A list of things you need to know about Ethereum mergers

Some time ago, Superphiz, a community consultant for the Ethereum beacon chain, predicted that the Ethereum merger will be completed in June 2022. In response, many optimistic and cautious supporters have expressed their support, and promotional materials related to the merger have been overwhelming, but the information is mixed, and few articles can clearly present the relevant knowledge.

Recently, Domotheus published an article titled "ethereum should know: Proof of Stake edition", which is concise and clarifies many issues of Ethereum merger and is widely circulated in social circles. The following content is a compilation of the article, compiled by Corn, the author of Ostrich Blockchain.

As the Ethereum merger approaches, there will definitely be more news and articles about it, which will bring more questions and discussions related to proof of stake, and repeated themes or the same misunderstandings will appear in many articles. I have seen this to a certain extent since the successful Kiln testnet merger was announced last week, and I expect to see more of the same, so this article is a collection of common questions I see and my views on the issues, of course, more about Ethereum .

merge

More information about the merger can be found at ethmerge.com, so it will not be covered in this section.

When the merger occurs, Ethereum will be secured by Proof of Stake (PoS) instead of Proof of Work (PoW).

The merger is not “ETH 2.0”, there is no ETH 2.0 at all, it is an outdated term.

If you currently hold ETH, you don’t need to do anything. You will still hold the same amount of ETH after the merger, there will be no “ETH 2 coins”, and you won’t need to migrate anything. Everything is exactly the same, only the underlying consensus mechanism has changed.

It is called a “merge” because it merges the beacon chain (consensus layer) with the current chain (execution layer) and abandons the PoW part of the execution layer.

“Consensus” is just a fancy word for ordering transactions and getting some economic guarantee that that order won’t change. Both PoW and PoS achieve consensus in different ways:

• PoW: It is too costly to disrupt the order of blocks, and it is more profitable to play by the rules.

• PoS: The cost of messing up the order of blocks is too high because if I mess up, I will lose all the money I staked as collateral.

Since it is just a change in the consensus mechanism, PoS itself will not significantly reduce gas fees.

Why merge?

1. Reduce security costs because less costs are required to reach consensus.

With PoW, you need miners to at least be able to cover all the hardware and energy they use, otherwise no one will mine. This requires issuing a large number of tokens and selling them quickly to pay off the debt.

With PoS, you just need to give stakers some yield to make people want to deposit their funds instead of just investing them somewhere else. There are no big bills to pay other than a regular computer and internet connection, so the yield only needs to reflect the opportunity cost and risk involved.

2. Strong sustainability:

The security of a blockchain is essentially proportional to the value of its token. This is true for both PoW (more valuable token rewards = more reasons to follow the rules = more miners = harder to disrupt consensus) and PoS (more valuable staked tokens = more reasons to follow the rules to avoid losing staked tokens).

The value of a newly issued token is essentially taken from all token holders and redistributed to others, and selling the token takes value from the network.

3. It opens the door to many future scaling solutions, such as data sharding, statelessness, light clients, etc.

4. It helps reduce some of the complexity of the code by separating concerns between execution and consensus.

5. Appeasing the environment and gamers is certainly a good role, but it is not the main reason for switching to PoS. The main reason is that Ethereum as a protocol does not have much control (the source of energy production, GPU supply chain, etc.).

When will the merger take place?

No official date has been announced yet. For various reasons, developers and the community are expecting mid-June and are cautiously optimistic.

Testing is still ongoing and the merge will not be released until the developers are completely confident that there won't be any issues.

I personally don't have high hopes for June, but I think it will be there in the summer, unless something goes terribly wrong during testing (e.g. a critical bug that will take weeks to fix, possible holes in the spec itself that will take months to fix and re-implement).

The difficulty bomb is due in June, so there will be a hard fork by then, merged or not.

I recommend keeping an eye on wenmerge.com, which is a quick way to see the latest estimates for each testnet merge.

Mergers may be delayed as they have been in the past

First some useless semantics: there is no official date announced yet, and there never has been one.

Statements like “Ethereum will move to PoS in 2018” come from an extremely optimistic view that underestimates not only the complexity of PoS design, but also the complexity of a secure transition from PoW to PoS. The work done at the time was to partially complete the specification of Casper FFG, a hybrid PoW-PoS mechanism that was eventually abandoned. But there are many differences today, some of which were not applicable at the time, but are applicable today:

After years of research, analysis of possible attack vectors and improvements, a complete protocol specification is available.

