The global community of cryptocurrency holders and investors will have their eyes on Ethereum for the next few weeks as this high-profile cryptocurrency is poised for a significant structural upgrade on Sept 19 that promises to be more sustainable, accessible, yet, secure.
This so-called “Merge” event will see the Ethereum platform merge its existing execution layer with its coordination mechanism, Beacon Chain, which is now running in parallel.
The Beacon Chain coordinates the network of “stakers” and following Merge, will see Ethereum moving into a new proof-of-stake (PoS) system from the previous proof-of-work (PoW) system.
While both the PoS and PoW systems help users perform secure transactions by making it difficult to commit fraud, the Ethereum community believes the move into the PoS system will bring about several benefits.
Since the start, Ethereum has been using the PoW system, which also underpins older blockchains such as Bitcoin (BTC). Under the PoW system, “miners” use their computers to solve complex problems to help extend the network, and receive some coins as compensation. Crypto enthusiasts have been known to carry out industrial-scale “mining” operations, guzzling up copious amounts of energy in their bid to mine more coins.
The PoS, however, is an alternative to PoW, that addresses the issues of energy usage, environmental impact and scalability. With the PoS system, validators (instead of miners) pledge an investment in digital currency before validating transactions with a proof of stake. Validators then put up stakes with coins of their own to validate the blocks. They also have to indicate how long they have been validating transactions.
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The choice for who validates each transaction is randomised through an algorithm that is weighted based on the amount of stake and the validation experience. After a block is verified, it is added to the chain and the validator receives compensation along with their original stake. If the validator does not correctly verify the block, the initial stake can be lost.
Under the PoS system, the traditional mining process will be replaced with a staking process, reducing the hardware (and energy) required for validators to access a new chain. This results in a lower barrier of entry for those interested in placing a stake on the Ethereum network.
The PoS system claims to have better security than the PoW too. Firstly, with the additional need for staking or providing initial collateral, validators are somewhat deterred from stealing coins or committing fraud, as the initial stake can be destroyed if the validator misbehaves.
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Secondly, the Ethereum community believes Merge will make it riskier to launch socalled “51% style” attacks. These attacks are described as such because miners controlling more than half of the network’s mining rate or computing power can mount an attack using “forks” (think of it as creating a new branch as a diversionary tactic) on a blockchain. This is because of the strength of the community on a PoS network that has the flexibility to mount counter-attacks.
For example, honest validators could decide to keep building on the minority chain and ignore the attacker’s fork while encouraging apps, exchanges, and pools to do the same. They could also decide to forcibly remove the attacker from the network and destroy their staked ether. These are strong economic defences against a 51% attack.
Long time coming
According to Daniel Dizon, Ethereum on a PoS system would be much more secure and easier to scale — processes that are particularly welcomed amid the ongoing “crypto winter”. “News around Merge is almost single-handedly keeping crypto markets optimistic and buoyant,” says Dizon, CEO and co-founder of Swell Network, a liquid-staking protocol for Ethereum.
“If all goes well, it will be one of the most defining moments for Swell Network and certainly, the wider industry,” says Dizon in an interview with The Edge Singapore.
Photo: Swell Network
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Echoing Dizon’s sentiments, Benjamin Stani, director of business development at Singapore-headquartered digital assets financial services firm Matrixport, says Merge is a sign of strength for the core developer team behind Ethereum for reaching this milestone. “This is something that has never been done before and a necessity for any future steps Ethereum wishes to continue to take moving forward,” says Stani.
While Sept 19 has been scheduled to be when Merge is expected to happen, Ethereum has several times delayed the event. This date is a soft deadline set by client developers, who have also noted that this date could change again.
Unsurprisingly, the process is a complicated one and is much easier said than done for Ethereum, which has a combined market now of around US$190.6 billion ($268.2 billion) and is traded actively by around 475,000 users daily.
“The refining process of the new PoS mechanism over the past few years has been an intensely complex one. One could compare it to changing the engine of a plane in flight, while making sure that all the edge cases are covered,” says Stani.
Photo: Matrixport
“And this is why the Ethereum foundation has been particularly careful and cautious about making sure the system is as bug and risk-free as possible before launching the change,” he adds.
