‘The merge’ has been the talk of the town for those in the crypto world for a while, and now it has finally happened. But for those unaware, what does it mean and why are people so excited? In this article, we turn to the industry to learn more about Ethereum’s proof of stake (PoS) merge as well as hearing experts’ thoughts prior to the big move and their initial reactions following it.
But before hearing these reactions, let’s take a few steps back, and understand why the merge happened in the first place. In short, the blockchain was aiming to increase its processing capacity, offer greater security, and significantly reduce energy consumption, and it believed this would be achieved via merging with a PoS consensus.
Previously, the Ethereum blockchain had a proof of work (PoW) consensus that required miners to spend energy to use their computing hardware to solve a puzzle with the objective of avoiding sybil attacks.
This was the original way blockchains were created, with the world’s biggest cryptocurrency, Bitcoin, being mined in this way. However, this method of crypto mining has come under heavy scrutiny for a variety of reasons, with economical concerns being one of the top causes for criticism.
According to Forex Suggest, Ethereum used the second most energy for each transaction in 2021, consuming 62.56 kWh, which produced 93.84 lbs of CO2. Despite being far more efficient than Bitcoin, this was still a very high energy cost that produced a worrying amount of CO2. Ethereum produced the second-highest amount of CO2 in 2020 with 16.6 million tons, and despite producing much less CO2 over the course of 2020 than Bitcoin, Ethereum was still operating at an unsustainable rate of energy consumption, which made it one of the dirtiest cryptocurrencies of the year.
Swapping PoW for PoS – where the real-world value invested comes from ETH staked directly in a smart contract – would remove the need for miners to burn energy to add a block into the blockchain.
Instead, with the new PoS consensus mechanism in effect, the more coins a node had staked (i.e., stored), the greater its chances of being selected to add the chain’s next block. “This power is thought to be self-limiting by the inherent interest the staking node has in Ethereum’s worth,” said Jaime Baeza, CEO of ANB Investments – the crypto hedge fund delivering uncorrelated returns for institutional investors.
Ethereum moving to PoS would make things more energy efficient (more than 99 per cent more energy efficient, said the Ethereum Foundation) but not cheaper, though. “The merge is a change of consensus mechanism, not an expansion of network capacity, and (notably) will not result in lower gas fees,” the Ethereum Foundation said.
Thoughts before the merge
The merge had been in talks for a while before finally taking place. In the weeks leading up to the event, we reached out to the industry to gather its thoughts on what this would mean for the crypto and blockchain marketplaces:
Kevin Murcko, CEO and founder of crypto exchange, Coinmetro said: “This week, Ethereum will attempt its most significant metamorphosis since it launched in the summer of 2015.
“The world’s second largest open-source blockchain is planning to move from a PoW mechanism to a PoS blockchain, and in so doing, will solve a number of headaches that have plagued the platform in recent years. Not least, reducing Ethereum’s electricity consumption by an estimated 10,000 per cent, and going a long way to assuage the environmental criticisms levelled at the crypto industry.
“Rumours of Ethereum’s big merging event have turned into anticipation, leading to a monumental surge in the price of Ethereum-based tokens and coins. We are already seeing this play out with Ether which showed a slight decline to $1,500 before recovering to $1,750, higher than the $1,600 it began the week at. The hashrate for Ethereum Classic rose by 500 per cent year-on-year, reaching a new all-time high.
“Traders are seemingly exercising one of the oldest tricks in the book: ‘buy the rumour, sell the fact’. I would not be surprised to see a price drop in the second half of September. But that won’t stop retail investors, driven by FOMO, from filling their bags in the meantime. In the long-term however, the merge will undoubtedly have a positive effect on Ethereum.
“There are still a number of risks on the horizon, not least how exchanges will deal with the uncertainty surrounding the merge. Some may choose to temporarily pause activity related to Ethereum while tests are run, while others may face challenges in incorporating the new protocol.
“Any disruption is likely to be minimal, as it’s in everyone’s interest that the merge is successful. Either way September is set to become another milestone in the history of cryptocurrencies, and that means an enormous scope for investment returns.”
