In about two months, one of the most influential events in the history of cryptocurrencies will take place that could impact Ethereum both technically and economically. This is the passage of Ethereum dal proof-of-work al proof-of-stake (known as “the merger”) is now closer than ever. The first public test of the fusion is expected in these days after seven other minor tests have already been carried out. If things go as planned, it is reasonable to expect the merger to take place in August.
It is since 2014, the year in which they released the first Ethereum white paper, that the developers of this crypto have explicitly told about their desire to adopt proof-of-stake instead of proof-of-work, but due to technical difficultiesuntil now, this has not been possible.
In light of this appointment, Mads Eberhardt, Cryptocurrency Analyst per BG SAXO, examines in a report the ways in which Ethereum will change, both from a technical and an economic point of view.
The transition from miners to stakers
The most substantial change, the report reads, is the transition from proof-of-work to proof-of-stake, i.e. the method by which the network verifies transactions. Instead of the enormous computing power made available to the network by the miners, Ether owners will directly verify the transactions. This means that holders will have the ability to use their Ether as collateral to be able to verify transactions, in jargon: to stake their Ether. In return they will receive the transaction fees along with a sum for ensuring the transaction is secure. Here, then, that the newly issued Ether will be generated.
With proof-of-stake, BG SAXO explains, the main security feature is that stakers can be cut. In the event that the network determines that a staker has been behaving unethically, for example, by attempting to reverse transactions, the network can exclude him from future transactions.
Significant energy savings
When proof-of-stake is implemented, Ethereum will reduce energy consumption by approximately 99.95%. To understand why, BG SAXO points out, we still need to consider the differences between consensus mechanisms. As for Ethereum, a new block is currently finalized approximately every 13 seconds. In these 13 seconds, each miner fights to be the one who finalizes the block. This involves the application of computing power and therefore requires electricity. However, the report reads, it’s just a miner that finalizes the block and verifies the transactions, although other miners have spent an enormous amount of energy on the same block. In terms of proof-of-stake, a “validator” is randomly chosen to finalize a block based on its amount of Ether staked. This happens before the block, so no other staker is trying to finalize the same block, ultimately reducing Ethereum’s power consumption by around 99.95%.
Could Ethereum Go Deflationary?
Since the energy required to verify transactions on Ethereum drops dramatically, too the cost of security can drop enormously. With the proof-of-work, the report reads, the security cost of Ethereum amounts to approximately 5.4 million Ether per year. This means that 5.4 million new Ether are being issued annually for the current supply of approximately 120 million Ether to encourage miners to verify transactions. After the merger, the cost of security would drop to about 0.5 million Ether per year.
BG SAXO explains that this is a large reduction in Ethereum’s inflation, which could even make it deflationary as the transaction costs paid are expected to outweigh the cost of security. Over time, this could result in a supply shock because the market is used to absorbing 5.4 million new Ether annually, but suddenly only about 0.5 million Ether could be emitted.
Consequences for scalability or to owners of Ether?
By default, the report reads, merge it doesn’t make Ethereum significantly more scalable. If the merge is successful, it will reduce the block size from approximately 13 to 12 seconds but will keep the same block size. This ultimately leads to an increase in transactional production of 7.5%, but not much more. Based on the current schedule, Ethereum will significantly improve scalability in 2023. Block chains are intended to be implemented here, which will greatly improve Ethereum’s scalability and perhaps require even less hardware to verify transactions.
However, BG SAXO points out, the merger will have no impact on Ethereum by other substantial means. First, it is not intended to affect or require Ether holders to take an active position. The merger will happen without them noticing. Secondly, the report reads, it shouldn’t affect tokens or decentralized applications that currently use Ethereum. This means that distributed tokens and smart contracts on Ethereum should work as usual. In any case, although the Ethereum developers have been working on the merger for years, this process can turn out to be negative or be further delayed. Just like everything related to crypto, BG SAXO concludes.