The Ethereum Merge is Done: A Market's Wrap Up
The big Ethereum update that everyone is talking about has already happened. We made an article called Post-Merge: 5 Facts You Need to Know in which we explained what it consisted of and that it was the fusion between the consensus layer and the execution layer. Ethereum has therefore moved from a Proof-of-Work protocol to a Proof-of-Stake consensus. The Merge is the first step in Ethereum's big roadmap that will take several years to deploy. If you have not seen Vitalik's talk at EthCC 5 that outlines the next major steps, we invite you to watch it here.
Introduction
The Merge took place and we are writing this article on September 19, 2022. Today we are going to look at the direct consequences of this event on the Ethereum blockchain and its token. We know that this may seem like yet another article about the Merge hype and that you may feel like everyone is talking about the same thing. It is true that there is a lot of content about The Merge at the moment but we will try in this article to approach the topics differently but especially to have a little more thoughts about this update and the ones to come.
Ethereum's energy consumption
One of the things that comes up a lot about The Merge is the energy consumption of the Ethereum network. It is something we hear absolutely everywhere and it is especially used by the people who talk about The Merge without knowing much about it. As you know, Ethereum is moving from a Proof-of-Work consensus-based protocol type to a Proof-of-Stake consensus type. So yes, it is a fact, from a technical point of view, the PoS system will consume 99.5% less than the PoW. Unlike the PoW system in which it is necessary to have a large number of validators that use a lot of electricity, in the PoS system, it is ETH tokens that are needed and not electrical resources. Thus, PoS is 2,000 times greener than PoW. If we look at since 2021, the energy consumption related to Ethereum has exploded and is now hyper-low:
Source: ethereumenergyconsumption.com
You have certainly heard the famous comparison between Bitcoin and Ethereum which consume as much electricity as a country:
Source: ccaf.io
Khazakstan consumes about 92.1 TWh/year while Bitcoin consumes about 95.3 TWh/year. That said, it is possible to mine Bitcoin via renewable energy or surplus energy that cannot be stored and then invest via the mined cryptocurrencies in green investments such as hydro dams for example. These water dams can be used for mining. This example allows us to qualify the comparison between BTC vs Countries.
Yes, PoS has its advantages but also its disadvantages. So does the PoW:
Source: bitcoinuptime.org
PoW has proven its resistance with BTC which has never been down or almost never.
PoS allows for a system that is certainly greener but potentially more exposed to hacks if the number of benevolent validators is not sufficient and can quickly become too centralized.
Going from PoW to PoS remains a huge revolution.
Should or will Ethereum 2.0 be a store of value?
One of the big consequences of The Merge impacts the ETH token. The number of ETH created should decrease by 90%. Staking rewards are going to be 1,600 ETH/day versus 13,000/day pre-Merge.
If certain specific conditions are met, ETH could even be a deflationary token. Almost everyone thinks this is a great thing. Indeed, few people like inflation, whereas deflation allows supply to decrease and potentially increase the asset’s prices. Having said that, let's try to go a little further in the analysis by having a nice angle of reflection on this subject.
Even if we have a very bad image of inflation because it is often considered as absolutely mismanaged by our dear governments and therefore reaches aberrant rates, a healthy inflation in a healthy economy clearly has its advantages. Inflation allows a currency to circulate, which is one of the most important things in economics because we do not want people just to save without using the money they have. It also encourages initiatives and creates new opportunities. Deflation, on the other hand, can slow down an economy and lead to difficult consequences. Yes, if you know that the more money you keep, the more purchasing power you will have in the future due to deflation, then you will simply stash it under your mattress and wait. If no one is exchanging and a currency is not being used, then the economy can suffer.
We see a well-known economic paradox here where deflation is linked to economic crises because companies cannot hire, people who have taken out loans have trouble paying them back and we can very quickly fall into a negative spiral. So be careful not to run away from an inflationary ecosystem because if it is well managed then inflation will be beneficial.
The ETH token is a token that will manage the ecosystem, secure the network and enable the growth of the protocol adoption.
Again, we don't have a crystal ball and the answer is not yes or no. From our research here are some things to think about:
So the conclusion is that if the ETH issue is well managed, then the ETH price will come out ahead. Why? Because everything in the Ethereum protocol is designed to encourage the circulation of ETH and it is important to remember that ETH is not inherently deflationary. It only becomes inflationary if we have a lot of activity on the network and a lot of ETH used for gas is burned. This is not detail and it really makes all the difference.
The MEV: the tax that everyone forgets
There is something that is very important on Ethereum and that is very little discussed because very little is known. However, it has allowed miners to generate more than 675 million dollars without the users really knowing it.
It's not a hack and it's not something illegal. It's clearly legal, but from an ethical point of view, it can be a concern. This phenomenon is what we call MEV: Miner Extractable Value.
