The Ethereum Merge

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This article is intended to be a journey through time, a point of support and reading to calibrate your thesis or bet on ethereum for the future and above all a research contribution to understand the importance and the crucial moment that ethereum is living. I encourage you to make this journey. I promise it will not be very long, but very detailed with explanations. This way you will better understand the strengths and weaknesses. The fundamentals, where it comes from, where it is now and where it is going.

Let’s clarify that the denomination of Ethereum 2.0 is the update of the network and not a new coin. I hope this does not generate more confusion, and most importantly do not fall for scams with promises of new coins if you give the seed of your wallet. The ethereum update goes through 3 stages. These stages have to be fulfilled with the greatest success one by one, which go low to high in complexity and importance.

Stage 1)

The Beacon Chain, the first network upgrade that was executed on December 1, 2020, nothing is changed in the user experience, as we are still with high transaction costs and PoWy is still a L1, therefore nobody realized that something already changed that day in ethereum for good (and hopefully for the better). The Beacon Chain, let’s say, was a new chain that was created in parallel to the original ethereum chain, with the only utility of being a consensus chain, not allowing to execute transactions or store SC, but it did allow ETH staking. Something surprising given the PoW nature of the main chain. The process is a bit complex, but keep in mind that your PoW ETHs were burned and then minted and passed to the Bacon Chain, where they were blocked for staking. 

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Sending wallet: https://ethereum.org/en/staking/deposit-contract/ 

Dirección: https://etherscan.io/address/0x00000000219ab540356cBB839Cbe05303d7705Fa 

If we enter the address with the explorer, we see that it has a whopping 13.5 Million eth, with a current market value of $21.3 Billion. This phase was done to be able to build and test the new ethereum PoS network at the same time, creating a secure and controlled environment to determine the ideal time to enter the second stage and make this transaction easier and simpler for everyone.

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Stage 2)

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The Merge, with a start date between September 15-18, 2020, is the update that will make a big difference in the ethereum project, since it merges the PoW network with the new PoS network. From that moment the 2 consensus protocols with more weight equalize their forces, since ETH goes to PoS and joining the rest of networks, protocols and PoS projects, gives this consensus the same weight that currently has PoW. From the moment the merge takes place, the PoS network will exist for better or worse, and at that moment the Bacon Chain will start to execute transactions and store SC effectively, moving to real mode.

Even for me the most critical and important point is transformation in stages. The Merge will not provide scalability (PoS networks are 10% faster than PoW networks, so this point will not be given at the moment) or cost efficiency (GAS FEES are a product that is created automatically between network demand and network capacity). It is important to understand this because the network capacity will not increase, it will only change the consensus protocol, so it will not be a cheaper network by technical improvement. Let’s say it is a facelift in terms of energy consumption, accessibility to transaction validation (leaving aside the chip monopoly), and thus having a smoother path before regulators and so that large investment funds can offer an asset to their customers that complies with environmental policies.

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This whole process can be seen and better appreciated in the following image. The Beacon chain is coupled in parallel at a given time while the network remains PoW as a consensus protocol, until the Merge arrives, while the Beacon Chain ceases to be a test network to become the main validation network in the PoS. At this point the probabilities of a fork are very high, since many miners will not want to upgrade to be able to continue validating transactions in the new network. Many will have to continue amortizing their equipment and mine the transactions that are executed by the PoW network of some ETH with another denomination. 

Power and weight to do so have sense and value little or none (see cases such as Bitcoin Gold, Bitcoin Cash, Bitcoin SV or Ethereum Classic among others). I am surprised that now there is talk of a possible fork in the ethereum network. From minute 1 of day 1 that was already raised, this road map gives ETH a different consensus. It was known of the possible forks, given the multi-billion dollar business that is for this network.