The client implementation is complete, and now all that's left is testing.

Everyone is preparing for the merge, and there is no other work to do except the merge. All the necessary steps before the merge are completed. It's not even a matter of "they've implemented something as complex as EIP1559, so now they can focus more on the merge", but "all attention must be focused on the merge". There can't be a situation where the merge is "delayed again" and developers start working on other things. So there is nothing else for developers to do until the merge is completed.

PoS has been running in the form of a beacon chain since December 2020. Ethereum’s PoS has been tested to some extent for a year, and more than 10 million ETH are now online, it just hasn’t generated blocks for the execution layer yet.

Millions of staked ETH will collapse the moment they are unlocked

To be sure, there will be many stakers who want to profit from this, especially those who locked up ETH when 32 ETH was worth $1. But on the other side of the equation, there is a lot to consider:

• The merge will not unlock any ETH. In the first hard fork after the merge, there will likely be a withdrawal after 6-8 months. These are months where no PoW (~13k ETH/day) is sold and no Proof of Equity is released into circulation.

• Just like there is a queue for depositing ETH, there is also a queue for withdrawals. Assuming a massive sell-off, everyone is in that queue, and the buyout rate is limited to 1,125 people per day, so there is no "opening the floodgates" moment. It would actually take more than a year for everyone to unstake. That's about 38,000 ETH/day re-entering circulation in a year (or... about 1% of average daily trading volume).

• After the merger, validators will also start to receive fee rewards, and the expected return will double. There are thousands of people waiting in line to stake now. They can earn 5% on their ETH, and I don't think they will be happy when it becomes 10%.

• By far the biggest risk involved with staking is consolidation, and despite this risk and the need for ETH to be locked up to an unknown floating date, many people have already staked and locked up their ETH for over a year. How many people/institutions are waiting for this risk to disappear before joining?

• Don’t forget, stakers exiting means fewer validators, which means higher rewards for those stakers who didn’t exit. It also means that others who weren’t staking before have more incentive to start staking…

• Of course it's crypto, crypto will be crypto. The merger will bring excitement and volatility, and maybe a lot of selling and a drop in prices, who knows. I don't pretend to know the future, but it seems more likely to me that more ETH will flow in than out.

If PoS is so good, why didn’t Ethereum do it in the first place?

PoW is easy to conceptualize and implement, while PoS is not. Especially in 2014, it was mainly a theoretical concept still being researched, with some blockchains implementing some version of it.

Before considering implementing PoS, there are several fundamental issues that need to be overcome from a research perspective.

PoS is not a panacea. Each PoS blockchain has its own PoS specification, with pros and cons in various areas, so it’s not as simple as “other blockchains do it, why can’t Ethereum do the same thing.”

The benefit of starting with PoW is that anyone can mine coins on their own without anyone’s permission, which helps with coin distribution. This is better than new chains that are PoS from the beginning and have to decide how to distribute the initial coins. Initial coins, which can’t really be done without permission.

Related to the above: yes, Ethereum still has a premine/presale, but after years of mining and multiple bull/bear cycles, ETH's supply has now been diluted to half, bringing it closer to Bitcoin. So in 2022, when Ethereum as an asset is extremely liquid and easy to acquire, this isn't really a big deal.

No, this is actually just a last ditch ploy to deceive miners after years of trying

PoS has been the ultimate goal since day one, and everyone who mines knows it will end one day. There is no pulling or unfairness here.

Economic factors trump any one miner’s loyalty to the blockchain. You can think of the blockchain as a business and the miners as employees:

• Miners/employees are already compensated for their services (i.e. secure consensus) via block rewards. Salaries are an expense to the employer, which comes from diluting the value of existing tokens held by holders (see “Why merge?” above)

• Miners go to the chain that offers the highest reward, and most of them would abandon Ethereum in an instant if another GPU mineable coin offered more rewards.

• Likewise, if stakers can provide services more cheaply, Ethereum will pay less for the services it needs.

This is not completely exclusive. Miners can also be holders of tokens and users of the blockchain. There is nothing stopping them from holding rewards and becoming stakers.

