions to be processed. The network then chooses a “committee of validators” that vote on the block’s validity. The block is sent to the whole network if everything is in order. Each node then rechecks the info and sends an attestation vote in favor of that block across the network if everything checks out. The network rewards nodes with new tokens and transaction costs for this collaborative work.
The incentive in this situation is the rewards gained through honest work. Conversely, the network can destroy tokens if nodes try to cheat.
Main Criticism Against Proof of Stake.
Although PoS is a more efficient and eco-friendly consensus algorithm, users have not tested it at scale. The community has concerns about its capacity to withstand attacks and maintain decentralization.
The main concern comes from who the validators will be. In the case of Ethereum, the largest holders of ether are projects with a legal entity. Thus, law enforcement can pressure validators to censor transactions from blocklisted addresses.
In this case, validators under legal obligations can choose to stop being validators. Or the network can do a social fork and remove any validator that tries to censor transactions.
Although these solutions exist, the fate of the Ethereum Blockchain is under much uncertainty. Only time can tell if PoS can withstand state-coordinated attacks.
More on the Ethereum Merge.
Currently, the Ethereum blockchain is a hybrid between PoW and PoS. In December 2020, the community launched the Beacon Chain. This PoS chain operates in the Ethereum network but is separate from the PoW chain.
At this moment, both chains are live and active. Both miners and validator nodes process transactions. But, this is coming to an end.
On September 14, the Merge will take place. This will represent the integration of the PoW chain into the PoS Beacon Chain. Thus, transforming the Ethereum network to fully PoS and eliminating mining.
The Merge is the first step of the Ethereum scaling strategy. Besides being more efficient, PoS is also more friendly to scaling, thus making room for a series of upgrades that aim to process 100k transactions per second.
In conclusion, the Ethereum Merge is an experiment that can forever change the crypto ecosystem.
Firstly, Ethereum will consolidate its role as “The World’s Computer” and open the door to processing 10.000 times more transactions at a fraction of the cost of current mining.
Secondly, The Merge can also drastically impact mining in general. Authorities may have a more critical approach to miners using so much electricity if other options are available.
And thirdly, it will show us how authorities relate to an eco-friendly blockchain that can run enterprise-level operations.