It has been eight years since Ethereum founder Vitalik Buterin began developing the cryptocurrency software upgrade known as “the merge,” but now, the new project that plans to cut carbon emissions by more than 99% is ready to launch in September, and the crypto world is going ballistic.
The upgrade plans to shift from the traditional transaction verification system, called ‘proof of work,’ currently used by many major cryptocurrencies, such as the likes of, Bitcoin, Ethereum and Dogecoin, to this new concept, called ‘proof of stake,’ which will soon leave the other cryptocurrencies stuck in the past.
Ethereum officially launched into the crypto world on 30 July 2015, with the main aim of creating a network that would run on decentralised smart contracts, essentially eliminating the ‘middle-man’ in transactions, so that all parties can immediately be certain of the outcome, without any intermediaries’ involvement or time loss.
Now, its native cryptocurrency Ether has the second largest market capitalisation, behind Bitcoin, in which its market capitalisation is larger than Coca-Cola and Nike.
Currently, the ‘proof of work’ concept underpins many major digital currencies in the crypto world.
First founded in 1993, and then later popularised when used as a key mechanism for Bitcoin in 2009, the ‘proof of work’ concept enables consensus to be reached between many participants on a network, as well as a way to secure and solidify the Bitcoin blockchain.
When there is a cryptocurrency transaction from one user to another, a block representing that transaction is created, and that’s when the ‘proof of work’ concept begins.
The block is sent to a distributed network of participants, known as miners, who race against each other to solve the virtual puzzle of validating this incoming transaction and then add it as a new block on the existing blockchain.
The other miners in that network validate the transaction once it has been solved.
In exchange, the miner who solves this puzzle, is rewarded with a certain amount of the cryptocurrency used in the transaction.
And it is a profitable business.
Bitcoin miners receive 6.25BTC, or roughly A$183,884 at today’s price, as a reward for solving the arbitrary mathematical puzzle. A bitcoin mining algorithm is solved every 10 minutes, on average.
By incentivising the miners with hefty rewards, the ‘proof of work’ system provides a decentralised method, which has a high level of security for every transaction.
Amaury Sechet, founder of the cryptocurrency eCash, also agrees, stating, “It’s a consensus mechanism that allows anonymous entities in decentralized networks to trust one another.”
However, it has some major flaws that only worsen over time.
These online puzzles become progressively harder to calculate as more of them are solved, as there are more security measures surrounding them, requiring additional funding, software, and equipment, to complete the algorithm.
Below is an image of the mining farm of Hive Blockchain Technologies Ltd.
Source: Midas Letter Live, ‘Hive Blockchain Technologies Reacting to Strong Bitcoin Rally’
And these big mining farms have huge levels of energy consumption.
Currently, the mining consumption for Bitcoin is at around 130 Terawatt Hours per year — 0.55% of global electricity production, or roughly equivalent to the annual energy usage of Sweden, according to Alex de Vries, a Dutch economist who operates the Digiconomist website.
Mr. de Vries estimates that the Ethereum mining consumption is slightly lower, at 72 Terawatt Hours a year.
Another point to add is that the reward for crypto miners follows the volatile nature of the crypto markets, in which currently the prices are significantly lower year on year. This has devasting potential to reduce the safety of the system if members become less enticed.
So, a new and improved system is necessary in helping to control the high levels of energy consumption and the financial costs associated with crypto mining.
The ‘proof of stake’ system eliminates all these issues, including speeding up the processing of transactions, thus reducing the bottlenecks that have led to networks crashing in the past. However, the system does not address some of the broader issues that underpin the crypto market space, which could act as a potential hindrance to the share price of Ether soaring.
The ‘proof of stake’ system involves a random election process, whereby one participant is selected to validate the transaction, eliminating participants from mining the blocks, and hence, removing all financial and environmental costs associated.
But not everyone can be selected. Participants must stake a certain amount of Ether into a network to be chosen.
And the size of the stake determines the chances of being selected. The higher the stake, the higher the chance.
If a participant is chosen to validate, they must check if all the transactions within it are valid, and if so, they then add it to the blockchain.
In exchange the participant receives all of the fees from the transactions that were in the block.
All in all, Mr. De Vries believes that by switching to this new system, there would be a 99.9% reduction in energy usage, which translates to the electricity consumption of Portugal.
And with soaring global energy prices, massive cost reductions will arise from the participants staking ether, as opposed to cryptocurrency mining.
Despite other cryptocurrencies including Cardano and Solana already implementing ‘proof of stake,’ none have done so on this scale, leaving the bigger crypto player – Bitcoin – facing criticism for its heavy reliance on the outdated and environmentally hazardous ‘proof of work’ system.
Although this system is an advancement from ‘proof of work,’ the concept still has some flaws, and its overall impact may be irrelevant due to the volatility of cryptocurrency itself.
- It is in its infancy stage. Because of this, there will be higher levels of confusion and an increased level of scam activity. “You should be on high alert for scams trying to take advantage of users during this transition,” Ethereum states.
- It is complicated. There are a lot of steps required for the average user. Participants must download the software, figure out how it is supposed to be run, obtain a wallet to stake Ether, and then do some more learning to secure the Ether.
- Lack of decentralisation. Participants with larger amounts of stake in the networks can have more of a chance to be selected to verify transactions, making it more difficult for smaller participants to contribute, disrupting the premise that Ethereum was built upon.
- Centralisation of power. The ‘proof of stake’ mechanism relies on a small number of validators to approve the blocks and them to the blockchain. If these validators are controlled by a single player, that player can have control over the entire blockchain network.
However, it is important to note that last two dot points are both negative aspects of the ‘proof of work’ concept as well, as larger amounts of capital are required to fund the machinery used to mine cryptocurrency.
Despite the upgrade to ‘proof of stake,’ there are still lots of issues surrounding the crypto world as a whole, a harsh and volatile market that can crash with no support, as evident over the past twelve months. Since last Friday, the crypto market has lost roughly US$100 billion, with September’s outlook looking worrying.
There is still an absence of regulation surrounding the space, heightening its risk.
Many still question the actual usage of cryptocurrencies. Currently, the main practice for cryptocurrencies themselves is trading them, and that is interesting for a lot of people, but at some point, there has to be a utilitarian reason for people to keep being interested in it.
The current high inflationary market, coupled with these underlying issues, have caused crypto trading volumes to crumble to two-year lows. Only with a stable market outlook will Ethereum’s new concept flourish to its full capabilities.