The Merge has a chance to be widely adopted

The banking sector is waiting for The Merge!

Ethereum Blockchain (ETH) is just one step away from a major and risky upgrade. If all is successful, it will significantly reduce the electricity consumption of the block network. This, in turn, would significantly increase the acceptability of Ethereum by policymakers and broadly understood financial institutions around the world. According to analysts from the ING bank, the transition to proof-of-stake may be a milestone for the most popular decentralized finance platform on the way to widespread adoption.

The Merge of the Ethereum network, i.e. a breakthrough update of the second most important blockchain in the world

After a long wait, the world's second blockchain is likely to switch from the "proof of work" (PoW) to "proof of stake" (PoS) consensus algorithm later this month. It follows that transactions on the Ethereum blockchain will no longer be recorded by miners who need a lot of computing power to be able to prove that they have worked hard to verify such transactions between users.

Upon entry into force of The Merge, transactions will be processed by validators who sacrifice ethers instead of computing power (previously sent security deposit of appropriate value) to maintain the stability and liquidity of the ecosystem.

- The discussion of the pros and cons of PoS vs PoW is almost as old as Bitcoin, and there is no place here to cover all the positives and negatives of these two consensus mechanisms. What interests us is that the transition to PoS over time will most likely have the effect of increasing the acceptability of Ethereum and all applications built on its basis for policy makers and regulators. This, in turn, could provide an impetus for traditional financial institutions to develop Ethereum-based services, forecasts ING in its latest analysis.

It is worth emphasizing that Ethereum is not the first blockchain to be based on PoS. What makes the entire crypto world pay close attention to The Merge update is that Ethereum is widely regarded as the most important blockchain after Bitcoin, being the building block of the decentralized finance (DeFi) universe. Moreover, Ethereum is not going to pause for a moment to update the network in the process of transitioning to PoS. Instead, as described by ethereum.org, the new PoS engine will be replaced "in flight". A flight that hosts various applications, tokens and platforms. Many things are very risky from today's perspective and may not go well for the Ethereum developers.

The Ethereum upgrade rate is extremely high

While the Ethereum community has spent a lot of time testing PoS (the test PoS beacon chain has been in operation since December 2020 and was launched by Polygon), implementing such a fundamental update while the network is still operational is extremely ambitious and difficult. All of this puts the fundamental reorganization of the Ethereum consensus mechanism at a significant level of risk.

Anyone who has ever tried to quickly update the operating system on their computer knows perfectly well that in almost every such situation unexpected faults appear, which most often end up spending much more time than initially anticipated.

"In our opinion, top Ethereum developers will spend entire nights glued to their screens during The Merge update," adds ING.

Another question during the update is how the Ethereum miners themselves will react. They have invested a lot in dedicated hardware, usually GPUs, which will no longer be able to be used to mine Ethereum after changing the consensus mechanism to PoS. Some miners may choose to continue to maintain a PoW-based blockchain by creating a "fork" in the network. Such duplication of the blockchain with all its tokens creates many problems, for example for exchanges and traders. On the positive side, the entire cryptocurrency community has gained experience in dealing with such forks over the years, for example with Bitcoin.

A successful update will make Ethereum universally accepted

Looking at all the challenges described above, one may wonder why Ethereum even undertook this project? Besides the efficiently improved scalability, the main reason is the drastic reduction in electricity consumption. Ethereum.org says that after switching to the PoS consensus mechanism, the network will use 99.95% less energy than before.

An important non-technical consequence of this huge reduction in electricity demand is that it could make Ethereum friendlier to policymakers and regulators. When the European Parliament discussed the upcoming EU Crypto Asset Markets Regulation earlier this year, sustainability was an important topic. It is worth adding here that a number of PoW-based cryptocurrencies are often the object of criticism from policymakers. This situation intensified during the war in Ukraine.

Politicians are not comfortable with the high consumption of electricity by the PoW-based consensus mechanism. Certainly, the advantages and disadvantages of PoW vs PoS are the rocket fuel for a fundamental and often heated debate that has far more nuances than the - admittedly impressive - kWh figures suggest.

It is clear to the entire cryptocurrency community that the switch to PoS removes energy consumption, which is one of the major concerns of digital currency for regulators. This in turn removes the obstacle for traditional financial institutions and other companies to offer Ethereum-based services, though other dilemmas will still remain in their path.

Proof-of-Stake is not the answer to all problems

It is important that PoS is not only superlatives, but also some disadvantages. Technically, its code is much more complex than that of the much friendlier PoW. This can create new vulnerabilities. Hackers and other criminals will no doubt be investigating the new infrastructure for hidden flaws. Another point is that PoS creates a new form of inequality. In the case of PoW, there was a feeling that anyone could join in and start mining cryptocurrencies. PoS as a consensus mechanism promotes users who have accumulated a significant amount of money in ETH.

The PoS architecture on the example of Ethereum was created in such a way that at least 32 ETH is required to be able to become a validator and win rewards for validation. An alternative are staking pools for PoS, which provide additional income opportunities for those who do not have such a significant amount of ethers. On the other hand, in the case of PoW on the Ethereum blockchain, the days when the old laptop was sufficient to mine coins profitably are also long gone.

Currently, a frequently raised argument related to the change of the consensus mechanism is that it gives increased possibilities of network censorship by PoS validators. In principle, however, PoW miners could also apply censorship. Nor is it obvious that PoS will lead to a more concentrated landscape of validators than PoW, where miners have long collaborated in interconnected pools. After all, it's not the technology that makes the difference, but rather the attitudes - and regulations - of those who use it.

Overall, in our opinion, there is a trade-off between censorship resistance and the application of the anti-money laundering policies and sanctions required for this cryptocurrency to be accepted by regulators. After all, we have to find solutions here - summarizes ING.

The upcoming shift of the Ethereum consensus mechanism from PoW to PoS is likely to be the largest planned event in the entire cryptocurrency market for many years. Migration itself and its consequences carry numerous risks and will most certainly be closely monitored. A successful migration would be a compliment to the Ethereum community: it would also remove an important obstacle to regulatory acceptance of Ethereum and thus to the development of Ethereum-based services by the banking sector and other traditional financial institutions.