Cryptocurrency investors are bracing for a big change this week that could alter the future of digital assets, as Ethereum gets ready to upgrade its system with “The Merge.”

A post on the Ethereum.org website states this will be the “most significant upgrade in the history of Ethereum,” claiming the new technology is more secure and environmentally friendly.

With the “The Merge” expected to take place on Wednesday, here’s what you need to know about it and how the transition could alter the future of crypto.

 

ETHEREUM 101

Ethereum is blockchain technology that facilitates cryptocurrency transactions. The decentralized network has its own digital asset called ether that individuals can use to send money directly to someone else, without a government agency or company.

According to the Ethereum.org, it moved US$11.6 trillion in 2021.

 

WHAT’S 'THE MERGE'

“The Merge” is basically like the next generation of Ethereum. On its website, the decentralized network uses an analogy of a spaceship that’s switching out its engine for a better one, mid-flight.

It will be merging the Ethereum Mainnet with the new Beacon Chain, and the change will set “the stage for future scaling upgrades.”

But, the main takeaway is that with this update, Ethereum will be transitioning to a new consensus, which is used for a network of computers to work together and stay protected.

It will be implementing a proof-of-stake (PoS) system, which is said to be “more secure, less energy-intensive, and better for implementing new scaling solutions,” than the previous proof-of-work (PoW) system.

According to Ethereum.org, the PoW system that’s being phased out, allows miners to “increase their odds of success by investing in more powerful hardware, creating conditions for an arms race with miners acquiring increasingly power-hungry mining equipment.”

But with the new PoS system, validators (which have the same function as miners) will use their personal ether as collateral.

“This staked ETH [ether] can be destroyed if the validator misbehaves, with more severe penalties for more nefarious actions,” a website post said on Ethereum.org.

“This strongly incentivizes active and honest participation in securing the network without requiring large energy expenditure.”

Lin William Cong, associate professor of finance at the Rudd Family Professor of Management with Cornell University and director of FinTech at Cornell Initiative, said this move will lower the bar to entry, as individuals only need to load three programs and stake their own ether in order to activate validator software, which “likely makes validation more decentralized.”

“It would be a milestone for PoS, which is more environmentally friendly, because the second-largest blockchain is adopting it,” Cong said over email. 

 

CUTTING ENERGY USAGE

A common, controversial issue in cryptocurrency is how much electricity is involved in digital mining and transactions.

According to the Digiconomist, a website focused on cryptocurrency sustainability, as of Sept. 13, Ethereum’s annual power consumption is comparable to the country of Chile and its’ carbon footprint is as big as Finland’s. As for a single transaction, it’s equivalent to powering an average U.S. household for 7.19 days.

Cong said the energy efficiency-side of Ethereum’s update is the most exciting part for fintech experts.

On the decentralized network’s website, it says that “the Merge” will help reduce the blockchain’s energy consumption by around 99.95 per cent.

In a note to clients Friday, Bank of America analysts Alkesh Shah and Andrew Moss said the PoS shift could also drive institutional adoption.

“The significant reduction in energy consumption post-Merge may enable some institutional investors to purchase the token that were previously prohibited from purchasing tokens that run on blockchains leveraging proof of work (PoW) consensus mechanisms,” Shah and Moss said.

Institutional investors would now be able to earn a “a higher-quality yield (lower credit and liquidity risk) as a validator” instead of earning a return from "black-box lending/borrowing applications."

 

THE IMPACT ON ETHER

Ethereum.org is warning users “do not need to do anything with your funds or wallet before The Merge” and “no action is required to upgrade on your part.”

But, it’s warning crypto traders should be on the lookout for scammers looking to take “advantage of users during this transition.”

Cong said it’s unclear how “the Merge” could impact the price of ether in the short-term, but in the long run it’s a meaningful move for cryptocurrency.

“The risks of hiccups as well as the benefits from PoS should all be priced in because the merge is public news. But market sentiments could cause under- or over-valuation,” Cong said.

“However, it’s going to have a big impact for the E in the ESG of cryptocurrency. As more institutions and regulators start to care about the sustainability aspect, the Merge would be a useful pilot.”