Excitement is building for Ethereum’s “Merge”, which hopes to increase scalability, security, and sustainability. Could the game-changing technology drive Ethereum to new highs?
Crypto enthusiasts await as the second-largest crypto by market cap gets closer to a massive upgrade that will strengthen its infrastructure and make it more sustainable. In doing so, Ethereum aims to get closer to realising its vision of a digital future on a global scale.
What is the Merge?
Ethereum’s merge, in its simplest form, is an attempt to switch from a proof-of-work model to proof-of-stake.
In the current proof-of-work model, miners complete complex puzzles to validate transactions. The process requires a lot of energy to power computers, making the process both costly and unsustainable due to its environmental impact.
With the planned proof-of-stake model, users would be able to validate transactions according to how many coins they contribute, or “stake”. In return for staking their coins, users may get chosen to validate transactions and earn rewards.
With the Merge, Ethereum’s blockchain would completely switch to the proof-of-stake model, called the Beacon Chain, making mining obsolete.
The completion of the Merge is expected sometime in the second quarter of 2022, without a precise date yet. More information on the exact timing may be delivered by Ethereum founder Vitalik Buterin at the ETHAmsterdam event on the 22nd of April.
Impact of the Merge
The Merge is expected to reinforce the positioning of the Ethereum blockchain as an energy-efficient global “Proof of Stake” blockchain network.
Energy consumption to fall by 99%
It’s predicted energy consumption will be cut by 99% as miners are removed from the picture. Miners, who typically purchase expensive equipment that includes computers, graphics cards, and other gear to build Ether mining rigs, have rushed to mint Ethereum before the Merge. One effect of transitioning to a more sustainable blockchain could be that investors and projects will be more willing to embrace the Ethereum blockchain. For example, Tesla, which shied away from buying more crypto because of its environmental impact, could turn to Ethereum. Many institutional investors with ESG criteria as part of their mandates, may also be more likely to turn to Ethereum because of its environment-friendly aspects.
An asset with a yield
The rewards that are currently going to miners through the “proof of work” system will go to users with the “proof of stake” model.
Users, through a form of passive investing on the network, will be able to earn yields estimated between 10 to 15%, making the cryptocurrency potentially attractive as a “carry” trade as some investors may be tempted to earn a regular income. Some sophisticated investors may also borrow in USD and to a certain level hedge the downside potential, just to benefit from the yield Ethereum provides.
Investors will need to deposit a minimum of 32 ETH (valued at approximately USD98’000) to participate in staking, although some services offer staking for investors with as little as 0.01 ETH. Both the sustainability appeal and yield of Ethereum, post the Merge, could attract a large pool of institutional investors as long-term holders.
Lower costs, higher security, and scalability
As the current proof of work model is extremely energy-intensive, with the proof of stake system overall costs should come down significantly and continue to decrease as more users take part in the blockchain.
The planned upgrades improve Ethereum’s security as validators must stake significant amounts of ETH into the protocol, and thus if they perform fraudulent changes, the protocol can automatically destroy their ETH.
The Beacon Chain will also assign validators to different parts of the blockchain, making it virtually impossible for them to collude.
Finally, staking, which is less costly than mining, should encourage more people to become validators, increasing the network’s decentralisation.
To scale, Ethereum needs more transactions per second, coupled with more nodes. The upgrade is expected to improve speeds beyond the current 15-45 transactions per second limit. Validators will only need to review their own part of the blockchain, making the nodes more lightweight, and allowing Ethereum to scale and remain decentralised.
Industry expert views
Industry experts tend to express very positive views on the Merge, as it is expected to strengthen the Ethereum blockchain and make it more attractive for investors.
Source: Bloomberg data, FlowBank
Former BitMex CEO Arthur Hayes believes Ethereum could run to USD10’000 before the end of the year, although in the near term he predicts crypto could be under pressure due to the fallout of the war in Ukraine and slowing global growth.
Billionaire crypto enthusiast Marc Cuban is also positive about Ethereum. He is most bullish about the aspects of smart contracts, which will be enhanced thanks to the greater scalability and security after the Merge.
Mike McGlone of Bloomberg intelligence sees ETH ending the year between USD4’000 to USD4’500. The latest Coinpedia prediction at the end of March forecasts ETH to trade between USD4’890 and USD10’870, by year-end.
Although these views are very bullish, it is important to note that crypto enthusiasts often have aggressive price targets that may not be realistic in a risk-off scenario.
According to the over-the-counter tech platform Paradigm, options activity also suggests that there is a lot of interest for call options with strikes at USD10’000 for the December 2022 expiry (last price: USD3’050), suggesting investors are making bets that Ethereum could reach 5 digits figure by year-end.
Effect on the DeFi ecosystem
Ethereum functions as the base layer for almost 3’000 decentralised apps. The altcoins include meme coins like Shiba Inu to metaverse tokens like MANA. Ethereum also enables NFTs, DAOs, and other encrypted technologies. The upgrade in Ethereum’s blockchain is expected to help fuel the entire ecosystem, particularly if Ethereum gains value as users may be more inclined to buy Ethereum and then trade it for NFTs and other digital assets.
Switching to a proof of stake system poses great challenges and a lot could go wrong. There could be software bugs, hacks, or miners could create an alternative Ethereum network.
A bug happened in 2020 during an upgrade, that saw Ethereum split into two, wreaking havoc on the DeFi ecosystem.
As a result of the risks involved, most centralised crypto exchanges are expected to pause Ethereum deposits and withdrawals around the Merge as a precaution. DeFi apps may do the same.
Ethereum miners may quit the mining business shortly before the Merge, figuring they can make more money by selling their equipment than by waiting until the last minute. If there is a steep drop in the network’s mining power, it could also cause a security issue before the Merge. Developers may in that case pause the Merge if they see the mining activity drop too much. It is likely the proof of work and proof of stake will coexist for a while after the Merge, until things can be completely stabilised.
The Merge offers a new version of Ethereum that should promote the blockchain technology for wider adoption as the enhanced security and scalability makes it even more attractive for DeFi. For investors, the sustainability and staking make it more appealing as a longer-term investment, as stakers are more likely to hold onto it, than miners which need to sell Ethereum to pay for the energy and mining equipment. The exciting upgrade does come with its own risks, and while the price of Ethereum could claim new highs, it will likely first require proving its new technology fully functions.