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Ethereum’s price climbed more than 10% over the last week and outpaced Bitcoin’s price rise, increasing its dominance in the crypto market. ETH prices in BTC terms have increased 41% since July 13.
This is because, in approximately a month, we could see Ethereum finally transition to Proof-of-Stake (PoS).
It’s an update that has been in development for the last couple of years and is one of the most anticipated events of 2022.
So, what could this update mean for Ethereum? Are there any risks hidden under the surface? And what does it all mean for the price of Eth?
If you are wondering about all these things, you have landed at the right place because that’s exactly what we will be discussing in this article today.
What is Ethereum?
Before we dive deep into Eth 2.0, let’s begin with an overview of the Ethereum blockchain.
However, if you are already up to date on it, feel free to skip to the next section.
Ethereum, in its current state, is a Proof-of-Work (PoW) blockchain that allows users to build their decentralized applications.
Specifically, it is a smart contract platform that supports the Solidity scripting language.
So, developers can use Ethereum to build applications using blockchain technology instead of having to build their cryptocurrency from scratch.
Over 200,000 digital tokens (half of the top 100 cryptocurrencies) have been created using the Ethereum blockchain so far, making it the largest ecosystem in the crypto world.
Originally, Ethereum was envisioned to become a global decentralized supercomputer that could execute anyone’s code (Solidity based) in return for a fee, called Gas.
Vitalik Butyrin, Ethereum’s founder, initially hoped Ethereum to become somewhat like a Google Play Store where anyone could upload their decentralized application for global use.
However, he couldn’t turn his vision into reality.
It was mainly due to the scalability issues in a manner that keeps the Ethereum network secured and decentralized, but less scalable.
Vitalik named it the blockchain trilemma.
The blockchain trilemma states that a cryptocurrency can either be:
- Scalable and decentralized, but not secure.
- Decentralized and secure, but not scalable.
- Or fast and secure, but not decentralized.
Problems with the Current Ethereum Network
Ethereum currently uses the Proof-of-Work Eth hash consensus mechanism to push blocks through the blockchain.
This means that Eth is similar to Bitcoin as miners have to devote raw power to validate transactions and secure the network.
This consensus model worked pretty well when the network was small and not as adopted as it is now.
Right now, nearly every other dApp is being run on the Ethereum network, which has bloated the network, slowing it down significantly and making the gas fee skyrocket.
So, Ethereum isn’t working out to be the global decentralized supercomputer Vitalik had hoped for.
Another problem with the Ethereum blockchain is its network complexity.
As there is a singular Ethereum network, all transactions performed using the blockchain have to be confirmed by all nodes within the network.
This wasn’t much of an issue when the network was small. However, as the network has grown globally, so has the number of nodes.
Right now, there are over 5000 Eth nodes around the world. Every one of these nodes has to store the blockchain data and agree on its state at any point in time. It makes the Ethereum blockchain less efficient.
What is Ethereum 2.0?
First and foremost, let’s address the elephant in the room.
To those who have been following the Ethereum 2.0 roadmap as close as we have, you won’t be surprised to learn that the term Eth 2.0 has been deprecated.
The Ethereum Foundation thought it best to retire the original name for the update as many people speculated that there would be two different versions of Ethereum.
According to a blog post published by the Ethereum Foundation, “One major problem with the Eth2 branding is that it creates a broken mental model for new users of Ethereum. They intuitively think that Eth1 comes first and Eth2 comes after. Or that Eth1 ceases to exist once Eth2 exists.”
“Neither of these is true. By removing Eth2 terminology, we save all future users from navigating this confusing mental model,” the blog post added.
They deemed it best to name Eth1 as the execution layer (the Mainnet) and Eth2.0 as the consensus layer (the Beacon Chain), with both of them merging to form Ethereum.
Another problem that this terminology created was people thought that with the upgrade they would see Ethereum 2.0 right off the bat.
In reality, the Ethereum upgrade is planned to be a multi-stage process with different steps.
The first upgrade of this multi-stage process is “The Merge” followed by the next step called “Sharding”.
Ethereum 1.0 vs Ethereum 2.0 — What’s the Difference?
Since April 2022, Ethereum has been running on two parallel blockchains.
The first blockchain runs on PoW, while the other runs via PoS.