Manuel Rensink, director of innovation and strategy at Securrency, a financial markets infrastructure technology company focused on enhancing capital formation and stimulating global liquidity, shared his thoughts on how the merge would cause DeFi and fixed income markets to enter a new paradigm:
“Ethereum’s upcoming move to PoS is a big event, not just for blockchain nerds, the environment, and ‘gas prices’. It will significantly impact financial markets. DeFi first, and then traditional interest rate markets. It’s worth noting that there are already PoS and dPoS blockchains, but Ethereum’s market cap is much greater than all those combined. Ethereum is around five times larger than the number two (BNB chain), which itself is five times larger than the number three.
“Ethereum2.0 will offer a yield that does not change significantly over time, persists over the long term, and remains high even with significant amounts of capital deployed into it. This brings the major benefit of introducing a stable and liquid yield curve.
“Other chains will quickly converge with this benchmark rate, which will be significantly higher than the current risk-free rate in the bond markets. It will be the base source of fixed yield for DeFi bonds and DeFi interest rate derivatives.
“Currently, all of DeFi is an insignificant fraction of the global bond market (±$100billion vs $120trillion) and part of the reason is that DeFi yields are exclusively variable, i.e. not reliable, and unattractive for most investors. The merge will set off a wave of innovation, think ‘yield only’ products that have crypto volatility risk hedged out, interest rates as tokens, structured products, and of course, with a little added compliance, the spillover into traditional bond and IRS markets.”
Lars Seier Christensen, chairman of the Concordium Foundation and founder of Danish investment bank Saxo Bank, explained how he did not believe much has changed as a result of the merge, but he would not call it a non-event:
“With low scalability and high fees, and I am very interested to see what the longer term impact will be. Will PoW Ethereum be a significant challenge as some actors will continue down this road? Will it affect existing use cases? On the positive side, the rewards will be lower, hence creating long-term less selling pressure. Also, the negative energy narrative that affects the entire industry will have less substance going forward.
“We have seen some ‘buy the expectation’ but could we see ‘sell the fact’ now?
“Overall, I don’t see it as a major positive that will change the current negative market sentiment and there is considerable downside risk if anything goes wrong. Upside – if it should occur – will meet heavy resistance above 2,000.”
Founder of artèQ and Qlindo, the real estate and energy investment platform, Farbod Sadeghian view’s were on the other end of the excitement spectrum, as he believed the merge would be highly impactful:
“We should see the cost of Ethereum and the time it takes to process decrease dramatically, which will improve blockchain sales in the foreseeable future.
“Most significantly, the Ethereum merge and subsequent removal of the consensus mechanism will improve the energy efficiency of blockchain by nearly 100 per cent. This is great news for the crypto industry – which is currently seen as a big carbon dioxide emitter – as it’ll greatly improve sustainability.
“The Ethereum merge is a massive milestone for the entire crypto and blockchain industry. We’ve never seen a major upgrade like this in the whole lifespan of Ethereum.
“I expect the hype surrounding the merge to lead to massive increases in the value of ETH. This growth will be sustained for several months.
“For tokens like ARTEQ and QLINDO, I see the merge as further proof that the ecosystem in the web3 space is constantly evolving. Therefore, I expect an increase for smaller tokens as well.”
What were some misconceptions prior to the merge?
Not everything was clear prior to the merge. We also reached out to the industry to hear about misconceptions that were floating about:
Steven Walbroehl, co-founder and CTO of cybersecurity company Halborn, tackled the most common misonception which was surrounding gas fees: “The biggest misconception on the merge is that it will lower gas fees. This is not true. It is a change of consensus mechanism, not an expansion of network capacity that would result in lower gas fees.
“That’s also why I don’t think the merge will have an impact on L2 projects. L2 blockchains exist to make up for limitations on the core L1 Ethereum network. If you look at what improvements are being made with the merge, the primary reason for this is energy consumption efficiency from moving from PoW to PoS. L2’s that provide speed, or savings in gas cost will still be used for those reasons since the Merge will not make transactions any faster than they are now, and will not reduce gas fees more than they currently cost.”
“I also hear lots of people talk about Ethereum flippening Bitcoin. I personally doubt it, but it’s always hard to say what happens long term. ETH does become more deflationary than BTC for the new economic model, however the pure supply/demand side of things can be hard to forecast.”
James Key, CEO and co-founder of Autonomy Network, discussed Ethereum’s scalability: “It’s a common misconception that the merge will bring more scalability to ETH, because while it introduces PoS which makes ETH more efficient and environmentally friendly, it won’t make txs cheaper – that comes in a later hard fork that it still at least a year away with the introduction of ‘sharding’.
