In case you missed the news, the Ethereum Merge has finally happened! After 5 years of discussion (that were meant to only take 5 months), September 15th marks the official date of the upgrade to the Beacon Chain.
There are still many more upgrades to come, but this is one major step towards realizing the roadmap. Its successful implementation removes development risk from the network, and the price of ETH rose significantly in anticipation of the upgrade.
Basics of the Merge
The Ethereum Merge is a major shift in the way the entire network is run. What makes it different from a simple software upgrade is that it changes the consensus mechanism from Proof-of-Work to Proof-of-Stake.
Now, Ethereum mining is no more, and the Ethereum network is entirely supported by validators.
Performing this upgrade while in “production” is a massive feat of engineering akin to changing tires while driving. It took an incredible amount of planning for the Ethereum community to successfully execute on it.
End of the Energy Consumption Narrative?
One of the most prominent criticisms of cryptocurrencies is the energy they consume in order to support network security.
Consensus mechanisms are how the network proves and validates transactions. For Proof-of-Work, the thinking is that burning energy validating each block makes it prohibitively expensive for fraudulent transactions to be submitted. Proof-of-Stake, the new mechanism that governs Ethereum, runs on the idea that investors are risking capital (and not energy) to validate the transaction. If they are wrong, their “stake” gets slashed and they lose funds.
By switching to Proof-of-Stake and lowering the estimated annual energy consumption to 0.01 TWh, this narrative loses all steam. Energy consumption will drop dramatically, as shown in the below chart:
For context, the banking system is estimated to use approximately 263.72 TWh each year powering its data centers, ATMs, bank branches, and card networks.
Greater Throughput, Lower Gas
The potential benefits go far beyond efficient energy usage. Ethereum has always been considered the “base layer” of Web3, and now it is capable of living up to that name. The cheaper and more efficient the network becomes to use, the closer we are to having programmable money.
The Merge will enable the ETH network to process transactions at a much higher rate. The below chart of throughput shows a massive projected increase in the performance of the network:
Note that the ETH Final Roadmap estimate is dependent on several upgrades that have not yet been implemented, but it shows the projected path the developers have in mind.
Gas prices are dropping, too. The below chart shows ETH gas fees decreasing to 11.78 gwei.from ~80 gwei a year ago.
The result of both of these is that Ethereum is now a much more “usable” network.
The Implications of the Upgrade
On the whole, the biggest thing we expect to see in the coming months is a flurry of activity on the ETH chain. There is no longer friction for buying or selling on ETH, which is going to open up a whole new level of building.
One of the most common complaints about ETH was the $80+ transaction costs that occurred at the peak of speculation on the ETH network. Lowering the cost of a transaction from $10 to under a dollar will make everyone more likely to use the network.
And when that happens, we’ll see a whole new wave of NFT mints and DeFi protocol launches.
SDM CRO Zach Friedman commented:
“Suddenly, buying and selling an NFT isn’t eating away at the principal, and experimenting with a new DeFi protocol doesn’t require 5- or 6-figures to make sense.”
We also expect to see low transaction costs lead to the creation of micropayments and streaming rewards dApps on Ethereum. If you can pay per consumption for the Web3-equivalent of services like Youtube or Medium, a whole new frontier of development has opened up.
A tertiary effect to keep an eye out for is what happens in gaming and chip manufacturing now that miners aren’t using GPUs to mine ETH. This may have an adverse effect on Nvidia specifically as they were selling a significant amount of chips to miners.
In the midst of a period in which most of the world’s currencies are seeing dramatic inflation, the Merge brings an interesting dynamic to Ethereum’s tokenomics. Under Proof-of-Work, rewards to validators (formerly miners) are dramatically reduced, which creates a scenario where more Ethereum is burned than issued within a transaction. As a result, Ethereum could become deflationary for extended periods, putting long-term upwards pressure on the coin’s price.
Not Out of the Woods Yet
Recent price action has shown the upgrade to be a “sell-the-news” event. Price decreased shortly after the upgrade as investors decided to de-risk, despite the fact the upgrade went very smoothly.
David Shafrir, SDM’s CEO has said:
“ESG has become a powerful tool in the investing world recently, and with Ethereum’s transition to Proof of Stake, it may finally be considered acceptable for ESG-oriented investors.”
There are still cryptocurrencies using Proof-of-Work, but hyperbolic narratives like NFTs causing global warming no longer bear as much weight as before.
Although the upgrade was executed smoothly, these are just the first few weeks after the Merge. There are still issues that could emerge and a true post-mortem won’t be possible for another 3-4 months.
However, the initial assessment is that the upgrade is a success, is lowering gas fees, and removes environmental issues around Ethereum.