Despite the several earlier rounds of delays, Stani is upbeat that Ethereum should be able to go ahead with Merge on Sept 19. There had been several rounds of tests and simulations to weed out possible bugs.
Not all parties within the crypto community are looking forward to Merge, however. The miners focusing only on Ethereum will effectively be rendered obsolete, for one. They will either have to stay on the Ethereum PoW fork, turn to Ethereum Classic or switch to staking operations on the new PoS system. Otherwise, they will just have to turn to other cryptocurrencies, says Dizon.
However, such dissent will likely just be “short-term noise”, says Annabelle Huang, managing partner of Singapore-based digital asset company Amber Group, as the wider decentralised finance (DeFi) ecosystem and important building blocks of the Ethereum community have already extensively rallied and vocalised their endorsement for Merge.
“Even a small percentage of miners have voiced support for Merge as well, so we are confident that Merge will go ahead as planned with full optimism,” says Huang.
Photo: Amber Group
Looming risks
However, just like all other cryptocurrencies, risks are constantly present and this is not an exception for Ethereum even after it has moved on to the PoS system. Experts warn that Merge should still be approached with caution due to the volatile nature of the crypto space and the potential of what the event can bring.
“Anything can happen until it happens,” says Huang, adding that with her several years of experience in the blockchain and cryptocurrency space, risk management is essential.
While the new PoS system is still susceptible to critical bugs in the network, Huang notes that a larger issue can surface within the system. For instance, fork tokens could experience certain regulatory scuffing when a new token is created from the existing chain due to Merge.
Huang says that the crypto community is arguing that the old Ethereum PoW token should still be worth something, especially compared to Ethereum Classic, which arguably has nothing going on, but is still trading at non-zero values. “If there are some developers who want to continue building [on the old chain] and keep it running, this will result in a [noticeable] split.”
“Under those circumstances, how would you ascertain which is the original when both are [technically] the same?” she adds. “This gets quite complicated when it comes to the idea of ownership and how it will be defined moving forward.”
In 2015, the Ethereum blockchain was created as a single chain; however, due to a hack in June 2016, the blockchain experienced a US$60 million loss due to stolen crypto. Due to this incident, a hard fork was performed to secure the network, resulting in the emergence of Ethereum and Ethereum Classic.
As Ethereum moves to the PoS chain, Ethereum Classic will continue with traditional mining on its own PoW blockchain even after Merge. As at Sept 7, Ethereum and Ethereum Classic are trading at $2,136 and $47.94 respectively.
Similarly, Bitcoin Cash (BCH) was created via a hard fork of Bitcoin. While bitcoin is treated as a store of value, BCH is intended to serve as digital cash, where its supporters ensure that it is cheap and easy to use. As at Sept 7, Bitcoin is trading at $26,419 while BCH is trading at $158.89.
When the BCH hard fork was announced, many investors viewed it as “free money” as anyone who held Bitcoin at the time of the fork would automatically hold an equivalent amount of BCH at no additional cost.
As a result, Huang says that this could lead to many players turning opportunistic, capitalising on the ambiguity of the situation. Possibilties include making claims for any extra value of any duplicate tokens that exist on the old chain produced at the fork, which could be the case with other stablecoins or non-fungible tokens (NFTs).
“The payoff ratio is so high that people out there might try to game the system a little bit [to try and extract extra value], so we have to be careful,” Huang explains. “It’s not going to be all rosy, and it might be hectic as well.”
Additionally, Dizon points out that one of the main issues with the increased prominence of staking from Merge is that there now will be more capital than ever entering Ethereum staking, which increases the risks of greater centralisation if the staking industry is monopolised by larger staking pools. The crypto community’s underlying philosophy is to eschew central control.
“Unchecked centralisation in this manner brings about governance issues for the community, from censorship to competition, and is the antithesis to what DeFi stands for,” says Dizon. “It can also lead to repeats of what we saw earlier in the year where large crypto players imploded, mainly because they were not representative of or practised true DeFi principles.”
Whether the benefits of Merge remain to be seen, the event sets a milestone for Ethereum and demonstrates to other major cryptocurrencies what could be achieved on the PoS system.
Cover Photo: Unsplash