To understand MEV, it is necessary to understand how a transaction is validated in a Proof-of-Work blockchain. Let's say you want to send a friend 1 ETH for his birthday. How will this happen in practice? You go to Bitget, start your sending process and the transaction will go to a mempool. A mempool is simply a big basket in miners will pick to fill the blocks they will validate. In the mempool there are all the transactions that are pending. A miner wishing to validate his block will take the transactions from this large basket, fill the block, organize it and form it. In exchange, the miner will receive two types of rewards: ETH for creating a new block, which is a reward that will be fixed according to the new amount of ETH that can be mined, and he will also receive the ETH fees of the transactions of the block he added. So if we imagine that all the users who made transactions contained in the block he created paid $100 in total transaction fees, then the miner will get this $100. Normally you begin to understand the trick here.
The fact that miners can get the transaction fees from the transactions they are going to validate, well that means that miners have an incentive to take the transactions with the most fees and not the first ones in order of arrival. Because if they take the transactions that have the most fees, and validate them in their blocks, then they will receive more rewards. Around this practice, which may seem quite simple, a whole ecosystem has developed in which there are so-called "searchers", i.e. traders who look for MEV opportunities and whose objective is to optimize the organization of each block in order to extract maximum profits. These searchers will create the most optimized block possible which they will then offer to a miner in exchange for a certain price. There was an update, EIP-1559 which tried to reduce the MEV because miners had extracted huge amounts of money under the noses of the users.
If ETH allows this, then miners are technically entitled to process the most profitable trades first. Code is law. However, this is like standing in line at a supermarket checkout with the option of giving the cashier some cash to go ahead of all the other customers. This gives rise to the execution of the free will of minors.
The question, then, is whether the move to PoS will affect this SRM, and if so, what?
Again, this is difficult to predict. There are a lot of conflicting opinions. In PoS as you know, it is no longer miners but validators who operate to validate transactions. These are people who will block their ETH in staking and who will propose and then verify the blocks. With the decrease in the number of new ETH created, validators will receive 85% less rewards than miners for the same work. So we can imagine that MEV is going to be a big issue in PoS. Some estimates predict a revenue increase of around +50%, which is huge. But a big change is in block building, the process of determining which transactions will be included in a block and in what order. In PoW, block building required very specific tools for the miners and there were only a few operators who were responsible for the majority of the block building. With The Merge, this will change as a new category of actors will be introduced in the consensus called "blockbuilders" which are actually actors specialized only in the construction of new blocks. This will be a new process that will touch the creation of Ethereum blocks. There will be a separation between those who propose the blocks and those who build them. This differs from PoW where the same person was responsible for both the proposal and the construction.
Layers 2
The implications of The Merge for Ethereum and Layers 2 are numerous. If The Merge does not directly improve scaling, in the long term, Ethereum has planned to implement internal solutions that will increase its capacity such as sharding, and theoretically may no longer need Layers 2 type solutions to prevent its network from being saturated.
Already, what is certain is that The Merge will not change much regarding the importance of Layers 2 on Ethereum. This is a fact. In the future, it is therefore also very likely that Layers 2 will continue to be necessary for the Ethereum ecosystem. In fact, the developers have said that they are including Layers 2 in their scaling plan.
It is important to understand that just because Ethereum is scaling does not mean that Layers 2 become useless.
In fact, the opposite is true. Layers 2 are directly linked to Ethereum. So if Ethereum improves its capabilities through sharding, then Layers 2 will also become more powerful. To achieve mass adoption in the near future, it seems that Ethereum clearly does not have the luxury of using sharding alone. Both solutions, sharding, and Layers 2, can be combined very well.
On the other hand, Layers 2 uses can be rotated and they could be used to process, for example, the smallest transactions in the network or have other roles that remain to be defined. It is also worth remembering that Layers 2 are not just for Ethereum and so we imagine an even greater multi-chain role for Layers 2 in the future.
Conclusion
There's a lot of data to consider and no one can really tell you for sure what is going to happen. What is certain is that Ethereum will open a new door in the ecosystem. It is the biggest blockchain and the one with the most users. That being said, Vitalik and his team have taken one of the biggest risks in the history of blockchains to optimize their ecosystem and do everything they can to make sure that Ethereum will be adapted and used by the masses in the years to come. Other projects will therefore also have to raise their standards and take risks if they want to follow Ethereum's pace, which may be beneficial for the entire blockchain ecosystem.
We can also wonder about the consequences of this update on the price of Ethereum as well as the entire cryptocurrency market. It is hard to know. There are a lot of things that should be taken into consideration: will The Merge be executed totally well? Will there be enough liquidity to drive up the price of the token? Will there be a lot of speculation? We don't know... Has The Merge already been priced before? Will this pricing happen when the consequences of The Merge overtake the speculation?
The Merge and the other major updates that are coming will really mark a change of era in the ecosystem. We have had problems and seen a lot of projects bragging about being Ethereum killers. Ethereum is trying to calm everyone down to show that hard work pays off. It will be very hard to get ahead of ETH. That said, it remains to run, and everything happens. If all goes well, then Ethereum will reign and dominate even more. It will be interesting to follow the new updates and we will, of course, write articles about these topics.
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