The Post-Merge Ethereum, A Multifaceted Analysis

Wow, Ethereum completed the merge. The asset now runs on a proof of stake blockchain and users didn’t have to do, download, or update anything. To them, and to the larger audience, the merge was invisible. On the other hand, for blockchain aficionados Ethereum’s transition was one of the most important stories of 2022. And the ecosystem will feel its implications and consequences for years to come.

The transition to proof of stake has been on the cards since 2015, when the Ethereum blockchain accounting system started producing blocks. The intrepid and naive developers of the time first promised to deliver it for early 2016. Since then, the promised merge followed Ethereum everywhere it went. Every postponement of the “difficulty bomb” that finally destroyed the proof of work chain felt like a Scarlett letter in Ethereum’s chest. Some thought the transition might never happen. They were wrong.

As a worldwide event, the merge transcends politics. It didn’t need government officials, licenses, or patents. It transcends all jurisdictions, despite SEC claims to the contrary. . The merge wasn’t imposed by anyone.  And because Ethereum is not a corporation, its merge didn’t need a corporate structure around, nor a CEO or a marketing team.

A new kind of organization made it happen. 

The long-term consequences of the event remain to be seen. In the short term, though, the green narrative might carry Ethereum to new heights. The new proof of stake consensus mechanism reportedly uses 99% less energy than its proof of work counterpart. There’s a possibility that ESG-focused institutions will turn their sights and wallets to Ethereum’s energyless alternative..

In a recent Cryptonized episode, I had the pleasure of interviewing Band Royalty’s Barnaby Andersun. We spoke just before the merge, and he came with stories. 

Barnaby Andersun On The Merge

Barnaby Andersun is an “award winning Ethereum developer.” He participated in a hackaton weeks before the merge and his projects were recognized. Ethereum’s founder Vitalik Buterin was in attendance and assured the crowd that everything was ready on the technological front. The team aced the tests on the testnets and they were ready to rumble.

As it turns out, Vitalik was right. 

I asked Barnaby about his predictions and observations about the post-merge Ethereum, and he went straight to issuance. The network is expected to drop from around 5% to less than 0.5% The effects this will have on the price could be tremendous. Barnaby also highlighted that all of the technicalities happened backstage and the average Ethereum user won’t even feel the difference. This is where I brought up the promise of speed. It was my understanding that the post-merge Ethereum would be faster.

According to Barnaby, that won’t happen at this stage. In the hackaton, Vitalik talked about sharding as one of the final stages of Ethereum’s proof of stake journey. The promise is that the blockchain will be able to handle hundreds of thousands of transactions for a fraction of a penny. 

Let’s enjoy the current victory and not get ahead of ourselves, though.

Other perspectives on The Merge

In a recent appearance in Bloomberg’s Odd Lots podcast, Galaxy Digital’s Christine Kim gave a masterclass on the merge and its implications. In the following quote, Kim points out the main advantage that Ethereum will have over bitcoin from now on. And then provides what she sees as the merge’s weak spot. 

“Obviously the ESG narrative of Ethereum will continue to thrive. And in comparison to Bitcoin, I think there's going to be a lot more narrative around, you know, the way that you mint NFTs, the way that you do all these things are no longer as energy intensive as they used to be. But I think one of the reasons why I say like all of this, isn't all that positive, which it is, it is very positive, is that I've been really waiting for a long time around Ethereum scalability. And The Merge really doesn't do very much for Ethereum scalability at all.”

For their part, Time magazine got Justin Drake to explain to them everything about the merge. Drake is one of Ethereum’s key researchers and a key part of the team that transitioned the asset to proof of stake. Using questionable logic, he explained how the move significantly improves the network’s security:

“The merge dramatically increases the security of Ethereum. An attacker needs 51% of the blockchain’s value to [take control]. With Proof of Work [the previous mechanism that powered Ethereum], you need on the order of $5 billion, which allows you to buy enough computers and transformers, connect all of them to the grid, and then carry out an attack. With Proof of Stake [the system Ethereum is transitioning to in the merge], we will have about $20 billion in economic security today—and this is a number I expect will grow dramatically.”

Last but not least, BitMEX’s Arthur Hayes left an extremely bullish prediction in the Entrepreneur's Handbook blog.

“If the merge is successful, there is a positive reflexive relationship between the price and the amount of currency deflation. Therefore, traders will buy ETH today, knowing that the higher the price goes, the more the network will be used and the more deflationary it will become, driving the price higher, causing the network to be used more, and so on and so forth. This is a virtuous circle for bulls.”

Since the controversial EIP-1559, Ethereum burns a part of most transaction fees. That, mixed with the severe reduction in issuance, might make ETH a deflationary currency. For that to happen, the network’s usage has to be through the roof and so do gas fees. The fact of the matter is that if it does happen it could do wonders for the asset’s price. “A virtuous circle for bulls,” indeed.

Possible problems for today and tomorrow

Before the merge, Ethereum’s price was pumping and it even challenged bitcoin dominance in a way that it hadn’t for years. After the merge, which by the way went wonderfully, Ethereum’s price is struggling and bitcoin recovered its lost ground and then some. Was it a “buy the rumor, sell the news” situation? It certainly seems that way. A textbook example, in fact. 

Still, people were expecting Ethereum to pump after achieving its childhood dream, but it didn’t. 

Another possible problem is Ethereum’s legal status. The SEC had previously classified ETH as a commodity, but the both network and the asset changed substantially with the merge. Now that Ethereum is a proof of stake blockchain, is Ethereum a security? That’s the question everyone’s asking Chairman Gary Gensler, who refuses to give a straight answer but keeps dropping hints.

A regulatory setback is probably the biggest risk Ethereum is facing right now. It may not happen, though. The SEC might reinforce its status as a commodity and call it a day. 

The third risk I see is, what if it was all a mistake, to begin with? The proof of work mechanism is tried and true and delivers what it promises. There are other proof of stake blockchains already running, but Ethereum is in another league altogether. So, a proof of stake blockchain hasn’t faced a real adversarial environment. What if it cannot hold? All of the technical expertise that brought us the merge can’t do anything if the general idea is misguided. 

This experiment might fail at any moment. But then again, it might not. And if it doesn’t, the merge might be one of the engineering wonders of our time. And pump Ethereum’s price at the same time.