What Is Ethereum 2.0? Understanding The Merge

The long-awaited update to the Ethereum blockchain could finally happen this summer.

At the ETH Shanghai Web 3.0 Developer Summit last week, Ethereum co-founder Vitalik Buterin said “the merge” will be completed this summer. This transformative update will switch Ethereum to a proof-of-stake consensus mechanism from a proof-of-work model.

“If there are no problems, then the merge will happen in August,” said Buterin.

What Is Ethereum 2.0?

Ethereum 2.0 is a new version of the Ethereum blockchain that will use a proof of stake consensus mechanism to verify transactions via staking, rather than proof of work.

Ethereum 2.0’s staking mechanism will replace the proof of work model where cryptocurrency miners use high-powered computers to complete complex mathematical functions known as hashes. The mining process requires an ever-increasing amount of electricity to verify Ethereum transactions before they are recorded on the public blockchain.

Proof of work systems devour a tremendous amount of electricity. Bitcoin mining, for example, currently consumes electricity at an annualised rate of 127 terawatt-hours (TWh). That’s currently higher than the power consumption of the entire country of Norway.

ETH currently has an annual power consumption roughly equal to Finland, producing a carbon footprint equal to Switzerland. Fortunately, the merge is expected to reduce Ethereum’s carbon footprint by up to 99.95%, addressing one of the major criticisms of the cryptocurrency.

Ethereum vs Ethereum 2.0: What’s the Difference?

Since April 2022, Ethereum has been running two parallel blockchains, one that operates using proof of work, and a test chain that operates via proof of stake. The merge will combine the legacy Ethereum Mainnet blockchain (ETH1) and the new Beacon Chain (ETH2) into one unified blockchain.

Ethereum developers recently ditched the ETH1 and ETH2 terminology over concerns that it would confuse users ahead of the merge.

Some investors who own Ether, the native cryptocurrency of the Ethereum Network, may have been puzzled over what appears to be two versions of the coin on Coinbase and other popular cryptocurrency exchanges.

When users stake their Ether on Coinbase, it is converted from ETH to ETH2, and the prices of ETH and ETH2 are identical. Once the merge is completed, these two versions of Ether will be combined into a single token.

Ethereum Is Moving from Mining to Staking

Staking is the process that will replace mining to verify Ethereum transactions once the merge is completed.

Staking requires users to lock up a certain amount of cryptocurrency to participate in the transaction verification process. In a proof-of-stake model, an algorithm selects which validator gets to add the next block to a blockchain based on how much cryptocurrency the validator has staked.

Investors must stake at least 32 ETH to become an Ethereum validator. There are currently more than 300,0000 Ethereum validators. The more ETH each validator stakes, the more likely that validator is to produce blocks. Each time a validator produces blocks, the validator earns rewards in Ethereum for handling validation duties.

Currently, the staking yield on Ethereum’s Beacon Chain runs around 4.3% to 5.4% annual percentage rate (APR).

With Ethereum trading at roughly £1,500, the minimum requirement of 32 ETH, which is more than £47,000, staking can be quite pricey for the average investor.

But individual investors can also join staking pools, which are collections of Ethereum stakers who combine their resources and split the rewards. Most large cryptocurrency exchanges also provide staking services for investors who are not willing or able to commit 32 ETH on their own.

Cryptocurrency’s Energy Problem

Critics of Bitcoin, Ethereum and other proof-of-work cryptocurrencies have often pointed out the massive energy costs of mining, particularly at scale.

In recent years, screening investments based on environmental, social, and governance (ESG) standards has become increasingly popular. In fact, a recent Forbes survey found that many investors would consider investing elsewhere if they understood that their cryptocurrency investment negatively impacted the environment.

John Warren, CEO of Bitcoin mining company GEM Mining, says there’s not a linear correlation between Bitcoin’s price growth and its energy use. Bitcoin currently has no plans to transition to a proof-of-stake verification model, a model which Warren says doesn’t make sense for Bitcoin.

“While there is certainly much room for growth in the proof-of-stake ecosystem, Bitcoin is the core protocol for all of crypto and thus needs the soundest, most secure consensus model available,” Warren says.

He says the energy consumed by proof-of-work verification demonstrates the security and strength of the model.

“You could think of Bitcoin as pristine collateral, and the utmost importance for its protocol is security, which is best delivered by keeping to proof-of-work,” Warren says.

Staci Warden, CEO of the Algorand Foundation, says a cryptocurrency’s energy usage is a major factor in its ability to scale effectively.

“On the supply side, a protocol can scale only to the extent that it has access to reliable sources of energy at a marginal cost that is lower than its marginal return,” Warden says.

She says subsidised or low-cost energy is necessary for proof-of-work cryptocurrencies to scale, which is why cryptocurrency prices have been pressured so much in 2022.

“On the demand side, a proof-of-work protocol’s ability to scale will be limited by the public’s willingness to tolerate fossil fuel-driven, proof-of-work protocols in general and preference for the growing availability of carbon-negative alternatives,” Warden says.

Ethereum vs. Bitcoin

Bitcoin and Ethereum are the two most popular cryptocurrencies, accounting for a combined 63.6% of global crypto market capitalisation.

Ethereum’s price has soared 648% in the past three years, more than double the 250% gains in Bitcoin during the same period.

The merge will make Ethereum a more attractive investment than Bitcoin from an ESG perspective, but it doesn’t necessarily make Ethereum a threat to dethrone Bitcoin as the world’s top crypto.

Chris Kline, chief operating officer and co-founder of Bitcoin IRA, says Bitcoin and Ethereum are more complementary than they are competitive within the crypto market.

“Bitcoin and Ethereum serve different purposes. Bitcoin is a proof-of-work, limited asset, monetary crypto, while Ethereum’s utility is [as] a Web 3.0 backbone. Both serve as critical and distinct elements of the overall digital asset ecosystem underway,” Kline says.

While cryptocurrency investors await The Merge later this summer, the next major event in the path to proof of stake for Ethereum will come in June.

Ethereum is expected to complete a major trial for the merge in June, using the test network Ropsten. Once the Ropsten upgrade is completed, Ethereum developers have just two more test networks to upgrade before the merge of the main Ethereum network.