Ethereum’s biggest-ever upgrade just took effect, in what industry experts are calling a game changer for the entire crypto sector. Thus far, all signs suggest the so-called merge — which is designed to cut the cryptocurrency’s energy consumption by more than 99% — was a success.
The very first proof-of-stake block of transactions has finalized with a nearly 100% client participation rate. This was, by far, the best-case scenario.
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The overhaul to the ethereum network fundamentally alters the way the blockchain secures its network and verifies transactions. Most of these changes are happening under the hood and the hallmark of a successful upgrade is if the end user doesn’t feel a difference in the hours and days ahead.
Cryptocurrencies such as ethereum and bitcoin are often criticized for the process of mining to generate new coins. Before the merge, both blockchains had their own vast network of miners all over the planet running highly specialized computers that crunched math equations in order to validate transactions. Proof-of-work uses a lot of energy, and it is one of the industry’s biggest targets for critiques.
But with the upgrade, ethereum has migrated to a system known as proof-of-stake, which swaps out miners for validators. Instead of running large banks of computers, validators leverage their existing cache of ether as a means to verify transactions and mint new tokens. This requires far less power than mining and experts say it will make the protocol both more secure and more sustainable.
The price of ether jumped following the merge. It is trading at around $1,640, up more than 3% in the last hour.
Nine teams and more than 100 developers worked on the merge for years. In the hours ahead, this decentralized network of programmers spread out across the planet will monitor the rollout and, if needed, debug as fast as possible.
Danny Ryan, a core developer based in Denver who has been working on the merge for five years, tells CNBC that they will be watching for any irregularities via both automated and manual monitoring systems. If issues come up, the corresponding team will debug and release a patch to users, but Ryan says they are pretty confident going into the merge given all the successful dry runs in the last few months.
“There might be some sort of small fire that gets put out very quickly,” said Ryan. “But the network as a whole — because of the redundancy across all this different software — will very likely be stable and fine.”
What changes
Part of why the merge is such a big deal has to do with optics.
Last week, the White House released a report warning that proof-of-work mining operations could get in the way of efforts to mitigate climate change. Slashing energy consumption by roughly 99.95% will not only establish greater sustainability for the network, but it will also go a long way toward lowering the barrier to entry for institutional investors, who struggled with the optics of contributing to the climate crisis.
Bank of America said in a note on Sept. 9 that the significant reduction in energy consumption post-merge “may enable some institutional investors to purchase the token that were previously prohibited from purchasing tokens that run on blockchains leveraging proof of work (PoW) consensus mechanisms.”
Analysts have said that institutional money entering the digital asset space at scale is critical to its future as an asset class.
The upgrade also changes the tokenomics around ethereum’s native coin, ether.
“Ether itself becomes a productive asset,” said Ryan. “It’s not something you might just speculate on, but it’s something that can earn returns.”
In this post-merge era, ether takes on some of the characteristics typical of a traditional financial asset, such as a certificate of a deposit, which pays interest to holders.
“It’s probably the lowest risk return inside of the ethereum ecosystem,” explained Ryan, who added that yield in other corners of decentralized finance, or DeFi, involve taking on smart contract risks and other types of counter-party risk.
The upgrade will also result in a significantly reduced supply of ether tokens in circulation, which could pave the way for ether to become a deflationary currency in the weeks and months ahead. Some investors say this could also help drive up the price of the token.
That reduced supply is the result of the new verification model that replaces miners with “validators.” The rewards for validators are much smaller than those that went to proof-of-work miners, meaning that less ether will be minted as a result of this upgrade. Validators are also required to lock up their tokens for a prolonged period of time, pulling ether out of circulation.
Additionally, as part of an upgrade that went into effect August 2021, the network is already “burning” or permanently destroying a portion of the digital currency that would otherwise be recycled back into circulation.
Developers say that enhanced network security is another critical feature of the upgrade.
“There are changes to the security guarantees of the chain,” said Sean Anderson of Sigma Prime.
Take a 51% attack, in which someone or a consortium of people control 51% or more of a cryptocurrency and subsequently weaponize that control to make changes to the blockchain.
Anderson says that it is much easier to recover from a 51% attack on a proof-of-stake network, because there are built-in mechanisms to financially punish malicious actors by reducing their stake.
“Because that economic asset is inside of the protocol, you get much better recovery mode, so you end up with a better kind of security profile,” Ryan told CNBC.
Next few hours, days are key
The next few hours and days will be key to gauging the health of the ethereum network post upgrade. Behind the scenes, developers will be monitoring metrics like the participation rate of validators to determine how things are going. But coders tell CNBC that in an ideal world, users would be totally oblivious to the upgrade.
“If everything goes perfectly, then an end user wouldn’t notice a difference,” said Anderson. “If anyone who’s trying to transact on ethereum doesn’t realize it, then it was smooth.”
The upgrade doesn’t immediately make ethereum faster, cheaper or more scalable. But those features come with future upgrades that are now possible post-merge.
Scalability, in particular, is something that Ryan says is desperately needed for the network going forward.
At the moment, layer two technologies such as sharding and roll-ups are working to address just that.
“More scalability, more ability to process user transactions is coming online in parallel through layer two constructions called roll-ups, but the scale is not being enhanced at the core protocol itself,” continued Ryan. That comes in subsequent upgrades instead.
Katie Talati, head of research at asset management firm Arca, says that her team is closely watching anything in the layer two space, especially the projects that are trying to offer scalability.
“The biggest issue right now is that it’s very fragmented,” said Talati. “You end up with these people who are now on ethereum, but they’re siloed from each other, because the L2s don’t necessarily talk to each other very easily. And so it’s just not a seamless experience,” she said.