Economy and Markets

What is the Ethereum Merge?

September 15, 2022
Bobbob Team

Today, 15 September, 2022 Ethereum's transition to proof-of-stake consensus, officially deprecating proof-of-work and reducing energy consumption by ~99.95%, took place.

Wait, what?

We break down:

▪︎ What is Ethereum?

▪︎ What is Proof of Work?

▪︎ What is Proof of stake?

▪︎ What is the Ethereum merge?

▪︎ How will the Ethereum merge affect you?

What is Ethereum 

Ethereum, released in 2015, is an open-source software platform that developers can use to create cryptocurrencies, digital applications, smart contracts and more.

Think of the Ethereum network as a language built on top of the internet, able to store and send value, write and adhere to contracts. Instead of trusting your landlord's attorney with your deposit, you're able to track it and let it live on the blockchain, no middlemen attached.

Ethereum’s native cryptocurrency, Ether (ETH) is the world’s second-largest cryptocurrency behind Bitcoin. Think of Ether as the currency used to pay for transactions, such as signing your rental deposit contract or sending your money into that contract. 

What is Proof of Work (1)

Proof of Work involves miners competing to add their copy of transactions to the Ethereum ledger. This requires powerful computers and is a highly energy-intensive way to process new transactions and keep the network secure.

Miners who successfully create a block are rewarded with ETH. The proof is the answer in their competition, while the work is the energy consumed and mathematical computing power used to get the answer.

What is Proof of Stake (2)

Proof of stake is a consensus model (algorithm) where validators (miners now become validators) vote on the next “correct” bundle of transactions.

Instead of using electricity and computing power to work/fight to solve the algorithm, validators must stake (think of it as a term deposit for Ether) a certain amount of ETH.

An algorithm then determines who is allowed to add a new block to the blockchain based on how much cryptocurrency the validator staked. The more ETH each validator stakes, the more likely it is for that validator to produce blocks (win).

The minimum stake to become an Ethereum validator is 32 ETH. Currently, there are more than 300,000 Ethereum validators. Validators are rewarded in ETH for handling validation duties every time they produce blocks, like interest.

What is the Ethereum merge?

Ethereum merge is a transition of Ethereum from a Proof Of Work (1) to a faster, more energy-efficient Proof of Stake (2).

Upon completion of the merge, staking will replace mining as a method for verifying Ethereum transactions. 

This is like swapping a plane’s engine while the plane is in flight ✈️

How will the Ethereum merge affect you?

1. Exchanges pausing movement

If you have some ETH or any kind of Ethereum-based token like USDC, you won’t be able to deposit or withdraw these tokens on exchanges as they halt movement to make sure no tokens get lost during the merge. (Just in case the engine swap doesn’t go so well)

2. Decrease in supply.

Market participants expect the merge to have a deflationary impact on ETH, thereby reducing its supply. Ethereum supply will change from ~4.62% inflationary issuance to roughly net zero inflation or potentially slight deflation!

Ethereum pays roughly $26M per day in rewards to miners to compensate them for running expensive hardware and energy used. After the merge, Ethereum will only pay around $3.2M per day to validators.

This compensation—called block rewards or validator rewards—happens via Ethereum minting new ETH. Therefore, the amount of ETH minted will be ~90% less after the merge. 

3. More income on Ethereum from Staking

Ethereum is shifting from a model that is primarily reliant on miners running rigs and intensive computation to secure the network to a model that uses economic voting and issuing fines to keep voters in check. PoS consensus model has proven its robustness in terms of security. 

4. Faster block confirmation times.

Essentially the speed to send ETH or any token on Ethereum, sign smart contracts etc. will now be processed slightly faster. PoS network typically processes transactions faster than PoW network. 

5. Gas Fees will remain the same. 

Ethereum transactions fees are not expected to change as a result of the merge.

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