If you know anything about crypto, you might have noticed that Ethereum increased in price by almost 40% in July, according to TIME, but why?
Well, it all traces back to the Ethereum Merge.
It is part of a massive upgrade to Ethereum, also known as Eth 2.0. The first phase was the Beacon Chain, and it was launched back in Dec 2020, according to ConsenSys, a blog by the blockchain tech company.
The Merge is the second phase of upgrade, and back in early July, it was announced to happen around September 15, according to Coinbase.
The news of the Merge being less than three months away excited the Ethereum and the broader crypto community and drove up its price. But why is the news such a big deal?
To understand the Merge, we must first understand mining. Currently, Ethereum mining is how a block of transactions is added to the blockchain. People or organizations called miners set up mining nodes, mostly large computers, to validate transactions and compete to add them to the chain.
The competition is a race to solve a difficult math problem. For each new block, the first miner to solve the math problem gets to add its block to the chain. And in return, the miner receives a block reward of 2 Ethereum for each block.
This reward is created out of thin air, or also known as minted. This works out to ~13,000 Ethereum rewarded to miners each day based on the approximate number of blocks every 24 hours according to Etherscan.
Although, it may sound profitable, it requires a lot of electricity to do the calculations that solve the math problems. The miners are pressured to pay for the electricity by selling their Ethereum. In summary, mining uses a lot of electricity, places a downward pressure on the Ethereum price from miners selling, and inflates the outstanding number of Ethereum.
Eth 2.0 will solve these problems. It will switch to something called “Proof-of-Stake.” Instead of having miners competing to produce the next block thru energy intensive math calculations, it will randomly assign the block to new entities called validators. For each block, the validator is given a small reward to validate the transactions.
But how is this different from the miner block reward? Well, the validators earn far less than 13,000 Ethereum per day. To be exact, on September 1 they earned 1,625 Ethereum. As the number of validators increase, the total validator rewards will increase. But it does not increase linearly since as the number of validators increase, the reward per validator will decrease.
For example, even if the number of validators more than double from the current 421,486 to 937,500, the daily validator rewards will only be 2716 Ethereum, which is far less than 13,000 according to Ethhub.
This leads us to our second question: How about the amount of electricity it uses? Well, validators do not need to solve complex math problems. This makes them far more energy efficient, making it possible to run a validator on a laptop. Furthermore, there are no more miners putting a downward selling pressure on Ethereum since they are being replaced by the validators.
So when will the validators replace the miners? As mentioned earlier, the first phase of Eth 2.0 launched the Beacon Chain. It is a chain that uses Proof-of-Stake and validators.
However, it is not validating any transactions to the Ethereum blockchain. All of its blocks are empty. All transaction are still being added by miners. The current Beacon Chain is like an empty train without passengers, testing out the new railroad tracks.
With the Merge, all Ethereum transactions will switch over from being added by miners to being added by the Beacon Chain. The Beacon Chain will finally carry the real load instead of practicing. This will put an end to the 13,000 Ethereum being minted every day.
This has huge impact on Ethereum’s inflation. Some even believe that Ethereum will become deflationary after the Merge, meaning that outstanding Ethereum will slowly decrease in the absence of miner rewards since Ethereum transaction fees are burned.
When the supply of something decreases assuming the same demand, its price will usually increase. And that is what compelled the Ethereum community to bid up its price.