The Ethereum blockchain is on the cusp of one of the most significant technological upgrades ever, moving from proof-of-work (PoW) to proof-of-stake (PoS), also known as Ethereum 2.0, or Eth2.
Ethereum devs gave September 19 as the perpetual date for merging the existing PoW chain with the PoS chain. The integration is expected to be deployed on the Goerli testnet in the second week of August. After the successful integration of the Goerli testnet, the blockchain will start the Bellatrix update in early August and roll out the merge two weeks later.
The transition debate started with a focus on scalability, so Ethereum developers proposed a three-phase transition process. The transition itself is nearly two years in the making, beginning on December 1, 2020, with the launch of the Beacon Chain, which begins Phase 0 of the three-phase process.
The Beacon chain started the transition to PoS, which allows users to stake Ether (ETH) and become validators. However, phase 0 did not affect the main Ethereum blockchain: the Beacon Chain exists alongside Ethereum’s mainnet. However, both the Beacon chain and the mainnet will eventually be connected to the merger.
Phase 1 was scheduled to begin in mid-2021 but was delayed to early 2022, with developers citing backlog and code reviews as the main reasons. From Phase 1 onwards, Eth2 will host all Ethereum transaction history and support smart contracts on the PoS network. Stakeholders and validators will officially step into action as Eth2 will take mining off the network.
Phase 2, the final phase of the transition, will see the introduction of the Ethereum WebAssembly, or eWASM, over the existing Ethereum Virtual Machine (EVM). Created by the World Wide Web Consortium, WebAssembly is designed to make Ethereum significantly more efficient than it currently is. Ethereum WebAssembly is a proposed deterministic subset of WebAssembly for the Ethereum smart contract implementation layer. eWASM was specially designed to replace EVM, which would see implementation in phase 2.
Marius Ciubotariu, co-founder of Hubble Protocol – a decentralized finance (DeFi) lending platform – told Cointelegraph that he is not really worried about the delays, as any new technology that has such a big impact on the ecosystem would take time:
“PoS is not live yet; however, I do not see this as a concern. I understand that the merger took longer than some would expect. But with new technology and opportunities for important issues, a hasty approach is not the best. Once this integration goes live, I’m sure more protocols will appear. We will continue to innovate within the Ethereum community; something I have and continue to enjoy seeing/experiencing.”
The impact of the merger on the Ethereum ecosystem
Barney Chambers, founder and co-developer at on-chain DeFi platform Umbria Network, told Cointelegraph that the merger will be challenging:
The upcoming merger will see the existing PoW mainnet merge with the Beacon Chain and transfer the entire Ethereum history to the new chain. A complete shift in consensus on an ecosystem as large as Ethereum will have dramatic effects from both a technical and political perspective.
“Ethereum’s accumulation will be centralized in the hands of validators who already hold the majority of the tokens. The Ethereum Foundation claims that the merger will not affect the price of Ethereum, but the merger will cause a fundamental change in how new tokens are distributed, and this will have a dramatic effect on the price of both Ethereum and the entire cryptocurrency ecosystem. “
The difficulty level of mining will skyrocket due to the difficulty bomb, making it unable to mine at an economically viable scale. The difficulty bomb is a piece of code embedded in the Ethereum protocol since 2015. It is set to run every time a certain number of blocks have been mined and added to the blockchain. It makes the mining of the current proof-of-work blockchain significantly more difficult.
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As a result, Ethereum’s proof-of-work chain would be forced to stop creating blocks, as difficulty bombs would make mining a block almost impossible. This state is described by its developers as an “Ice Age”. The simple goal of the bomb is to encourage miners to merge completely, which will increase the adoption of the proof chain.
The transition to a new PoS network became necessary for Ethereum, given that its expanding ecosystem resulted in several network bottlenecks and very high gas fees. Over the past year, however, the narrative has also shifted towards PoS being more environmentally friendly than PoW. While some are praising Eth2 for paving the way for greener protocols, Patricia Trompeter, CEO of carbon-neutral cryptomining company Sphere3D, has other thoughts. Trompeter told Cointelegraph:
“PoS only leads to unnecessary waste and misallocation of energy resources, as ‘Band-Aid solutions’ and marketing schemes such as the ‘Change The Code’ campaign offer no solutions to the overall industry shift towards renewables.”
