Ethereum Merge and its results: a deep dive + what’s next

The Merge on September 15, 2022 was perhaps the most important upgrade in Ethereum’s history, turning it from a PoW into PoS blockchain. However, it’s only a stepping stone on the way to Vitalik Buterin’s vision of an incredibly fast and scalable network. We’ll explore how the post-Merge Ethereum works and what the event means for miners, ETH price, and more.

TL;DR

• The Merge is a crucial Ethereum upgrade that saw the new PoS Beacon Chain merged with the mainnet (transaction layer). It happened on September 15, 2022 and turned Ethereum from a Proof-of-Work into a Proof-of-Stake blockchain.

• The Beacon Chain’s main task is validator management: selection, registry, rewards, penalties, etc. It doesn’t have smart contracts and doesn’t process transactions.

• The Merge was completed very smoothly, without any downtime. Over 40,000 people joined the Merge Party livestream.

• PoW miners had to either pull the plug or switch to mining other cryptocurrencies, though few of them are profitable right now.

• Two new PoW hard forks were launched: EthereumPOW and Ethereum Fair. After an initial price surge, both dropped dramatically in price and hashrate.

• With the transition to PoS, Ethereum’s energy consumption was reduced  by 99%, though gas fees remained the same. The network didn’t become faster or more scalable, either. This will happen once the devs introduce sharding, but there is no set date yet.

• ETH issuance rate dropped by 90%, from around 14,600 ETH to 1,600 ETH a day. The annual inflation rate has gone down from 5% to 0.5%. Ether isn’t deflationary yet, though.

• The next big upgrade on the roadmap is Shanghai, but nobody knows when it will happen and which changes it will feature. Supposedly, it will focus on danksharding (the new sharding model) and fee reduction.

What is the Merge?

The Ethereum Merge was an Ethereum upgrade that joined the Proof-of-Work mainnet, or the execution layer, with the Proof-of-Stake Beacon Chain, or the consensus layer. It took place on September 15, 2022, at the block height of 15,537,394.

After the Merge, Ethereum officially became a Proof-of-Stake blockchain. It’s the most important step on the way to a scalable sharded architecture that will be able to process up to 100,000 transactions per second.

Before the Merge, the execution layer was the Ethereum mainnet we were all used to – the Proof-of-Work blockchain where all transactions and smart contract interactions happened.  

To understand how the Merge worked and why it matters, we first need to talk about the Beacon Chain and its functions. Next, we’ll look at the impact of the Merge on the ETH price and issuance rate, energy consumption, and the mining industry.

What is the Beacon Chain?

The Beacon Chain was a Proof-of-Stake blockchain used for testing the new consensus engine for Ethereum 2.0 (Eth2) – or, as it is now called, the consensus layer. The Beacon Chain has been described in many ways: as the network’s heartbeat, its spine, or its core pillar.

Vitalik Buterin conceived the idea of the Beacon Chain back in 2015. In a blog post from March 2015, Ethereum release coordinator Vinay Gupta wrote that the PoS and PoW mechanisms would have to run in parallel for a while before a full switch to Proof-of-Work – which is exactly what happened.

The Beacon Chain was launched on December 1, 2020. For almost two years, it ran independently from the Ethereum mainnet. The two blockchains didn’t affect each other in any way until the Merge on September 15, 2022.

Ethereum Beacon Chain functions

Validator management and staking

Validator selection

Every epoch (32 blocks or 6.4 minutes), the Beacon Chain randomly chooses a set number of validators from the huge pool of candidates. At first, this number stood at 4, and it stayed this way until the total number of validators reached 327,680. After this, for every 65,536 validators that join the network, one additional validator will be activated.

As of October 2022, there are around 441,000 validators, with 5 of them active every epoch. When the total count hits 458,752 (327,680+65,536+65,536), there will be 6 validators per epoch, and so on.

Reward distribution

Validators receive rewards for several types of activities:

- voting on new blocks (as long as a validator’s vote matches the majority opinion);

- proposing new blocks;

- participating in committees (occasionally).

