Expert opinion and analysis on Ethereum (ETH), one week after the merger





Last week, Ethereum made a historic switch from proof-of-work to proof-of-stake, officially ditching the power-hungry miner-based system it previously used to process updates to its decentralized big ledger.

In crypto circles, the occasion of the merger has been observed as a holiday, celebrated virtually and in person at watch parties with music, speeches, and even a few special guests.

This article originally appeared on Valid Points, CoinDesk’s weekly newsletter that looks at the evolution of Ethereum and its impact on the crypto markets. Sign up to receive it in your inbox every Wednesday.

The largest Merge watch party was sponsored by the Ethereum Foundation and featured talks from Ethereum co-founder Vitalik Buterin and other community leaders. It had 41,000 concurrent YouTube viewers at its peak.

The fact that the merger took place overnight across much of the world only added to the excitement of many viewers. Staying up until 3am and waiting for Ethereum to finish its first proof-of-stake blocks was like waiting for the ball to drop in Times Square on New Year’s Eve. In any case, the excitement built up until the critical moment when, in an instant, the world jumped from one reality to another.

But in the same way that watching a crystal-encrusted disco ball slowly slide down a pole feels a little contrived, one can’t help but feel a little disappointed when, after years of waiting, a successful merger is marked with a block. text, difficult. to decrypt, on a black and white computer terminal. At least there were fireworks for New Year’s Eve.

However, the network is already showing signs of change.

The immediate impact of the merger, the first and most obvious, was the one it had on the energy consumption of the network. Going from mining to staking meant removing precisely the component of blockchain technology that gives it a bad environmental reputation.

The proof-of-stake lottery-based block proposal system is much more energy efficient than its power-hungry predecessor, proof-of-work.

Justin Drake, a researcher at the Ethereum Foundation, told CoinDesk that he expects the merger, by upgrading the second largest blockchain network to a more efficient mechanism, will reduce global energy consumption by 0.2%.

This statistic has been disputed. In the short term, many Ethereum miners have found refuge on other networks, such as Ethereum Classic, which continues to operate on proof-of-work. Moving spot miners from Ethereum to these other chains has slightly mitigated the impact the merger will have on declining overall cryptocurrency issuance.

But in the long run, mining on proof-of-work blockchains is unlikely to be profitable enough for most Ethereum mining companies to continue operating.

Chandler Guo, the miner behind a controversial proof-of-work (ETHW) fork of Ethereum, admitted as much himself in an interview with CoinDesk’s “First Mover”: “Some people [mineurs] have free electricity and can [continuer] to work on the [chaîne ETHW] Guo said. “The remaining 90%, bankrupt.”

Switching to bitcoin isn’t really an option either, as the most suitable computer chips for mining Ethereum (GPUs) tend to be poor at mining Bitcoin, which miners often use specialized computer chips called ASICs.

So while the immediate environmental impact of the merger has been somewhat mitigated by the existence of other proof-of-work chains, its net positive impact on emissions is still positive.

Ethereum’s new validation system has spawned a new cast of characters tasked with keeping the chain running. With these new characters came new concerns about the centralization of the network.

Shortly after the merger, Martin Köppelman, founder of Gnosis Chain, drew attention to a tweet noting that 420 of Ethereum’s first 1,000 proof-of-stake blocks had been offered by just two entities: Lido, the community validators that we have already talked about. in this newsletter, and Coinbase, the US-based cryptocurrency exchange.

Ethereum developers are promoting proof-of-stake as a more decentralized and secure alternative to mining, allowing anyone with 32 ETH to play a role in supporting the network, without fancy equipment.

As Time Beiko of the Ethereum Foundation explained to CoinDesk ahead of the merger last week, “Proof-of-work is a mechanism by which you take physical resources and turn them into security for the network. If you want your network to be more secure, you need more of these physical resources. In the case of proof of stake, we use financial resources to convert them into securities. »

But some entities like Lido, Coinbase, Kraken, and Binance have amassed more than 50% of the resources needed to protect the network. They achieved this by allowing people with less than 32 ETH to pool their resources and become validators, almost like a crypto equivalent of split shares.

Lido, Coinbase, Kraken, and Binance control over 50% of the stake in the Ethereum Proof-of-Stake network. (Beaconcha.in)

Centralization is not just a proof-of-stake issue. Köppelman followed up on his original tweet by noting that Bitcoin, which continues to use proof-of-work, also has centralization issues: “No dear Bitcoin fans, it’s not better at Bitcoin. In fact, you only need 4 entities to get to >72%”

But it’s hard to make a 1:1 comparison between Bitcoin mining pools, which include computers owned and operated by individual miners, and Ethereum staking pools, which include ETH staked by a set of holders. One of the key differences: While Bitcoin miners can withdraw their equipment from a pool, Ethereum token holders will not be able to withdraw their stake until the Ethereum upgrade in Shanghai, which takes place in six to twelve months.

This means that Etheruem pool operators can, at least for now, operate without fear of their users getting angry and cutting ties. (To be fair, Lido splits its stake among several different validation services, which means it should be more difficult for one party to act unilaterally against the network’s best interests.)

Regardless of whether or not things got worse with proof of stake, why might centralization be a problem? Well, we have recently seen that centralization makes it easier for regulators to exert influence over the operations of a blockchain.

Recent US sanctions against Tornado Cash, the Ethereum minting program used to obfuscate transactions, are forcing validators and their legal teams to consider whether they should stop Tornado-related transactions to comply with regulations. If enough validators refuse to offer or certify blocks containing Tornado-related transactions, it will be difficult for those transactions to end up on the Ethereum ledger.

With a lawsuit earlier this week suggesting that the US Securities and Exchange Commission considers all of Ethereum to be within its jurisdiction, one imagines that centralization concerns will continue to take center stage in the coming months.

The most visible impact of the on-chain merger was the issuance rate of ETH, the network’s native currency.

With Ethereum’s upgrade to proof-of-stake, the network has significantly reduced the amount of new ETH issued with each block. In the long term, due to a burn mechanism introduced with the EIP-1559 network update, it is possible that this will make Ethereum deflationary, meaning its token supply could decrease over time.

Ethereum is not yet deflationary: about 4,000 new ETH have been issued since the merger. But that’s still 95% less ETH than would likely have been issued as part of proof-of-work (around 70,000 new ETH, according to ultrasound.money).

New ETH issuance has fallen by around 95% since the merger. (ultrasound.money)

The price of ETH has fallen significantly since the merger. But for ETH holders, the reduced issuance was heralded as a reason for hope: less ETH in circulation means that each individual token is theoretically more valuable.

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Thomas E.
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