If you don’t expend real-world energy to mine the token, the token no longer has intrinsic value

I really don't buy into this argument. There's nothing magical about computing hashes over and over until you find one that satisfies arbitrary requirements. I mean, you could have a PoW blockchain where work is done by solving Sudoku puzzles, and it works exactly the same way: NP-complete problems that are hard to compute one way, but easy to verify once a solution is found. That doesn't mean that solving Sudoku itself adds value to the world. Making it harder to mine coins doesn't make everyone richer, it just makes mining coins less profitable - unless, of course, demand also goes up, which hasn't been a big deal in the cryptocurrency world so far.

In my opinion, the value of a token ultimately comes from supply and demand, and demand comes from the value of block space. People need ETH to buy block space, whether that ETH is generated by miners or stakers. Of course, the more miners there are, the more security/decentralization there is, which further increases the value proposition of block space in a positive feedback loop, but there are feedback loops in PoS Ethereum as well, and they are pretty cool too!

PoS is a recipe for complete centralization

PoS is basically the same as PoW, but with slight differences. "Better" or "worse" really depends on your perspective. In my opinion, PoW is really just PoS with an extra step.

Ethereum as a community places a high value on decentralization, and the research team will look for solutions to mitigate any potential centralization vectors, even if it comes at the expense of other important factors, such as scalability (for example, keeping the gas limit low so that more nodes can participate in decentralization, even if this leads to congestion and high fees).

There are some shortcomings at the moment, decentralization is a range and process, we are not there yet, and there are a lot of centralization crutches that need to be removed in the long term. That said, none of these crutches represent a risk to the network, and in fact, for any "it's centralized because of X" argument, there is a project on the roadmap that targets X. I personally think what should be done is to come up with a bunch of ways to solve X rather than giving up on it and saying "it can't be done because of X".

There is an interesting aspect of Ethereum’s PoS design that is often overlooked: quadratic penalties. A single validator that fails, messes up, or outright attacks the network is not penalized very badly. A thousand validators doing the same thing at the same time are penalized much worse.

This means that if you are a whale with thousands of validators, you are better off spreading them out, avoiding cloud hosting, using different clients, etc. Sure, capital is still centralized, but at least the points of failure are distributed, which is good for the health of the network as a whole.

In contrast, large mining operations rely on a central location to amortize costs, which can be detected from energy usage, and shut down if the authorities don't like it. It's difficult to move mining equipment around the world, but staking relies only on private/public keys, not any actual hardware outside of consumer-grade computers.

PoS actually means "rich people make more money"

Yes. Unfortunately, we live in a world with huge wealth inequality. Blockchain cannot solve this problem.

The same is true for PoW: whoever has the money can buy more mining machines and make more money. Except for mining, the ROI gets better with economies of scale: centralized mining has deep pockets to get bulk/discounted hardware and move operations to where electricity is cheap. Individual miners simply can’t really compete. With PoS, everyone gets the same benefits in proportion, and they can invest $10 or $10 million.

They may be centralized, but those large mining companies have no reason to attack the network and cripple it since they have invested millions of dollars in the infrastructure.

But is your deposit just passive interest? Printing money out of thin air?

You have to really stretch it to do this, but I have seen people do it. These usually start with "PoS is nothing new".

Validators are still doing “work”: creating blocks and validating other blocks. It’s just that the work done consists entirely of actual useful work required for the blockchain to reach consensus, rather than computing hashes over and over until one of them satisfies arbitrary requirements.

This isn’t really “money printed out of thin air”, there are still costs involved in staking capital, they’re just more abstract and less direct than an energy bill:

• Opportunity cost – Why take the risk of an equity investment if another investment could give you a better return?

• Lack of liquidity - From the moment you deposit your funds are locked up in a queue until your validator activates, and then when you withdraw your funds there is another queue before you can get them back.

• Inherent risks — This is still fairly new, things could go wrong, there could be serious vulnerabilities, the network could be attacked, your staking hardware could be compromised, etc.

• Volatility - at the end of the day it is still a volatile asset, and if you are the type of investor who invests in your national fiat currency, then an asset with a 5% yield can drop 30% overnight which is not really a big deal (however, doubling an asset by 5% is quite big, turning a 100% gain into 110%).

• Maintenance — You still need to maintain and secure your validator, ensure 100% uptime, update software, etc.

