Ethereum 2.0 Merge Explained: Everything you need to know

Ethereum is a remarkable and visionary platform. It was the first ever decentralised global computer network capable of executing smart contracts, or code that runs trustlessly on the blockchain. Launched in 2015, Ethereum is now home to the largest ecosystem of decentralised financial applications and other projects in the blockchain space.

However, despite its capabilities, Ethereum has limitations that place it far behind the TradFi industry and prevent its widespread usage. As it stands, Ethereum cannot scale to compete with the conventional financial sector.

Ethereum Upgrades is a far-reaching series of improvements to the network designed to address the current shortcomings. These were originally called Ethereum 2.0, and while the Ethereum Foundation now discourages this term for various reasons, the crypto community still prefers it.

After many years of planning, the first phase of these updates is now imminent. This will see Ethereum move to a proof of stake (PoS) consensus model as it merges with the Beacon Chain, or Consensus Layer, which will in turn enable future upgrades. The Merge, as it is known, will bring a series of immediate benefits, including greater energy efficiency, security, and decentralisation.

Problems With Ethereum 1.0

Ethereum 1.0 (the current network) has a number of problems that started to come to light in 2017, when the number of transactions submitted to the blockchain increased dramatically.

Throughput. Ethereum can only support around 15 transactions per second (tps). Major TradFi networks like Visa can support up to 24,000 tps, and routinely process 2,000 tps.

Gas costs. Because more transactions are submitted to the network than miners can process, it’s a seller’s market: users have to compete with each other to pay to have their transactions added to the blockchain, driving up gas fees. A simple token transfer can cost $20-40 in gas during busy periods.

Delays in confirmations. Those who do not pay high fees to ensure their transactions are confirmed quickly are forced to wait, with their transactions ‘pending’, until network congestion is lower. This can take hours or even days at times of peak use.

Energy consumption. As a large proof-of-work (PoW) network, Ethereum uses a huge amount of energy – with an annual power consumption similar to that of Finland, and a carbon footprint around the same as Switzerland’s.

Security. While Ethereum is a decentralised network, the costs associated with mining mean that many miners join large pools, which can represent a significant proportion of global hashrate (mining power). As centralised entities, these pools may be shut down or exploited, compromising network security.

The Merge will not, in itself, increase network throughput, or reduce gas costs or delays. It will improve energy consumption and security, while paving the way for future upgrades that will increase scalability.

From Proof Of Work To Proof Of Stake

At present, Ethereum uses a proof of work (PoW) consensus model. Miners compete with each other to produce the next block and add it to the blockchain, with the winning miner being paid new ETH (block rewards) and transaction fees. Mining requires specialist hardware and a large amount of power, since it involves carrying out a ‘computationally-expensive’ process in which trillions of calculations are made.

Ethereum uses this model because when it was launched in 2015, there were no tried-and-tested alternatives. Bitcoin, which also uses PoW, had proven robust and secure for the previous six years. Proof-of-stake (PoS) was still relatively new, and there were concerns about whether it was safe. 

Today, research and the experience of new protocols have shown that PoS is not only secure, but may be more secure than PoW in many circumstances, as well as being extremely energy efficient, since it does not need any specialist hardware.

In December 2021 the Ethereum Foundation launched the Beacon Chain, the PoS blockchain that will serve as the ‘Consensus Layer’ for Ethereum 2.0. This is currently a separate network that runs alongside the PoW Ethereum 1.0, or ‘Execution Layer’. 

Very soon, these two networks will be merged, and Ethereum blocks will only be produced via the PoS Beacon Chain, ending Ethereum’s PoW era. Instead of competing with computational resources, Ethereum’s validators will be chosen at random, in proportion to the amount of ETH they have staked. This model has several major advantages.

Energy efficiency. PoS does not require specialised mining rigs. A simple hosted server is more than enough. This will reduce Ethereum’s power usage by around 99.95%.

Greater decentralisation. Mining rigs are expensive. With PoS, anyone can stake their ETH and be paid to help secure the network. The lower barrier to entry means a larger number of users will stake, making the network more robust.

