On August 12, Ethereum founder Vitalik tweeted that “the terminal total difficulty has been set to 58750000000000000000000. Bordel.wtf predicts the merge will happen around September 15, though the exact date depends on hashrate.” The Merge, which has been delayed several times, represents a major turning point for the entire Ethereum ecosystem.
The Merge will combine the current Ethereum mainnet (the existing execution layer) with the Beacon Chain, and its consensus mechanism will shift from proof-of-work (PoW) to proof-of-stake (PoS). However, the Merge is just the beginning, and it will be followed by “the Surge”, “the Verge”, “the Purge”, “the Splurge”, etc.
What led to the Merge?
PoW has always been criticized for its heavy energy consumption, and Ethereum must break away from this shackle if it wishes to become a super ecosystem in the crypto market. As such, the network has decided to shift to PoS, which will reduce energy consumption by about 99.95%.
Secondly, under PoW, Ethereum has failed to quickly process the interaction requests of the network. Initially, Ethereum 2.0 was a plan that aims to scale the network by dividing the mainnet into 64 shards. However, struggling with the complexity of sharding, the Ethereum team chose to complete data sharding via the Rollup solution to improve the network’s TPS.
Consensus security is another concern. Under PoW, miners can stop mining and leave the network at any time. Additionally, mining pools have centralized the computing power of Ethereum, which represents a threat to the entire network. Once it shifts to PoS, if nodes were to launch a malicious attack against Ethereum, the network would confiscate their assets, which creates a cost that all attackers must bear.
Additionally, Ethereum also introduced the “validator committee” to the Beacon Chain, which will be soon merged with the mainnet. This randomly selected committee can easily verify the state of the Beacon Chain through voting-based “authentication”. Apart from that, validators will be changed periodically, which will boost the security of Ethereum’s network consensus.
Basic facts about the Merge
There are two types of Ethereum nodes: block-producing nodes and non-block-producing blocks. Only block-producing nodes will need to “stake 32 ETH”, while others do not, whether it’s before or after the Merge.
Why do nodes have to stake 32 ETH? 32 is a square number – 2^5. Since node messaging is exponential, lowering the ETH validator requirement from 32 to 16 would quadruple the amount of messaging across all the nodes. 32 has been chosen as the minimum amount of ETH stake that can also produce “finality” inside of 768 seconds (2 epochs). That said, 32 is not permanent, and it might be changed in future upgrades.
Ethereum has set a withdrawal/deposit queue, which limits the speed of making deposits and withdrawals. This makes sure that the rapid fluctuation of the application layer will not compromise the network’s security performance. As such, withdrawals by Ethereum stakers are expected to be unlocked 6 to 12 months (or even longer) after the Merge.
What changes will the Merge bring?
The Merge will reduce the annual ETH inflation rate from 4.3% to 0.43%. With PoS, the ETH issuance is reduced by over 90%, which will be seen as bullish news if the market demand for ETH remains the same.
There will be deflation because the ETH issuance will be reduced after the Merge and the burning ratio will be scaled up at the same time. When GAS fees on Ethereum are 7 gwei or higher, the rate of ETH being burnt is higher than the rate of ETH being issued, making the supply of ETH decrease. Here, it should be noted that such GAS fees (7gwei) are rare both in a bull market and a bear market.
After the Merge, Ethereum’s block time will go from 13.6 seconds on average to 12 seconds, which represents a 12% increase in transaction capacity, and therefore also a 12% reduction in GAS cost.
In the meantime, Ethereum will consume 99.95% less energy after the Merge. With PoS enabled, the energy cost for Ethereum will equal that needed for running a node — about 2.6 MWh per year.
What are the impacts of the Merge?
For miners, the Merge will be a huge blow. Ethereum plans to switch from PoW to PoS, which has more pros than cons for the whole ecosystem. That said, ETH miners will have to struggle to find the next destination. One choice is to switch to other PoW-based cryptos. However, considering the mediocre returns on other chains, as well as costs such as electricity and maintenance fees, it will be difficult for them to make a profit. Another way out is to sell their GPU mining machines now to stop losses in time. Finally, miners can also go with the “Ethereum fork”, which has generated heated debates over the recent period.
