Ethereum developers are scrapping that model and moving to a greener system for processing transactions, called proof of stake. Instead of mining, Ether owners use tokens as collateral to validate transactions, “staking” them to the network in exchange for a yield paid in Ether tokens.
“The Merge is the most significant upgrade in crypto history,” “It’s similar to changing the engines on an airplane in mid-flight. One flaw in the code could wreak havoc on the crypto ecosystem.” Sami Kassab, an analyst for crypto research firm Messari.
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 nearly $200 billion market value, now uses the same method of validating transactions as Bitcoin.
Computers compete to solve cryptographic puzzles in that process known as proof of work. The network reaches a consensus on the winner, proving that a block of transactions is valid and should be added to the chain. The winner then receives some Bitcoin, a practice known as mining.
It’s highly energy-intensive, requiring a massive amount of computing work and electricity. Ethereum was built on the same system, and it is also an energy hog, using roughly the same amount of electricity in a year as countries like the Netherlands.
Now, developers are scrapping 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 to the network in exchange for a yield paid in the Ether token. The shift should eliminate Ether mining. It will cut Ethereum’s energy usage by more than 99%, according to the Ethereum Foundation, sharply reducing the network’s carbon footprint.
That’s just the start of a more extensive makeover. The Merge should also reduce the newly minted Ether produced yearly. And developers are planning more upgrades over the next few years to increase Ethereum’s throughput and lower its usage fees. Ideally, the aim is to turn Ethereum into the crypto internet—a base layer for apps, financial services, and many more digital assets like NFTs.
Yet The Merge may also have casualties. It could cause glitches, outages, or losses of tokens as the current Ethereum blockchain merges with a new one called Beacon. “A laundry list of elements will need to keep working seamlessly post-Merge to keep exploits and liquidations at bay,” says Sean Farrell, head of digital assets at Fundstrat Global Advisors.
The stakes are high because so much of the crypto industry has a stake in its performance—from exchanges like Coinbase to mining operations, NFT platforms, and stablecoin issuers.
The most immediate effect could be on Ether’s price. Since mid-June, the token has soared more than 50%, while Bitcoin has stayed flat. Both tokens are down about 60% this year, under pressure from rising interest rates and weaker demand for highly speculative tech.
Some analysts say that a successful Merge could make Ether ripe for another run. That’s partly because moving to proof of stake should reduce token issuance to about 0.5% yearly, down from 4.5%. Decreasing the issuance could push up the price.
Ether’s Ups and Downs
The Ethereum network’s token has pushed higher lately on hopes for “The Merge.”
Demand, meanwhile, could get a lift as owners stake their tokens in return for a yield. According to Talati, investors may earn 4% to 8% by staking, depending on how much revenue the network generates and other factors. Institutional funds with a mandate to invest in environmentally friendly assets could also buy Ether as the blockchain’s carbon emissions become less of an issue.
The upgrade could be a boon to 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 of any income generated. The staking business has already “grown into a great source of subscription and services revenue and is growing nicely,” said CEO Brian Armstrong on an earnings call in August.
However, as in any tech upgrade cycle, there will be a legacy of obsolescence. Some of the biggest losers in this cycle could be mining companies that spent hundreds of millions of dollars on hardware that might be rendered worthless. In August, 8 Mining (HUT), leaders mining both Bitcoin and Ether, said they were studying how to adapt their Ether mining machines to other tokens or projects. Hive Blockchain Technologies HIVE -1.41% (HIVE), another miner, said a shift to proof of stake “may render our mining business less competitive.”
Chip maker Nvidia looks like another casualty. The industry has adopted the company’s graphics chips and cards to mining Ether. But demand now appears to be evaporating. Nvidia, whose stock is already ailing from a slowdown in gaming and other core areas, said on its recent earnings call that it couldn’t predict how reduced crypto mining might hit demand.
The potential for dueling 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. Creators of crypto apps such as Uniswap, Compound, and stablecoin USDC have pledged to recognize only the new Ethereum blockchain.
The crypto market is suffering from a crisis of confidence, having lost $2 trillion in value over the past year and drawn the ire of governments worldwide. An Ethereum split has some crypto leaders worried that scammers could find new ways to perpetuate theft and fraud. A successful Merge may not revive the market or its reputation. But it could make crypto a bit greener, at the least, on its path forward.
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