The Beacon Chain and Ethereum Merge
What is the Merge and What Does It Mean for Ethereum?
In this post, we will discuss
The Ethereum merge, and
What it means for the price of Ethereum
If you have been keeping up with crypto in the past few years, you have most certainly heard of Ethereum. It is the second largest crypto by market capitalization and has the largest ecosystem of decentralized applications. Starting from NFTs to DeFi, some of your favorite projects are probably built on top of it.
If you spend some time lurking in crypto, you will very quickly hear of Proof-of-Work (PoW) and Proof-of-Stake (PoS). For beginners, let’s do a quick recap of what these are:
Proof-of-Work (PoW):
In a Proof-of-Work consensus, miners compete against each other to produce hashes which are then validated by the rest of the miners.
The winning miner’s block is added to the chain and he/she is rewarded with some newly issued crypto.
Proof-of-Stake (PoS):
In a Proof-of-Stake consensus, miners are replaced by validators. Validators are responsible for staking their currency in order to earn rewards.
The winner is selected at random but staking a larger portion of the pool directly correlates with a higher chance of receiving rewards.
The Ethereum that you know today uses a Proof-of-Work consensus and runs on something called the Mainnet. For a long time, Ethereum’s roadmap has included the plan to switch over to Proof-of-Stake. There’s many benefits to this, as I mentioned above, but to summarize - it allows for easy staking (validators and cheap security) and is generally more environmentally friendly.
To facilitate the shift, Ethereum launched the Beacon Chain in December of 2020. Think of the Beacon Chain as a chain that runs in parallel to the Mainnet today. The idea is to test this new consensus and fix any issues related to Proof-of-Stake and Ethereum. Developers want to be confident that nothing will go wrong once the consensus mechanism changes. Eventually, the Mainnet and Beacon Chain will merge and ditch Proof-of-Work all together.
This is “the merge” that you will find Ethereum fans talking about every so often.
What does this mean for Ethereum?
First of all, it is probably important to clarify that if you hold Ethereum, you do not need to do anything. All the merge does is change the consensus mechanism of your Ethereum. The amount you hold and the coin you hold stays exactly the same.
The merge is expected to happen sometime in Q2 of 2022 according to the Ethereum Foundation’s website. Important to remember that this is assuming that no other issues or bugs show up on the Beacon Chain before that time. Ethereum developers also have a track record of being a little too optimistic with their timelines, but given that testing has already been going on for over a year, the merge seems closer than ever.
The merge is extremely bullish for Ethereum’s price for 2 reasons:
1) Supply and Demand
Under the Proof-of-Work consensus, Ethereum miners are currently earning 12,000 ETH/day. Many miners are forced to then sell some of this Ethereum in order to pay for mining rigs and electricity costs.
After the merge, the amount of new ETH issued per day will decrease to just 1,280 ETH/day (-89.3% reduction in new supply). Electricity costs are also minimal/non-existent with Proof-of-Stake, meaning that the selling pressure from miners will no longer exist.
2)Staking Yields
Staking Yield on ETH will go up from 4.8% to ~10% after the merge
Ethereum becomes 2x as attractive to HODLers and stakers
What happens to the staked ETH on the Beacon Chain?
There are some concerns with what happens to the staked Ethereum once the merge finally happens. Many stakers will want to finally take their profits once the locked up ETH becomes available again.
This is mostly a misconception, and Ethereum’s tokenomics allow for a smooth transition that likely won’t lead to a downward spiral of price.
First, staked ETH doesn’t necessarily become unlocked right away after the merge. It will become available after the first hard-fork following the merge, which could take up to 6 to 8 months.
Second, selling the staked ETH requires you to go through a queue, limited at 1125 validators per day. That amounts to roughly 38K ETH per day, which is only 1% of total daily volume.
Third, since the staking yield goes from 4.8% to 10%, a lot of stakers will simply opt to not sell their Ethereum after the merge. Staking is becoming 2x as attractive. Some may sell due to liquidity, but my guess is that many will not.
In Conclusion…
Regardless of whether you believe in ETH or not, the merge is bound to be one of the most important next steps for the industry as a whole. Safe to say that everyone in this community will be paying close attention, and you probably should too.