Illustration by Timo Lenzen
is crypto’s answer to gold, Ethereum is the closest thing it has to its own internet. Anyone who wants to mint a new token, launch a crypto app, or spend $150,000 on a Bored Ape nonfungible token, or NFT, probably uses the Ethereum network. More than $3 billion in transaction volume flows through Ethereum daily, traded in the network’s native token,
About $60 billion in crypto assets sit on its blockchain through third-party apps. Aside from Bitcoin, no other network is more critical to crypto’s infrastructure or its future.
Tinkering with Ethereum is no trifling matter. Yet the network’s developers aren’t just about to tinker—they’re on the cusp of overhauling the core plumbing and mechanics of Ethereum in an upgrade that enthusiasts call The Merge.
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The change, slated to happen around Sept. 15, is a big technological risk and could be a transformative moment for crypto. Companies like
(ticker: COIN) will feel the impact almost immediately. And there are likely to be ripple effects throughout the industry, touching everyone from crypto miners to chip makers like
(NVDA), and investors with some Ether in their portfolios.
“The Merge is the most significant upgrade in crypto history,” says Sami Kassab, an analyst for crypto research firm Messari. “It’s similar to changing the engines on an airplane in midflight. One flaw in the code could wreak havoc on the crypto ecosystem.”
Years in the making, The Merge may be crypto’s answer to critics who say the industry is a colossal waste of energy. Ethereum, with a market value of nearly $200 billion, now uses the same method of validating transactions as Bitcoin.
In that process, known as proof of work, computers compete to solve cryptographic puzzles. The network reaches a consensus on the winner, proving that a block of transactions is valid and should be added to the chain. The winner then receives some Bitcoin, a practice known as mining.
It’s highly energy-intensive, requiring a massive amount of computing work and electricity. Ethereum was built on the same system, and it is also an energy hog, using roughly the same amount of electricity in a year as countries like the Netherlands.
Now, developers are scrapping that model and moving to a much greener system for processing transactions, called proof of stake. Instead of mining, Ether owners use their tokens as collateral to validate transactions, “staking” them to the network in exchange for a yield, paid in the Ether token. To participate, a staker must deposit 32 Ether tokens, worth about $50,000, and run some software. The system randomly selects validators, like a lottery. Crypto exchanges and other firms run staking pools, allowing anyone to participate with smaller amounts of Ether.
The shift should eliminate Ether mining. In doing so, it will cut Ethereum’s energy usage by more than 99%, according to the Ethereum Foundation, sharply reducing the network’s carbon footprint.
That’s just the start of a larger makeover. The Merge should also reduce the newly minted Ether that’s produced each year. And developers are planning more upgrades over the next few years that aim to increase Ethereum’s throughput and lower its usage fees. Ideally, they aim to turn Ethereum into the internet of crypto—a base layer for apps, financial services, and many more digital assets like NFTs.
“Today, we talk about decentralized finance. In 10 years, if we are successful, people will just call it finance, full stop,” says Justin Drake, a researcher for the Ethereum Foundation who’s helping with the project. “For almost any financial transaction, they will use Ethereum.”
Yet The Merge may also have casualties. It could cause glitches, outages, or losses of tokens as the current Ethereum blockchain merges with a new one, called Beacon. “A laundry list of elements will need to keep working seamlessly post-Merge to keep exploits and liquidations at bay,” says Sean Farrell, head of digital assets at Fundstrat Global Advisors.
The stakes are high because so much of the crypto industry has a stake in its performance—from exchanges like Coinbase to mining operations, NFT platforms, and stablecoin issuers. “Usually, when you push out a change for a website and it breaks—oh well, it’s not the end of the world. In this case, you can lose a lot of money,” says Katie Talati, director of research at Arca, a crypto-asset manager.
The most immediate effect could be on Ether’s price. Since mid-June, the token has soared more than 50%, while Bitcoin has stayed flat. Both tokens are down about 60% this year, under pressure from rising interest rates and weaker demand for highly speculative tech.
A successful Merge could make Ether ripe for another run, some analysts say. That’s partly because moving to proof of stake should reduce token issuance to about 0.5% a year, down from 4.5% currently. Reducing the issuance could push up the price. “In the current market, supply and demand is relatively in balance,” says Steve Goulden, a senior analyst for Cumberland, the crypto arm of trading firm DRW Holdings. “Post-Merge, there will be a material supply deficit.”
