Deciphering the Merge
The ETH 2.0 Merge is Ethereum’s move from Proof-of-Work (PoW) to Proof-of-Stake (PoS). So with the PoW model, Ethereum currently follows the mining model of Bitcoin which consumes a great amount of electricity. Crazy high-end hardware has to be used by miners in their race to win the block reward. This kind of hardware costs and specs limits the number of participants in the mining pool as not everyone can afford to invest in such hardware nor do they have access to cheap electricity. This makes it harder for the network to become truly decentralised.
So what is Proof-of-Stake (PoS)
The PoS mechanism completely eliminates the need of high-end hardware and dependency on cheap electricity. It’s functions on the fundamental principles of Staking. Instead of a miner now connecting their mining rigs to the network and solving calculations to win the block reward, miners would now be staking their Ethereum to verify transactions in exchange of a fee.
Validators will be selected randomly for transactional verification and this selection will be proportional to the amount of ETH staked by the said validator.
Currently due to PoW model, miners have to sell their Ethereum to cover their electricity cost, but with the ETH 2.0 Merge, validators will have no need to sell their ETH for the same. This would overall reduce the sell pressure on Ethereum, which is bullish in every way.
Problems solved by the ETH 2.0 Merge
- Decentralisation: Currently a large miner can buy large sums of hardware and have an unfair advantage in the mining network process, ETH 2.0 merge will eliminate that as the network will require a minimum amount of operating nodes to validate transactions.
- Scalable: The PoS model will open the door to SHARDING. The ETH 2.0 model will spread the load of the network across 64 separate shards.
- Sustainable: The entire Proof-of-Stake model will reduce electricity consumption by 99% compared to the Proof-of-Work model.
How does ETH 2.0 work?
Staking and running a node would require
- Staking 32 ETH on the network to become a full validator
- Locking up the staked ETH
The workings of the entire framework is quite straightforward:
- Deposit 32 ETH to become full validator or some ETH to be part of a staking pool
- The protocol stakes the ETH and activates the validator software
- The user staking the ETH will receive a liquid wrapper equivalent to the amount of ETH staked
- The staked ETH earns interest until sold/withdrawn from pool
This entire framework makes ETH deflationary
The EIP-1559 upgrade began the process of burning some of the taxation fees rewarded to miners. This made ETH kind of deflationary in a small way.
With the ETH Merge, the rewards paid to miners will be reduced by 90% (approx)
So basically this process will have more ETH burned than ETH issued into circulation. BULLISH!
What is SHARDING on ETH 2.0?
This will not be a part of ETH 2.0 before 2023, but effectively Sharding will make ETH faster and less computer intensive.
Currently Ethereum can handle around 30 transactions per second (tps), with sharding going live, Ethereum will be able to do above 1000 tps.
The Supply Factor
The biggest bullish indicator for Ethereum with ETH 2.0 will be the supply squeeze the market will experience.
Current issuance of Ethereum is around 5.4 million ETH/ year. ETH 2.0 will reduce this issuance to just 0.5 million/year. That is -90% reduction in total supply.
Overall, the ETH 2.0 Merge is a huge step-up for the entire Ethereum network and ecosystem. This is when ETH truly becomes deflationary, scarce and with Sharding coming in 2023, we can clearly expect the high gas fee problem of ETH getting solved.
Today ETH is used across the crypto board for multiple outlets, from buying NFTs, signing smart contracts, taking out loans on DeFi, swapping of coins on Decentralised exchanges and so much more, ETH 2.0 is a massive revolution in the world of crypto. It will be interesting to see how Polygon (Matic) performs when Sharding on ETH 2.0 will actually solve the scalability and gas fee problem of ETH. The future for ETH looks BULLISH! 🚀