is crypto’s answer to gold, Ethereum is closest to its own internet. Anyone who wants to create a new token, launch a crypto app, or spend $150,000 on a Bored Ape non-fungible token, or NFT, is probably using the Ethereum network. Over $3 billion in transaction volume passes through Ethereum daily, traded in the network’s native token,
Around $60 billion in crypto assets sit on its blockchain through third-party apps. Other than Bitcoin, no other network is more critical to crypto’s infrastructure or its future.
Tinkering with Ethereum is no small feat. Yet the network developers aren’t about to tinker, they’re about to overhaul Ethereum’s core plumbing and mechanics in an upgrade enthusiasts are calling The Merge.
The change, which is expected to happen around September 15, is a big tech risk and could be a transformative moment for crypto. Companies like
(ticker: COIN) will feel the impact almost immediately. And there will likely be ripple effects across the industry, affecting everyone from crypto miners to chipmakers like
(NVDA), and investors with Ether in their portfolios.
“The merger is the most significant upgrade in crypto history,” says Sami Kassab, analyst for crypto research firm Messari. “It’s like changing the engines of an airplane mid-flight. A flaw in the code could wreak havoc on the crypto ecosystem.
Years in the making, The Merge may be crypto’s answer to critics who say the industry is a colossal waste of energy. Ethereum, with a market value of nearly $200 billion, now uses the same transaction validation method as Bitcoin.
In this process, known as proof of work, computers compete to solve cryptographic puzzles. The network comes to a consensus on the winner, proving that a block of transactions is valid and should be added to the chain. The winner then receives Bitcoin, a practice known as mining.
It is very energy intensive, requiring an enormous amount of computer work and electricity. Ethereum was built on the same system, and it’s also an energy hog, using roughly the same amount of electricity in a year as countries like the Netherlands.
Now the developers are ditching that model and moving to a much greener system for processing transactions called proof-of-stake. Instead of mining, Ether owners use their tokens as collateral to validate transactions, “staking” them on the network in exchange for a return, paid in Ether tokens. To participate, a staker must deposit 32 Ether tokens, worth around $50,000, and run software. The system randomly selects validators, like a lottery. Crypto exchanges and other companies run staking pools, allowing anyone to participate with smaller amounts of Ether.
The change should eliminate Ether mining. By doing so, it will reduce Ethereum’s energy consumption by more than 99%, according to the Ethereum Foundation, significantly reducing the carbon footprint of the network.
This is just the start of a bigger makeover. The merger is also expected to reduce the new Ether produced each year. And the developers are planning more upgrades over the next few years that aim to increase Ethereum’s throughput and lower its usage fees. Ideally, they aim to turn Ethereum into the internet of crypto-a base layer for apps, financial services, and many other digital assets like NFTs.
“Today, we are talking about decentralized finance. In 10 years, if we are successful, people will call it finance, period,” says Justin Drake, a researcher at the Ethereum Foundation involved in the project. “For almost all financial transactions, they will use Ethereum.”
However, The Merge can also claim victims. This could lead to issues, outages, or token losses when the current Ethereum blockchain merges with a new one, called Beacon. “A long list of elements will need to continue to operate seamlessly after the merger to avoid exploits and liquidations,” says Sean Farrell, head of digital assets at Fundstrat Global Advisors.
The stakes are high as much of the crypto industry has a stake in its performance, from exchanges like Coinbase to mining operations, NFT platforms and stablecoin issuers. “Usually when you make a change to a website and it goes down, well, it’s not the end of the world. In this case, you can lose a lot of money,” says Katie Talati, research director at Arca, a crypto-asset manager.
The most immediate effect could be on the price of Ether. Since mid-June, the token has climbed more than 50%, while Bitcoin has remained stable. Both tokens are down around 60% this year, under pressure from rising interest rates and falling demand for highly speculative technologies.
A successful merger could make Ether ripe for another run, some analysts say. This is partly because the move to proof-of-stake is expected to reduce token issuance to around 0.5% per year, from 4.5% currently. Reducing the issue could drive up the price. “In today’s market, supply and demand are relatively balanced,” says Steve Goulden, principal analyst at Cumberland, the crypto arm of trading firm DRW Holdings. “After the merger, there will be a significant supply shortfall.”
