Fintech

The Merge is Ethereum’s insurance against government control

The cost of running the network will drop by a factor of 10, which will have big impacts on Ethereum and the rest of the industry.

Ethereum symbol

The Merge, if it goes off smoothly, could do much to bolster Ethereum’s position as the home to a host of cryptocurrencies and the largest smart contract network.

Illustration: Christopher T. Fong/Protocol

Ethereum is expecting to make its biggest change ever this month, transforming how transactions are processed and secured on the blockchain. But the Merge, as the switch from proof of work to proof of stake is known, is more than just technical. It’s expected to bring major changes to the security and economics of the network, and ultimately its structure of control.

The most visible and popular aspect of the upgrade is reducing Ethereum’s environmental impact, with the Merge cutting energy consumption by about 99%. But proof of stake, advocates believe, will also make the network more resistant to a hostile takeover or government interference.

It’s far from the only change coming to Ethereum, which is facing increasing competition from other blockchains. Major improvements to increase transaction speed and lower costs are arriving later. But the Merge, if it goes off smoothly, could do much to bolster Ethereum’s position as the home to a host of cryptocurrencies including its native ether and the largest smart contract network.

One major change will be increased security, which should bring more confidence in Ethereum, developers say. The move to proof of stake for verifying transactions will make it much harder for anyone to make a 51% attack, which is a way hostile parties try to take over a network and steal tokens by cornering its processing power, according to Ben Edgington, ConsenSys product lead for Teku and a core developer involved in the Merge.

In Ethereum’s new proof of stake model, if anyone tries such an attack, the network can automatically detect it and slash their stake of tokens. “Under proof of stake, basically, there's no way to succeed — once you revert the chain, it will slash your stake and you lose all of your ether,” Edgington said. That kind of defense is hard to do in proof of work, he said.

Control of the network won’t change with the Merge. Decisions about network rules are still determined by all the nodes in the network, through means such as Ethereum Improvement Proposals for voting. And core developers who have a large influence in the development have regular public meetings to discuss potential changes.

A lot at stake

However, the process of running the network and processing transactions is changing dramatically, as are the people involved. Instead of miners, the new network will have stakers as validators for transactions. Proof of work mining requires hardware and large amounts of power and is therefore a scale game, and the largest miners typically win, pushing small or individual miners out.

Proof of stake, however, doesn’t require hardware, just holdings of ether. While there’s a minimum contribution of 32 ether, worth about $50,000 at present, to become a validator, individuals can contribute ether to a pool to join up. That should open up the network to a much wider range of people to operate it, Edgington said. The goal is to make Ethereum more “censorship”-resistant — meaning less subject to the actions of particular governments.

“If you've got a lot of operators in a single jurisdiction, then you become vulnerable to regulatory capture,” Edgington said. “And so by having the network so that no one jurisdiction is dominant or can single-handedly take down the network, then everything is much more robust.”

Proof of stake’s transaction model makes the network more distributed compared to proof of work’s miners, who typically consolidate and centralize in fewer places, he said.

“If 80% of nodes are in the U.S., and OFAC says, ‘You can't do this,’ that means they have to conform to those rules,” Edgington said. “And that forces those rules on to the rest of the world. And so we avoid that by making sure that we have very broad geopolitical dispersion of the nodes.”

Money matters

The other large change in Ethereum is the economics of the network. Beyond price action as traders bet on the pros and cons of the Merge, the move to proof of stake is expected to have a deflationary effect on ether, or ETH. Last year, Ethereum passed EIP-1559, a measure which burns, or destroys, some of the ETH paid to process every transaction. That has had some deflationary effect as it reduces the supply of tokens. But the Merge will do more.

Under the current proof of work system, miners are paid 2 ETH per block (about $4,000) partly to cover the cost of hardware and electricity. Those 2 ETH are newly created and hence inflationary. But under the new proof of stake system, the cost to pay validators goes down by a factor of 10 for each block, because the cost for validators to participate is minimal.

In addition to less inflation, there is expected to be less selling pressure on ether. Miners typically need to sell some of their ether to pay for hardware and electricity. But validators don’t have electricity or hardware costs and could end up just staking their rewards.

As a result of both factors, many see deflation coming for ether. “We expect the economic dynamics to be more favorable under the proof of stake,” Edgington said.

These economic changes could also have an impact on many other trading pairs that use ether across the crypto industry.

Chain of tools

The Merge could also have an effect on Ethereum’s competition with other upstart blockchains, many of which already use proof of stake. These top-level blockchains are known as Layer 1 chains, while blockchains built on top of them are known as Layer 2. Both categories could be affected.

“This removes one of the biggest differentiators between Ethereum and many of the newer chains — that most of them are already on proof of stake systems,” said Steven Goldfeder, CEO at Offchain Labs, which works on Arbitrum, an Ethereum-based Layer 2 network, noting that Ethereum’s strength is its long-tested technology and its robust community.

The Merge shouldn’t hurt newer Layer 1 blockchains much in the short term, said Urvashi Barooah, a crypto investor at Redpoint Ventures. “Many of these alt Layer 1s have vibrant communities and DApp ecosystems which won't move away overnight,” she said.

However, if Ethereum rolls out further improvements to speed and cost next year, it could increase Ethereum’s sway over other networks, Barooah said.

The Merge will also have an impact on the Layer 2 blockchains that run on top of Ethereum. The consensus mechanism for Ethereum Layer 2 blockchains will stay the same, meaning no big disruptions. But if the Merge goes well, it will bring more confidence to developers and others that want to use Ethereum or Layer 2s on top of it. “Many will have renewed confidence in Ethereum not only being the winner today, but being the winning smart contract platform for quite a long time,” Goldfeder said.

The Merge will also set the stage for coming changes that will increase transaction speed and lower costs. One upcoming proposal, EIP-4844, would significantly lower costs, particularly for roll-ups, a technique for settling transactions off-chain and later consolidating them.

“I personally think once the Merge is complete, there'll be a lot more focus turned towards data sharding and the proposals to significantly reduce the cost for blocks,” Goldfeder said.

About 70% of the cost of an Arbitrum transaction comes from data expenses. Upcoming changes could lower those costs by “an order of magnitude,” he said.

There’s a consensus that Ethereum’s future will depend on Layer 2s to handle transactions, so lower costs on Layer 2s ultimately benefit Ethereum.

First, though, Ethereum has to finish the Merge. Software clients will need to be updated Tuesday, setting a clock for the changeover. Any hitches in the transition could spook developers and Ethereum holders, but the core group working on the Merge seems confident they can pull it off. And though the Merge is a big milestone, it’s only one of many changes to come as crypto keeps evolving.

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