Greater security. Any staker who tries to attack the network by confirming a fraudulent transaction will have their stake ‘slashed’, or may be removed from the network for a time. These economic penalties do not exist in the same way for PoW, and will incentivise greater honesty and reliability.

Potential for scalability. The move to PoS enables the Beacon Chain to coordinate consensus between more than one chain, or shard. Sharding, the next stage of Ethereum’s upgrades, will bring vastly increased capacity to the network.

What Happens To Ethereum 1.0 Tokens?

No changes to ETH or Ethereum tokens will occur as a result of the Merge. Holders will not need to take any action, and all dApps should continue to work as before without requiring any intervention by users or devs.

Warning: Any messages telling you to upgrade your account or wallet are scams.

Following the Merge, tokens will appear in users’ wallets just as before. ETH2 is not a new asset. Exchanges may pause deposits, withdrawals and trading around the Merge just in case there are any unforeseen problems. For example, Coinbase has stated:

‘During the Merge, Coinbase will briefly pause new Ethereum (ETH) and ERC-20 token deposits and withdrawals as a precautionary measure. Although the Merge is expected to be seamless from a user perspective, this downtime allows us to ensure that the transition has been successfully reflected by our systems. We do not expect any other networks or currencies to be impacted and expect no impact to trading for ETH and ERC-20 tokens across our centralized trading products.’

Other exchanges are also likely to take this approach.

One potential complication to the Merge is that miners (who will become obsolete) may choose to support the old PoW chain, forking the network and effectively creating two versions of Ethereum. Major projects such as USDC and USDT have stated that they will support the PoS network, but it’s likely that the PoW network token will be supported by some DeFi initiatives – much as occurred when Ethereum forked to create Ethereum Classic in 2016. 

If this happens, users will automatically receive an equal number of tokens on each chain. However, users who hold ETH on exchanges may or may not receive the additional token. This will depend on whether it is deemed to have value, and whether the exchanges decide to support it. If in doubt, users should withdraw their ETH before the Merge.

The ‘Triple Halving’

One of the most discussed aspects of the Merge is the effect it will have on Ethereum’s token economics. The Bitcoin ‘Halving’ (or ‘Halvening’) is a four-yearly event in which mining rewards are halved, decreasing the supply of new bitcoins. 

Ethereum’s Merge will see a ‘triple halving’, as three different mechanisms take effect. This is not exactly a halving in the same sense as Bitcoin’s halving. However, the changes to the network will likely make Ethereum deflationary, rather than merely less inflationary.

1. Block rewards. The biggest difference will occur when block rewards are reduced from their current total of around 12,500 ETH per day to 1,500 ETH per day. The move to PoS means that miners do not need to be compensated for their investment of hardware and power. Only around 1,500 new ETH per day will be generated.
2. Burning. Since the EIP-1559 upgrade in 2021, a percentage of every transaction fee has been burned. As a result, Ethereum has had a handful of deflationary days over the past year, and this will continue to balance the effect of any new supply.
3. Staking. Finally, staking will lock ETH up and prevent stakers from moving coins for six months after the Merge. This will have a medium-term effect on available supply. 

Overall, analysts have suggested that these will be bullish catalysts for ETH, enhancing its narrative as a store of value, like BTC. ETH will actually become deflationary, with steadily falling supply.

When Will The Merge Occur?

The first part of the Merge is expected to happen on (or around) 15 September. The closer the Merge gets, the more accurate the forecast date and time will be. 

https://wenmerge.com/ shows the estimated time left until the Difficulty Bomb and the launch of the Ethereum 2.0 mainnet. The Difficulty Bomb acts as a kind of self-destruct mechanism and will see mining become substantially harder and therefore less profitable, incentivising the shift to PoS.

Future Roadmap

The first phase of the Ethereum Upgrades will see the Merge and Ethereum running on a PoS network. 

Scalability updates will be implemented in Phase 2, which will see shard chains added to the network. The aim is to have 64 shards, which will process transactions in parallel, coordinated by the Beacon Chain. The current Ethereum 1.0 blockchain will be one of these 64. Sharding is currently expected to be launched sometime in 2023.