The ‘Merge’, which happened during the morning hours of Thursday, September 15, 2022, marks the beginning of scalable Ethereum as the state machine execution layer transitions from relying on Proof-of-Work for consensus to Proof-of-Stake. The transition has been planned since nearly the beginning of Ethereum itself and was officially set in motion in December 2020 with the launch of the Beacon Chain — which until now was essentially a naked consensus layer with no capabilities besides messaging between validators. After the merge the ‘execution layer’, or the state machine that support’s Ethereum’s ability to do computation, will rely on the Beacon Chain for consensus and finality, meaning that all operations on the Ethereum chain will be secured by Proof-of-Stake.
The primary effects of this event, which will be activated by the ‘Paris’ hard fork upgrade, are as follows:
- The execution layer will be secured by Proof-of-Stake; Ethereum miners will no longer be able to produce blocks for the main chain
- Emissions of new ETH will be reduced from 2 ETH per block to a sliding scale based upon the total amount of staked ETH; emissions will be reduced by ~85%
- Blocktimes become a deterministic 12 seconds
- The overall power consumption of the network will be reduced by ~99% due to computational work being replaced with risked capital to ensure security
- Validators on the beacon chain will begin receiving fees from transactions
What will NOT take place after the merge:
- Fees will not be reduced for the average transaction
- Transaction speed / capacity will not immediately go up
- Validators will not be able to withdraw their ETH from staking on the beacon chain
- There will be no need for decentralized applications or other services reliant on Ethereum execution layer data / computation to take any specific action (besides all clients updating to the latest version of their software)
The most important aspect of the merge is that it lays the groundwork for future upgrades that will enable data sharding, which will eventually increase the total throughput and scalability of the network by multiple orders of magnitude.
Proof-of-Stake Ethereum will be incredibly scalable in its final form compared with the original Proof-of-Work chain. One of the biggest hurdles to mass adoption of Ethereum throughout its history has been the increase in fees that coincide with an increase in demand for blockspace. In recent history Ethereum saw its highest average transaction fee day on May 1, 2022, when fees on average were $200 in USD according to Etherscan.
Currently the Ethereum chain processes around 1 million transactions per day. At its highest single day of activity 1.7 million transactions were processed by the network. This took place on May 10, 2022, in close proximity to the high water mark for fees.
The rise of alternative Proof-of-Stake chains such as Solana, Avalanche, Cosmos, and others that deliver lower fees and higher throughput compared to Ethereum have demonstrated that users do not want to pay 10s or 100s of dollars to send single transactions. Indeed, even at current fee levels, which are down significantly from highs, the costs associated with transacting on Ethereum is far too expensive for a large percentage of the world population. To make Ethereum accessible to everyone globally, fees need to be far lower than they currently are. Data sharding and its foreshadower, proto-sharding, promise to deliver the scalability needed to both make rollup fees competitive with alternative chains and deliver base-layer scaling Ethereum needs.
The latest proposals for the data-sharded future of Ethereum are the Danksharding proposals, which reflect the rise of a rollup-centric Ethereum roadmap since 2020. Due to the increased adoption of rollups as long-term solutions with their own network effects, data sharding has been revised to reflect the long term position of rollups within Ethereum. The original vision for sharding proposed a fixed number of data shards that each had separate blocks, block proposers and fees. With the latest sharding model outlined in EIP-4844 instead, the fee market for an unspecified number of shards is merged instead; thus one proposer chooses all the data that is included in one slot.
In order to reduce the computational load on validators that this change would introduce, proposer-builder separation is also introduced, that separates the roles of the block builder and the block proposer. The block builders bid on the right to have their blocks included and the proposer selects the highest valid bidder to include. Because the proposer no longer has to process all data in the block, their computational overhead is reduced.
Sharding will also include a new transaction type called blobs. Blobs are chunks of data included in blocks that the EVM will not process. These data are to be used by rollups to push bulk data from their own execution environments back to Ethereum at reduced cost. Proto-danksharding proposes to introduce the blob transaction type ahead of the full implementation of sharding, providing cost reductions to rollups and making them more competitive with alternative base layers.
The upcoming Shanghai upgrade may implement proto-danksharding (among other improvements to Ethereum, including Beacon Chain withdrawals) and is expected to occur within the next 6 months. If it is not implemented at Shanghai, a different proposal will be implemented (reduce the cost of CALLDATA in transactions), which has the same effect of lowering the transaction costs for Ethereum rollups. Set in motion by the merge, future upgrades to Ethereum will bring adoption of far more users at a lower cost to users by introducing significantly improved scalability in phases.
Economic impact of the merge
The biggest immediate effect of the merge will be the reduction in total yearly emissions of ETH tokens. Emissions will reduce to between 1,500–1,800 ETH per day from current levels. Due to the base fee burn mechanism introduced in August 2021 during the London hard fork upgrade, Ethereum will likely also become a deflationary asset at most times. Per Kraken Intelligence, at current validator numbers, which sit around ~420,000, a base fee of just 15 GWEI will result in deflationary Ethereum:
In addition, until the Shanghai upgrade, the newly emitted ETH will be locked on the Beacon Chain and unavailable for withdrawal. Beacon Chain ETH can currently only access liquidity of other tokens (i.e. Execution layer ETH, stablecoins) via liquid staking derivatives from protocols including Lido and RocketPool.
Ethereum’s Proof-of-Stake transition marks the beginning of scalable, sustainable Ethereum. As more stake enters the Beacon chain and more decentralized liquid staking options come to market, Proof-of-Stake Ethereum will evolve into a robust, decentralized network with high enough capacity to support billions of users.