Illustration by II
Forget financial performance and forget the fire hose of metrics regularly pumped out by the cryptocurrency industry. Ever since cryptocurrencies captured the imagination of investors a few years ago, the market has been driven by stories, not data.
First came the narrative that Bitcoin was destined to become a new form of money in a digital global economy. Then there was the pitch that decentralized finance, or DeFi, would sideline banks and the rest of the old guard and deliver consumers better ways to manage their assets.
Now comes the latest story. It’s called the Merge, and while it may sound like the title of the latest Netflix sci-fi series, it’s actually a sweeping redesign of the blockchain network that underpins Ethereum, the most valuable cryptocurrency after Bitcoin. Like most things in crypto, the Merge is arcane and technical. And yet it presents institutional investors with a simple question: Will this development finally demonstrate the utility of cryptocurrency — or is it just another dose of hype?
There’s a lot at stake. The cryptocurrency market has lost more than half its value this year and has been rocked by the failures of some major ventures, including Celsius and Terra, which vaporized more than $60 billion in market capitalization over a few days in May. Meanwhile, U.S. authorities are sanctioning popular platforms for alleged money laundering as part of a broad clampdown. The bad tidings have plunged the industry into its worst crisis of confidence since the crash of 2018, leaving even seasoned crypto figures in a deep funk.
“The window of opportunity for DeFi to prove that it is worthy of … being considered a public, neutral financial utility rather than regulated as banks has now closed,” said Rune Christensen, founder of MakerDAO, a leading crypto lender, in a recent blog post. “DeFi failed to deliver anything of real value, and the massive crashes of Terra, Celsius, etc. ruined its mainstream image.”
The Merge can change all that. At least, that’s the hope.
In the run-up to its launch on September 14 at 9:30 p.m. Eastern time, crypto social media channels have brimmed with anticipation that the upgrade will kickstart a glorious new period of mass-market adoption. Most intriguingly, the change is supposed to erase Ethereum’s carbon footprint and make it a green, ESG-worthy digital asset, in contrast with Bitcoin, which consumes as much power annually as the country of Pakistan. Even as the Federal Reserve’s interest-rate hikes have spurred investors to take risk off the table, Ethereum’s token, Ether, has soared 39 percent in the third quarter, compared to a 7 percent fall in Bitcoin’s price.
“This is the most significant catalyst in crypto history in terms of its magnitude,” Travis Kling, founder and chief investment officer of Ikigai Asset Management, a crypto investment firm, said on a recent podcast. “But there are many risks going into this Merge in terms of price, technical design risk, technical implementation risk, hack risk, illiquidity risk . . . . There’s a lot of risk.”
Now is the moment for Ethereum’s supporters to bolster the value of their network, and cryptocurrencies as a whole. Yet what exactly is the Merge?
In a nutshell, the upgrade changes the way Ethereum processes transactions and adds data to its online ledger, or blockchain. For the last seven years, Ethereum has employed the same approach as Bitcoin. Called proof-of-work, the process entails cryptocurrency miners competing to solve complex mathematical problems. The winners get to add blocks of data to the chain and reap Ether as a reward. Because this is a race, miners harness as much computing power as possible. That’s why these outfits run vast server farms in China, Kazakhstan, and the U.S., the countries that dominate crypto mining. More than three-quarters of China’s electricity comes from burning fossil fuels, according to the Center for Strategic and International Studies.
Now Ethereum is about to switch to an alternative way to maintain its blockchain, called proof-of-stake. Instead of mining, the approach relies on so-called validators to stake their Ether tokens into pools and work together to evaluate and add new data blocks to the network. The upgrade is called the Merge because it will fuse Ethereum’s main network with the Beacon Chain, a proof-of-stake system developers have been using to test the technology.
