Since it was first published in a white paper by Ethereum’s founders, the idea of “proof of stake” has fascinated the cryptocurrency community. However, many still need clarification on what this term means and how it would affect Ethereum’s future.
In this blog post, we answer those questions and more. First, we’ll discuss what cryptocurrency proof-of-work is and why it has some problems. Then we’ll take a look at what proof-of-stake is.
Next, we’ll talk about the consensus requirement of proof-of-stake and how Ethereum’s upcoming Casper protocol will affect the platform’s need for proof-of-work. Finally, we will examine why Ethereum has decided to move to a proof-of-stake consensus algorithm and what this means for the future of Ethereum and cryptocurrency.
What is the Merge?
The Merge will result in a modification to the validation process for Ethereum transactions. In the past, Ethereum operated in a manner analogous to that of Bitcoin. Transactions were “mined” by a decentralized network of computers, which competed to solve mathematical puzzles and were awarded new currency when they were successful.
The “proof-of-work” consensus process is particularly energy-intensive since it requires computers to reach a consensus on which transactions will be added to a new block before the computers may proceed.
According to estimates provided by the Ethereum Foundation, the network should become approximately 99% more energy-efficient as a result of the Merge, which resulted in the transition of Ethereum to a consensus mechanism known as proof-of-stake, which consumes a great deal less power and should make the network significantly more environmentally friendly.
As part of the proof of stake protocol, transactions are validated by addresses that have “staked” or “pledged” a significant amount of ETH to a smart contract.
Those who have wagered more ETH are awarded proportionately higher incentives. Even though proof of stake theoretically causes the rich to get even wealthier, it does not in any way cause the oceans to boil.
Since the first introduction of the Ethereum blockchain in 2015, the Ethereum community has been hard at work preparing for the switch to proof of stake.
The merging is one of a group of changes that should also make Ethereum faster and cheaper to use. These upgrades are collectively referred to as the upgrade set.
At the moment, Ethereum is being held back by a combination of poor transaction times and high transaction prices. A straightforward trade on Uniswap for tokens with a value of $1 might cost you more than $50 in transaction fees during times of high congestion.
However, the merger alone will not solve the problem of high gas prices; rather, it will merely pave the way for a series of enhancements that will eventually result in cost reductions. These enhancements were once known as Ethereum 2.0; however, that terminology was abandoned at the beginning of 2022.
The Ethereum Foundation has already laid out a timeline for future updates. And while this timeline is subject to change, it offers a good forecast of where the network is headed in the short term.
Why did Ethereum merge?
When Ethereum’s proof-of-work blockchain launched in 2015, the platform was under the impression that it would be a platform for developing decentralized applications and smart contracts.
However, as the network gained traction and more developers started to join its ranks, it became evident that Ethereum was much more than a blockchain for decentralized apps.
As Ethereum’s popularity increased, so did its size. At this point, a blockchain that runs on a proof of work can’t handle the strain of running such a large network. This is because proof-of-work blockchain networks are slower to process transactions (thereby making them less attractive) and more expensive to run (making them less profitable).
If Ethereum is to keep up with its growing user base, the platform must make it easier for users to transact with each other. One of the most powerful arguments against cryptocurrencies is that it has an effect that is harmful to the environment.
The White House has been vocal about the need for energy efficiency measures in the crypto mining industry. As a result of the Chinese government’s crackdown on cryptocurrency mining, miners have begun to relocate their operations to the United States.
If efforts to make the mining process more environmentally friendly are unsuccessful, the administration currently in charge of the White House has gone so far as to float the concept of examining alternative measures to limit energy-intensive mining, such as bitcoin mining.
The primary challenge of mining cryptocurrencies is the amount of energy necessary to authenticate transactions on blockchains that require proof of work.
To reduce its environmental impact, Ethereum has decided to transition away from the energy-intensive proof-of-work system and toward the more ecologically friendly proof-of-stake system. According to the Ethereum Foundation, the change reduced Ethereum’s overall energy consumption by 99.95 percent.
This is how the Merge process went. Beacon, a new independent proof-of-stake blockchain, was released by Ethereum on December 1, 2020. On September 15, 2022, the original Ethereum Mainnet and the Beacon Chain came together to form a single chain. This event took place.
Because of the substantial reduction in energy use, this merger is good news for socially conscious investors because it will result in fewer greenhouse gas emissions.
The combination is expected to make it easier to implement network enhancements in the years to come. Despite this, lower transaction costs still need to be implemented across the Ethereum network.
A simple Ethereum transaction may cost well over $50 in fees, which is currently more expensive than the ideal number for a cryptocurrency. The latter is called the Gwei for a good reason. Gwei is a unit of measurement that stands for one hundred millionths of a bitcoin.
What is proof of stake?
