Ethereum’s $415.3 Billion Valuation Hinges on Successful ‘Merger’

Later this year, Ethereum is set to make the biggest change in its nearly decade-long history, an event that is sure to ripple across the entire cryptocurrency and digital asset ecosystem. . Think of it this way: Crypto’s most important commercial highway is about to be completely repaved.

Ethereum is basically computer software that uses so-called blockchain technology to provide a digital ledger to record transactions. It has become the most popular basis for a growing range of trading crypto assets and applications, including lending products, non-fungible tokens (NFT), as well as its native token, Ether. Ethereum is not owned by anyone but is built and refined by a community of developers, and it runs on a network of data centers around the world. These data centers operate as “miners” on the network, ordering transactions that are recorded in the digital ledger. In return, they are paid in Ether. This system has been dubbed “proof of work”.

Developers working to refine the Ethereum software roll out periodic updates, but none have been as big as the one expected this year. Called “the Merge”, it will replace miners with so-called stakers. Miners order transactions by solving complex calculations using millions of powerful servers – a system that has been criticized for its high electricity consumption. Stakers, on the other hand, will order transactions by installing their own Ether on a new system, which has been in testing since December 2020. People can already use their digital wallets to stake Ether on this test system, called the Beacon string; after the merger, they will begin to be randomly selected to become so-called validators, ordering transactions on the Ethereum digital ledger in blocks and being paid with new Ether. This is called “proof of stake”.

Ethereum’s $415.3 billion market capitalization depends on whether the merger goes well, but so do the thousands of companies that operate on the blockchain, as well as millions of users. Some $121.5 billion in capital is locked in Ethereum decentralized finance(DeFi), according to tracker DappRadar. Most of the NFTs, whose total value is also in the billions, use Ethereum.

“There has never been, in the history of blockchain networks, a change at scale in Ethereum’s transition from proof-of-work to proof-of-stake,” says Hunt Devensanalyst at the researcher Messari.

The merger will be biting because a lot could go wrong. There could be software bugs or hacks, or miners could create an alternate Ethereum network. During a network upgrade in 2020, a bug split Ethereum in half, wreaking havoc on its nascent DeFi ecosystem, the apps that let people trade, borrow, and lend without intermediaries like banks. .

Most centralized crypto exchanges are expected to suspend Ether withdrawals and deposits around the merger as a precautionary measure. DeFi apps can also shut down if something goes wrong.

“With all the tech upgrades on all these big chains, you have to be careful,” says Katie Talati, research director at Digital Asset Manager Arca. “Ultimately, we are dealing with unknown technology.”

Miners cause the most concern. Many may leave the network just before the merger, thinking they can make more money selling their gear than waiting for the last of the rewards. Too much of a drop in the network’s mining power, or “hash rate,” could weaken Ethereum’s security, spelling disaster for its token and the various applications using the network. Ethereum core developers have foreseen this scenario. “If we see the hash rate going down, we could push the merger forward,” says Tim Beiko, a computer scientist who coordinates the developers of Ethereum. “All software is built with an emergency option.”

Miners can also choose to fork Ethereum, taking existing proof-of-work software and continuing to support it. This would create two different versions of Ethereum that would work in parallel: proof of work and proof of stake.

“We believe POW and POS will coexist for some time after the change,” says Danni Zheng, vice president of BIT Mining, a mining provider that is also expanding its staking services.

In this scenario, crypto exchanges and users might become confused as to which Ether chain they are holding or trading. Two networks will mean more work for app developers, says Dieter Shirley, chief technology officer at Dapper Labs, the creator of an Ethereum-based cat breeding game, CryptoKitties.

“A controversial fork, it’s likely to hasten our departure from the Ethereum ecosystem,” Shirley says. Dapper might consider moving CryptoKitties to its own blockchain, Flow, he says.

A fork, or at least a lot of public criticism, is extremely likely as many Ethereum miners don’t seem to know the merge is coming. Ethereum developers are communicating about the merger on Discord and Telegram, messaging apps that many miners don’t use, Beiko says. Mining pools, which today provide most transaction orders on Ethereum, take a percentage of miners’ revenue, and it is in their interest not to tell their members about the merger so that mining continues at least until the network upgrade, he said.

“I’m more concerned about people who don’t even know this is happening, and they buy this $3,000 miner, and three months later it stops working,” Beiko says. “It would be a bad idea to start mining today.”

And some miners just don’t believe the merger is really happening, because it’s been delayed in the past.

“There’s a lot of skepticism because Ethereum promised proof-of-stake for five years,” Beiko says. “It’s hard to convince people that this time it’s for real.”

The shutdown of the old Ethereum chain will send shockwaves through the cryptomining industry. Striving to find other uses for their equipment, miners will migrate their machines to other similar chains such as Dogecoin, Litecoin and Monero. The hash rate on these other chains will inflate 5 to 10 times overnight, says Sam Doctor, chief strategy officer at Bitooda, a digital asset fintech company. Overall revenues from this type of mining could drop by up to 90%, pushing many miners out of business, he says.

U.S. miners will pursue clients outside of the crypto industry, in areas such as artificial intelligence and genome sequencing, Doctor says. “But none of them have experience in customer acquisition.”

Investors can benefit from the merger. The number of new coins issued on Ethereum as rewards for order transactions is expected to decrease by 50% to 90% as the proof-of-stake chain will offer lower rewards, Beiko said.

Over the next two years, the amount of Ether used for staking will likely increase by 8% to 80%, according to staking service provider Staked. This will reduce the ether in circulation, potentially increasing its value.

Stakers will be able to use the Ether they receive as rewards for order transactions, but not the Ether they stake, at least not until another software update, which is expected around six months after the merger. Stakeholders are more likely to hold onto their Ether for the long term than miners, who often need to sell some to cover electricity costs, says Kyle Samani, co-founder of Multicoin Capital.

After the merger, Ethereum’s network power consumption is expected to drop by more than 99%. To order transactions on the new proof-of-stake network, a validator can use a high-end laptop computer instead of a server farm. The entire Ethereum proof-of-stake is expected to consume about 2.62 megawatts, or about as much as a small town of 2,100 US homes. In contrast, the current proof-of-work setup guzzles the energy of a mid-sized country.

“Even my daughter caught the ‘NFTs are boiling the oceans’ hysteria,” says Ben Edgeton, lead product owner at ConsenSys, which is building infrastructure for the Ethereum blockchain. “I expect freeing us from the drawbacks of proof of work will certainly help make applications like DeFi and NFT much more socially acceptable, leading to significantly accelerated adoption.”

Everything will depend on how well the merger goes, of course. “If we do our job well, no one will notice when Ethereum transitions from proof-of-work to proof-of-stake,” Edgington said.