Demand, meanwhile, could increase as owners stake their tokens in exchange for a return. Investors can earn 4% to 8% by staking, depending on the amount of revenue generated by the network and other factors, according to Talati. Institutional funds with a mandate to invest in environmentally friendly assets could also buy Ether as blockchain carbon emissions become less of an issue.
The upgrade could be a boon for companies like Coinbase. The exchange is developing a service that makes it easy for investors to stake their Ether, with Coinbase taking a 25% cut on any revenue generated. The staking business has already “become a great source of subscription and service revenue and is growing well,” CEO Brian Armstrong said on an August earnings call.
As with any technology upgrade cycle, however, there will be a legacy of obsolescence. Some of the biggest losers in this cycle could be mining companies that have spent hundreds of millions of dollars on hardware that could be rendered worthless. Executives from Hut 8 Mining (HUT), which mines both Bitcoin and Ether, said in August that they were exploring how to adapt their Ether mining machines to other tokens or projects.
Hive Blockchain Technologies
(HIVE), another miner, said switching to proof-of-stake “could make our mining business less competitive.”
Chipmaker Nvidia looks like another victim. The company’s graphics chips and cards have been adopted by the industry to mine ether. But demand now seems to be evaporating. Nvidia, whose stock is already suffering from a slowdown in gaming and other key areas, said on its recent earnings call that it could not predict how the reduction in crypto mining might affect demand. . Analysts at investment bank Baird say The Merge is likely to “generate a wave of GPU mining [graphics processing units] on the second-hand market, which aggravates inventory problems.
In the longer term, Ethereum could pose a greater threat to rival blockchain networks. Blockchains and tokens such as Solana, Avalanche and Tezos have been launched with the promise of being faster and more efficient than Ethereum. All are proof-of-stake and have established various uses, but if Ethereum is successful in its upgrades, they may run out of time to prove their relevance. “Now that Ethereum has caught up with proof-of-stake, there is less of an argument for many other blockchains,” says Kassab.
Some crypto companies do not take The Merge lying down. The threat led a few miners to launch a competing Ethereum blockchain, called a fork, using the proof-of-work method. The idea is to create an Ether spin-off and parallel universe of smart contracts, NFTs, and decentralized finance, or DeFi, applications.
The dueling potential of Ether blockchains forces companies to choose sides or declare neutrality. Exchanges like Coinbase, Binance and FTX say they will apply their usual listing standards to forked tokens and may allow them to trade. The creators of crypto applications such as Uniswap, Compound and stablecoin USDC have pledged to recognize only the new Ethereum blockchain.
A split from Ethereum has some crypto leaders worried that scammers could find new ways to perpetuate theft and fraud. “Someone is going to spend 80 real Ethers on a fake Bored Ape,” says Robert Leshner, Founder and CEO of Compound Labs, a DeFi company. “There will be all kinds of disasters,” he says, advising investors to wait until the problems are resolved and “do nothing.”
Another unknown is Washington’s reaction. Securities and Exchange Commission officials have indicated that Bitcoin and Ether should be treated as commodities, which could remove these tokens from SEC scrutiny. But since many investors will buy Ether expecting a return, some advocates believe this could make the token look more like a security. If the SEC agrees, crypto exchanges like Coinbase could be vulnerable to lawsuits or enforcement action if they let it trade on their platforms anyway.
Changes of this magnitude are an “opportunity to try to distinguish past analysis from current analysis,” says Teresa Goody Guillén, partner at BakerHostetler and former SEC attorney, who believes Ether would still not be considered. like a title. The SEC declined to comment.
As with all things crypto, the hype around The Merge already exceeds reality. Proponents say it could be the start of a renaissance of useful apps and services, finally silencing bewildered critics of a multi-billion dollar industry that has yet to find its purpose outside. of speculation. Conversely, if it fails, it would be another setback for a technology long in complexity and short of real-world utility.
“The most important part of The Merge is the narrative,” says Kassab. “It’s something everyone is talking about that could bring people back to Web3 and crypto, assuming it succeeds.”
The crypto market is now suffering from a crisis of confidence, having lost $2 trillion in value over the past year and drawing the ire of governments around the world. A successful merger may not revive the market or its reputation. But it could at least make crypto a little greener on its way.
Write to Joe Light at [email protected]