This article was compiled and organized by BlockWeeks
An Ethereum upgrade that has taken seven years and gone through several name changes is now entering the final stage of testing and development. In Ethereum's history, this upgrade has been called Serenity, Casper, Shasper, and Ethereum 2.0, and is now named "The Merge." It will completely restructure Ethereum's core consensus protocol—the underlying rules that determine how transactions are validated and how blocks are produced: replacing the existing proof-of-work (PoW) with proof-of-stake (PoS).
As the most complex and radical code change Ethereum has seen to date, the Merge is expected to strengthen the value narrative of ETH across three dimensions: an environmentally friendly asset, a store of value, and a productive asset capable of generating cash flow.
Energy consumption cut by 99.9%: miners exit, validators take over
The primary motivation for moving away from PoW is to reduce energy consumption. Developers estimate that after the Merge is completed, the Ethereum network's electricity consumption will drop by more than 99.9%. The path to achieving this is to make "mining" a thing of the past on Ethereum: block production will no longer be done by miners but by validators, and node operators will need to stake 32 ETH (about $3,000 at the time of writing) with the network as collateral. Unlike other PoS chains, a single node operator can stake in integer multiples of 32 ETH, thereby running multiple Ethereum validators.
By shedding its reliance on PoW mining, Ethereum will for the first time have an "environmentally friendly" narrative that Bitcoin cannot match—the latter, as the world's earliest and largest cryptocurrency by market capitalization, has a security model built on PoW mining.
Supply: from continuous issuance to deflation
What the Merge directly impacts is Ethereum's issuance mechanism. Currently, the vast majority of new issuance occurs on Ethereum's existing PoW chain, that is, the execution layer (EL): miners receive a fixed reward of 2 ETH per block, equivalent to about 13,292 ETH per day. In addition, the PoS network known as the Beacon Chain—that is, the consensus layer (CL)—also issues a small amount of ETH. The Beacon Chain has been live and continuously issuing since December 1, 2020, and its issuance depends on the number of active validators online and participating in consensus: the more ETH staked, the more rewards the consensus layer distributes.
Another variable affecting the current growth of Ethereum's supply is burning. EIP-1559, implemented in August 2021, stipulates that the minimum ETH fee paid in network transactions will be permanently removed from circulation. Assuming about 11 million ETH has been staked in the consensus layer and about 4,000 ETH is burned per day, ETH's daily new issuance is expected to be 10,803 ETH, corresponding to an annualized supply growth rate of about 3.32%.
After the transition to PoS, the portion of issuance from miners' daily output will disappear, and Ethereum's ETH supply is expected to shift from year-over-year growth to deflation and overall contraction. This will further consolidate ETH's narrative as a "store of value."
Staking economics: higher yields, more liquidity
After the Merge, the revenue structure for validators will undergo substantive changes. With the addition of two revenue streams—priority fees and maximal extractable value (MEV)—validator rewards are expected to more than double. This means the return on staking ETH will become more volatile, more liquid, and more substantial, thereby strengthening ETH's positioning as a "productive asset"—one that can generate yield and cash flow like a perpetual bond, rather than merely being "fuel" consumed when interacting with dapps.
Based on this, BitMEX co-founder Arthur Hayes predicts that the premium of liquid staking derivatives relative to ETH will grow increasingly larger. However, whether such trends materialize still depends on whether staking derivatives can efficiently and reliably track the underlying value of staked ETH, especially during periods of fluctuating performance among validator node operators. To date, Ethereum staking yields have been stable, but they sit at the lower end of the yields users can obtain on other PoS chains.
At the same time, as ETH's use as dapp fuel competes with its use as a yield-bearing, bond-like asset, Ethereum's progress on its scaling roadmap after the Merge will be particularly noteworthy. Developers plan to expand transaction throughput through Layer-2 networks and rollup technology, both of which will further abstract dapp activity away from Ethereum's execution layer and consensus layer.
In addition to a possible decline in ETH's velocity of circulation, decentralized staking-as-a-service providers are expected to gain higher adoption and attention, because they play a key role in maintaining the long-term health and security of Ethereum as a PoS protocol. Several campaigns to promote client software decentralization have already achieved substantive results during preparations for the Merge: in January 2022, 68% of Ethereum validators ran the Prysm consensus layer client; after sustained calls from community members such as Superphiz, this proportion fell to 61% within four months. Liquid staking service provider Lido has also committed to advancing more thorough decentralization.
Little change in user experience, no need to migrate assets
The Merge mainly affects Ethereum stakeholders who interact directly with the consensus layer—whether to obtain data or earn network rewards. From a user experience perspective, the way transactions and decentralized applications (dapps) are executed will not change: user API endpoints, application toolchains, and especially network fees are expected to remain largely as they are. In addition, exchanges, custodians, and users who hold ETH directly on the Ethereum chain will not need to transfer assets or change how they access funds after the Merge, and the operation of smart contracts and externally owned accounts will likewise remain unchanged.
The only scenario that could affect users' ETH holdings is if some pre-Merge PoW version of Ethereum continues to be developed and mined after a hard fork. If that happens, users can still access their ETH on Ethereum as before, while also being able to access tokens on the PoW version in a manner similar to how ETH holders received equivalent tokens through Ethereum Classic (ETC) after the 2016 DAO fork. However, given the PoW version of Ethereum's lack of developer and user support, the likelihood of a long-term network split caused by the Merge is considered extremely low.
The Merge is not the end, but the beginning
Developers have not yet determined the specific total terminal difficulty (TTD) for the Merge, and activation is initially estimated for summer or early autumn 2022. If subsequent testing uncovers unexpected bugs in the code, both the Merge and the difficulty bomb may be further delayed.
The Merge is far from Ethereum's last major upgrade. After successful activation, the network will also see hard forks such as Shanghai, bringing more improvements including better scalability and EVM optimization. One of the significances of the Merge is precisely to free up core developers' time and energy to focus on more pressing network issues such as scalability and statelessness.
Risks: unprecedented complexity and centralization concerns
Never before has any blockchain of comparable scale completely replaced its core consensus protocol. Such a drastic underlying overhaul inherently carries technical risk. In addition, PoS networks generally face centralization risks from large token holders such as exchanges and staking pools. Moreover, the complexity of the Ethereum protocol has been accumulating since its first hard fork in 2015, and the two-layer network structure brought by the Merge will continue to add to it.
Therefore, the impact of the Merge is a double-edged sword: it is expected to strengthen ETH's investment narrative as an environmentally friendly crypto asset, a store of value, and a productive asset, but it also comes with significant complexity and technical risk.
