Imagine having to change the engine of a spaceship mid-flight. A similar task is facing Preston Van Loon and a few dozen more developers working on a critical software upgrade to Ethereum, the blockchain underpinning thousands of decentralized applications and ether, a cryptocurrency with a $190 billion market capitalization.
Awaited for years, the upgrade entered its first phase–called Bellatrix–at 7:34 A.M. EST today, setting the stage for the blockchain’s merge with another decentralized ledger named the Beacon Chain and changes in the economics of ether (ETH). If all goes well, around Sept. 15 Ethereum will adopt the Beacon Chain’s method of processing transactions, proof-of-stake, which is approximately 99.95% more energy efficient than the current proof-of-work mechanism.
“We’ve been testing the Merge for maybe a year at this point,” says Van Loon. “We’re not sleeping much in part out of excitement and in part out of a little bit of anxiety because it is such a big deal with so much at stake.”
No major blockchain has faced an overhaul of this scale.
“I consider this the most significant catalyst in crypto history in terms of its magnitude and the fact that ETH is the second largest crypto,” says Travis Kling, chief investment officer at crypto asset management firm Ikigai.
The Merge is “laying the foundation for a more scalable chain, one which is more usable for the general public,” notes Joseph Ayoub, global infrastructure analyst at Citi.
To be clear, users will likely not experience significant changes in the immediate aftermath of the Merge. According to a Citi research report, the time needed to add a new block to the chain will simply drop to 12 seconds from 13.6, “marginally” affecting Ethereum’s transaction processing capacity and fees. Those will improve with a series of further upgrades, according to Ethereum cofounder Vitalik Buterin. “At the end of the roadmap, Ethereum will be able to process 100,000 transactions per second,”— more than the current 15—Buterin promised at the Ethereum Community Conference in Paris in July.
What will change fundamentally, however, is the nature of ether, Ethereum’s native cryptocurrency. Ethereum’s transition to proof-of-stake solidifies ether as a yield-bearing asset (the network’s validators currently earn about 4.2% annually) and is expected to reduce ETH’s issuance, coincidentally also by 4.2% a year, improving the asset’s prospects as a store of value, according to Ayoub.
Matt Hougan, chief investment officer at Bitwise Asset Management–which runs the world’s largest crypto index fund–belongs to a sizable group of investors who think ether could soon become the most valuable cryptocurrency. In addition to the new economic model, Ethereum’s transition to carbon near-neutrality could draw a horde of institutional investors who worry about environmental mandates. “It’s entirely possible that we’ll see ethereum flipping bitcoin at some point in the future,” he says. “It is going after, in my view, a larger addressable market.” For now, ether’s $190 billion capitalization trails bitcoin’s $381 billion in a crypto market worth just below $1 trillion. The stablecoin tether follows well behind at $67.5 billion
That said, “anyone who’s expecting the Merge to happen on Sept. 15 and ETH price to double, I think, will be sorely disappointed,” Hougan warns. “If you look at other pre-planned events in crypto, like bitcoin halving, there’s often a sell-the-news phenomenon in the weeks surrounding the event.”
If the Merge is successful, Ethereum would get much closer to its original vision of “the world computer,” but what could go wrong?
“Anything,” acknowledges Van Loon. “Software is fallible, humans are fallible. We’re anticipating and ready for any kind of activity, any kind of chaos.” He says there could be operator errors or bugs that make a protocol more difficult to run but is optimistic: “We think that since we have such a variety of software, we have alternatives. It’s like if your rocket ship exploded on launch after you’ve tested it a million times but you have another rocket that you can use. It will take a few weeks to pick up the pieces, something like that.”
Ayoub points to the risk of another delay or a fork. The latter would essentially be a blockchain split, it would allow the miners to decouple from Ethereum post-Merge and attempt to preserve the proof-of-work version of the chain. After all, once Ethereum fully transitions to proof-of-stake, they will lose their source of income. In that case, new tokens might get created, but it remains unclear how much they could be worth or if they would be accepted by vendors in the same way ether is.
All major crypto exchanges including Binance, Coinbase, Kraken and FTX announced that they plan to briefly pause deposits and withdrawals for ETH and Ethereum-based tokens at various points during the Merge, though spot trading will largely remain unaffected.
“Whatever the outcome may be, whether there’s a new token created, whether there’s an airdrop [ether holders could get free tokens equal to their ETH balances in case of a fork], we want to make sure we open up spot markets as soon as possible. There’s less risk there,” says Haider Rafique, chief marketing officer at cryptocurrency exchange OKX. “Naturally, there’s more risk on the derivative side, not just in terms of how the configuration is handled, but also on our side. Can we support it from a treasury standpoint? For derivatives, we need a little more information.” The pause in deposits and withdrawals is necessary to make sure that order books are calibrated and that all systems are operating properly, he explains.
“We’re not risking customer funds during that journey,” says Rafique. “We know that anything can happen until the Merge actually takes place.”