Value, not price

At this point opens an interesting reflection on the value of an asset depending on the structure of the consensus protocol and the network where it circulates, explanation:

Let’s say that in the PoW network the miners are the shareholders of the network, since they receive a dividend from it in the form of a reward per mined block, therefore the value of the native asset of that network (for example bitcoin) is in the use of the network, i.e. the greater the use of the network the greater the value of the asset that represents it, since it serves in the first place to secure it. Logic and history here lead us to believe that, given these circumstances, the network’s natural asset will increase in price per use, indirectly impacting the security budget. The higher the price per value of bitcoin, the higher this budget will be. On the other hand, in PoS networks, the shareholders become the holders of that asset. If you delegate it to validate transactions, you will be the one who takes part of the commissions that the network pays for that work, so the greater the number of holders participating in the business, the higher the price of the native asset of that network (ETH in this case) should be, since a shortage is created in the market by blocking in wallets outside the exchanges. 

At least it is curious, interesting and very deep this struggle of power and common sense towards changes in many networks to ensure their survival depending on the numbers presented from this moment both bitcoin in PoW and ethereum in PoS.

Stage 3)

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Sharding, or in other words, the arrival at ethereum of scalability, low costs and the end of the whole process of change. The success of this stage involves spreading or distributing data storage over multiple networks, thus lightening the weight of the main network. Do not confuse this scenario with what we currently have with layers 2 or L2 such as Arbitrum, Optimist, etc., as these layers have been coupled to ethereum to provide scalability solutions and low cost fees, thus simplifying its development and code in a certain way. With Sharding, ethereum will host these L2s and couple them into its ecosystem, so that they are independent networks under the same roof, providing them with security and space.

Let’s say that a blockchain by nature is a constant data storage space. That data weighs and takes up space, the proposed improvement makes ethereum redistribute all that space and all that data with L2 networks, running in them all the hubbub of transactions and validating only once on the main network or L1. Therefore it is important to understand that the L2s will store information and execute code, so there will be a lot of information stored in the L2s (Arbitrum, Optimist, etc.) that is not stored in the L1 (ethereum). 

This 3rd stage will be developed in 2 sub-phases;

Phase 1, where we will have data availability thanks to the fact that ethereum already recognizes these L2 (roll up) as improvements that will be integrated into its ecosystem in a functional and direct way. The ethereum network will activate this coupling to ensure that 100,000 transactions per second can be executed with guarantees of success, note that when I speak of the ethereum network at this stage of the change (3 stage), I no longer refer to the ethereum L1 network but to all the networks that ethereum will integrate to be able to bring it to these levels of transactionality by scalability, where these L2 will be very economical in terms of fees.

Phase 2, execution of code by the L2s, making them fully functional and independent in their operation, without a code that has been fixed in the previous stage, but without losing the integration with ethereum’s L1. Operationally in this phase the difference between L1 and L2 is expected to be null, because all of them execute code, store data and allow to integrate tools, protocols and new markets in them.

Conclusion

On the one hand ethereum can become the standard of monetary asset, and on the other hand we must start paying attention to what is happening in these L2, how many developers they have, how they form and maintain their communities, what capital is being blocked in their protocols, the levels of transactionality they have and other data that can allow us to value them at the level of organic growth before speculative growth arrives, since many of these L2 will enjoy a very important position in the industry in the medium term (2-4 years). With these expectations, getting ahead of the masses and detecting this value to form an investment thesis at least to me seems a necessary exercise to do now, since it allows you to position yourself before the vast majority does it by fashion or trend, if you add to this thesis a clear strategy and well-defined objectives, you have a high probability of making the right decisions based on data and studies, and not on a personal bet.

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Let’s see the outcome of other factors that can break or slow down the integration of the merge. We have economic factors since during the integration we will have 2 Wbtc, one in the PoW network and another in the PoS network backed only by 1 btc, we will also have 2 USDT or 2 USDC backed only by 1 USDT or 1 USDC. Technical factors, such as the oracles and their position on which network they will really support to be able to continue presenting their service, liquid staking projects are an unknown as to how they will respond to this change, as they play a different role when exposed to a possible fork, and finally the legal aspects, since many projects developed without a clear legal framework such as Real Estate, Logistics and Insurance have many contracts signed under PoW, leaving a vacuum and doubt as to whether these SC will then be valid at the time of a resolution with a PoS network.

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