When it comes to the fork, Vitalik said that, in light of the importance of stablecoins to the ecosystem development of the protocol, centralized stablecoins such as USDT and USDC may become “a game changer for future and controversial hard forks”. Next, let’s check out how the market has reacted to this potential fork.
Proponents:
On August 4, Poloniex, a TRON-based crypto exchange, announced that it will support the ETH 2.0 upgrade and the potential fork and will launch two potential forked ETH tokens (futures), as well as the corresponding markets, on August 8.
On August 8, MEXC introduced the ETHS/USDT and ETHW/USDT trading pairs. If the hard fork fails, users of the exchange would need to exchange ETHS and ETHW tokens for ETH at a ratio of 1:1.
On August 9, Gate.io launched the ETH swap function for ETHS and ETHW. On the swap page of the exchange, users can convert ETH into two potential forked tokens (ETHS and ETHW) at a ratio of 1:1, or swap the tokens into ETH at the same ratio.
On August 9, BitMEX launched ETHPOWZ22, a USDT-margined (ERC-20) ETHPoW futures contract, with up to 2X leverage, and it is reported that the ETHPOWZ22 futures contract has gone live on the testnet.
On August 10, APENFT announced that it will back the ETH2.0 upgrade and potential hard fork. APENFT Marketplace, its NFT platform, will support NFT trading on the new chain after the ETH fork. In addition, the platform welcomes all NFT projects in favor of the fork.
Neutral parties:
On August 8, f2pool, the second largest Ethereum mining pool, said: “Ethereum miners are the unsung heroes of the Ethereum ecosystem. It doesn’t matter anymore whether to support the ether fork or not, we will let the miner community decide.”
On August 9, Deribit, a crypto derivatives exchange, announced its policy about the Merge and the potential fork and said that it will award users with this/these forked token(s) if the forked token’s value exceeds 0.25% of ETH PoS and the new chain is stable and working normally.
On August 10, Binance said in an announcement that it was closely monitoring the ‘Merge’ that’s expected to take place in Q3/Q4 2022 and that incident might result in the creation of certain forked tokens.
On August 11, OKX announced that “In the event of a hard fork and new forked tokens, OKX will evaluate and support the airdrop and withdrawal of forked tokens.”
On August 12, Kevin Como, CEO of BitKeep (a Web3 multi-chain wallet), said that the wallet will consult users before deciding whether it will support the forked chain.
Opponents：
On August 9, USDC issuer Circle stated that it shall only support the Ethereum PoS chain once the network has gone through the Merge.
On August 9, ETC Cooperative explained in an open letter why they believe the Ethereum PoW fork wouldn’t work or even become a hard nut to crack.
On August 8, smart contract wallet Argent officially stated that it has no plans to support any forks.
On August 8, the oracle protocol Chainlink said on its official website that it does not support forks of the Ethereum network, including PoW forks.
On August 9, the one-stop DeFi wallet DeBank announced that DeBank and all its products won’t support any services for the potential forked chains.
On August 9, FTX stated that its Ethereum futures and perpetual contracts will track the price of PoS ether.
On August 9, the Aave community put forward the “New Proposal: Only the Merged PoS Chain”.
On August 9, NFTScan announced it does not support the PoW fork of the Ethereum network.
In addition, TRON founder Justin Sun, Hongcai Guo (known as Baoerye), the aWSB community, and the 33 Foundation decided to kick off the first global Ethereum PoW hackathon, preparing for the ecosystem growth after the successful fork.
Responding to the fork controversy, Vitalik Buterin described those advocating for a hard fork of Ethereum to keep PoW as “just trying to make a quick buck” in a closed press briefing during South Korea Blockchain Week.
