Is Investor Enthusiasm for The Merge Misplaced?

Amidst a crypto winter that has wiped off billions in token valuations, the price of Ethereum’s ether popped recently. It skyrocketed by more than 50% to trade at $1636.17 and has, since, fallen by 15%. Analysts are attributing the surge in Ether’s prices as a vote of confidence by investors to a possible September event called The Merge.

The Merge is expected to make Ethereum’s blockchain more energy-efficient and pave the way to making it more scalable. In the short-term, however, it will not have a not a noticeable impact on user experience in the world’s second-most valuable blockchain. It will not reduce congestion or transaction fees. And it will not decentralize Ethereum further.    

What is The Merge?

Simply, The Merge is Ethereum’s transition from the Proof of Work (PoW) consensus mechanism to Proof of Stake (PoS). The former method requires deployment of significant computing power, in the form of hundreds of mining rigs, to mint new coins. The PoS consensus mechanism eschews energy intensive mining practices for staking, in which nodes deposit ether on the blockchain. The greater the amount of ether staked by a node, the higher its chances of winning the rights to create a block of transactions.

In a PoS system, miners will be replaced with validators to confirm and assemble transactions. Ethereum researchers are marketing the change from PoW to PoS as a development that will enhance the blockchain’s “economic security” because it will increase the costs of attacking the blockchain. As the amount of ether staked at validators increases, so do the costs of taking control of the blockchain through a 51% attack.

According to Justin Drake, researcher at the Ethereum Foundation, an investment of between $5 billion to $10 billion, primarily in the form of mining rigs and electricity costs, is needed to take control of the Ethereum blockchain in its current form. But there is about $15 billion of ether staked on its blockchain, meaning it could possibly be more expensive to disrupt Ethereum’s operations in a PoS consensus mechanism.

The increase in economic security will complement a corresponding decrease in Ethereum’s energy consumption.

Drake told online publication The Defiant that Ethereum’s energy consumption will come to down “almost zero” of the global production of electricity from the current figure of between 0.1% to 0.3%. The shift to PoS will also reduce the barriers to entry for running a node in the Ethereum network because it does not require expensive equipment, says Drake.

Ether circulation numbers were originally designed to be unlimited. But the current shift in consensus mechanisms will decrease its numbers over time. “In an open and competitive market, profits tend to zero,” Drake said by way of explanation. Over time, this means that the token’s price should increase as Ethereum becomes a popular hub for decentralized applications. In the short-term, i.e., until The Merge occurs, however, ether numbers are expected to increase and peak at roughly 120 million.

Validators – the new entity responsible for confirming transactions – will see an increase in their payday. Drake says all transaction fees and tips that currently go to miners will be transferred to validators and the rewards to generate a block will double.   

 A Misplaced Enthusiasm?

Investor enthusiasm for The Merge, which has been postponed several times in the past, may be misplaced because it does not affect significantly affect Ethereum in the short-term. The event may be a momentous shift in the platform’s workings, but it hardly makes it more usable or increase its utility. What’s more it does not solve Ethereum’s immediate problems.

One of those is scalability. Ethereum’s network is prone to immediate congestion. Previous surges in the popularity of certain applications have delayed transaction confirmation times. The Merge will result in slightly higher block sizes but that change does not guarantee a shorter confirmation time. It also does not solve the problem of high transaction fees on its network. In fact, in the period immediately following The Merge, fees are expected to increase.

Most cryptocurrency blockchains. Including Ethereum, are prone to centralization. The Merge will not decentralize its network. In his interviews, Drake emphasizes the importance of PoS in decentralizing Ethereum by lowering the barriers to entry. All one needs to participate in Ethereum’s network is a stake of 32 ETH. At current prices, that amounts to a minimum investment of roughly $44,000. That sounds like a reasonable figure to put into a new business.

But there is a catch here. While staking more than 32 ETH does not provide the validator with more voting power or blocks, investing in a massive numbers of nodes will.

Already, the Beacon chain – a chain that is currently running in parallel with Ethereum’s main chain and will be merged with the main chain – provides a glimpse of the future. There are staking pools on it that control vast amounts of staked ether through their validators. This practice grants them enormous voting power in Ethereum’s future trajectory.

The biggest of these is Lido Finance, an entity that is already implicated in the current crypto crash. Other prominent holders of ETH tokens are well-known exchanges in the crypto ecosystem: Coinbase, Kraken, and Binance. Together, they control roughly 30% of all validators in the Beacon chain. Unknown whales, or nodes with substantial holdings of ether, also control a significant chunk. If a future where the overwhelming majority of ether is staked does indeed come to a pass, such entities will control the blockchain’s workings.

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