How to Prep for the ETH Merge

A (non-financial advice) guide to one of the biggest blockchain updates ever

Sep 01, 2022

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Now onto this week’s post…

If you’ve been tracking crypto prices recently, you may have noticed that Ethereum has been outperforming Bitcoin and most other top crypto assets.

You can easily see it on the charts, without even knowing the prices involved.

Here’s Bitcoin over the past three months:

And here’s Ethereum:

Sure, it’s down overall—just like everything else is. But it’s less down. Why is that? The Merge.

What is The Merge?

At a high level, it is the transition of Ethereum from a Proof of Work (PoW) to a Proof of Stake (PoS) blockchain. PoW and PoS are different types of consensus mechanisms, meaning the method by which transactions are validated. PoW uses miners for consensus, which is what Bitcoin uses and is very energy-intensive because it requires a lot of computing power. Alternatively, PoS uses validator nodes, which are essentially computers with ETH on them that are used to store data, process transactions, and add new blocks to the blockchain. You can learn more about how ETH staking works here.

From its inception in 2015, the Ethereum blockchain was always meant to eventually become a PoS blockchain. The core development team decided to launch with PoW since it was more proven at the time. This means that the move to PoS has been in the works for seven years.

For the past few years, it has seemed like The Merge was always supposed to be right around the corner. It became a joke that the day would never actually arrive.

LYLΞ (✌️,👽) @lylemckeany

the 3 in web3 means we're always 3 months away from the ETH 2 merge

But now there’s an official date. Well, sort of.

The Merge is divided into two stages: a network upgrade called Bellatrix on September 6th, then the Paris upgrade estimated to occur sometime between September 10-20th. The exact date depends on how active the blockchain is leading up to the switchover determined by a value called Terminal Total Difficulty (TTD). When TTD reaches a value of 58750000000000000000000, the Paris upgrade will go through and the switch will be flipped from PoW to PoS. You can track the current TTD and estimated Merge date here.

Why is it affecting prices now?

Moving to PoS is not only much better for the environment, but it should also be better for the price of ETH.

Mining Ethereum is an expensive business. There are capital expenditures, such as real property, computing power, and lots and lots of electricity. All of those costs create selling pressure on ETH because they need to sell the ETH they’re rewarded to pay for them. Roughly 13,000 new ETH tokens are rewarded to miners every day and the vast majority of them end up being sold, which drives the price of ETH down.

In a PoS system, the rewards will be about 90% lower, so the supply of ETH will increase more slowly. If it even increases at all. Depending on how active the network is post-Merge, there’s a chance that ETH will become a deflationary asset due to the amount that’s burned with each transaction. Burning some ETH (i.e. removing some ETH from circulation) with each transaction was implemented as part of EIP-1559, an Ethereum governance proposal that was enacted last summer. It was designed to help stabilize the fluctuation of gas fees on the network.

Here’s a quick explainer about how EIP-1559 works:

The other thing to consider is that the ETH rewarded to stakers will be issued to people who have already committed to holding onto ETH for the long-term and are therefore much less likely to sell it. You can see what ETH issuance might look like in the future here.

All of these factors add up to a bullish outlook for the price of ETH in the long run, which is why it has been outperforming many other assets recently—it’s all mostly speculation in anticipation of The Merge.

How should you prep for it?

If you currently hold ETH, there’s nothing you need to do. Assuming all goes according to plan, as it should since the core team has been testing it extensively for nearly two years, The Merge will happen and you won’t notice anything.

But there are some things you should be aware of and some misconceptions about what The Merge does and doesn’t do.

Gas fees on Ethereum will not be cheaper

Intuitively, it makes sense to think that 90% less rewarded ETH and the potential for a deflationary supply of the token post-Merge would cause gas fees to go down too. But they likely won’t change. Gas fees will still shift based on network congestion the same as they do today. There are Layer 2 blockchains like Arbitrum and Optimism that are actively being built out and are designed to work closely with Ethereum and address things like high gas fees.

Transactions won’t go through faster

It’s true that other PoS blockchains, such as Solana where our Decentralien NFTs live, have much faster transaction throughput. Solana currently processes roughly 2,600 transactions per second vs Ethereum’s 20. But Ethereum’s move to PoS doesn’t mean it unlocks more processing speed. At least not yet. Vitalik Buterin recently said at a conference that Ethereum will eventually be able to process up to 100,000 transactions per second, but that’ll occur after other upgrades are implemented and won’t happen for many years down the road.

There could be a fork of Ethereum

After learning more about The Merge and how it works, you might be wondering what will happen to all the miners. It is an estimated $19B industry, after all. It’s doubtful that they’ll all just close up shop and call it a day.

Many are likely getting ready to start mining different tokens that still use a PoW consensus mechanism such as Ethereum Classic, the network that emerged from the 2016 hard fork of the blockchain after The DAO hack.

There are also rumors that miners may fork Ethereum again and keep the current PoW consensus mechanism in place on their version of the chain, which some are already dubbing ETHPoW. Whether people will care enough about miners or that they’re transacting on a PoW blockchain remains to be seen. Regardless, it will likely only be used by a small subset of users.

If ETHPoW does happen, an exact copy of the blockchain will be created at that time. This means that everything that exists on the main Ethereum chain will also exist on ETHPoW—all tokens, even including NFTs.

At first glance, it seems like the ETHPoW fork could be a windfall for everyone, like free money that’s created out of thin air. But there’s more nuance to it.

In order to sell your tokens, there must be a liquid market. If the new blockchain has few users, there’s a lower likelihood of deeply liquid markets on decentralized exchanges or NFT marketplaces. If there’s any liquidity at all, it will be low, which means more slippage—the difference between what you expect to pay when you execute an order and what you actually pay. There will also likely be much more sophisticated actors who can do things like build bots and front-run your transactions, leaving you with even less.

Swapping out the engines

The ETH Merge has been described as “swapping out the engines of a plane in mid-flight.” It’s one of the biggest blockchain updates to ever happen and if all goes well, it will happen seamlessly.

It’ll be a stressful time for the core Ethereum development team. But, for most people, the best approach to this momentous event is to just sit back, watch, and learn.

Disclaimer: Nothing in this piece should be construed as financial advice.

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