Ethereum enters the proof-of-stake era. What’s next?

The Merge upgrade went seamlessly. Here’s what it means for the environment, institutional adoption, and ETH price & issuance.

Ethereum long-awaited transition from proof-of-work to proof-of-stake called the Merge took effect at block height 15537393 at 06:42 UTC, September 15. So far, everything suggests that the upgrade, which was worked upon by more than 100 developers for years, was a success. The Merge, dubbed one of the largest technological events in the crypto industry to date, even got a countdown clock in Google featuring two happy bears, black and white, approaching each other to hug and unite into a single panda bear, a nod to an Ethereum panda meme.

“And we finalized! Happy merge all,” Vitalik Buterin, the co-founder of Ethereum, said on Twitter. “This is a big moment for the Ethereum ecosystem. Everyone who helped make the merge happen should feel very proud today.”

The name of the upgrade refers to the original Ethereum mainnet (the execution layer) merging with the separate blockchain called Beacon Chain (the consensus layer). The latter went live in 2020 and, instead of miners, is secured by validators using proof-of-stake. Before the Merge, validators weren’t processing transactions, but now they are responsible for attesting to the state of the chain and proposing blocks, being rewarded with newly minted ETH for their service.

From the viewpoint of an ordinary Ethereum user, nothing had changed except that the block time (“slot” in Ethereum-speak) decreased from roughly 14 seconds to 12 seconds. And yet, the Merge will have profound implications for Ethereum and the entire crypto industry. What are they?

Decreased environmental impact

According to the Ethereum Foundation, a non-profit that helps maintain the platform, the Merge slashed the network’s energy consumption by roughly 99.95%, opening the door for institutional investors and reducing negative sentiment towards NFTs and web3 applications in general.

A single Ethereum PoW transaction used to consume enough energy to power an average US household for a week, as per data from Digiconomist, a platform that tracks crypto energy usage.

“If successful, the merge will significantly reduce ETH’s power demand; this reduction will likely be equivalent to the electrical energy consumption of a country like Portugal,” Digiconomist tweeted several days before the upgrade went live. “Moreover, it would likely become the final nail in the coffin of Bitcoin’s PoW. Excuses running out.”

Increased pressure on PoW-based cryptocurrencies

Following the Merge, the United States-based Environmental Working Group (EWG) announced the launch of a $1 million campaign aimed at urging Bitcoin to abandon its “outdated protocol” and go green. At the same time, the environmental activist group Greenpeace initiated a petition to Fidelity Investments to push Bitcoin to follow Ethereum’s lead in switching to an energy-saving proof-of-stake protocol.

“Ethereum has shown it’s possible to switch to an energy-efficient protocol with far less climate, air and water pollution. Other cryptocurrency protocols have operated on efficient consensus mechanisms for years. Bitcoin has become the outlier, defiantly refusing to accept its climate responsibility,” said Michael Brune, director of the EWG campaign titled “Change the Code, Not the Climate.”

Even before the Merge, many U.S. lawmakers have been already targeting Bitcoin miners, demanding major firms disclose the energy consumption of their facilities and the share of renewable energy used for mining. On the state level, New York passed the bill that would impose a two-year moratorium on certain crypto mining operations that use electricity from power plants that burn fossil fuels.

Growing institutional adoption of Ether

Now when Ethereum isn’t boiling the oceans anymore, ESG-concerned institutional investors may start entering the digital asset space en masse, potentially altering its price dynamics. “A successful transition to PoS would flag a huge signal to regulators that the crypto industry has the power to adapt in a way that prioritizes our planetary well-being,” the World Economic Forum wrote about the Merge.

Meanwhile, blockchain analysis firm Chainalysis suggested that Ethereum's transition to proof-of-stake can result in ETH “decoupling” from other cryptocurrencies, as it becomes more similar to an instrument “like a bond or commodity with a carry premium.”

According to CryptoQuant, the number of new accounts that deposited over 32 ETH to the staking contract skyrocketed in the first hours after the Merge, proving that many institutional investors indeed view running a validator node as a lucrative alternative to traditional bonds. And even more are expected to join the network over time as fears of fatal bugs in PoS code diminish.

Ether may become deflationary

The transition to PoS slashed the amount of new Ether issued to reward block proponents by roughly 90%, from about 14,600 ETH/day pre-merge to about 1,600 ETH/day post-merge. Since mining is an economically intense activity, it required higher ETH issuance to sustain. But it’s no longer the case — instead of power-hungry GPUs used for mining, Ethereum 2.0 validator node can be hosted on a consumer-grade laptop with a stable internet connection.

In addition to decreased issuance, the network will continue to burn Ether coming from transaction fees. According to calculations by the Ethereum Foundation, at least 1,600 ETH will be burned each day at an average gas price of at least 16 gwei, effectively bringing net ETH inflation to zero or less after the Merge. However, as per data from ultrasound.money, a website monitoring ETH burn and issuance, Ether still remains inflationary even after the Merge.

A screenshot from ultrasound.money showcasing ETH supply change since Merge.
Image: ultrasound.money

According to Ethereum infrastructure provider ConsenSys, the deflation should be expected not earlier than spring 2023. After all, Ethereum burn-to-issue ratio directly depends on the transaction volume, which has been sluggish lately due to the ongoing bear market.

Wen sharding

Finally, a successful Merge clears the path for future scalability upgrades, including sharding, which is expected to ship “sometime in 2023.” The implementation of sharding will split the Ethereum database horizontally to spread the load, therefore reducing network congestion, increasing TPS, and potentially lowering gas fees.

According to Vitalik Buterin, sharding could scale the Ethereum blockchain 100-fold. “Sharding is the future of Ethereum scalability, and it will be key to helping the ecosystem support many thousands of transactions per second and allowing large portions of the world to regularly use the platform at an affordable cost,” he wrote in his April 2021 blog post.