Ethereum’s proof of stake (PoS) merge
12 August 2022
Ethereum’s long-awaited move to a proof-of-stake consensus algorithm is finally underway. The highly-anticipated upgrade, which is expected to improve Ethereum’s scalability and energy efficiency, is currently in its testnet phase. Here’s what you need to know about Ethereum’s proof-of-stake merge.
What is proof-of-stake?
Proof-of-stake is an alternative consensus algorithm to proof-of-work. Under proof-of-work, miners compete to validate blocks by solving complex mathematical problems. In proof-of-stake, however, validators stake their ETH to secure the network. The more ETH a validator has staked, the greater the weight that validator has in deciding what the true block is.
As of February 2020, over 90 percent of major cryptocurrencies have launched a proof-of-stake mechanism. One of the last holdouts was Ethereum. That is, until February 25, when the Constantinople + Staking “combined” upgrade went live. This change moves the Ethereum network to a proof-of-stake system and also introduces several other improvements to the network.
What does it mean for ETH holders?
This merge is a big deal for ETH holders, as it will allow them to earn interest on their holdings. This meant that the ETH that holders owned would become able to earn staking interest. Staking is when a holder leaves their coins on an exchange or in a wallet to help validate transactions on the blockchain in exchange for rewards.
When the upgrade takes place, miners will no longer be able to mine new ether (ETH). Instead, users will need to prove they own a certain amount of the cryptocurrency to become stalkers. This means the process of verifying transactions and adding them to the blockchain will change dramatically. With miners gone, who is going to perform this task? The Proof of Stake system provides an answer: validators.
How to prepare?
Ethereum’s Proof of Stake merge is right around the corner. Here’s how to prepare! If you’re an ETH holder, there’s a good chance you’re aware that Ethereum is moving to a Proof of Stake (PoS) consensus algorithm. PoS is a big change for the Ethereum network, and it’s important to understand what it is and how it will affect you. The good news is that, unlike other forks or protocol upgrades, the PoS merge doesn’t require any action on your part. Your ETH will automatically be converted to stake ETH (stETH), and you’ll be able to participate in PoS without having to do anything special. However, there are a few things. Ethereum is hard forking to a proof of stake model, which means that ETH holders will need to take some action to ensure they can still participate in the network.
When does the Ethereum merge happen?
Merge is coming when network Terminal Total Difficulty (TTD) hits 58750000000000000000000. This is estimated to occur on September 15th or 16th.
Will the merge affect Ethereum price?
During this market downturn, all cryptocurrencies floundered, and the price of ETH managed to grow by more than 59% from the bottom in anticipation of its upcoming merge. But ETH still lost 58% of its value from its peak. Investors’ opinions vary on whether it’s underpriced. Still, many believe that a bright road is ahead for Ethereum – the second-largest cryptocurrency – as it is trading with lower volatility.
Post-Merge, the network may see a rise in demand for blockspace and gas because of increased network demand. Staking rewards will increase from what they are on the beacon chain as transaction fees that used to go towards mining become paid out to validation nodes. Ether could then become a much more attractive asset which would lead institutions to be interested enough in its potential return on investment.
With the end of its proof-of work system, the Ethereum network will become much less inflationary as it will experience sharp decrease in the issueance of new ETH tokens (estimated even for 90%). This means that with a combination of the fee-burning mechanism introduced with EIP-1559, there will be less ETH issued annually, which could turn deflationary during periods of high demand.
How to profit from the merge?
The safest way to gain exposure is to buy ETH simply. We expect a decrease in selling pressure from miners who are now selling their ETH to cover their operational and hardware costs. Another consequence is that when large amounts of Ethereum get staked to validate the transactions, it will be removed from the circulating supply, greatly reducing the amount of ETH available for retail and institutional investors to buy on the market.
The increased demand for Ethereum’s blockspace and gas fees post-merge is expected to drive up Layer 2 scaling solutions such as Starkware, Arbitrum, and Optimism. This expectation is also visible by significant increase in the prices of these tokens.
With an increase in ETH staking, there will be more incentives for people to use the Lido and pStake protocols. As retail and institutional investors seek ways to obtain liquidity on their staked ETH, they will increasingly migrate over to liquid staking providers.
With its transition from an energy-intensive proof of work consensus system to a sustainable and environmentally friendly one, Ethereum will gain an important point in the eyes of institutional funds that use the ESG narrative in their investments.
Important step forward
The successful implementation of Ethereum’s proof of stake merge is a significant step forward for the cryptocurrency and its community. The PoS merge is an important milestone in the Ethereum roadmap and will help to make Ethereum more scalable, secure, and decentralized. The PoS merge is a complex process, and there are still many challenges to be overcome, but the Ethereum community has shown that it is up to the task.