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If you were following the news this week, you would have heard of a monumental event in the crypto space called “The Merge”.
Heck, it was so big it even got coverage from traditional finance media like Bloomberg, Yahoo Finance, Forbes, etc
Personally, I believe it to be the second biggest technological event in the last 15 years, only topped by the birth of Bitcoin in 2009. I’m also well aware of the weight of that statement, but time will tell!
In order to understand what “The Merge” is, and why the event that happened to the Ethereum network this past week has the potential to change the landscape of technological innovation for decades to come, we first need to understand the difference between Proof of Work (PoW) and Proof of Stake (PoS).
What is Proof of Work (PoW)?
In order to achieve decentralization within a blockchain, it must create a network that doesn’t rely on a single centralized source of power/authority in order to process transactions and secure the blockchain.
One of the most popular ways (led by Bitcoin) to do so is called Proof of Work. In PoW blockchains, transactions are “signed” onto the blockchain with a solution from a mathematical (computer code) problem that is very hard to determine. The first person to do so is rewarded with a prize in the form of the blockchain’s native token. As a result, a lot of computing power is needed to determine the correct answer and “mine” the transaction onto the blockchain to make it official. This math problem can be attempted by anyone on earth with a computer, and generally, the faster your computer is, the more likely you are to arrive at the answer first.
There are no entry fees and no monthly subscription fees. You don’t even need to own the blockchain’s native token. All you have to do is plug your computer into the network and you can become both a miner and a node validator on the PoW network. In this scenario, the barrier to entry is in the form of CPUs and cheap electricity.
Transactions are difficult to maliciously manipulate as the blockchain is constantly being updated and distributed to everyone running a node, so when the next block is signed by a different miner and sent to nodes to validate, the updated blockchain will not include the manipulated transactions, as only the 1 malicious actor will have the manipulated transaction from the previous block. In addition, as the equation is created and governed by code for miners to solve, it is virtually impossible to manipulate.
Manipulation can only happen in the long run if the malicious actor controls more computing power than everyone else combined. In that case, as 51% of nodes would have the history of the blockchain with the malicious block, that would be recognized as the official blockchain going forward.
Given the money already invested by numerous different parties to mine and secure the Bitcoin blockchain, it would cost a ridiculous amount of money to do just that.
Put simply, PoW blockchains are basically the equivalent of your neighbourhood settling transactions to and from your bank account instead of the bank. All of your neighbours would have a running total of your bank balance (scary thought!), and anytime you made a transaction, a math equation would be sent to the whole neighbourhood. First person to get the answer correct would get a monetary prize, and then get to share the transaction with the rest of the neighbourhood, who would all add it to their notebook. The neighbours would then post the updated total onto a groupchat to make sure everyone else has the same new total in your bank account!
Decentralization is crucial because there is no single point of attack that can take down the network. In this case, if one of your neighbours goes on vacation, you are still able to make transactions as the rest of the neighbourhood is there to continue verifying them. In a centralized banking system, you can only make wires/ACHs during bank hours. In addition, no single neighbour can manipulate the system and try to change your bank balance to $0 if they didn’t like you, as every other neighbour would be able to verify that the single bad actor’s total isn’t correct.
What is Proof of Stake (PoS)?
In a Proof of Stake decentralized blockchain, verifying transactions is left to those who are financially invested in the chain itself. Individual actors are able to stake a certain amount of the blockchain currency in order to be able to sign transactions onto the blockchain. There is no “mining” that occurs.
The main premise of PoS is that individual actors who have a financial stake in the future success of the blockchain will not do anything malicious to harm it. Security is inherently built in as those who own the blockchain do not want to see it destroyed. It’s basically the equivalent of the expectations on how well someone maintains their home/car when they own it versus when they are renting.
In this case, manipulation can happen if an individual actor spends enough money to accumulate a significant portion of the circulating supply of the blockchain’s native token, which would provide them the opportunity to potentially become a majority validator and approve any and all malicious transactions.