“The Merge”, which is only about a month away will unify the legacy Ethereum Mainnet Blockchain (ETH1) and the new Beacon Chain (ETH2) into a single blockchain.
The hope with this upgrade and Ethereum’s shift to PoS is that consensus can be achieved more quickly.
Let us explain that in simpler terms.
Imagine Ethereum as a car that is good for intracity travel but is not suited for intercity travel. So, the engineers (Ethereum developers in this case), built a new engine specially designed for it so that the car could overcome its limitations. They just have to merge the new and better engine into the existing car and it is good to go.
The third and final test for the Ethereum upgrade called the Goerli Testnet took place on the 10th of August at around 9:45 EST.
This Testnet stimulated an identical process that is going to take place during September on the Mainnet. The Testnet will allow the developers to check for bugs and security holes to determine the success of the merge before it is officially rolled out.
If everything goes well, the merge to Mainnet will come sooner than expected.
What Will Be the Impact of The Merge on Ethereum?
It would shift Ethereum from a PoW network to a PoS network.
This update could fundamentally change the Ethereum blockchain for the better.
However, people have lots of misconceptions about how the Merge will impact Ethereum.
We’ll try to be as less of a killjoy as possible, but Vitalik himself has addressed some of these rumors.
The truth is that the Merge isn’t going to have a significant impact on Ethereum’s scalability and gas fees issues.
Let’s dig deeper into it.
There are three layers on the Ethereum blockchain:
- The Execution Layer
- The Consensus Layer
- The Data Availability Layer
The Merge is an update to the consensus layer as it will be shifted from PoW to PoS. However, the execution layer is going to remain unchanged, which is responsible for the gas.
It’s mainly due to the blockchain trilemma. An improvement in Ethereum’s scalability would mean reducing block time, which would result in reduced security and decentralization.
So, Ethereum’s shift to PoS won’t reduce the gas fee or improve its scalability.
However, as we mentioned before, the Merge is only the first update in a series of multi-stage processes.
The improvement to gas fee and scalability will come later with Sharding and other updates.
Still, that doesn’t mean that the upcoming update isn’t significant.
While it won’t affect Eth’s gas fee or help with scaling, one of the primary advantages it provides is the reduction in energy consumption.
As iterated by the Ethereum organization, the merge will reduce Ethereum’s energy consumption by ~99.95%.
Now, it may not sound like a big deal for retail investors but being eco-friendly is pretty huge to attract institutional volume.
Moreover, the biggest reason to look forward to the Merge is that Ethereum would become deflationary.
After the merge, the amount of Eth being issued will be dropped to around 90%.
It means an inflation rate of 4.3% pre-merge to 0.43% post-merge.
To take things into perspective, the current Bitcoin inflation rate is about 1.7%.
So, Ethereum is going to become a scarce asset just like Bitcoin, which is going to increase its demand. If you are a long-term Ethereum holder, it’s good news for you.
Another reason why the Merge is going to be a huge win for Ethereum is due to the introduction of staking rewards. Institutional investors will more likely load up on Eth and earn those sweet staking rewards in return.
Will the Merge Affect Ethereum’s Price?
The short answer to this question is yes. As we have discussed above, the merge is going to kickstart a significant change to how the Ethereum blockchain works. Let’s discuss some bullish and bearish scenarios for Ethereum post-merge.
Bullish Case
Any Eth that is staked on the network post-merge will be locked up for some time. It means that people who have staked their coins won’t be able to sell them and it will remove those coins from circulation. It would have a positive impact on its token’s price as limited supply and more demand mean a price increase.
Moreover, as Ethereum is going to shift to a PoS consensus system, it is going to attract lots of investors simply because PoS will make Eth less energy-intensive to mine.
Bearish Case
There is a possibility worth keeping into account that the merge might simply fail. While it’s not as likely as the Testnets are going pretty well, there is always a chance that something unforeseen may happen when deploying the upgrade on the Mainnet. If it were to happen, it would cause Eth’s price to crash.
Moreover, there is also a general misconception that the merge would help the Ethereum network scale. The scaling update with faster transactions and lower fees is going to come later with the Sharding upgrade.
So, using the Ethereum network is going to result in the same problems it did before (high gas fees and low speed). It is going to give another layer1 smart contract blockchains like Avalanche, Solana, Near, and Cardano an argument to lure frustrated Ethereum users to their network.
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