Validators need to lock up at least 32 ETH to run Ethereum PoS software, but many have a much larger balance than that because they run staking pools where anyone can deposit some ETH to participate in the rewards.

The Validator Leaderboard shows that the largest single participating address has over 2.4 million ETH staked – equivalent to more than $3.2 billion. It belongs to Lido Finance, a liquid staking service that controls more than 4 million ETH in deposits.

The APY for stakers isn’t that great, actually, by DeFi standards: around 4.9% for validators and 4.3% for those who stake passively without running a node. However, one can use liquid staking services like Lido Finance to receive special derivative tokens and enjoy additional DeFi yields while also earning the staking rewards. Check out our detailed guide to liquid staking to learn more.

Applying penalties

When validators fail to check new blocks or vote in time, they are penalized by having a fine taken from their staked balance. For more serious violations, such as voting for two candidate blocks at the same time, one can get “slashed” and lose a larger amount.

Validator registry

The Beacon Chain maintains an updated list of the blockchain addresses of all validators, adding and removing them as needed. It also stores the staked balance and current status of each validator (such as pending_queued or active_slashed), as well as their votes and slashing history.

Shard management

PoS is much more energy-efficient than PoW– as we’ve explained in our article on the fastest blockchains – but it’s not necessarily ‘faster’. What should make Ethereum 2.0 much faster and more scalable than PoW Ethereum is its new architecture: it will feature up to 64 shards, or partitions of the blockchain. They will process transactions in parallel, which should help Ethereum scale up to 100,000 TPS.

An Ethereum roadmap from 2019 lists sharding as planned for 2020. It’s now late 2022, and the release of sharding is scheduled for ‘sometime in 2023’.

The solution itself is constantly evolving. The original design was somewhat similar to Polkadot parachains, with each shard having its own smart contracts and processing transactions. Ethereum validators would submit votes both for the Beacon Chain blocks and for blocks on the shards that they are assigned to. The Beacon Chain would help shards exchange messages and transactions, ensuring interoperability.

In addition, it was proposed that the Beacon Chain would select block proposers for each shard, as well as designate committees to check that each shard’s validators are following the rules.

This is still an option, but a second model  called “danksharding” has gained traction. In it, most (or all) shards would  make sure that all data is available by wrapping them into ‘blobs’ and sending those blobs as huge transactions. However, they wouldn’t handle smart contract transactions.

According to Vitalik Buterin, some shards can be pure ‘blob’ data handlers, while others will be able to execute smart contract code. The former are easier to build and can bring huge scalability benefits to the network, so we may see this ‘blob’-based danksharding solution implemented first. It’s a hotly debated issue, and technically complex; for details on danksharding, check out the excellent Hitchhiker’s Guide to Ethereum.

It’s important to stress the difference between sharded Ethereum and blockchains like Aptos, which also achieves parallel execution, but without splitting the blockchain state into shards. Instead, it has a so-called parallel execution engine, called Block-STM. Thanks to this engine, many transactions are processed simultaneously but are only validated at the end - and if there’s a problem, a transaction is aborted and executed again. This parallel model should allow Aptos to achieve 160,000 transactions per second with sub-second finality.

As Pontem Network is building foundational dApps for Aptos (including Pontem Wallet and Liquidswap DEX), we are very interested to see how Ethereum’s eventual capacity and time to finality (TTF) will compare to Aptos. You can learn more from our detailed comparison between Aptos and Sui, another L1 blockchain based on the Move language.

The Merge: how it happened

The Merge was ‘one small step’ for the Ethereum network but a giant leap for the blockchain industry. There was even a Merge viewing party, with 41,000 people in attendance. After the upgrade was finalized, Vitalik congratulated the community:

Minutes after the Merge, miners started switching to Ethereum Classic, which uses the same PoW algorithm (we’ll talk about it later in the article). Soon, Martin Köppelmann (co-founder of Gnosis, the best-known multisig wallet protocol for EVM networks) reported that the network remained remarkably stable.

Normally it took Ethereum miners 12 seconds to add one block; right after the Merge, there were some spikes from 5 to 50 seconds, but less than 300 blocks after the Merge the average block time went back to the standard 12 seconds.

