Imagine having to change the engine of a spaceship mid-flight. Preston Van Loon and a few dozen additional developers are working on a critical software upgrade to Ethereum, the blockchain that underpins thousands of decentralized applications, and Ether, a cryptocurrency with a market capitalization of $204 billion. dollars.
Expected for years, the upgrade has entered its first phase – called Bellatrix – at 7:34 a.m. EST today, setting the stage for the blockchain merging with another decentralized ledger named Beacon Chain and changes in the Ether (ETH) economy. If all goes well, around September 15, Ethereum will adopt Beacon Chain’s transaction processing method, proof-of-stake, which is about 99.95% more energy-efficient than the current proof-of-work mechanism.
“We’ve been testing the merger for maybe a year at this point,” says Van Loon. “We don’t get much sleep, partly out of excitement and partly out of a bit of anxiety, because it’s such a big deal with so much at stake.”
No major blockchain has faced an overhaul of this magnitude.
“I consider this to be the most significant catalyst in crypto history in terms of magnitude and the fact that ETH is the second largest crypto,” said Travis Kling, chief investment officer of crypto asset management firm Ikigai.
The merger “lays the foundation for a more scalable, more usable chain for the general public,” notes Joseph Ayoub, global infrastructure analyst at Citi.
To be clear, users probably won’t experience any significant changes immediately after the merge. According to a Citi research report, the time it takes to add a new block to the chain will simply drop from 13.6 seconds to 12 seconds, “marginally” affecting Ethereum’s transaction processing capacity and fees. These will improve with a series of additional upgrades, according to Ethereum co-founder Vitalik Buterin. “At the end of the roadmap, Ethereum will be able to process 100,000 transactions per second,” – more than the current 15 – Buterin promised at the Ethereum Community Conference in Paris in July.
What will fundamentally change, however, is the nature of ether, the native cryptocurrency of Ethereum. Ethereum’s transition to proof-of-stake reinforces ether as a yield-earning asset (network validators are currently earning around 4.2% annually) and is expected to reduce ETH issuance, coincidentally as well by 4.2% annually, improving the asset’s prospects as a store of value, according to Ayoub.
Matt Hougan, Chief Investment Officer at Bitwise Asset Management–which manages the largest crypto index fund in the world–belongs to a large group of investors who believe that ether may soon become the most valuable cryptocurrency. In addition to the new business model, Ethereum’s transition to near carbon neutrality could attract a horde of institutional investors who are concerned about environmental mandates. “It is entirely possible that we will see Ethereum overturn bitcoin at some point in the future,” he says. “It is aimed, in my view, at a broader addressable market.”
For now, Ether’s $190 billion capitalization trails Bitcoin’s $381 billion in a crypto market worth just under $1 trillion. The stablecoin link follows far behind at $67.5 billion
That said, “Anyone expecting the merger to happen on September 15th and the price of ETH to double, I think, will be deeply disappointed,” Hougan warns. “If you look at other pre-planned events in crypto, like the bitcoin halving, there is often a news selling phenomenon in the weeks surrounding the event.”
If the merger is successful, Ethereum would come much closer to its original vision of the “computing world,” but what could go wrong?
“Anything,” admits Van Loon. “Software is fallible, humans are fallible. We anticipate and are ready for any type of activity, any type of chaos. He says there could be operator errors or bugs that make a protocol harder to run, but he’s optimistic: “We think that since we have such a variety of software, we have alternatives. It’s like your rocket explodes on launch after you’ve tested it a million times but you have another rocket you can use. It will take a few weeks to pick up the pieces, something like that.
Ayoub points to the risk of a new delay or a fork. The latter would essentially be a split of the blockchain, this would allow miners to decouple from Ethereum post-merger and attempt to preserve the proof-of-work version of the chain. After all, once Ethereum fully transitions to proof-of-stake, they will lose their revenue stream. In this case, new tokens could be created, but it is unknown how much they could be worth or if they would be accepted by vendors in the same way as ether.
All major crypto exchanges, including Binance, Coinbase, Kraken and FTX, have announced plans to briefly suspend deposits and withdrawals for ETH and Ethereum-based tokens at various times during the merger, although trading at cash is largely unaffected.
“Whatever the outcome, whether there is a new token created, whether there is an airdrop [ether holders could get free tokens equal to their ETH balances in case of a fork], we want to make sure we open the spot markets as soon as possible. There is less risk there,” says Haider Rafique, chief marketing officer of cryptocurrency exchange OKX. “Naturally, there are more risks on the derivatives side, not only in terms of configuration management, but also on our side. Can we support it from a treasury perspective? For derivatives, we need a bit more information. The pause in deposits and withdrawals is necessary to ensure order books are calibrated and all systems are working properly, he explains.
“We are not risking client funds on this trip,” says Rafique. “We know anything can happen until the merger actually happens.”