Ethereum, the second-largest blockchain by market cap, is about to undergo a massive transformation known to the crypto community as “the Merge.”
It’s a long-awaited systemwide upgrade that experts say will reduce the blockchain’s energy consumption by about 99% by switching its transaction verification system away from “proof-of-work,” which relies on crypto “miners” using massive amounts of computing power to validate transactions.
After the Merge, Ethereum will use a “proof-of-stake” system that instead uses an algorithmic lottery to determine who gets to validate transactions (and win tokens as a reward for doing so) out of a pool of “stakers” who temporarily deposit their coins to help secure the network.
Crypto’s environmental impact has long been a point regulators and the public count against it — a single Ethereum transaction, for example, consumes about as much energy as an average U.S. household does during a full workweek, Fortune reported last year. That’s part of why Vitalik Buterin, Ethereum’s most visible founder, has been laying the groundwork for the Merge since as early as 2014.
The upgrade was meant to take place in 2016 but kept getting pushed back by the Ethereum Foundation, the nonprofit that helps maintain the Ethereum blockchain. It seemed like it would finally occur earlier this summer and then was pushed back yet again.
It appears the Merge is finally going to happen on September 15, now that testing has been completed. But despite the longstanding discourse about it, there are still plenty of misconceptions floating around regarding what will actually happen during the Merge.
“It’s always compared to changing the engine on an airplane midflight without the plane crashing,” Freddy Zwanzger, Ethereum ecosystem lead at crypto infrastructure firm Blockdaemon, told TechCrunch in an interview. “Really, everybody on the plane, including layer-twos, or any dApp, should not notice any difference, and everything should continue to function as it is.” (Layer-twos are separate blockchains built on top of an underlying chain such as Ethereum meant to improve efficiency — Polygon and Optimism are two popular Ethereum-based layer-twos. Decentralized apps, or dApps, are user-facing products built on top of the blockchain).
Zwanzger said he isn’t concerned about implementation going wrong because of how extensively the Merge has been tested and how much developers on the network have prepared for the event. If everything goes according to plan, Zwanzger believes the upgrade will be good for the network not only because it mitigates Ethereum’s environmental footprint but also because it would increase decentralization in the system (that second part is a topic for another time, though, as it’s a hotly debated point even among experts in the crypto community).
TechCrunch got Zwanzger’s thoughts on some major areas he feels are widely misunderstood about the Merge. One source of confusion comes from the timeline of the upgrade and how it will affect current stakers’ ability to access the rewards they’ve already accrued.
A rewarding merge
As I alluded to above when mentioning testing, the Merge isn’t a discrete event. It will take place over a series of phases, officially kicking off around September 15. In early 2023, once the Merge itself has been deployed, a second phase is to kick in, known as the Shanghai Upgrade.
It is only after the Shanghai Upgrade that stakers will be able to withdraw protocol rewards they have earned for staking their coins. Any newly issued ETH will remain locked up in the network, illiquid, until then.
“One of the big misconceptions about the merger is that it will allow the withdrawal of the collateral or the rewards that have accumulated so far [right away], and that is not the case,” Zwanzger said.
There are three types of rewards that stakers will earn after the Merge. The first two already exist under the proof-of-work system and will still exist under proof-of-stake. One type is transaction-fee rewards — validators receive about 30% of fees charged to transact on the network, according to Cointelegraph.
The second type is maximal extractable value (MEV) rewards, which refer to the profit a validator can make by using their discretionary power to determine the specific sequence of transactions within a given block because they get to see it early. MEV rewards are essentially profits from arbitrage opportunities, and validators will continue to be able to earn them by running complex algorithms to detect these opportunities on the network.
The third type of reward is the protocol reward. This is new under proof-of-stake, and it refers to the tokens the network pays out to reward stakers in exchange for them pledging their coins to secure the network. Staking has been possible on the Ethereum network since December 2020, although this activity has been siloed on a separate chain prior to the Merge.
Yields go up based on the amount each depositor stakes, and prior to the Merge, the maximum annual reward yield has been around 18% (not counting fees taken by staking platforms such as Ledger and Coinbase). Essentially, the bigger stake someone has in the system by depositing more coins, the more rewards they’re entitled to — sort of like how smaller equity holders get diluted in a fresh venture funding round.
Under proof-of-stake, Zwanzger expects protocol reward yields to stay constant but said current models show overall rewards may double, mostly driven by a higher amount of MEV reward opportunities.
While protocol rewards won’t be accessible until the post-Shanghai Upgrade, the transaction fees and MEV rewards will be liquid directly after the Merge, he added.
What about transaction costs?
Another misconception surrounding the Merge is that “gas fees,” or transaction fees on the network, will go down. Zwanzger said this is not the case because gas fees are determined by supply and demand for capacity on the network. There’s no reason the Merge would change the network capacity in the short term, he explained, and even if there is short-term demand volatility, it should eventually settle.
In the long term, though, Zwanzger said the Merge may set the groundwork for the network to achieve greater scalability, which has long been a challenge for Ethereum as evidenced by events like the Otherside virtual land sale that clogged up the network temporarily because of its popularity. The Merge is also expected to enable sharding, a scalability solution that has to do with the way the proof-of-stake validator sets are constructed, Zwanzger explained.
“[The Merge] doesn’t have any immediate effect [on network capacity] right now, but it will enable certain scalability things later down the road,” he said.
The long-term effects of the Merge are still largely unknown; at this point, they are more possibilities than certainties. But for now, investors are betting that the pilots of the Ethereum ecosystem will be able to successfully change out the engines midflight and that the Merge will ultimately benefit the network, partly because of the new solutions it could enable and partly because a successful Merge would quell one of the main criticisms regulators level against cryptocurrency as a whole — its carbon footprint.
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