Many exchanges and dApps, including Binance, Coinbase, and Aave, had paused ETH and ERC-20 transactions for the Merge because of a potential fork, disruptions, and volatility. However, the upgrade went very smoothly. There was no downtime and no disruption – a remarkable achievement indeed.

The results of the Merge

The effect on the ETH price

From a trading standpoint, the Merge was a ‘buy the rumor, sell the news’ event. The price of ETH rose 100% from $990 to $1,990 from mid-June to mid-August, then fell from $1,760 to $1,300 between June and September 18 – including a 9% fall on the day of the Merge. It has been trading relatively flat since, reacting to macro-economic events like FOMC meetings and inflation data.

Validators and rewards

The number of validators has been growing steadily, reaching 441k at the time of writing. However, many have also pointed out that ETH staking is now more centralized than ever. Lido Finance, Bitstamp, and Coinbase together control 70% of all ETH staked on the Beacon Chain. Lido alone accounts for 30%.

As for rewards, an average validator can expect to earn between 6.1% APR, according to the analyst  @pintail_xyz. To this, you should add the additional yields from liquid staking, though those  can be hard to predict.

ETH issuance rate: could Ethereum become deflationary?

Before the Merge, the Proof-of-Work execution layer awarded 2 ETH per block or 13,000 ETH per day to miners, while the Beacon Chain distributed 1,600 ETH a day to the stakers.

Post-Merge, the system only  issues 1,600 new ETH per day. At  $1,340 per ETH, the total daily reward is$2,144,000. This is distributed between the validators in proportion to how much ETH they stake. We won’t go into the details of how individual rewards are calculated, but you can read about it here.

Compared to pre-Merge, the annual inflation rate of ETH has gone down from 5% to 0.5%. This is a major check on ETH inflation. Since many investors price crypto assets based on their scarcity, this could be beneficial for ETH’s value.  

There is another factor in play, however: the burn. After the London upgrade in August 2021, part of the Ethereum transaction fees (the base fee) are burned. The burn amount fluctuates depending on the network load.

If the level of activity keeps growing, it’s quite possible that the burn rate will exceed the issuance rate and Ethereum will become slightly deflationary.

ETH energy consumption and gas fees

When the PoW network shut down, the amount of electricity consumed by Ethereum dropped by 99.99%, as did its CO2 emissions. Note that the total amount of energy used by the crypto mining industry decreased by a smaller amount, as many miners simply switched to other coins – but the benefits for the environment are still considerable.

By contrast, the gas fees have gone down just a little bit: from $0.5-$1.5 in early September to $0.4-$1.2..

What did ETH miners do?

Prior to the Merge, the overall hashrate (computing power) of the Ethereum network was around 1 PH/s (petahash per second). One petahash/second means that all the mining devices around the globe generated a quadrillion (one with eighteen zeros) potential solutions to the block’s PoW puzzle each second.

PoW mining ended with the merge. At this point, miners – who had spent thousands of dollars on equipment - had a few options.

1) Switch to mining ETC

Ethereum Classic (ETC) was born as a hard fork in 2015 after the infamous DAO hack. It uses the Ethash algorithm as ETH, so both miners using GPUs and ASICs can switch between ETH and ETC. For Ethereum ASICs (“Application Specific Integrated Circuit” -- a specialized type of mining rig), this is virtually the only option, as they are built to use Ethash and nothing else. And since ASICs accounted for 30% of the network’s hashpower (according to some estimates), the Merge would force these miners out of Ethereum and bring a massive inflow of hashpower into Ethereum Classic.

Indeed, the price of ETC began to rise when the Merge was successfully tested on the Sepolia testnet.  It went from $15 to $44 and stayed above $38 until the Merge on Sep 15.

Indeed, just after the Merge, ETC hashrate hit a new all time high – but began going down soon after, as difficulty automatically increased. The increased competition made it more difficult to find a new block, the profitability of ETC mining dropped, an so for many miners it made no economic sense to stay.

The problem with ETC is that it lacks an ecosystem and a real use case. It’s now in the interests of the large mining pools to give it one, so AntPool invested $10 million in dApp development on Ethereum Classic, but it remains to be seen if ETC can face the competition against other L1s and remain profitable for miners.

