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The Merge: Ethereum’s Road to Being a Killer App

Most people that have at least some exposure to the crypto ecosystem know that something is happening with Ethereum. That something is called the Merge, and it will fundamentally shift the way this blockchain and network operates.

Today, a participant in the Ethereum network that processes, validates, and confirms transactions is called a miner. As users send and receive funds, miners compete to guess the answer to a hard math problem generated by the system. These guesses are generated by computer hardware in a very energy intensive process called mining. A miner that guesses correctly can then add those transactions to a block, similarly to how a banker would write transactions on a page in his ledger. That block is then broadcast to other miners in the network. If the other miners agree that the guess is correct and that the transactions are valid (e.g. no double spending), that block is added to the chain and the block’s creator receives its transaction fees and a reward as incentive. And thus, another page in the ledger is turned.

The process (or consensus mechanism) described above is called proof-of-work. There are numerous reasons that the Ethereum network is migrating away from this mechanism. Before diving into these reasons, it’s important to first understand how the network is changing.

Where we are headed

The Merge is an event that will move Ethereum from proof-of-work to proof-of-stake. In this new mechanism, the network is made up of validators instead of miners. In order to become a validator, one must deposit (stake) 32 ether (ETH) to the network (more on this later). Instead of having to solve a math problem, a validator is chosen at random by the system to propose a block. Other validators then check to make sure the transactions in that proposed block are valid, and if so, they can give it their stamp of approval (called an attestation).

This process is done using a two-layer system. The execution layer is where validators pull transactions from in order to create a block. The consensus layer is where the network agrees (attests to) whether that block is valid or not.

Ethereum’s consensus layer, known as the Beacon Chain, is what underwent the Bellatrix update. It launched in December 2020 and has since been running in parallel with Ethereum’s proof-of-work chain, the execution layer. During the Merge both layers are merged into a proof-of-stake Ethereum. This will occur once the sum of the mining difficulty for all Ethereum blocks reaches 58750000000000000000000. This number is known as the total terminal difficulty (TTD) and it’s expected on the night of September 14th. Once the TTD is reached, both layers will merge, the proof of work chain will halt, and the next block proposed will be proof-of-stake.

The proposed block from the execution layer will reside inside a slot in the consensus layer. The consensus layer acts as a sort of wrapper for the execution layer, containing its block, as well as other data such as slot number, epoch number, and attestations.

To become a validator, one must deposit 32 ether into the Ethereum staking contract, which will enable the ability to sign attestations (publicly saying that a block is valid) and be eligible to propose a block. To do this, the prospective validator must be running a validator client, a consensus client, and an execution client. The validator is also known as a staker because they have 32 ether (ETH) at “stake”. This 32 ether is at “stake” because it can be destroyed in a process called slashing if a validator acts maliciously. Validators are thus incentivized to act in the community’s best interest while working to collect transaction fees and block rewards.

Now that we have an high-level understanding of what the Merge is, let’s dive in to why it matters.

Why are we going?

The road to the Merge has been a long one. As early as 2015, Ethereum developers, namely co-founder Viktalik Buterin, were socializing plans to migrate Ethereum to proof-of-stake. While there are certainly numerous underlying technical benefits to proof-of-stake, the overarching impact can be summarized as: energy, security, and speed.

Mining equipment, typically Graphics Processing Units (GPUs) or Application Specific Integrated Circuits (ASICs), consumes a significant amount of energy. It is estimated that the Bitcoin network consumes nearly 128 TWh of energy annually and the Ethereum network 83 TWh. This level of energy consumption is comparable to that of the entire country of Spain (which used 233 TWh in 2020). As mentioned above, proof-of-stake does not require mining equipment; a validator can be run on a common laptop. As such, the post-Merge Ethereum architecture allows it to consume approximately 99.95% less energy, which is, “not on the scale of countries, provinces, or even cities, but that of a small town”.

With the exit of mining comes another benefit, security. The cost of running a profitable mining operation is largely prohibitive to the average would-be participant. This high cost of entry promotes centralization which poses a threat to the network in the form of a 51% attack. This threat is lessened by Ethereum’s migration to proof-of-stake. This new model lowers the cost of entry for participation, allowing more participants to join the network which inherently decreases centralization risks (smaller attack surface area). Additionally, the cost of a 51% attack on proof-of-stake is exponentially higher because of slashing, where the community “could decide to forcibly remove the attacker from the network and destroy their staked ether”. Other attacks that Ethereum’s new architecture either neutralizes or mitigates include long-range attacks, short range ‘reorgs’, bouncing & balancing attacks, and avalanche attacks.

On the day of the Merge, the ecosystem immediately benefits from this newfound energy efficiency, security, and decentralization. In the months following the Merge, the Ethereum team will be focused on an upgrade known as sharding, which will vastly improve Ethereum’s speed. Today, Ethereum can process roughly 13 transactions per second (TPS). This is rather slow, but is mitigated through the use of layer 2 blockchains known as roll-ups. A roll-up, like Arbitrum or Optimism, is a chain that helps Ethereum to scale by “rolling-up” transactions in bulk before bringing them to Ethereum for execution. Ideally, “if everyone moves to [transacting on] rollups, we will soon have ~3000 TPS”. Sharding will push this even further, to an estimated 100,000 TPS. This helps to drive down the cost of using the network and may even get transaction fees (gas costs) as low as $0.05. Although the Merge will not directly lower fees, it unlocks the ability to do so with sharding, which is expected to commence in 2023.

CipherTrace has upgraded its infrastructure and will be supporting the Merge on day one to help keep customers safe. Our Inspector and Sentry solutions will support the proof-of-stake Ethereum chain (ETH), with historical information intact and no user impact. Although some miners have signaled that they will continue to mine proof-of-work Ethereum (tentatively called ETHW), CipherTrace believes the proof-of-stake chain will be the dominant one and has focused efforts accordingly. We will monitor traction of the proof-of-work fork after the Merge and react to Market needs accordingly.

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