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Ethereum 2.0 and ‘the merge’: 8 things you need to know

Stylised image showing Ethereum coins standing on a computer motherboard.
Big changes are on the way for Ethereum. (Source: Getty) (Dado Ruvic / reuters)

As the world’s second-largest cryptocurrency, Ethereum has received a lot of attention from investors, and the upcoming ‘merge’ has become one of crypto’s most anticipated events.

‘The merge’ references an upgrade to the Ethereum blockchain that will see it move to a proof-of-stake (PoS) model, which is intended to improve its overall performance - making it consume less energy, improving its transaction speed and enhancing its scalability.

This is a complex change and its impact on the price of Ethereum is yet to be determined.

To understand the significance of this upgrade and how it will affect Ethereum holders, let's start at the beginning.

1. What is Ethereum?

Ethereum was officially launched in 2015. Whereas Bitcoin (BTC) seeks to become a digital, decentralised form of currency (or ‘store of value’), ETH seeks to use cryptocurrency to decentralise products and services in a wide range of use cases beyond money.

Decentralising is the process of removing points of control, in theory making them harder to disrupt and more democratic.

Ethereum’s cryptocurrency is called ether (ETH). Using the Ethereum network, you can send ETH to anyone for a small fee.

However, the Ethereum blockchain is used for far more than payments, which leads to it describing itself as a ‘marketplace’ of financial services, games and apps.

You’ll often see ETH and Ethereum used interchangeably online to refer to the cryptocurrency ether. ETH is available to buy, trade and sell at numerous cryptocurrency exchanges.

2. How does it work?

Today, Ethereum uses proof-of-work (PoW) mining to power its blockchain.

In a proof-of-work protocol, computers solve mathematical puzzles to ensure the validity of transactions recorded on the blockchain and, in turn, for every successfully validated transaction, a new block is added to the blockchain and miners are rewarded with the newly minted ETH for that work.

A room full of computers mining Ethereum.
Ethereum currently uses proof-of-work mining to power its blockchain. (Source: Getty) (Manuel Medir via Getty Images)

This is very similar to Bitcoin. The big difference between the two is that while Bitcoin has a set hard limit on the amount available to be created, ETH does not. Instead, the supply of ether is programmed to increase 4.5 per cent each year, with 2 ETH currently minted for every block mined.

This reward has been decreased twice in the network’s history, and was originally set at 5 ETH. There is a proposal for this method to be replaced by an entirely new consensus/validation method (see point 5 below).

3. What are the use cases?

ETH is perhaps the most ‘useful’ cryptocurrency, in that it has myriad applications.

Ethereum’s blockchain is used for fundraising, NFTs and is the blockchain of choice for the DeFi (decentralised finance) movement, which seeks to replicate traditional finance services.

The important thing to remember is that any applications or protocols operating on Ethereum must continually purchase and spend ETH to operate, creating a continued demand for the asset as long as people are utilising Ethereum for their projects.

4. Who invests in it and why?

With so many applications utilising Ethereum, ETH remains valuable because it essentially ‘powers’ these innovative projects.

Unlike Bitcoin, which was built primarily with finance in mind, Ethereum was built with a more flexible approach. As the world’s second-largest cryptocurrency, it also enjoys a lot of investor and miner attention.

The often-used analogy to Bitcoin and Ethereum are the precious metals gold and silver.

Silver is used to store value but is not as popular as gold in that use case. What makes silver special is that it also has industrial uses, which gives it additional value.

Viewed through this lens, ETH is in many ways the ‘silver’ of digital assets.

5. What is Ethereum 2.0

Ethereum 2.0 is a planned sequence of changes to Ethereum intended to improve its overall usability and performance.

The main upgrade is a transition to proof of stake, which will see the Ethereum blockchain move away from new coins being minted by people ‘mining’ (aka proof of work) for new ETH, to ‘staking’ (aka proof of stake).

Under the Ethereum PoS model, users - called validator nodes - can lock ETH cryptocurrency in a smart contract, which then would earn rewards for solving computations needed to add new blocks to the blockchain.

The minimum amount of cryptocurrency required to become a validator node is 32 ETH, which allows them to support the network by verifying transactions, storing data and adding new blocks to the blockchain.

The PoS model is vastly more energy efficient than a PoW model. It also enhances the speed of transactions.

6. What is ‘the merge’

This is the moment when Ethereum and Ethereum 2.0 are merged into a single, unified network.

This will see the existing Ethereum chain, which contains the full Ethereum history, integrated as one of the branch chains (known as ‘shards’) in the new Ethereum 2.0 system, and will fully transition Ethereum from PoW to PoS.

While the final merge is still to come, the process has been underway for years. The Ethereum 2.0 blockchain, known as the Beacon Chain, was created in November 2020 and has existed with limited functionality until the final merge happens.

The Beacon Chain contains ‘shards’, which are essentially extra branches of chains that hold layers of stored data.

Once the merge happens, the final upgrades on Ethereum 2.0 will occur. This involves adding functionality to the ‘shards’, enabling them to process transactions and execute smart contracts so that developers can deploy applications on the Ethereum 2.0 blockchain.

7. When is it happening?

The merge is getting closer as preliminary testing has begun.

These tests serve as precursors for the final merge and will give developers insight on what to expect and how to prevent any potential problems that may arise.

The final merge has been delayed a number of times, but is predicted to happen sometime between August and November this year.

8. How will it impact ETH?

Outside of the benefits mentioned above - enhancing the usability of the network, improving future scalability and reducing energy consumption - the merge will also impact sentiment and the price of ETH.

If the Ethereum community can complete this extremely complex change, it will likely boost confidence and sentiment around this cryptocurrency.

While it's impossible to predict the future price of any asset, some market observers are speculating the merge will help boost the price of Ethereum.

It’s another exciting moment for the crypto industry and one that many people will be watching closely.

As always, it's worth remembering that it's early days for crypto and there are lots of improvements to be made and many innovations to come that we can’t even imagine right now.

Jonathon Miller is a crypto expert and managing director of Kraken Australia.

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