BrazilThe Ethereum merge: The changes, benefits and risks
On 15 September Ethereum’s long-awaited merge will take place, in what is expected to be a major leap forward for the cryptocurrency industry – and in particular cryptos that leverage the Ethereum network. Cem Adiyaman, a consultant at RSM, outlines some of the key changes, benefits and risks that can be expected.
The much talked-about merge represents (without getting too technical) the joining of the existing execution layer of Ethereum (the Mainnet) with its new proof-of-stake consensus layer, the Beacon Chain. It eliminates the need for energy-intensive mining and instead secures the network using staked ETH. Down the line, a more scalable and sustainable Ethereum network should emerge.
While the best-known cryptocurrency, Bitcoin, is deemed a false narrative consuming huge amounts of electricity, the merger will enable Ethereum to take the green path.
Sustainability
Ethereum's energy consumption will be reduced by ~99.95% following the merge from proof-of-work (PoW) to proof-of-stake (PoS). After the merge, Ethereum will generate dramatically less carbon.
Not only does this mean that the upgrade should benefit the environment, but at the same time it should benefit network adoption and growth. Companies can more easily and confidently build on top of the Ethereum network without worrying about electricity use and sustainability regulations.
Yield
After the merge has occurred, Ethereum will generate a yield of approximately 4% to 6% on an annual basis if the holder stakes its Ethereum on the network. By staking Ethereum, the network grows and becomes more secure because the proof-of-stake model rewards honest validators whilst punishing dishonest validators and their delegators.
In return for this risk of using the Ethereum protocol, the Ethereum smart contract offers yield in its own currency: $ETH.
This may sound simple and ordinary, but it in fact means we will witness the first ‘internet bond’. Ethereum is the largest decentralized network built on top of the internet that enables smart contracts which can be owned. As a result, digital ownership of a network that generates yield is created.
This digital bond, just like the regular bond, should attract institutional investors, family offices but also regular companies. All these investors, with cash reserves, have seen their cash reserves on their balance sheets reduce over the past 12 months. Government bonds are yielding virtually zero returns (although that is slowly beginning to change in the current macro environment), forcing them to hold onto these reserves and accept inflation.
After the merge, these parties can put some of these reserves to work and receive returns on the world's fastest growing, sustainable technological yielding asset.
This yield providing asset will change adoption drastically. Contrary to other hard assets like gold, digital assets like Ethereum are a lot easier to hold on the balance sheet. The cost and effort to store them securely and the impossibility of getting yield on physical gold made gold less interesting as a treasury asset which forced companies to search for the safety of government bonds.
But now that inflation is significantly higher, and likely to remain so, than government bond yields, we will likely see investors in the market with cash reserves slowly deploying capital into Ethereum.
Some risks
Although the merge will take about 13 minutes and more than 150 Ethereum developers will be tracking every second of these minutes, there are some risks. The first risk is the risk of centralization and governance. Now that Ethereum is moving towards proof-of-stake, the validators of transactions will no longer be the miners but the stakers of Ethereum.
At the time of writing, 60% of the stake is in hands of four big parties. What will happen if the authorities require these parties to vote against a certain transaction or even vote against a new Ethereum Improvement Proposal?
Another big concern could be scams. The Ethereum network and some other crypto communities have been using the term “ETH2” to refer to the proof-of-stake layer. This could lead to confusion during the merge and scams trying to take advantage of users during this transition by making them believe that they need to take steps to upgrade to ETH2 or swap their current tokens for new ones.
Finally, there are the miners who are left with nothing to mine after the merge. The proof-of-work Ethereum network, known as Mainnet, has relied on miners to validate blockchain transactions for the past years. For years, they have been purchasing expensive equipment to deliver stability and security to the network in return of freshly minted Ethereum.
To recover these incurred costs, they might choose to continue on the old Ethereum chain, the Mainnet. This could lead to a so-called fork which will mean there will be two different Ethereum chains although it is not very probable that this will happen.
Two major parties have already stated they will support the proof-of-stake chain. The biggest oracle network, Chainlink and one the biggest stable coins, USDC by Circle, have announced that they would support the new proof-of-stake chain. It will be an ‘”adapt or die” situation for smaller decentralized applications which have chosen Ethereum as their preferred blockchain. They will either continue with the old Ethereum chain and risk becoming obsolete, or adapt.
The outlook
All in all, at RSM, we believe that the merge will – despite the short term risks which may unfold – unlock a boom period for Ethereum on the back of several new developments, decentralized apps and new use-cases. The best part of the development is that everyone can own a piece of these developments, which was not yet possible with the internet.
About the author: Cem Adiyaman is a consultant in the Business Consulting practice of RSM in the Netherlands, where he focuses on emerging technologies.