However, the incentive to do so would be very minimal given the fact that it would be extremely costly since every additional token purchased would be at an incrementally higher cost, especially when the public starts to figure out what is happening. In addition, once this attempted takeover of the network is made public, people will stop using the blockchain and move onto the next one, which would subsequently decrease the value of the blockchain’s token. Remember, blockchains are open-sourced, transparent, and public. All transactions can be seen by everyone at any time.
Using the same neighbourhood example, all of your neighbours would have a running total of your bank balance and are entitled to collect interest on the amount, and anytime you made a transaction, it would be broadcasted to everyone in the neighbourhood. Everyone would add it to their notebook and then post the updated total on a group chat. Once a certain threshold of members in the neighbourhood have posted the same updated total, it would be updated into your bank account and you would now have a new official balance. If anyone has a balance different than the newly calculated one, they would be excluded in the future until they fixed their balance and their interest payments would stop.
In this case, nobody has to solve any tough math problems, and everyone plays a role in verifying new transactions onto the blockchain!
What is “The Merge”?
Since 2020, Ethereum has been operating on two parallel blockchains. One that runs on PoW (mainnet) with all of the activity, and one that runs on PoS known as the Beacon chain.
“The Merge” that happened on September 14/15 (depending on which time zone you live in) signified the merging of those two blockchains into one.
The PoW historical transactions are still recognized to ensure that your balance before the merge is the same as after, but moving forward, all new transactions are verified onto the blockchain using PoS, as we transition from Ethereum mainnet to the Beacon chain (which will inevitably be called “mainnet” in regular conversations).
Why Move to Proof of Stake?
There are many reasons that this move was made, but we will highlight the three most significant ones:
1) Environmental Impact
One of the biggest negatives to PoW blockchains are that they take a significant amount of computing power to mine transactions and secure the blockchain through node validators. As a result, they are very high in electricity usage in a world that is becoming increasingly conscious of negative environmental impacts. In fact, in August 2022, Ethereum’s annualized carbon emissions were on par with the country of Singapore. There is a tremendous cost-benefit analysis ongoing with PoW blockchains to determine whether the value provided is worth the carbon emissions.
By moving to PoS, it is estimated that Ethereum will reduce its energy usage by 99.95%.
2) Inclusivity
As stated earlier, the race for the best computing machines and fastest networks in PoW blockchains in order to increase the chances of solving the mathematical equations has become very costly, making it very difficult for the majority of the ecosystem to participate. In addition, there is a limitation geographically for access to cheap electricity.
In PoS blockchains, the minimum number of the blockchain’s native token required to be staked to be a validator participant is much lower from a financial perspective. In addition, there are even decentralized protocols that help to combine smaller amounts from the community in order to reach the minimum threshold to participate, giving the ability for anyone with any amount of tokens to be a part of securing the network.
3) Rewards
As PoS blockchains don’t require a mathematical equation to be solved and also require individuals to have a stake in the ecosystem, it also doesn’t need to provide as significant of a reward to the validator. In contrast, a sizable dollar amount of Bitcoin is given to the miner who is able to solve the transaction. Since PoW requires much more electricity to operate, the miner often has to sell the Bitcoin in order to pay electric bills and make a profit.
As a result, PoW blockchains have a significantly higher token supply issuance than PoS. With this move, Ethereum issuance will decrease from roughly 13,000 ETH/day in mining rewards to roughly 1,600 ETH/day in staking rewards.
This significant structural decrease in supply and sell pressure is a bullish catalyst for the Ethereum ecosystem from a price and investment perspective, without sacrificing decentralization or security. Of course, the more investment into the ecosystem, the more attractive it becomes for developers to build on, which then attracts more activity and thus beginning an economic flywheel.
Hopefully, the above provides you with a very high level understanding of the difference between the two types of blockchains, and what everyone in Web 3 is talking about when they mention “The Merge”!
This was one of the most monumental events in the crypto space to date, and will open up the door for Ethereum to scale on its quest to bring Web 3 applications to the masses.
For a more comprehensive look at the future of Ethereum and what is next after the Merge (including serge, verge, purge, splurge), please watch the video presentation below from Vitalik on his future vision for Ethereum.