After years of delays, Ethereum (ETH-USD) is ready to ditch its all-important consensus layer for a new one.
This software change, also known as "the Merge," represents a crucial milestone for the digital asset sector's most widely used blockchain and its cryptocurrency, ether.
The Merge will see the Ethereum blockchain shift from proof of work to proof of stake.
Right now, Ethereum is a blockchain protocol secured by miners who validate its transactions in real-time using their computing power in return for new tokens. After the Merge, the protocol will be secured by validators who post capital in return for a percentage yield on their pledged funds.
The upgrade is a technological feat that will cause Ethereum's energy consumption to plummet, with proponents believing it will bolster Ethereum's longterm prospects.
But with a completion date right in the middle of September's major macroeconomic events — and the Merge necessitating some coordination from a host of industry groups — the process could be far from straight forward.
What's going to happen during the Merge?
As Ethereum co-founder Vitalik Buterin explained during a keynote in July: “The Ethereum protocol right now is in the process of this long and complicated transition.”
That process includes several software upgrades, all rhyming with Merge, and none of which can be completed until the Merge is finished.
The Merge itself changes Ethereum's consensus layer, or the blockchain's governor for determining who owns what on its ledger.
“Its a big deal,” Jeff Dorman, CIO with Arca told Yahoo Finance. "In the sense that it's been a telegraphed event that the Ethereum community has been driving towards for 3 or 4 years and to actually complete that is powerful."
In Ethereum's current proof of work model, the protocol's transactions are processed by crypto miners solving increasingly difficult computations in return for ether. Once the Merge completes, Ethereum will only employ staking validators who pledge capital (at least 32 ETH) on the blockchain to receive staking rewards.
At the same moment the protocol effectively sheds its proof of work consensus layer, the rest of the Ethereum blockchain — also known as its execution layer — will Merge with a new proof of stake layer called the Beacon Chain.
Bitwise CIO Matt Hougan suggested said the Merge is "like switching from gas to electric on a car, changing how Ethereum's core engine functions."
"They're replacing the wheels as its still going," Kevin Zhou, co-founder of hedge fund Galois Capital, which is "net short" on the Merge, pointed out.
"It’s kind of like a Y2K moment, where everyone’s sort of not 100% certain what will happen," Arca's Dorman said of the Merge. "Maybe it's a non-factor like Y2K, maybe it's bigger than that."
Immediately, Ethereum's energy consumption will see a sharp decline after the Merge.
By eliminating mining, projections from the Ethereum Foundation and analysts see the protocols energy consumption — which currently needs as much power as Finland — dropping by 99.5%.
Optimistic the Merge will enhance Ethereum's long term value, Arca's Dorman is also quick to suggest the anticipation for immediate value appreciation may dash market expectations.
"Ultimately, the event itself will not be that big of a deal from a financial standpoint," Dorman said. "It's really 6 and 12 months out where we will see the effects."
When will the Merge be complete?
The second to last stage of the Merge, known as Bellatrix, begins September 6 and ends sometime between September 10-20 once its final stage, known as Paris, initiates.
Timing in the September 10 to 20 window depends on when Ethereum reaches its total accumulated difficulty, or TTD, which Ethereum core developer Danny Ryan has predicted will mean approximately 12:13 a.m. New York time on September 15.
According to the Ethereum Foundation, the last stage will reach "finality" approximately 12 minutes after TTD is reached which, if all goes well, will be the time required for the protocol's first block of transactions to be created and recorded by Beacon Chain validators.
As we highlighted earlier this month, these dates also fall between the next U.S. inflation report and the Federal Reserve's next interest rate decision, leaving crypto traders braced for significant market volatility around the Merge.
What does it mean when Merge happens?
For Michael Anderson, co-founder of the crypto-focused VC firm Framework Ventures, the risks of the Merge going wrong are minimal given its past “dress-rehearsal” tests.
Crypto infrastructure providers such as Alchemy, which power NFT marketplaces and DeFi apps on Ethereum, have "been working hand-in-hand with the Ethereum Foundation," said Mihir Chitalia an Alchemy customer product engineer.
However, crypto trading platforms such as Coinbase (COIN) and Binance aren't taking any chances.
Both have announced they will pause deposits and withdrawals for ether and other ERC-20 tokens, such as Shiba Inu (SHIB-USD) coin, around the Merge while a number of exchanges are offering Merge-specific trading products and discounts.
At least part of the reason for these operational pauses goes back not just to what's changing in Ethereum's Merge, but what its biggest losers might do according to Thomas Dunleavy, a senior research analyst at Messari
"Around that period, there could be a whole lot of confusion around who owns what," Dunleavy said.
A cohort of Ethereum miners led by Chandler Guo aren't happy with losing their mining revenue. Ethereum mining generated $19 billion last year, according a Messari report.
Those miners are trying to fork Ethereum's codebase to continue operating a version of its blockchain with proof of work. Futures trading on the Circle acquired exchange Poloniex is pegging the value of Guo's proposed token — ETHW — at roughly 3% of ether's relative value against the dollar.
As Dunleavy put it: "Anyone can create a copy of an existing blockchain just by running a full node and downloading the history of the chain, but if people don't recognize or use the forked chain, then all assets on it are worthless."
"[Exchanges] just don't want to take any risk of anything going wrong," Galois's Zhou said.
What happens to ETH?
Over the last week, Ethereum has carried a market capitalization that has floated between $187-228 billion, plus an additional $36 billion in total value locked. That puts the money in the Merge on par with mega cap publicly traded companies like Wells Fargo (WFC), Walt Disney (DIS) and Toyota (TM).
As cryptocurrencies have rebounded along with the broader market, ether's gains since the start of July have outpaced bitcoin by a wide margin, with ether rising about 50% over the period while bitcoin is up 7%. Much of the relative momentum comes from optimism around the Merge, according to all markets sources we talked to.
“We're an industry that loves to jump from narrative to narrative," said Framework's Anderson. "And this just is the narrative du jour right now, and [it's] exciting because we've only had negative sentiment over the last couple of months."
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