The Ethereum Merge

The Ethereum Merge is finally here and many who are unfamiliar with the transition from Proof-of-Work (PoW) to Proof-of-Stake (PoS) are asking…what’s the difference and why is it important? For starters, both decentralized consensus mechanisms are used to verify new transactions, maintain the blockchain, and distribute token rewards. Proof-of-Work was first introduced with Bitcoin and is a tried and true way to maintain a decentralized ledger. However, there are certainly downsides to this method and, as seen this week, many are critics of its energy consumption, including the White House. On the other hand, Proof-of-Stake was introduced as alternative method to blockchain maintenance, but there cons to this consensus mechanism as well. Many argue that PoS is the future of blockchain maintenance and transaction verification. Ethereum’s merge from a PoW to a PoS network will be a true test of that theory.

General Consensus Mechanisms

Consensus mechanisms are an integral part to decentralized economies. To maintain a fully-decentralized, publicly verifiable ledger, a host of computer nodes must all agree on the validity of the network’s transactions. The way in which these nodes agree on transactions and the subsequent addition of these transactions to the blockchain is referred to as the general consensus mechanism. As it stands today, the two major consensus mechanisms are proof-of-work and proof-of-stake.

Review of the Six Types of Blockchain Consensus Mechanism

Proof-of-Work (PoW)

Proof-of-Work (PoW) was the consensus mechanism first introduced with the Bitcoin network. In a PoW mechanism, multiple miners compete to solve complex algorithmic puzzles, effectively verifying transactions and adding them to the blockchain. The first miner to solve the puzzle and add the block of transactions to the ledger is rewarded in that blockchain’s native token (in the case of the Bitcoin network, miners are rewarded in bitcoin). As a result of the economic incentive and the nature of time sensitivity, mining companies have built large operations involving thousands of miners running to solve these puzzles first. These intensive computational operations lead to a large amount of energy consumption. The main critics of PoW highlight the inefficiencies of PoW transactions and the hot-button issue of energy consumption. Just this week, the White House proposed a ban on crypto mining mainly due to the size of its energy consumption. Blockchains like Cardano and Ethereum 2.0 aims to solve these PoW issues.

Pros: Harder to meddle with transactions due to processing power required, older and more established method of consensus

Cons: Energy intensive, trouble scaling, not smart contract compatible (needs to be able to process high number of transactions)

Proof-of-Stake (PoS)

The concept of proof-of-stake (PoS) involves “staking” the blockchains native token, projecting to the blockchain valid network participation. Once these tokens are staked, the validators (in the case of PoS, miners are referred to as validators) are randomly selected to forge the next block of transactions in a lottery-style selection. The more tokens staked, the greater the chance that group of validators has to forge the next block and receive the network rewards.

In the case of Ethereum 2.0, staking pools must have at least 32 ETH to have the chance to be selected. This creates a high barrier to entry as only serious validators will enter the chance to be selected and maintain the network. Many staking pools allow for anyone to contribute their ETH to the pool and receive a portion of the rewards returned. However, this does not come without risk. To deter bad actors or unfit validators from participating, Ethereum has imposed a slashing penalty for bad validations. In other words, if validators get selected and cannot properly forge the block, their staked ETH will be reduced as a penalty.

Proof-of-Stake mechanisms allow for networks to remain decentralized and maintain public ledgers without the need for intensive computing. Ethereum 2.0 is estimated to reduced Ethereum’s energy consumption by 99.5%, according to Ethereum.org. Additionally, PoS allows for larger blocks of transactions to be verified at a time. This benefits layer 1s like Ethereum, which is processing transactions for decentralized exchanges, NFTs, and various smart contracts.

Pros: Less energy intensive, can process higher number of transactions more efficiently, anyone can participate in staking pools to receive rewards making the token more valuable to hold

Cons: High barrier to entry (32 ETH), centralization concerns (70% of nodes hosted at the moment are on AWS services and centralization due to Lido having such large share), slashing for bad validation, maximum extractable value (MEV) could worsen

Read more about these concepts from the Ethereum Foundation below:

Proof-of-Work

Proof-of-Stake

Nodes and Clients

Maximum Extractable Value (MEV)

What Will Happen To My Ether Post-Merge?

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