September 15, 2022

The Ethereum Merge: What It Is and Why It Is Important

Holland & Knight IP/Decode Blog
Daniel J. Barsky
IP/Decode Blog

There is a lot of buzz around "The Merge" for the Ethereum blockchain, and it is finally here. But what is The Merge, and why is it important? The Ethereum Foundation describes it as "the most significant upgrade in the history of Ethereum." This is hardly hyperbole. This much-discussed and widely publicized event, which is happening sometime this week (most likely sometime on Sept. 15), represents a fundamental shift in the way the Ethereum blockchain works and is one of the most significant events in the history of blockchain technology. This post will address what The Merge is, why it is so important and what will likely happen next.

What Is The Merge?

The Merge is the merger of two blockchain systems: the current Ethereum Mainnet and the Beacon Chain proof-of-stake system. This merger will convert the Ethereum blockchain from a proof-of-work system to a proof-of-stake system. To fully understand The Merge and its consequences, we should break down both types of blockchains and what it means for one to use either "proof-of-work" or "proof-of-stake.".

A. Blockchain Basics and the Problem of Determining the Authoritative Copy

A blockchain is a distributed ledger, meaning the list (or ledger) of transactions on the chain is spread across (or distributed) a number of computers (known as nodes) on the network. Transactions on the ledger are bundled into "blocks," which are then linked together, block to block, to form a chain. We discussed how blockchains link blocks together, and how to build one, in a previous post.

Distribution of the ledger is one of the key security features of a blockchain – no single node can permanently alter the ledger because there are multiple copies of the ledger. The nodes decide which transactions are logged to the ledger, as well as the order of those transactions. Because the ledger is distributed across a number of nodes, losing a node (or even multiple nodes), whether by accident (such as a power outage) or by design (by a threat actor attacking the system), does not compromise the entire network, because the remaining nodes can continue running the network with no loss or corruption of data.

Distributing the ledger, however, gives rise to problems. First, as the volume of transactions on the blockchain increases, it is possible that authentic transactions are logged by different nodes at slightly different times and in slightly different orders. This would create discrepancies in the ledger. Second, if a threat actor attacks one of the nodes, then there needs to be a mechanism to identify, and eliminate or correct, the false copy of the ledger. These two problems can be restated as a simple question: Which copy of the ledger is the authoritative copy? While the question is simple, the answer is decidedly less so.

Blockchains attempt to solve these problems by using a "consensus mechanism." There are 10 general consensus mechanisms used by various blockchains; and the two most popular – proof-of-work and proof-of-stake – are at issue in The Merge. Let's take a more detailed look at each.

B. Proof-of-Work

A proof-of-work consensus is one consensus mechanism used in blockchain technology, and it has been used to power Bitcoin since its launch. Proof-of-work is essentially a race between computers (the nodes) to be the first to solve a mathematical puzzle. The puzzle can be solved only through brute force computation; there is no knowledge or technique that can be used to increase the odds of any one computer winning the race by being the first to solve the puzzle.

When there are enough new transactions on the chain to form a new block, the nodes race against each other to solve a new proof-of-work puzzle. The node that wins the race receives a reward and is declared the authoritative block (think of this as the "official" copy of the ledger), while the other nodes then work to verify the winning node's work. For its trouble, the winning node receives a reward, usually a crypto token or two. The other nodes copy the "winning" node's block, then the process repeats to "mine" a new block in the chain.

C. Proof-of-Stake

A proof-of-stake consensus mechanism does not rely on brute force computing of complex mathematical problems. Instead, node operators, known as "validators," "stake" their cryptocurrency, in this case, Ether. Ethereum requires each validator to deposit 32ETH (worth approximately $51,064 as of Sept. 14, 2022) into a deposit contract. The staked cryptocurrency is permanently committed for an extended period of time and is not accessible by the owner of the validator. (Currently, there is no way to withdraw staked Ether. That functionality will not be enabled until the "Shanghai" upgrade, which is not expected to occur until the first quarter of 2023.)

Instead of waiting on blocks to be ready for processing, a proof-of-stake system processes blocks in regular time intervals; on the Ethereum blockchain, these intervals are named "slots" (which occur every 12 seconds) and "epochs" (which are 32 slots, or every 6 minutes and 24 seconds). For each slot, a validator is selected at random and is responsible for creating the new block while a committee of validators is randomly chosen to verify the work of the validator creating the new block. The randomly selected validators receive a reward of Ether for their efforts. Presently, validators average a 4.01 percent reward on their staked Ether.

Why Is It Called "The Merge?"