When sharding is introduced, however, at first glance you might expect that L1 scaling means cheaper fees for L1 txs and therefore people use L2s less, however the opposite will be true for L2s, especially on L2s like Optimism. This is because as ETH itself scales, then some volume from cheaper L1s would migrate back over to ETH, as well as attracting more users to ETH that weren’t on any chains in general, ultimately leading to more ETH usage.
“Fees on L1 ETH will go down, but they probably won’t go down to the level of current Polygon fees, because many DeFi applications will want to be on the same shard (you can imagine sharding as though there are 1000 different ETH blockchains that can’t talk to each other quite as easily as if they were the same chain/shard).
“Since fees will still be cheaper on L2s, and L1 ETH will have more users, it gives an even greater incentive to use L2s compared to today – therefore the price impact for L2 tokens is expected to be positive when scalability on ETH is introduced after the merge.”
Don’t forget about taxation
Importantly, Tony Dhanjal, UK head of tax at Koinly, a crypto tracking and tax reporting tool for investors, discussed the tax implications for investors following the merge: “The Ethereum merge has been a success – and it seems as though a hard fork is imminent with ETHW (Ethereum Proof Work) going its own way.
“In the US the IRS has not issued any guidance on a merge event per se. However, the IRS offers clear guidance when it comes to hard forks and that is – if an investor receives an airdrop of ETHW following the hard fork, then they have taxable income – it is based upon the fair market value at the point of receipt of a PoW token airdrop in the hands of the investor
“If an investor holds Ethereum on an unsupported exchange, then it is unlikely they will receive an airdrop of ETHW – in this scenario, it will likely be deemed a non-hard fork event has taken place, from a tax perspective.
“In the UK – according to current guidance, it can be inferred that income tax is not applicable upon receipt of ETHW tokens. Instead, the investor will be subject to capital gains tax on any gains or losses crystalised, based on an apportioned cost basis for the ETHW
“If your scenario is a deemed non-hard fork event, whether you are in the US or UK, the change in PoW to PoS consensus mechanism resulting from the merge will not create a taxable disposal by virtue of there being no new crypto asset – ETH will remain as ETH in your wallet.
“Existing ETH holders will simply get an ETH PoS token in exchange for the original token on a 1:1 basis, and the original cost basis is attributed to the new PoS token. This should not be treated as a crypto to crypto trade.”
So what now?
On 15 September 2022, the long-awaited merge took place: Ethereum upgraded to a PoS consensus to be a less-energy-intensive technology. Here, we hear how the industry reacted and how they predict the change will impact the grander crypto industry:
The personal financial advice and innovative digital solutions provider, deVere Group’s CEO, Nigel Green said: “The years-in-the-making merge, a network-wide, grand scale upgrade is here.
“This is far-reaching overhaul of the most commercially important blockchain in the digital asset ecosystem is probably the most important, landmark event in crypto history, since the launch of Bitcoin.
The deVere CEO and high-profile cryptocurrency advocate predicted that the “historic occurrence” would fuel prices across the market.
“Whilst some of the news has been priced-in already, let there be no mistake: this event will be a major catalyst driving prices higher in the long term,” he affirmed.
“The slashing of energy consumption will be the main reason as it will become significantly more appealing to institutional investors, who bring with them enormous capital, expertise and reputational pull.
“Those institutional investors who have been sitting on the sidelines are now likely to move in.”
He went on to add: “Besides having a more positive climate impact, the merge’s effect of reducing supply, cutting costs and speeding up transactions will also appeal to both individuals and institutions.
“Due to the significance of the merge, we expect the developments to bolster prices across the wider crypto market to some degree.”
Nigel Green has for many years spoken about the potential of Ethereum. He has previously spoken in the media about it “being more useful than Bitcoin and having tech advantages over its better-known rival.”
He concluded: “The Merge represents a major boost not just for Ethereum but for blockchain technology itself.
“This is a momentous day for crypto.”
Jeremy Roberts, CEO of Funganomics, the company looking to build an ecosystem for the future of NFTs, NFT gaming and the metaverse, said: “The merge from what we can see has been a success which will be pleasing to Vitalik and the development team no doubt.
“This is a really positive move in the right direction as we personally wouldn’t have used Ethereum as our main NFT platform network otherwise.
