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Ethereum's life as a proof-of-work blockchain ended with block number 15537393 on September 15th. In true crypto fashion, a collector spent $50,000 (at the time) to memorialize the event with a non-fungible token. Since then, the Ethereum network has been successfully running under proof-of-stake and this long-awaited merge marks a huge turning point for the Ethereum network.
In the short-term, Ethereum miners have sold off their holdings en masse, leading to a 20-percent-plus drop in ETH price. More concerning, though, is the concentration of staking power in the hands of a few major providers. Lido, for example, controls around a third of the Ethereum staking landscape, and with their expansion to Optimism and Arbitrum, that number is only expected to grow.
This lack of diversification presents a risk to the Ethereum network if Lido were to act maliciously or get hacked. With $20 billion worth of ETH staked under Beacon Chain, a lot is at risk. The Merge, however, has also brought many benefits.
Benefits of the Merge
The first proof-of-work blockchain, Bitcoin, was long criticized for its high energy consumption and the mining equipment required to validate the network. Ethereum too has been dogged by these issues. The move to proof-of-stake, then, is a major boon for the network as it requires much less energy to run and anyone can participate in validating the network. The move also reduces ETH issuance and removes miner sell pressure.
This is because staking doesn't rely on energy-intensive mining hardware. While mining involves competing to solve a cryptographic puzzle, staking simply requires locking up one's ETH in a validator node, and pledging it as collateral in exchange for a modest ROI. As a result, Ethereum's energy consumption is set to drop by well over 99.9%. This is good news for the environment and for those worried about Ethereum's carbon footprint.
Finally, this move to PoS could one day, in theory, lead to an increase in decentralization and network security. So far, this has not been the case as major staking providers control the majority of the hashrate, but if staking becomes more widespread, this could change.
Ethereum's proof-of-work energy consumption was estimated to be around 112 TWh/year, similar to that of the entire country of the Netherlands. Post-merge, we’ve seen that number drop to ~0.01 TWh/year, which is around 26X smaller than that of PayPal. Pointedly, one estimate pegs Ethereum's emissions at 45 times less than that of Gangnam Style's YouTube views in 2019.
This move won't directly make transactions faster, but it does lay the groundwork for major scalability improvements down the road. In particular, it paves the way for sharding, which promises transaction speeds of ~100,000 TPS.
In this process, the network is split into multiple sub-networks, or shards. Each shard processes a small subset of transactions in parallel. In the future, this should lead to a significant speed-up in transaction processing times.
Economic implications
Moreover, the move to proof-of-stake will also have major economic implications. First, there will be no more miner selling pressure. In a proof-of-work system, miners need to sell their ETH in order to pay for equipment and energy costs. This selling pressure has been a major driver of Ethereum's price over the years.
We've seen this effect magnified recently, as the price of ETH has dropped over 20% since the Beacon Chain launch. This selling pressure will diminish over time, as those miners simply have less ETH to sell. Under proof-of-stake, validators will be incentivized to hold their ETH, and selling pressure may be replaced by buying pressure as stakers seek to increase their stake.
Second, there's also the potential for Ethereum's supply to become deflationary thanks to EIP-1559. This upgrade burns a small portion of each transaction fee, effectively reducing the total supply over time.
In addition, ETH validators must hold their ETH in order to participate in staking. This, combined with the fact that validators are slashed (i.e. have some of their ETH taken away) if they act maliciously, provides a strong disincentive for validators to sell their ETH. On the flipside, non-malicious validators have an obvious incentive to hold their ETH as long as possible, if not indefinitely: Earning interest. There's a strong reason to HODL when staking.
Finally, the move to proof-of-stake will also have major implications for decentralized finance. In particular, it will make it easier for users to earn interest on their ETH holdings. In a proof-of-work system, users need to put their ETH in a mining pool in order to earn rewards on it. This process is complicated, and often requires users to give up some control over their ETH.
In a proof-of-stake system, users can simply stake their ETH in a validator node and earn rewards. Further, liquid staking lets users maintain control of their ETH through staking derivatives. As a result, we're likely to see a surge in the use of ETH as collateral in DeFi protocols.
Changes to the Ethereum landscape post-merge
In today's post-merge environment, staked ETH is still locked up on the Beacon Chain. This has been the case since December 1st, 2020, when the Beacon Chain went live. At present, there's over $19 billion worth of ETH locked up on the Beacon Chain.
When withdrawals are enabled, though, stakers will be free to move their funds around as they wish. It's still unclear when this will happen, but it's likely to be 6-9 months after the merge.
Some analysts are worried this will lead to a "run on the banks" style event. Lido, for example, currently holds 31% of all staked Ether.
Other analysts argue that the move will simply lead to a "great reshuffling" of the Ethereum landscape. As stake becomes available to withdraw, it will be interesting to see where people who hold funds with staking as a service providers decide to move their money. The staking industry should see more competition being created as user funds will no longer be locked. Newer protocols like Geode Finance, which offer a turnkey liquid staking infrastructure to DAOs, should benefit from this as more companies desire to offer staking to their users resulting in staking yields becoming more prevalent and easier to access.
In a fully functioning proof-of-stake Ethereum ecosystem, liquid staking infrastructure will thrive. This would provide a major boost to the still nascent DeFi industry. ETH staking yields would become a base, expected yield for DeFi participants, providing strong revenue to DAOs who adopt some form of staking infrastructure, as they charge staking as a service fees for access to staking yields.
DAOs that integrate with and become early adopters of staking infrastructures like those Geode Finance provides will reap the rewards of this growing industry. As a result, they’ll be able to offer their members increased investment yields, while also building a reliable revenue stream for themselves.
Ultimately, Ethereum bulls have waited years for the move to proof-of-stake. The merge is a major turning point for the network, and it's one that comes with many benefits. In the short-term, there may be some volatility as users adjust to the new landscape. In the long-term, though, the move is a clear net positive.
Author Bio
Simon Furlong is the Co-Founder of Geode Finance, a white label liquid staking protocol for DAOs and DeFi protocols. Simon has more than a decade of combined experience in the financial, digital product, and media rights sectors, working previously as a risk analyst, product lead, and media rights director. His professional experiences and passions have inspired his mission to build products that support the growth of an efficient, decentralized, and vibrant Web3 ecosystem.
Disclaimer
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