Proof-of-stake is an energy-efficient alternative to proof-of-work. The more of a crypto asset you own, the more that crypto asset will be able to benefit you in the form of additional rewards.
For a proof-of-stake system to function optimally, a cryptocurrency must have at least two addresses: one type is still used for value storage and transfer, while the other is used only for staking.
The proof-of-stake idea is somewhat complicated, but in a previous post on our website, we did our best to explain it in layperson’s terms. Because cryptocurrencies are decentralized, a centralized authority such as a bank or other financial institution can’t monitor and validate their transactions.
Because of this, the validation of cryptocurrency transactions in various cryptocurrencies is accomplished through either proof-of-stake or proof-of-work. In essence, both are distinct algorithms enabling users to add transactions and record them on a blockchain, an unchangeable public ledger.
To generate Ethereum tokens before the Merge, you were required to go through a procedure known as proof-of-work (PoW), which required significant energy. PoW was the first consensus process utilized by bitcoin to verify transactional data.
Miners compete against one another to solve difficult mathematical puzzles as part of the PoW mechanism. The miner who can solve the challenge first will be granted permission to add a transaction block, resulting in them receiving rewards.
Because mining needs a significant amount of electricity, this procedure results in mining devices all over the world computing the same issue. This results in a significant amount of energy being consumed.
According to the proof-of-stake mechanism, users of cryptocurrencies have the ability to stake their cryptocurrencies on the blockchain and construct their own validator nodes.
For permission to validate transactions, the validator must first stake some of their cryptocurrency on the network for a predetermined time.
The Proof of Stake (PoS) protocol selects a validator node to conduct an accuracy check on a batch of transactions. After that, the node contributes the correct block to the blockchain in exchange for cryptocurrency rewards. On the other hand, a validator will suffer a loss of a portion of the cryptocurrency they have staked if they contribute a block that contains an error.
Validators in a proof-of-stake system must have a financial interest in the blockchain. Therefore, to become a validator on the network, one is required to make a substantial investment (32 ETH).
The “validators” who check the legitimacy of transactions on the blockchain are chosen via the Proof of Stake (PoS) protocol. Validations carried out lawfully and accurately are rewarded with new ether blocks. Because of this, being a validator on the network now requires more than just a graphics processing unit (GPU) that is adequate in performance.
Many people who advocate for Bitcoin continue to believe that the proof-of-work system is more secure and that the blockchain ought not to transition to the new system.
Ethereum, on the other hand, has been discussing the possibility of making this transition for several years. Another issue with the Proof-of-Stake (PoS) protocol may be the potential for a small group of influential users to control the voting process. These users would need to be able to stake a greater quantity of ether in the first place.
What does the Ethereum Merge mean for investors?
The biggest significance of the Ethereum merge is that mining will take place in a more energy-efficient manner. Data from the Ethereum Foundation suggests that this efficiency may reach 100 percent during the first year of operation.
This explains why the Ethereum network has already started reporting lower transaction fees and why these fees will continue to decrease throughout the first years of operation.
This could also explain why many commentators have suggested that Ethereum may become a relatively safe investment compared to bitcoin or other altcoins.
The fact that mining is entirely based on proof-of-stake could make for a system of cryptocurrency that is more resistant to the dangers of hackers or DDoS (distributed denial of service) attacks.
The Ethereum network will also be able to move these network fees into its structure. An Ethereum block rewards concept has been in place since July 2015, meaning miners have already been paying fees on the Ethereum network in ether.
Just one day after the merger, the head of the Securities and Exchange Commission (SEC), Gary Gensler, said that the cryptocurrency might be regarded as a security today.
This has caused investors in Ethereum to feel uneasy. Gensler’s comments regarding the staking incentives were as follows: “From the coin’s standpoint, there’s another indicator that under the Howey Test, the investing public is anticipating returns based on the efforts of others.”
Many investors are currently concerned about how Ethereum will eventually be categorized. Even though the SEC has not yet issued a formal comment regarding whether or not they consider Ethereum to be a security rather than a commodity, this is incredibly disturbing news that has the potential to shake up the entire cryptocurrency market.
If ether and any application on the blockchain were considered securities, then the Securities and Exchange Commission (SEC) would require them to be registered.
It also implies that Ethereum was trading as an unregistered security for a considerable time, which could result in some substantial fines being levied on Ethereum and possibly being levied against the platforms that permitted trade.
Securities that have been registered are required to reveal their management team, offer relevant financial information, and discuss any potential hazards.
In many ways, the Ethereum merge is a momentous occasion. It proves that the network is already developing rapidly alongside its parent company, which is working towards making a new version of Ethereum.
The Ethereum Foundation has constantly said that the network needs to be ready to be merged with Bitcoin, which indicates that some issues need to be resolved before the network is made available to the general public.
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