Years ago, the Ethereum community decided it was desirable to change from a proof-of-work to a proof-of-stake consensus mechanism. After working through a number of proposals and technical issues, on Dec. 1, 2020, the Ethereum community launched the "Beacon Chain," a testing ground for proof-of-stake consensus that runs alongside, and in conjunction with, the main Ethereum chain. There are more than 400,000 validators on the Beacon Chain who have collectively staked over $23 billion in Ether. During the week of Sept. 12, 2022, the Beacon Chain will be merged into the Ethereum main chain and proof-of-stake will take over. Proof-of-work will disappear from the Ethereum main chain.

Why Is The Merge Important?

There are substantial differences between proof-of-work and proof-of-stake consensus mechanisms. These differences will have a number of impacts on the Ethereum blockchain – some immediate and some more long-term.

A. Power Consumption

The most immediate result is the drastic reduction in power consumption by the Ethereum blockchain. The proof-of-work mechanism relies upon brute force computing, meaning there is no shortcut to solving the mathematical puzzle. If a proof-of-work miner desires to increase their chances of solving the puzzle first, and thus increase their chances of receiving the reward associated therewith, their only recourse is to employ more computing power. More computing power requires more power consumption.

How much power does the Ethereum blockchain consume? According to one estimate, approximately the same amount as the Netherlands. The Merge is expected to result in a 99.9 percent reduction in the amount of power needed to operate the Ethereum blockchain, from approximately 112 terawatt hours per year to approximately 0.04 terawatt hours per year.

There are two obvious benefits to the reduced power consumption. First, the Ethereum blockchain will become drastically more environmentally friendly. Second, a substantial cost associated with operating the blockchain (paying for electricity) will be mostly eliminated.

A third benefit of reduced power consumption will be increased access to participating in the blockchain. Some jurisdictions, such as New York, have proposed laws that will ban proof-of-work consensus mechanisms unless they are run entirely by renewable power. Thus, the change to proof-of-stake will allow individuals in jurisdictions that ban proof-of-work consensus to continue operating nodes on the blockchain.

B. Access

There are other ways the change to proof-of-stake is expected to increase access for users to participate in the Ethereum blockchain. This may seem counterintuitive given the requirement of staking 32ETH to run a validator. That staking cost, however, is not dramatic when compared to the costs associated with proof-of-work mining. Proof-of-work mining requires complicated computer hardware, such as mining rigs running multiple, customized graphical processing units, specialized cooling, and complicated multiple-rig linking. To run these machines, a user must find a location with sufficient electrical connections to power the machines. In contrast, the Ethereum proof-of-stake system can be run on most modern laptops that can be purchased for less than $1,000, do not require specialized cooling and can operate using standard home power. Additionally, the power consumption of proof-of-work tends to push miners to locations where power is cheaper, such as locations with state-subsidized electricity.

Beyond the monetary costs of operation, the technical skills and knowledge barriers to entry are substantially lower in a proof-of-stake system. Proof-of-work mining requires the operation of multiple, complicated pieces of software. Meanwhile, the Ethereum proof-of-stake system requires only three programs that involve minimal technical ability to operate. Overall, a proof-of-stake consensus mechanism is more accessible to the average person than a proof-of-work system.

C. Reduced Centralization

The combination of reduced power consumption and increased access will have another effect: reduced centralization. Proof-of-work blockchains tend to have higher centralization because proof-of-work miners pool their computational resources together in consortiums to increase their chances of winning the computational contest and receiving the associated reward. If the consortium wins the race, the reward is distributed across the members of the consortium.

D. Security

The foregoing factors are expected to combine to create increased security of the Ethereum blockchain. A key security feature of blockchain technology is the distribution of the ledger across multiple nodes. Increased access and reduced centralization lead to more users, which in turn increase the number of nodes on the blockchain. A greater number of nodes makes it harder for a threat actor to co-opt more than 50 percent of the network, the minimum necessary to process fraudulent transactions on a blockchain. It is estimated that the cost for a threat actor to effectively take over the Ethereum blockchain will increase from approximately $5 billion to 10 billion, to $20 billion, an increase of at least 100 percent.

What Happens Next?

The Merge is only one step in a series of planned upgrades to the Ethereum blockchain. The next upgrade is the Shanghai upgrade. After Shanghai, Ethereum expects to go through the "surge," then "verge," followed by the "purge." The surge refers to the implementation of a technology known as "sharding," which is expected to increase Ethereum's maximum transaction processing rate from 15 to 20 transactions per second today to approximately 100,000 transactions per second. Next, the verge is the proposed implementation of a mathematical proof known as "Verkle trees," which will permit nodes on the blockchain to operate without downloading the entire history of the chain. Finally, the purge will result in the deletion of legacy data on the chain. Combined, these three upgrades will result in a smaller, easier to use and substantially faster blockchain.

The Merge represents a fundamental shift in the operation of the Ethereum blockchain and is the largest change in the underlying operation of a blockchain in history. There will likely be wide-ranging, and unexpected, consequences of The Merge, which we will cover in future posts.

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