Ethereum is a cryptocurrency with the second largest market cap after Bitcoin. Launched in 2015, in mid-September 2022, Ethereum is changing the way it validates its transactions. It is moving from a Proof of Work to a Proof of Stake mechanism. Among the crypto community, this is being christened ‘the merge’ and dubbed the ‘biggest event in crypto history’. It is called ‘the merge’ because it is merging the Proof of Stake Beacon chain, which has been running alongside the original Ethereum, to launch Ethereum 2.0.
Proof of Work (PoW) and Proof of Stake (PoS)
PoW is the most well-known consensus mechanism, first used by Bitcoin. The PoW process is known as mining, and the nodes are known as miners. Miners solve a complex cryptographic puzzle in what is effectively an open competition in which miners compete for the right to create a block and are rewarded when they do. The puzzle requires a lot of computational power to solve but is easy to verify once solved. The first miner to solve the puzzle publishes the block, which is then validated by its recipients and (if it is valid) accepted by them onto the chain.
The other common consensus mechanism, PoS, selects block creators (known as validators) using an algorithm based on how large of a stake a person holds (how many tokens they own). Nodes stake their tokens to become validators, meaning they lock their tokens for a certain time (similar to a security deposit).
The three main technical challenges facing blockchain are scalability, integration, and interoperability. This merge shows that Ethereum has the capacity for self-improvement and adaptability, revealing a future filled with more possibilities for innovation.
What will be the effect?
Blockchain using the PoW mechanism is also infamously environmentally damaging. According to estimates by Cambridge university, Bitcoin, another PoW cryptocurrency consumes so much energy that if it were a country, it would rank in the world’s top 35 by energy consumption, surpassing Belgium and Finland. PoS, however, will require 99.9% less energy to maintain. It has even been calculated that the effect of ‘the merge’ on emissions will be as though, overnight, the Netherlands had been switched off.
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Chipmakers may see demand for their GPUs decrease as they are no longer needed in the same volume to mine for Ether. For example, NVIDIA, a chipmaker, saw its revenues from May to July 2022 fall by half compared to the previous three months. This has been credited in part to rumors of an impending merge. Meanwhile, on eBay, the prices of second-hand graphic cards are tumbling.
Some Ethereum miners have invested as much as $5 billion in hardware to run the proof-of-work consensus mechanism. Some mining infrastructure companies like Hive Blockchain and Hut 8 Mining Corporation have released details of how they will redirect their focus from Ethereum mining. As a result of this switch of mechanism, Ethereum will pay out just 10% as many tokens per block validated by stakers post-merge as it did to miners before it. The many outcomes of the merge are hard to predict. Which PoW blockchain will benefit from it, whether this will put pressure on Bitcoin to change, and what impact it will have on emissions. Ultimately no one will know the true effect and efficacy of the merger until it is completed. Whether this merger goes off with a bang or falls flat, it will be a defining day for decentralized finance