2) Switch to mining another PoW cryptocurrencies

Miners who use GPUs (graphic cards) can always replace one software client with another and switch to mining a different PoW cryptocurrency, such as Ravencoin,

However, in the current bear market this is only profitable for those  with access to cheap electricity. For example: an Nvidia RTX 3080 isone of the most popular mining GPUs.  It is capable of 1 million hashes per second.  At $0.2 per kW/h (the national average in the US), you could make between $0.3 and $1 per day based on current ming rewards. The GPU itself costs at least $700, so you’re looking at several years just to break even.

3) Walk away and try to sell the hardware

Instead of mining for pennies, many choose to sell their GPUs in the secondary market – primarily to gamers and often at a loss.

According to Bloomberg, miners spent $15 billion on GPUs in 2021 and the first half of 2022, causing the prices to skyrocket. Many never broke even.

The big GPU sell-off started after the crypto crash in June 2022 and intensified after the Merge. In China, prices dropped by 30-50%, often much lower than the manufacturer price. So, if you are a gamer and always wanted a fancy video card, now is your time to go shopping.

4) Create a hard fork to preserve PoW-based Ethereum

During a major upgrade, some of the miners or validators may choose not to accept it and instead start a new blockchain. The forked chain will contain all the same data as the original chain up until the point of the split – and then continue on its own independent path from there, with completely different transactions. A single tree trunk splits in two.

This is called a hard fork. Ethereum Classic was the result of a hard fork, as wereBitcoin Cash (BCH) and Bitcoin SV (BSV).

The Merge also resulted in a hard fork, where part of the miners decided to keep the PoW mainnet going under the new name EthereumPOW (ETHW). The project went live 24 hours after the Merge. Everyone who held ETH in a non-custodial wallet like MetaMask or on an exchange that supported the Merge was automatically entitled to an 1:1 ETHW airdrop.

While the smart contracts of all Ethereum dApps are formally live on EthereumPOW, their end users migrated to the new PoS Ethereum. In response, the team of ETHW called on developers to submit information on the dApps they would maintain or build specifically on the POW fork. They received dozens of responses, including DEXes, bridges, and memecoins.

EthereumPOW initially gained the support of the Poloniex exchange, which belongs to Tron’s Justin Sun. However, on Sep 15, Poloniex announced that it would instead support a rival fork, called Ethereum Fair (ETF).

After an initial  surge to $58, the price of ETHW dropped to $5. The interest in the forked network declined as users complained that they couldn’t connect to the new chain. As of October 2022, ETHW was trading at $8 and the hashrate remained stable around 40 terahash/s, or 0.004% of Ethereum’s pre-Merge hashpower. As for ETF, it first went up to $20, then dropped to below $2 and is now trading at $1.3 and has a total hashrate below 5 Th/s.

What’s next after the Merge?

The transition to Ethereum 2.0 is far from complete. Speaking at the Messari Mainnet conference in September, Vitalik Buterin outlined the road ahead, with additional stages cleverly named Surge, Verge, Purge, and Splurge. The whole process could take decades according to Vitalik, so we have dozens of important upgrades to look forward to.

The first of them is Shanghai, which doesn’t have a set date yet – or even a set of features that will be implemented. Among the EIPs (Ethereum Improvement Proposals) proposed on GitHub are blob-carrying transactions (an early version of danksharding) and measures to reduce gas fees.

If you were worried that the Merge makes Layer 2s (like Arbitrum or Optimism) and fast Layer 1s like Aptos obsolete, you can relax. It will take years for Ethereum to become a competitively  scalable and efficient blockchain – so there’s plenty of time for alternative blockchain ecosystems to grow.

Aptos is, in our opinion, the most interesting of them, with over 150 projects ahead of the mainnet launch. With its tiny gas fees and near-instant processing, Aptos could really be the blockchain to onboard the first billion users. To learn more about Aptos, follow us on Twitter and Discord – and tune into the weekly AMA livestreams with the Pontem co-founder and Key Protocol Contributor Alejo Pinto.