Demand, meanwhile, could get a lift as owners stake their tokens in return for a yield. Investors may earn 4% to 8% by staking, depending on how much revenue the network generates and other factors, according to Talati. Institutional funds with a mandate to invest in environmentally friendly assets could also buy Ether as the blockchain’s carbon emissions become less of an issue.
The upgrade could be a boon to companies like Coinbase. The exchange is developing a service that makes it easy for investors to stake their Ether, with Coinbase taking a 25% cut of any income generated. The staking business has already “grown into a great source of subscription and services revenue and is growing nicely,” said CEO Brian Armstrong on an earnings call in August.
As in any tech upgrade cycle, however, there will be a legacy of obsolescence. Some of the biggest losers in this cycle could be mining companies that spent hundreds of millions of dollars on hardware that might be rendered worthless. Leaders of Hut 8 Mining (HUT), which mines both Bitcoin and Ether, said in August that they were studying how to adapt their Ether mining machines to other tokens or projects.
Hive Blockchain Technologies
(HIVE), another miner, said a shift to proof of stake “may render our mining business less competitive.”
Chip maker Nvidia looks like another casualty. The company’s graphics chips and cards have been adopted by the industry to mine Ether. But demand now appears to be evaporating. Nvidia, whose stock is already ailing from a slowdown in gaming and other core areas, said on its recent earnings call that it couldn’t predict how reduced crypto mining might hit demand. Analysts for investment bank Baird say The Merge is likely to “generate a wave of mining GPUs [graphics processing units] on the secondhand market, compounding the inventory woes.”
Longer term, Ethereum may pose more of a threat to rival blockchain networks. Blockchains and tokens such as Solana, Avalanche, and Tezos launched with the promise of being faster and more efficient than Ethereum. All run on proof of stake and have established various uses, but if Ethereum pulls off its upgrades, they may run out of time to prove their relevance. “Now that Ethereum has caught up with proof of stake, there’s less of an argument for many other blockchains,” Kassab says.
Some crypto companies aren’t taking The Merge lying down. The threat has led a few miners to launch a competing Ethereum blockchain, called a fork, using the proof-of-work method. The idea is to create an Ether spinoff and a parallel universe of smart contracts, NFTs, and decentralized-finance, or DeFi, applications.
The potential for dueling Ether blockchains is forcing companies to choose sides or declare neutrality. Exchanges like Coinbase, Binance, and FTX say they will apply their usual listing standards to forked tokens and may allow them to trade. Creators of crypto apps such as Uniswap, Compound, and stablecoin USDC have pledged to recognize only the new Ethereum blockchain.
An Ethereum split has some crypto leaders worried that scammers could find new ways to perpetuate theft and fraud. “Somebody’s going to spend 80 real Ether on a fake Bored Ape,” says Robert Leshner, founder and CEO of Compound Labs, a DeFi company. “There will be all sorts of disasters,” he says, advising investors to wait for the kinks to be ironed out and “do nothing.”
Another unknown is how Washington will react. Officials at the Securities and Exchange Commission have indicated that Bitcoin and Ether should be treated as commodities—potentially removing those tokens from SEC oversight. But because many investors will buy Ether with the expectation of a yield, some attorneys believe it could make the token look more like a security. If the SEC agrees, crypto exchanges like Coinbase could be vulnerable to lawsuits or enforcement actions if they let it trade on their platforms anyway.
Changes of this size are an “opportunity to try to distinguish the prior analysis from the current analysis,” says Teresa Goody Guillén, a partner at BakerHostetler and former SEC attorney, who believes that Ether still wouldn’t qualify as a security. The SEC declined to comment.
As with all things in crypto, the hype around The Merge already exceeds the reality. Proponents say it could be the start of a Renaissance of useful apps and services—finally silencing the critics bemused at a multibillion-dollar industry that has yet to find a raison d’être apart from speculation. Conversely, if it flops, it would be another setback for a technology long on complexity and short on real-world utility.
“The most important part of The Merge is the narrative,” Kassab says. “It’s something that everybody is talking about that could bring people back into Web3 and crypto, assuming it’s successful.”
The crypto market is now suffering from a crisis of confidence, having lost $2 trillion in value over the past year and drawn the ire of governments worldwide. A successful Merge may not revive the market or its reputation. But it could make crypto a bit greener, at the least, on its path forward.
Write to Joe Light at email@example.com