Big upgrades are meant to fix big problems, and Ethereum has been hit with a load of issues as it’s grown in popularity. For starters, Ethereum has struggled to cope with the demand to process financial transactions as a host of other crypto platforms have piggybacked on its network. Ethereum can only handle a measly 15 transactions per second, compared to more than 2,300 at Solana, one of a bevy of would-be Ethereum-killers that have cropped up in the last year or two. Meantime, Visa, the global credit card and payments giant, says it’s capable of processing 65,000 transactions per second, though in practice it handles about 1,700.
Ethereum is also expensive to use. The average transaction cost on the network has been running between $2 and $5 since early August, and the level spiked to more than $30 earlier this year, according to Messari, a crypto data provider. That’s just too pricey to win over mainstream users. By comparison, Solana transactions cost just 25 thousandths of a cent. Given that DeFi is supposed to provide consumers with a cheaper and more efficient way to manage their money, Ethereum’s limitations are a deal-breaker. And this is a key reason why investors continue to see Ether as a speculative asset instead of one that reflects real business value. Its long-term prospects are super fuzzy.
It’s little wonder then that the Merge has the cryptocurrency’s supporters so excited. The idea is that the shift to proof-of-stake will solve Ethereum’s problems in one fell swoop. After all, Solana uses a variation on the proof-of-stake approach to notch its high speeds and low transaction costs. And so, too, do a bunch of other blockchain networks, including Cardano and Polkadot, both of which were set up by co-founders of Ethereum.
Yet here’s the rub: The Merge won’t make Ethereum more efficient, at least not yet. That’s a misconception, says the Ethereum Foundation, the Switzerland-based organization that governs the network. The Merge isn’t designed to expand the network’s capacity, so fees and transaction speed will remain pretty much the same. The big change will be a 99.95 percent reduction in the Ethereum blockchain’s energy consumption, the foundation says.
That’s no small feat. By dropping crypto mining, Ethereum may become a prime ESG candidate for responsible investors looking for green crypto assets.
“The reduction in consumption is a huge improvement,” says Timo Lehes, a co-founder of Swarm, a Berlin-based crypto exchange. “Whether institutions now class Ether as an ESG asset depends on criteria. If energy efficiency is part of a company’s ESG criteria, Ethereum 2.0 would arguably fit the bill.”
Even so, the Merge is bound to differentiate the cryptocurrency from its older, carbon-spewing sibling Bitcoin.
Make no mistake, decoupling from Bitcoin has been the dream of Ethereum supporters for the better part of a decade. It drives them crazy that Ethereum continues to be joined at the hip with Bitcoin. Designed to be a global currency free of interference from central banks, Bitcoin has proved anything but. In the last year, the token has utterly failed to be a hedge against inflation and interest-rate policymaking — a core value proposition. Bitcoin moves in lockstep with the stock market, which begs the question: What’s the point of investing in it?
Ethereum’s developers, meanwhile, are still laboring to produce software that supports all manner of applications and smart contracts, programs that automate transactions and agreements. Think of it like an operating system for crypto. While mass-market acceptance still looks quixotic, the Ethereum community is committed to building technology that can be valued and judged like a business.
This is only the first stage in Ethereum’s narrative, as Vitalik Buterin, the 28-year-old co-founder and primary architect of Ethereum, pointed out at a conference in Paris last month. He told his audience that Ethereum was only about 40 percent complete. Buterin also said the Merge would be followed by at least four more phases of upgrading and expansion, dubbed the Surge, the Verge, the Purge, and the Splurge.
Silly? Yes, perhaps. Still, Buterin assured the room that Ethereum would get to a point where it could process 100,000 transactions per second. “At the end of this roadmap, Ethereum will be a much more scalable system,” he said.
There’s little doubt the Merge is going to be anticlimactic when it goes live on September 14. Traders are probably running up the price of Ether to profit from anticipation. When you compare the arc of Ethereum’s narrative to those of other technology breakthroughs — the internet browser, broadband, streaming, fintech — it’s clear the first act of this story is still well under way. The Merge will be a test, but by no means the denouement.
