The Ethereum blockchain
Ethereum is an open-source blockchain network with smart contract functionality, designed to be scalable, programmable, secure, and decentralized. Ethereum blockchain users can build apps, dApps, DeFi apps, NFT marketplaces, hold assets and make transactions, with no central authority or intermediaries involved. Ethereum has its own cryptocurrency, Ether (ETH), which is used to pay for certain activities on the Ethereum network. It is the second-most valuable cryptocurrency by market cap, after Bitcoin. Like on the Bitcoin blockchain, Ethereum transactions are public. The Ethereum Merge, which took place in September 2022, has been a trending topic. Let's look into why!
Proof of Work
In a proof-of-work system, miners compete to solve complex mathematical puzzles in order to validate transactions and add them to the blockchain. In order to run the very complicated algorithms, miners in the PoW mechanism need highly specialized hardware which incurs large costs, making mining only accessible to special mining pools. Because of its lottery-like system, the mining process can also be very energy intensive, which has led to critiques of the consensus and its environmental impact, with Bitcoin mining using more electricity annually than Finland and Belgium.
The Bitcoin (BTC) blockchain was designed for cryptocurrency mining, leaving out smart contract functionality. Therefore, it mostly just has to process incoming and outgoing bitcoin transactions. The Ethereum blockchain, however, also has to process DeFi transactions, digital assets sales and minting, and many other smart contracts.
Proof of Stake
Proof of Stake (PoS), also employed by other blockchains such as Cardano, switches out the importance of computational power for staked ETH, and replaces miners with validators. Validators stake their ETH to activate the ability to create new blocks. They don't compete to create blocks, they are chosen at random by an algorithm. The system uses financial incentives and penalties to accomplish the task. If two out of three validators agree on the state of a block, it is considered final.
Because validators are selected at random instead of miners competing to solve a puzzle, Proof of Stake consumes a lot less energy than PoW. Validators also don't need any special tools and equipment that require huge computational power. This process is often considered to be more energy-efficient and sustainable, as it does not require the same level of computational power.
With Proof of Stake, validators can only validate blocks if they have a security deposit or "stake", meaning if they attack the blockchain, try to double-spend or steal coins, they can't do so without losing their investment. With PoW, if one group of miners gains more than 50% control, they can prevent transactions from being confirmed and can also spend coins twice. This is called a 51% attack. PoW is the most secure consensus algorithm, while Proof of Stake security remains untested in comparison.
Until September 2022, both Ethereum and Bitcoin used the Proof-of-Work (PoW) consensus mechanism. To maintain security and decentralization, Ethereum on proof-of-work consumed large amounts of energy.
The Ethereum Merge, also known as Ethereum 2.0 or Eth2, was a highly anticipated upgrade to the Ethereum blockchain that aimed to address scalability, security, and sustainability issues. It involved a shift from a Proof-of-work (PoW) consensus mechanism to a Proof-of-stake (PoS) mechanism, as well as the implementation of sharding and a new beacon chain. The upgrade had been on Ethereum's roadmap since its inception. It was led by the Ethereum Foundation and a team of Ethereum developers, including co-founder Vitalik Buterin.
While the Ethereum Merge had the potential to bring about significant benefits to the Ethereum blockchain and ecosystem, potential risks and challenges could have arisen during the transition. For example, the crypto market is known for its volatility, and there is always the risk of scams and fraudulent activity. At the time of the merge, Binance and Coinbase, amongst others, temporarily paused ETH deposits and withdrawals as a precautionary measure. Nine hours following the merge, ETH was down just 5% compared to the price at the time of the transition.
Ethereum moved to the Proof of Stake (PoS) consensus mechanism and the rollout took place on the Ethereum mainnet in September 2022. This transition will, according to the Ethereum Foundation, cut the network's energy consumption by 99.95%. The merge could change the narrative around the entire industry in relation to potential climate benefits.
Following the Merge upgrade, many have criticized Ethereum for becoming more centralized, because Lido Finance and Coinbase own over 40% of the staking power. However, it must be noted that before the Merge, three mining pools owned over 50% of the overall network hashrate in Ethereum.
The Ethereum Merge introduced sharding, which aims to improve the scalability of the Ethereum network by dividing the blockchain into smaller chunks known as "shards." This will allow the network to process more transactions in parallel, resulting in faster transaction speeds. Gas fees however, remained unchanged post-merge.
In addition to these technical improvements, the Ethereum Merge is expected to bring about significant changes to the Ethereum ecosystem as a whole. For example, the switch to a proof-of-stake mechanism is expected to result in a shift in the distribution of Ether, as stakers will receive a portion of the issuance as rewards for participating in the validation process.