Patricia believes that PoS further dismantles the decentralized infrastructure of crypto, “pushing power towards the richest holders with unpredictable control over users.”
After the merger, ETH issuance would drop to approximately 0.6 million per year, with a similar 2.7 million ETH burned, meaning a net 2.1 million ETH burned per year, or -7% per year ETH supply, making it a depreciating asset. ETH miners will officially stop when the difficulty bomb hits, and will be forced to mine other PoW coins with the same hashing algorithm for their current rig or exit the market entirely.
Ethereum co-founder Vitalik Buterin has predicted that the transition would not only help expand the network but also reduce energy consumption by 95%. Transaction processing speed is expected to be on par with centralized payment methods. However, none of these features would come with the Sept. 19 merge.
The main scalability solution called sharding that allows for parallel transaction processing will only come after the completion of phase 2, which is expected to take place in the second half of 2023.
Daniel Dizon, co-founder and CEO of the non-custodial and liquid ETH staking protocol Swell Network, told Cointelegraph:
“The merger represents a significant change in Ethereum’s underlying economic model and hardware requirements, resulting in a massive reduction in power generation.” It is expected that there will be a significant demand for ETH as the rewards of participation in ETH staking will increase significantly due to priority fees and MEV capture. The result of the merger is not fully priced. Increased demand and lower issuance for ETH will lead to structural upward price pressure given Ethereum’s current state today.”
Does the merger make Ethereum a security?
Regardless of the technical and financial implications of the merger, the biggest debate seems to be whether Ether qualifies as a security once the network transitions to PoS. The debate has gained a lot of resonance on the Internet in recent days, and the answer to the question depends on who you ask.
The debate about the security status of Ethereum was prevalent long before the transition to PoS entered the picture. The debate gained momentum after the US Securities and Exchange Commission (SEC) filed a lawsuit against Ripple, citing its sale of Ripple (XRP) tokens as security.
Many XRP advocates have since pointed to Ethereum’s “pre-mining” and have often blamed the SEC for giving Ethereum free access. The confusion and problem surrounding the security posture stems from the lack of clear rules for the crypto market. While lawmakers agree that Bitcoin (BTC) can be considered an independent asset class, Ethereum’s status has been a topic of debate.
Adam Levitin, a research professor at Georgetown University Law Center, described what could make Ethereum’s PoS-based network secure in the eyes of regulators:
I’ve had some backlash here, so I’ll elaborate. “Security” includes “Investment Agreement”. An “investment agreement” is defined by SCOTUS in Howey as K for an investment in a joint venture where profits are expected “solely from the efforts” of a third party. 2/
— Adam Levitin (@AdamLevitin) July 24, 2022
He added that “Howey talks about investing ‘money’ but that has always been interpreted to mean value investing.” Placing an object easily satisfies this factor.”
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Coin Metrics co-founder Jacob Franek countered Levitin’s argument, suggesting that Ethereum is one of the most decentralized platforms with open support.
3/ Is there a problem with disclosure today?
Ethereum is an open, distributed project.
It has arguably the most transparent and real-time disclosure of any decentralized project, and certainly more so than a traditional, centralized enterprise.
— Jacob Franek (is hiring) (@panekkk) July 24, 2022
Another major concern regarding the PoS transition has been the centralization of the decision-making process. Konstantin Boyko-Romanovsky, CEO of reward monitoring and transaction closure verification system Allnodes, told Cointelegraph:
“While the risk of centralization with Ethereum’s new PoS consensus system is there, it is far from a reality. So far, the strong community behind the Ethereum network has met all the challenges, and there is no reason to believe that the centralization issue will not be resolved either.
The Ethereum blockchain has become the backbone of DeFi, inflexible tokens and decentralized independent institutions. Although the ecosystem will continue to support such new use cases, the real transition to PoS with fragmentation and high scalability features will only be available after 2023. The success of Eth2 will greatly depend on the implementation of the final phase, but many market experts are still skeptical, compared to the previous delays.
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