The significance of the fork
To begin with, we should make it clear that the fork would be a hard fork if it does happen, which means that the blockchain will be divided permanently. After major upgrades to the blockchain system, Ethereum would be split into two chains with identical blocks before such upgrades.
That said, Ethereum went through a hard fork before when it was hit by the $50 million ETH hack against The DAO. Following the incident, Ethereum founder Vitalik Buterin decided to launch a hard fork to roll back the blockchain to recover Ethereum’s losses. Subsequently, some users stuck with the hacked chain and refused to upgrade, which is why Ethereum was split into Ethereum Classic (ETC) and Ethereum (ETH).
If this hard fork were to succeed, the whole network would have to face one problem: As the two chains share the same history, assets (e.g. USDT, USDC, etc.) and protocols (e.g. MakerDAO, AAVE, etc.) would also be bifurcated, and the hard fork would be pointless if the forked chain fails to provide a decent solution to such a problem.
In addition, unable to fully reproduce its ecosystem due to the number of projects supporting the fork, the post-fork Ethereum would result in a fragmented network. As such, Ethereum would also face a major challenge in its future growth.
If the forked chain is entirely for miners, then its existence would produce zero value because there would be no demands, let alone liquidity, and the whole ecosystem would be fractured.
Opportunities presented by the Merge and the potential fork
Opportunities presented by the Merge
Let’s first focus on the opportunities presented by the Merge.
For retail investors, liquidity staking represents an easy, less risky investment channel available on platforms such as Lido (LDO), Rocket Pool (RPL), and Stakewise (SWISE).
DeFi investment constitutes another major opportunity. In light of ETH staking and the possible hard fork, the demand for ETH would go up, and the deposit rate offered to ETH lenders by the relevant DeFi platforms would also increase. Of course, making such deposits comes with a risk: As the demand for borrowing ETH soars, lenders might not be able to withdraw all their assets before borrowers repay their loans or more users make ETH deposits.
Opportunities presented by the potential fork
We will now turn to the opportunities that the potential fork could bring. In this regard, a less risky tactic is to profit from online airdrops. In other words, investors could transfer all their ETH holding to the Ethereum mainnet or borrow ETH by collateralizing other cryptos and transfer the borrowed to the mainnet to wait for airdrops after the fork.
You could also earn arbitrage profits on exchanges. At the moment, some platforms have already introduced ETHS/ETH and ETHW/ETH trading pairs. Once the combined exchange rates exceed 1, you could then buy ETH, swap it into ETHS and ETHW proportionally, and sell your holdings immediately to earn arbitrage profits. Doing so would also require you to keep track of the ETHS/ETH exchange rate. If the rate falls below 1, you could buy ETHS, and convert your ETHS holding into ETH at the 1:1 ratio and profit from the spreads. However, the trading volume of the pairs at the moment does not allow for such arbitrage tactics.
Meanwhile, some crypto users proposed a riskier and more complicated strategy: Swap WETH back to the mainnet before the fork, borrow ETH by collateralizing coins that might zero out in value after the fork, and then withdraw the borrowed ETH to the mainnet. Of course, if you were to adopt this strategy, then you might have to face skyrocketing interest rates in the early stage of the fork. You can also withdraw your funds from AMM pools featuring “ETH-coins zeroed after the fork” to avoid impermanent losses.
Of course, in the event of a successful fork, many unpredictable problems might occur. In addition, the earning channels above might also be subject to plenty of risks. Therefore, before making any investment, be sure to stay on alert and keep your assets safe.
Conclusion
The Merge is a major milestone in the evolution of Ethereum, and it will lead to huge progress in both technical designs and economic models. Some might argue that the hard fork would not be consistent with the blockchain principles, but they are wrong: It is the blockchain space that created the possibility of this hard fork, and only the market will have the final say as to whether it will succeed or fail.
That being said, no matter which camp you side with, be sure to account for the risks before making any investments.
Disclaimer: This article offers no investment advice, and all statistics mentioned herein are for reference only. The information provided herein may not be relied upon for investment decisions, for which you will be fully liable.
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