This morning the main Ethereum blockchain completed the ‘Merge’, which moved the blockchain from the Proof of Work security mechanism that burns oodles of energy to the more efficient Proof of Stake. Instead of using electricity to solve lots of mathematical problems to write transactions to the network, with Proof of Stake, users risk ETH cryptocurrency to ensure that only legitimate transactions are validated. Bad actors are ‘slashed’ or lose their crypto.
With $23 billion of DeFi value on Ethereum, securely making this sort of live upgrade is no mean technical feat. To address the risks, some DeFi protocols, such as Aave, voluntarily reduced activity. In the last 24 hours, the DeFi value locked on Ethereum has dropped by 27% compared to small single-digit percentage declines for other chains, according to Defi Llama.
Apart from sustainability, Proof of Stake creates a new business model for Ethereum token holders because they now have the option to earn a crypto return, currently around 4.5% on their tokens. That’s something that other newer blockchains that leverage Proof of Stake have already been offering. Institutions are getting in the act with the likes of the SIX Digital Exchange (SDX) offering staking services.
According to Token Terminal, Ethereum has earned $1.4 billion in protocol revenues in the last six months and $7.6 billion in the past year.
The combination of being more sustainable than previously and providing a revenue stream should make Ethereum more competitive with the numerous upstart Layer 1 blockchains.
However, the latest upgrade does not solve all of Ethereum’s growing pains. The network’s scalability challenges persist, and hence transaction costs will remain high. Instead, to address scaling issues, it relies on layer 2 solutions and sidechains, which sort of batch transactions.
A more imminent additional upgrade will allow those who stake their ETH tokens to withdraw them. The current staking lockin carries some risk.
With many token holders using centralized institutions such as cryptocurrency exchanges for staking, there are concerns that it will be easier for governments to impose controls, such as with the US Treasury’s ban on Tornado Cash.
At Ledger Insights, we’re more focused on business use cases for blockchain rather than crypto as an investment. But given Ethereum is a cryptocurrency, there’s a money-making angle to the move. Some of the transaction gas fees will go to the Proof of Stake validators. But most of the ETH transaction revenues will be burned. In other words, the net amount of ETH cryptocurrency in circulation will decline, making ETH deflationary. Hence – ignoring all other price inputs aside – this should increase ETH’s price.
Some of the miners running the Proof of Work computers are planning to continue the old Proof of Work version of the blockchain, hence creating two Ethereum blockchains, a fork. That means that those who own ETH tokens now will also own ETHW.
Yesterday we explored what that means for NFTs. In very few cases, someone now owns the same NFT on both the Proof of Stake and Proof of Work chains, but it depends on the NFT license. In most cases they will only have rights to the NFT on the Proof of Stake chain.
From an institutional perspective, a number of companies have issued ETFs or ETPs based on Ethereum tokens. In some cases, this will mean the ETP owner will get an additional ETP representing ETHW.
It also remains to be seen if the breakaway ETHW network will have sufficient participation to remain secure. Hence while ETC Group said it plans to give its Ethereum ETP holders an additional ETHW ETP, Coinshares said it intends to but wants to wait and see what happens with ETHW.
Now that the transition is out of the way, developers and business people can return to focusing on using the blockchain.