How The Merge will change DeFi and dApps on the network. “The Merge” – the shift from proof-of-work to proof-of-stake – represents a major paradigm shift for Ethereum. Changing an element as important as the consensus algorithm, along the way, on a network that secures so much liquidity: represents an unprecedented balancing act.
Assuming its success, the entire ecosystem of dApps and smart contracts will remain active on the blockchain – and will be backward compatible following the update. This feat will be neither more nor less than a turning point in the history of blockchain and DeFi.
Ethereum (ETH) is set to become the largest proof-of-stake (PoS) cryptocurrency
Until now Ethereum used proof of work (PoW) like Bitcoin.
To validate transactions on its network, Ethereum used specialized computer equipment to continuously “mine” ETH. These ASICS were deploying their computing power to solve cryptographic challenges, each challenge solved allowing to validate a block and recover a reward in ETH.
Assuming the success of “ The Merge ”, Ethereum would join the list of blockchains working with proof of stake (PoS, for “proof of stake”). No more ASICS and competition between validators, since each of them will have a chance to validate transactions.
However, you will have to deposit a minimum of 32 ETH and agree to block them to participate in securing the network.
Good to know: The choice of validators in proof of stake.
In a PoS algorithm, ETH holders are thus drawn at random to validate the transactions. With this probabilistic model, all validators theoretically have a chance of validating a block. However, this probability is weighted by the number of ETH held.
With this change, Ethereum will become the most important proof-of-stake cryptocurrency. The largest of these so far has been Cardano (ADA), which is capitalized at just under $15 billion. Ethereum (ETH) weighs more than 180 billion at the current price.
A change in rewards and their perception
This is the first major change: ETH issued to pay “miners” will now be used to pay validators, those who, as we indicated, block their ETH tokens to secure the network.
Currently, 2 ETH are issued at the creation of each block. Knowing that a block is validated every 13 seconds, 5 million ETH in rewards go to miners annually.
Adding the rewards paid to users who do staking (approximately 500,000 ETH), brings the total issuance to 5.5 million ETH per year.
After switching to PoS, no more than 2 ETH was issued for each block. Only ETH created to reward validators will exist. However, it will not have escaped your attention that in August 2021 the Ethereum network had evolved with - among other updates - the EIP-1559.
The purpose of this is to remove from circulation (“ burn ”) most of the ethers issued as transaction fees. Put simply, this amounts to withdrawing around 2.9 million ETH per year.
Thanks to this update, Ethereum has become a deflationary cryptocurrency.
Good to know: A deflationary cryptocurrency.
A cryptocurrency is said to be deflationary when token emissions are slower than token withdrawals.
A cryptocurrency is said to be deflationary when token emissions are slower than token withdrawals.
The immediate consequence is as follows: if since August 2021 the issue has been at an annual rate of +4%, it will now drop to -1.4% with The Merge.
For those interested in the monetary aspect of Ethereum, this will give ETH an effective base rate of around 4% per year. Contrary to what some observers say, this is not a real return. Indeed, it will be paid from an issue of ETH, and not from an external source (as for a bond coupon). Clearly, those who do not invest their ETH in the network, being diluted, will be those who actually pay those who do.
This exemplifies the shift in vision that all Ethereum participants will face. Not everyone is required to support the network through staking, but failure to do so will result in a transfer of value to those who engage in this activity.
New dynamics of value creation on Ethereum - Newsbtc.com
A change in the narrative around DeFi's energy consumption
The second major change concerns Ethereum's carbon footprint.
By switching to proof of stake, Ethereum will reduce its energy consumption by 100 TW per year: roughly, this is the annual consumption of a country like Finland or the Netherlands.
Because of its environmental impact, Ethereum was not until now the privileged choice of institutions to launch their projects.
Despite its status as the #1 blockchain for dApps, institutions preferred other networks to meet ESG criteria in their crypto investments.
Now that the Ethereum network will become up to 2000 times more efficient, it will therefore be possible to launch a whole eco-responsible narrative similar to that surrounding the Solana network.
Good to know: Blockchains and their carbon footprint.
A report commissioned by the Solana Project (SOL) team established a small hierarchy of the most eco-friendly blockchains.
- The most polluting are proof-of-work blockchains: Bitcoin (BTC), Ethereum (ETH), Litecoin (LTC). They consume around 100 kWh for one transaction, the equivalent of a 200 km journey in a diesel sedan.
- Then come the layer 2 blockchains: Polygon (MATIC), Arbitrum, and Optimism. They consume around 10 kWh per transaction, the equivalent of a 20 km journey in a diesel sedan.
- The least polluting are proof-of-stake blockchains: Cardano (ADA), and Solana (SOL). Their consumption drops to less than 0.010 kWh per transaction, the equivalent of a search on Google!
PoS will make Ethereum a 2000x greener blockchain
A change in dApps fees
Another change concerns the fees paid by users to use Ethereum's decentralized applications. There is a recurring misconception around The Merge that network fees (“ gas fees ”) will go down.
What is true, however, is this: the update will allow the possibility of generating random numbers on the blockchain.
Good to know: Random numbers in cryptography
Random numbers are essential for many applications, which have so far depended on external tools – “oracles” such as Chainlink – to feed them price and volume data, with additional costs involved.
Without going into details, the introduction of random numbers will make a difference for dApps developers and users.
While this won't make ChainLink obsolete overnight, it will give developers options in achieving sharding.
Among the scenarios to expect:
- Decentralized AMM-type exchanges such as UniSwap will have to adjust their algorithms to adapt to new market conditions.
- Stablecoins such as MakerDAO's DAI will need to change collateral requirements for token issuance.
Evolution of the average fees of dApps on Ethereum
A reinforced role for layer 2 Optimism, Arbitrum and Polygon
The last major change brought by The Merge is the enhanced role of Ethereum overlays in the issue of gas fees.
It should be understood that the update is not intended to fix the fee issue. There is no reason to expect changes in network costs unless transaction volumes increase or contract after the merger.
Therefore, Layer 2s remains the solution to this problem.
Good to know: Layer 2 or overlays
A layer 2 blockchain is a secondary network built on top of an existing blockchain. Polygon, Arbitrum, and Optimism are layer 2 of Ethereum. For example, transactions are validated in batches of 1000 on Polygon, before being validated all at once on Ethereum. This effectively escapes congestion issues and high fees on Ethereum!
However, if the update does not solve the problems of congestion and fees, it does mark an inevitable step before getting there.
Developers refer to it as “ sharding,” which is part of the project roadmap. Sooner or later, Ethereum developers will have to tackle it.
Good to know: Sharding
Sharding is a computer technique that consists of dividing a blockchain into several subnets. This fragmentation makes computing easier, resulting in significant gains in throughput, security, and transaction costs.
Before and after The Merge in the Ethereum roadmap
The crypto ecosystem has been badly battered since the start of the year and badly needs a win. If The Merge isn't the catalyst for a new, broad-based bull market, it will at least give decentralized finance new ways to gain traction and weather the wave of attacks targeting it.
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