Proof-Of-Stake: Will The Ethereum Merge Really Lead To A Rally?
- The Ethereum merger is finally complete as the cryptocurrency switches to the proof-of-stake (PoS) mechanism for verifying transactions on the blockchain.
- There are concerns now that the SEC could introduce regulations on proof-of-stake cryptocurrencies, which would impact almost the entire crypto space, aside from Bitcoin.
- The price of Ethereum has dropped since the merge due to fears of possible regulation.
You may have heard about the Ethereum merger over the past few weeks. The merge refers to the long-awaited upgrade from a proof-of-work mechanism to the proof-of-stake model. The move was supposed to fix some of Ethereum’s problems by improving transaction speed and making transactions cheaper. However, it appears that the price has dropped since the transition went through on September 15.
Ethereum is the second largest form of cryptocurrency based on market cap, trailing only Bitcoin. So when something happens to Ethereum, it impacts the entire cryptocurrency space.
We’re going to look at what proof-of-stake is all about and what the merge means for Ethereum investors.
Why did Ethereum merge?
A major criticism of cryptocurrency is that it has a negative impact on the environment. The White House has been calling for crypto mining standards to reduce energy usage. With the government in China cracking down on crypto mining, the US has become a hub for miners. The White House administration has gone as far as to float the idea of exploring possible options to limit energy-intensive mining, like Bitcoin, if the process doesn’t become greener.
The major issue with mining crypto is the amount of energy required to verify transactions on blockchains that require proof of work. Ethereum decided to shift from the energy-intensive proof-of-work to the more environmentally friendly proof-of-stake system. The Ethereum Foundation has claimed that the transition reduced Ethereum’s energy consumption by 99.95%.
The actual Merge went like this. On December 1, 2020, Ethereum launched a separate proof-of-stake Beacon chain. On September 15, 2022, the original Ethereum Mainnent merged with the Beacon Chain to exist as one chain.
This merger is positive news for those who are socially conscientious investors because of the significant decrease in energy consumption. The merger should make it easier to introduce upgrades to the network in the future. However, lower fees haven’t come into effect on the Ethereum network yet.
What is Proof of Stake?
The proof-of-stake concept is fairly technical, and we did our best to break it down in a previous post here. Cryptocurrencies are decentralized, meaning they don’t have the control of a financial institution to verify transactions. This is why many cryptos either use proof-of-stake or proof-of-work to validate crypto transactions. Both are essentially different algorithms that allow users to add transactions and record them on a blockchain, an immutable public ledger.
Before the merge, you had to go through the energy-intensive process known as proof-of-work (PoW) to create Ethereum tokens. PoW is the original consensus mechanism for verifying transactions that Bitcoin used. Under the PoW mechanism, miners compete to solve complex mathematical problems. Whichever miner solves the problem first is allowed to add a block of transactions that earns them rewards. The consequence of this process is that mining devices worldwide compute the same problem, which uses a substantial amount of energy since mining requires lots of electricity.
The proof-of-stake mechanism allows users of crypto to stake their crypto on the blockchain so that they can create their own validator nodes. The validator stakes their crypto on the network for a set period in order to be allowed to verify transactions. The PoS protocol chooses a validator node to check a block of transactions for accuracy. The node then adds the accurate block to the blockchain in exchange for crypto rewards. On the flip side, if a validator adds an inaccurate block, they lose some of their staked crypto.
Proof-of-stake requires validators to have an actual stake in the blockchain. So to become a validator on the network, one must put up a decent investment (32 ETH). The PoS protocol selects the users known as “validators” to verify transactions on the blockchain. Legitimate and accurate validations are rewarded with new ether blocks. This means that you need more than a decent graphics processing unit (GPU) to be a validator on the network now.
Many Bitcoin supporters still feel that proof-of-work is more secure and that the blockchain shouldn’t switch over. Ethereum, on the other hand, has been talking about this move for many years now. Another concern with the PoS protocol is that the voting control could be in the hands of a few key players who are able to put up more Ether to stake in the first place.
How did the Ethereum merge go?
From all accounts, it appears that the actual merge on September 15 went just fine, despite concerns from various experts. However, many users may have had high expectations that simply haven’t been met yet. Left unfixed by the merge were Ethereum’s high fees and congestion. Some are saying the merge only laid the infrastructural foundation for future solutions to these issues. There’s hope that quicker transactions and a reduction in fees could lead to more investors on the Ethereum network.
The price of Ethereum dropped in value after the merger. The price was down about 20% around the morning of September 21 (1,245.65) and has now risen more than 5% per share since.
Nothing changed drastically for Ethereum users since The Merge was just an infrastructure upgrade. This means that wallets, addresses, and transactions still work the same. So if you had Ethereum in your trading account – or wallet – it’s still there, right where you left it. Ether, the cryptocurrency that’s native to the Ethereum blockchain, will continue to trade on all platforms.
However, investors must watch out for possible scams. Many are popping up on social media targeting crypto-users in general. Be alert for fishing scammers posing as crypto exchanges or crypto wallets sending you instructions or requesting information.
The network should theoretically become safer now that it’s now more expensive to validate transactions on the blockchain. If you want to activate validator software, you will have to stake 32 ETH (a hefty price that fluctuates depending on the price of 1 ETH). This should be a big enough barrier to ensure security.
What does the Ethereum Merge mean for investors?
Ethereum investors are concerned after the head of the SEC, Gary Gensler, indicated that the cryptocurrency could be considered a security now just a day after the merger. Gensler’s comments on the staking rewards were, “From the coin’s perspective, that’s another indication that under the Howey Test, the investing public is anticipating profits based on the efforts of others.”
Many investors are now worried about the future classification of Ethereum. While the SEC still hasn’t made an official statement on whether they consider Ethereum a security instead of a commodity, it’s very alarming news that could shake the entire crypto space.
If Ethereum were to be considered as a security, then ether and every application on the blockchain would have to get registered with the SEC. It would also mean that Ethereum was trading as an unregistered security for a long time which could lead to some hefty fines for Ethereum and possibly the platforms that allowed trading. Registered securities must disclose their management team, provide financial information, and share potential risks.
Why does the SEC care about Ethereum now?
Proof of stake means that users can earn ether by locking their coins in to validate transactions. When you validate with your coins, it’s believed to indicate that investors are expecting profits based on the efforts of others. The SEC didn’t specifically mention Ethereum, but the timing led to people getting worried about the future of Ethereum.
As you can imagine, all of this drama with the SEC could lead to serious issues. We can’t comment much on the topic until further announcements are made, but this news has continued to impact the already damaged prices of crypto.
How does the Merge impact cryptocurrency?
The cryptocurrency space has been concerned with how SEC regulations could impact the market. If this merger were to lead to SEC regulations, it would shake the entire crypto market. Increased scrutiny and regulations have also been an ongoing fear for crypto enthusiasts.
Cardano and Solana are already using the proof-of-stake method. If the SEC were to crack down on Ethereum, this would set an unwanted precedent for the rest of the cryptocurrency space that uses a proof-of-stake system, and undesirable regulations for decentralized cryptocurrency.
How should you invest?
It’s important to remember that investing in any form of cryptocurrency is risky as it’s still a volatile asset. The price of Ethereum hit a record high of $4,865.57 in November of 2021, according to CoinDesk. The digital currency Ether is down 63.21% in 2022 as the crypto market has experienced high volatility and severe downward swings since the beginning of the year.
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