What is the Merge?

Summary

• The Ethereum network will soon undergo an update known as the Merge.
• The primary goal of the Merge is to transition Ethereum’s consensus mechanism from a model known as proof-of-work (PoW) to one called proof-of-stake (PoS).
• The move to PoS will usher in structural changes in how Ethereum transactions are processed, reduce Ethereum’s energy usage, and set a foundation for future network upgrades aimed at enhancing the blockchain’s throughput and scalability.

The Merge is an extraordinary achievement in the history of crypto and open-source software development more generally. Although it took a number of years to implement PoS, the ultimate decision to change Ethereum’s consensus mechanism — and the roadmap for execution – was community driven. The fact that a decentralized group of actors worked together to manage a major upgrade of a live network is testament to the power of blockchains to incentivize trustless social coordination.

Background

Blockchains are a special type of shared database that take digital information and replicate it across multiple computers, called nodes, that make up a decentralized network. Certain nodes — called miners in PoW systems and validators in PoS systems — are responsible for maintaining the blockchain according to a fixed set of rules, known as the protocol, that define how and when the blockchain’s underlying data can be updated or changed.

Since blockchains are designed to operate through code alone (i.e., with no required connection to real-world identities or legal systems), there needs to be a mechanism built into the protocol that ensures that the nodes can only make legitimate updates to the blockchain’s data by adding blocks to the blockchain. This is known as the blockchain’s consensus mechanism.

Proof-of-work consensus

PoW consensus mechanisms require miners to expend computing resources (and, by extension, electricity) to compete against each other to solve a mathematical puzzle. The winner of the puzzle gets the right to make an update to the blockchain and is compensated with the blockchain’s native cryptocurrency through transaction fees and a block reward.¹ Being paid in cryptocurrency provides the miners with direct monetary value and aligns the financial interests of miners with the goal of maintaining system integrity. If a miner wanted to rewrite the entire history of blockchain data, they would have to independently solve every past puzzle, which is effectively impossible using today’s computing technology.

Proof-of-stake consensus

PoS consensus follows a different approach, but it also relies on economic incentives to ensure that validators do not behave badly. In a PoS system, validators make a refundable deposit in exchange for validation privileges.² According to a fixed schedule, validators are randomly chosen to approve updates to the blockchain and are in turn compensated with cryptocurrency for their role in maintaining the network. If a validator does not faithfully fulfill its validation responsibilities, the cryptocurrency that it put at “stake” to become a validator could be slashed, causing a direct financial loss to the validator (and an additional loss of future earnings from validation that they will not participate in).

What’s in a name?

What makes the Merge so remarkable is the fact that such a large, complex, and consequential upgrade is happening on a network with zero downtime. To pull off this feat, the Ethereum community will actually combine two blockchains (which is where the name the Merge comes from): the Ethereum Mainnet and the Beacon Chain.

In PoW systems, anyone with the right hardware and software can become a miner, or stop being one, whenever they please. Being selected to add a block to the blockchain is a function of randomness and computing power. PoS systems require more coordination for consensus because they need to keep track of validators’ stakes and manage the validator selection lotteries — coordination that can be managed with a separate blockchain.

In anticipation of the move to PoS, the Ethereum community first created the Beacon Chain to serve as the future PoS “consensus layer” for Ethereum. Since its genesis in December 2020, the Beacon Chain has existed as a standalone blockchain running in parallel to the Mainnet. It has been going through the motions of PoS, but it has not been securing any actual transactional information from the Ethereum Mainnet.

When the Mainnet reaches a predetermined point, it will automatically retire the PoW consensus mechanism and will begin using the Beacon Chain as its consensus layer for coordinating validator activity. The Mainnet will still exist as the Ethereum network’s execution layer, where transactions and any associated data are stored and updated/changed over time. Although they will be two separate blockchains, they will operate in concert as one.

Implications

The Merge has a number of implications for Ethereum and the broader crypto community.

The blockchain will become more energy efficient

PoS consensus changes Ethereum’s security model and relies on collateral to align validator incentives. As a result, the Ethereum Foundation estimates that Ethereum will use 99.5% less energy after the Merge.

The Merge may also have implications for crypto geopolitics, as there will be less of an economic incentive to locate miners in jurisdictions with low energy costs and cool ambient temperatures. High-income countries are likely to benefit from this change in dynamics, however, the ultimate impacts are difficult to forecast with precision. One potential downside is that it could lead to a decrease in investment in renewable energy.

In addition, analysts at Morgan Stanley have speculated that Ethereum’s move to PoS could blunt global demand for specialized computer chips used for PoW mining, known as graphics processing units (GPUs), which has further geopolitical implications related to manufacturing and industrial capacity.

It will be easier to make additional upgrades in the future aimed at further improving Ethereum’s scalability

Throughput and scalability concerns have plagued public blockchains since their introduction. As the Ethereum community grows and Ethereum projects experience broader adoption, blockspace will become increasingly important. Ethereum will need to implement scaling solutions in order to avoid network congestion and other knocks to efficiency.

The Merge will put Ethereum further along its long-term scaling plan and will enable future scalability solutions that depend on PoS (to be covered in future Paradigm Policy posts). One set of solutions involves segmenting the blockchain into smaller pieces, called shards, where subsets of nodes are responsible for only a piece of the blockchain’s activity, instead of making every node verify every transaction. Another set of solutions — known as “layer 2” solutions — involve moving some transaction computation off of the main Ethereum blockchain and onto separate blockchains that frequently sync back to the main blockchain for extra security.

The Ethereum development community has worked tirelessly over several years to reduce the transition risk of the Merge

For consumers holding ETH, there are no requirements to update software or hardware before the Merge. If you control an Ethereum account with ETH before the Merge, the ETH will remain in your account after the Merge. Confusion over this point has led to a number of successful phishing schemes that have tricked users into giving away their ETH.

There are, however, certain required software updates for users operating nodes. Operating a node involves running specialized software that communicates with the other nodes that maintain the blockchain. This software is typically referred to as a “client”. After the Merge, validators will need to run both an execution layer client AND a consensus layer client in order to access the network.

To mitigate the risk that faulty client software could disrupt the Merge, the Ethereum community has engaged in extensive testing and has undergone a sequential transition where client migration is phased in over time to mitigate the risk that a single error could derail the entire process.

Concluding thoughts

For policymakers, the Merge represents a novel proof of concept for a decentralized system. The Merge was the work of years by a broad community united not by corporate bonds or partisan political ends, but simply by the idea of a better system of operation. There was no CEO or Chairman of the Merge, or singular organization responsible for its success. Many doubted that such a project could be accomplished absent the structures of more traditional finance and government. Yet, the Merge has arrived.