While the “Merge” is undoubtedly good news for the environment, it brings other problems to the surface.
The Ethereum blockchain last month completed the long-awaited and promising “Merge“, a technical change in the way it operates.
It is one of the most widely used digital universals in the world and the main platform for Web3, NFTs and decentralized finance (DeFi).
However, while the “Merger” is undoubtedly good news for the environment, it brings other problems to the surface.
As a reminder, blockchain is based on what is known as a “consensus mechanism”. Prior to Merger, Ethereum used the “proof of work” consensus mechanism, with so-called “miners” using massive amounts of electricity to power computers, which solve complex mathematical problems to add transaction blocks to the blockchain.
The miners are then compensated with cryptocurrencies for their work.
The bitcoin blockchain still does it this way. Verifying bitcoin transactions requires more energy than countries like Norway.
In areas where a lot of bitcoin mining takes place, local populations suffer from rising energy costs and noise pollution.
Ethereum’s shift
Ethereum’s shift to the “proof of stake” protocol reduces these environmental costs. Ethereum now uses an algorithm that randomly selects someone to create a new block to add to the blockchain. Also, the more someone stakes in Ether, Ethereum’s native token, the more likely they are to be selected to create the new block.
This creates incentives to acquire more and more Ether, so it seems reasonable to predict that any blockchain based on the proof of stake protocol “concentrates” transaction processing capacity in a few hands.
Staking is already a highly concentrated business involving some of the largest companies in the industry, such as Coinbase, according to data provider Nansen. More centralization seems inevitable.
However, it should be pointed out that the whole point of having a blockchain with a consensus mechanism is to avoid centralized intermediaries to verify transactions. Without meaningful decentralization, one has to wonder if all the other problems associated with Ethereum are worth solving.
Congestion
For example, the Ethereum blockchain receives a lot of criticism for congestion during peak hours, which manifests itself in slower transaction processing times and fluctuating transaction fees (known as “gas fees”).
During peak periods, gas fees can be prohibitive for users trying to complete smaller transactions (in May 2022, average daily gas fees reached nearly $200), and the Merger did not change the way gas fees are calculated or charged.
Paying up Validators
Such congestion adds another problem. Users can pay validators higher commissions for performing their transaction first on a block. This is a cost that benefits the larger validators who will be selected to create more blocks and, therefore, have more revenue.
A validator may even enter their own transaction before others in order to take advantage of market movements, a practice known as MEV or “maximum exportable value”.
Extensive Security Claims
The Merger will also not make the blockchain more secure. Claims that it will do so assume that the Merger will increase decentralization. But, if the reverse is true, there are risks. A report from the US Defense Advanced Research Projects Agency found that the blockchain can be manipulated if the number of validators is too small.
Legal Uncertainties
The shift to proof of stake also increases legal uncertainties. Prior to the merger, US Senator Debbie Stabenow proposed a bill that listed Ether as an example of a “digital commodity” that does not fall under the jurisdiction of the SEC (in the US, securities are regulated by the SEC, while Commodity Futures Trading has oversight of commodity markets).
So now that stakers are raising Ethereum in hopes of being compensated by the Ethereum blockchain’s gas fees, the SEC may have something to say about…
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