Here’s where it gets interesting: the more people stake, the lower the individual rewards. This basically means that all of these costs mentioned above will be priced in by the market itself. It’s easy to understand why: if the staking yield is too low, then the returns won’t justify the costs, and people will withdraw and invest elsewhere, driving the yield back up. Likewise, if the staking yield is too high, that will attract more money and pull it down.

In terms of inflation: Assume the entire market thinks 5% is a desirable rate of return, with 3% coming from issuance. This equates to printing 900,000 new ETH per year with about 30 million ETH staked. With a total supply of 120 million ETH, the inflation rate is 0.75%. As long as the gas fee is at least 23 gwei, it will be exceeded by the EIP1559 burn. (I can't stress this enough: Ether will soon become a yield-yielding deflationary asset)

ETH has never had a supply cap, and they are constantly changing their monetary policy.

• For years, the goal has been “minimum viable issuance to ensure network security,” prioritizing network security over arbitrary supply caps.

• None of the updates to monetary policy have increased supply inflation. Low inflation (and specifically disinflation) has been our goal since day one.

• Once the EIP1559 burn rate matches the issuance rate, there will be an equilibrium that serves as an effective supply cap - again determined by market forces valuing Ethereum blockspace. That’s pretty awesome, if you ask me.

So yes, there is no "central Ethereum bank" arbitrarily adjusting interest rates and printing money to its cronies. The market itself determines the level of inflation/deflation, and no single entity can control it the way a central bank controls fiat inflation rates.

Whales with enough funds to take over and change the rules, and cut off honest stakers?

No, for the sake of thought, Ethereum does not have any form of on-chain governance. Protocol updates are a community effort (layer 0), and you do not need to invest any money to propose improvements and participate in the process.

This is exactly the same as PoW: even if you have 99% of the hash power, you can't steal people's money without their private keys, or change the rules of the protocol. The 1% of honest nodes will reject any blocks that don't follow the rules, and you'll be mining on an invalid/useless chain. Now replace hashpower/mining with stake/stakes, and the same is true for PoS (the difference is that if someone is found to be reorganizing blocks, their entire stake will be destroyed, while blockchain cannot completely destroy mining equipment)

Simply put, there is a lot of ETH involved. It was around 10 million before the merger, and it is still increasing. At today's prices, it is about 30 billion US dollars. Both the "amount of staked ETH" and the "value of ETH" are expected to rise, so attacks are becoming increasingly unlikely.

32 ETH is too much, most people don’t have that much money

I agree that 32 ETH is a lot, but they don't seem very high on the priority list at the moment.

The reason the number is so high is that it has to fall into a technical sweet spot. In short, it has to be low enough to be accessible and have enough validators to secure the chain, but high enough so that there aren't too many validators and overhead bloating the chain. There is a fixed number for each validator so that the weight of the distributed randomness process that generates each block is exactly the same for each validator, which greatly reduces complexity.

From a technical perspective, the value of 32 ETH requires a lot of math, and at the time, 32 ETH was worth about $7,000. Early math from 2017 even suggested at least more than 1,000 ETH.

Thankfully, just like mining pools exist, there are staking pools that allow for small amounts of staking in smaller amounts. Since RocketPool, Secret Shared Validators (not yet launched), etc. use smart contracts to be permissionless, decentralized, and non-custodial, it doesn’t necessarily go against the “not your keys not your coins” mantra. And because of the quadratic penalties mentioned above, I believe decentralized staking operations will outperform centralized ones in the long run. I recommend superphiz’s staking guide for more information. Obviously, if you value decentralization, I agree that staking through exchanges is terrible.

Related to the above, something like Rocket Pool is better viewed as a higher-level abstraction over underlying staking, rather than “just a staking pool”.

PoS is not proven yet, but we know PoW works

Only time will tell, I just think this is irrelevant in the context of Ethereum's transition to PoS. If you don't believe in it, don't participate/invest in it. I personally do believe in the long-term sustainability of Ethereum PoS, but even so, I'm happy that Bitcoin will continue with PoW .

Regardless, this is all part of the crypto experiment. Either it will be a fad that fades into obscurity, which will surely be disappointing, or we will succeed in creating strong networks that outlast humans, and the key to achieving that is to prioritize decentralization.

I see in Bitcoin and Ethereum that prioritizing decentralization is key in order to achieve this goal. While the philosophies of the two are very different, I am excited to own both to truly see the value in the long term.