1. What are the “Proof of” systems for?
Cryptocurrencies wouldn’t work without blockchain, a relatively new technology that performs the old-fashioned function of keeping a ledger of time-ordered transactions. It differs from pen and paper records in that the ledger is shared on computers around the world. Blockchain must perform one more task that isn’t needed in a world of physical money – ensuring that no one can spend a cryptocurrency token more than once by manipulating the digital ledger. Blockchains function without a central custodian, like a bank responsible for the ledger: both proof-of-work and proof-of-stake systems rely on group actions to order and protect a blockchain’s sequential record.
Until the merger, transactions on both the main Bitcoin and Ethereum networks were grouped into “blocks” that were published on a public “chain”, but only after the proof-of-work order was completed. In Bitcoin’s software, this happens when the system compresses the data in the block into a puzzle that can only be solved through trial and error calculations that may need to be performed millions of times. This work is done by miners who compete to be the first to find a solution and are rewarded with free cryptocurrency if other miners agree it works.
3. What are the disadvantages of proof of work?
When Bitcoin and Ether were pennies, mining was cheap. But as currencies rose in value, an arms race of sorts set in as miners poured in resources to mine new coins. The Bitcoin system’s software responded to increasing competition by increasing the computational difficulty of the blockchain puzzles. The resulting sky-high power consumption led to calls from the environmentally conscious to steer clear of bitcoin and ether. The European Union considered banning proof-of-work practices before deciding that cryptoasset providers should be required to disclose the energy use and environmental impact of the assets they want to list. The proof-of-work system has also led to growing dominance through huge, centralized mining farms, a development that has created a new vulnerability for a system designed for decentralization. In theory, a blockchain could be rewritten by a party that controls much of the mining power.
4. What is Proof of Stake?
The idea behind the proof-of-stake system introduced by Ethereum in the merge is that its blockchain can be secured in another way: by giving a group of people a set of carrot-and-stick incentives to participate in the task to work together. Individuals who raise or stake 32 ethers (1 ether traded at around $1,600 on Sept. 14) can become “validators,” while those with fewer ethers can collectively become validators. Validators are chosen to order blocks of transactions on the Ethereum blockchain. When a block is accepted by a committee whose members are called attestors, validators receive ether. But someone who tried to play the system could lose the coins wagered. Ethereum’s Proof-of-Stake system was first tested on a blockchain called Beacon Chain, which was separate from the Proof-of-Work system. The two blockchains were brought together during the merger.
5. What are the advantages of the system?
The move to Proof of Stake should reduce Ethereum’s energy consumption – estimated at 45,000 gigawatt hours per year, or slightly more than New Zealand’s – by 99.9%. In terms of its carbon footprint, it would be essentially like any other internet operation whose energy consumption involves nothing more than running a network of computers, rather than being a corporation resembling a collection of gigantic digital factories.
6. What are its weak points?
Proof of Stake is less battle-hardened than Proof of Work, whose security has been under scrutiny for more than a decade. In this way, new vulnerabilities could be found. There is also a risk that another new player in the Ethereum ecosystem could become dangerously powerful: the so-called builder. Builders package transactions into blocks and forward them to the validators. There are currently more than 420,000 validators, but few builders. If a major provider of crypto wallets, software used to transfer and store coins, decides to send all of its transactions to a specific builder, that builder may be able to censor transactions and charge high prices. Proof-of-stake advocates believe that the risks are worth what would be gained in terms of environmental benefits, and that a wider group of users are involved in the process than was possible than was possible, to become a miner, which could require a lot of effort for specialized computers.
7. What kind of problems might occur during the merge?
Major software upgrades almost never go smoothly. Despite years of testing prior to the merge, various bugs and issues could arise in the weeks and even months following the transition. Some of these issues relate to so-called forks – copies of Ethereum that are expected to appear and will still use miners. Because of these forks, there is a risk of replay attacks, where hackers replay a user’s transaction running on a chain on Ethereum’s main proof-of-stake network to steal coins. While Ethereum has been hardened against such attacks, some applications running on the network may not have the necessary protections built into their code.
8. Will the merger change the Ethereum user experience?
No, merging does not change network transaction costs or speed. But it lays the groundwork for future software upgrades, both of which the platform’s backers hope will improve.
9. If the merger is successful, what does it mean for proof-of-work blockchains?
If the new Ethereum system starts to perform well, it could put more pressure on other proof-of-work systems (Bitcoin’s in particular) to also switch to a more energy-efficient process. Environmental concerns related to such blockchains have long prevented major companies and funds committed to fighting climate change from investing in crypto. Ethereum’s hope is that once the platform becomes more eco-friendly, more institutional investors will take a second look at its coin, Ether, and more developers who have avoided mortgages, gaming, and other uses for the network due to its high energy consumption will relocate. This could potentially lead to what cryptoheads refer to as “flips” — essentially Ether’s market cap surpassing Bitcoin’s for the first time. Before the merger, the value of bitcoin was roughly twice that of ether.
10. How could merger change the economics of ether?
By changing the properties of ether, the merge will make it more reminiscent of yield-bearing securities. According to Tracker Staking Rewards, staking ether will generate a return that is expected to be around 5.2% right after the merger. Coupled with an expected net decline in Ether token supply, possibly a few months after the update, this should make the coin more attractive to investors. Today, only about 11% of ether in circulation is used for staking on Ethereum. After all, around 80% of ether can be staked, which means it will be locked for a period of time. This could have implications for Ether’s long-term pricing and liquidity. The token’s new status as a revenue-generating asset could also prompt financial regulators to treat it as a security, a possibility raised by US Securities and Exchange Commission Chairman Gary Gensler shortly after the merger. Such a designation would allow a more detailed examination.
11. What does it mean that staked ether is locked?
Ethereum has yet to undergo another software upgrade — expected to occur at least six months after the merger — before staked Ether can be withdrawn. Even then, withdrawals are capped. So investors take a lot of risks when locking their ether.
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