“It drastically reduces energy consumption on the ETH network (99 per cent) this will be a key driver in the future for certain projects as factor to build on Ethereum.
“Although this is a positive move in the right direction it still doesn’t solve the gas fee problems we saw in the last upward market. I do hope it is solved before the market picks up as it become a real issue. Gas fees topped out at $7,500 to mint an item at one point.
“Scalable Layer 2 Solutions are the key driver in current markets and likely to be the driver for the foreseeable future. Funganomics will be seeking to build our own custom Layer 2 solutions to meet the needs of our own ecosystem.”
Eugene Zomchak, product owner at crypto lending platform CoinLoan, looked at the core pillars of Ethereum and how they would be changed by the merge: “What are the most important characteristics of Ethereum? Trust and ecosystem.
“The trust of the community (volunteers, blockchain geeks, crypto enthusiasts, degens, and active traders), investors in ETH (from the retail hodlers to the huge whales), businesses (previously miners, now validators), partners (nodes, exchanges, wallet providers, API solutions, payment services, side-chain extensions, and cross-chain bridges), and even the developers itself. Trust, despite that incident with the DAO which has proven the ecosystem is antifragile.
“Then, a large-scale ecosystem based on Ethereum — bigger than even Bitcoin. It includes all kind of DApps (including DeFi projects, DEXes, all types of staking), L2 scaling networks, various initiatives (EEA, Hyperledger, OASIS, Baseline), the Ethereum Foundation, regular devcon events, and private blockchain integrations (among them Santander and Societe Generale banks). When you start enumerating them one by one, it sounds really impressive.
“With this in mind, it becomes clear why the merge upgrade got much attention. This seems to be the start of a new epoch, changing everything, shaking up the industry… But in fact, it’s an adequate logical step, another achievement in the ambitious roadmap.
“The merge is incredibly important for the Ethereum ecosystem and strengthening the trust of the community. However, we have plenty of other initially PoS-based (plain one or variations) blockchains: Cardano, Solana, Polkadot, Cosmos, Algorand, TRON, and Stellar.
“We’ve come far, but there is still a long road ahead of us. I believe in a bright future of Ethereum filled with innovative, exciting releases. However, we don’t know at this time whether Bitcoin could be thrown off the pedestal. Ethereum could lose its spot in second place by those so-called “killers” who lead in the smart contracts sphere.
“Calm competition, ongoing progress, beneficial technologies, and sober thinking are always going to drive success, and the merge is not an exception.”
Vijay Ayyar, vice president corporate development and global expansion at crypto exchange Luno, analysed the gamble that the blockchain was taking: “Ethereum successfully moving to PoS is also a huge point of validation that the technology works and will pave the way for many more PoS networks to flourish.
“On the flip side, there is always a risk that the merge could fail and that PoS will prove less secure than PoW. This could lead to a hard fork as some miners might continue on the PoW blockchain which may result in a split.
“A move to PoS for Ethereum paves the way toward a more efficient and scalable industry in the long run. With a more environmentally sustainable network, the merge could help improve how cryptocurrencies are viewed and attract institutional and retail investors. This allows Ether to move toward becoming a deflationary asset, this will also bring its net coin supply inflation to zero or less. Further, most new blockchains are already adopting PoS based consensus and this will only increase.”
Benjamin Dean, director, digital assets, WisdomTree, the exchange-traded fund and exchange-traded product sponsor and asset manager, looked at both the pros and cons of the merge: “The consequences of this change offer both opportunities and risks for investors. The opportunities will present themselves in terms of a staking yield for those who stake their ether holdings.
“Risks will be seen in cybersecurity terms, should there be a critical bug in the updated code base, and in terms of compatibility with the many decentralised applications (dApps) that rely on the Ethereum base layer. There is also the chance that a break-away group decide to ‘hard fork’ the network so as to preserve their mining revenue streams, which has implications for current ether holders.”
Ultimately, it is too soon to tell if the merge is going to be a success. The general consensus from the industry is that this was a momentous occasion, even if there was going to be little immediate change as a result. Over time, the Ethereum blockchain will be able to reap the rewards of the merge if it is able to maintain investor confidence. Should this waver, that is when questions will be brought up, but for the time being, it seems Ethereum has made a great move to become more sustainable and increase its processing capacity.