Invented and incubated in Canada, Ethereum, the second largest cryptocurrency by market capitalization and the foundation of the most innovative development happening in the industry, has just completed a software update dubbed The Merge.
Around the world, computer programmers, blockchain enthusiasts, and even some skeptics have organized virtual streaming parties to witness the event in real time. It was one of the biggest events in crypto history, but many people outside of the industry probably didn’t realize it, perhaps thinking it was just more crypto kids starting to spend more technical nonsense.
However, it is important to understand what this software update is all about. Blockchains at their core are all about recording information. Bitcoin secured and ordered these transactions through a process called proof-of-work (PoW), more commonly known as mining, when it was created in 2009.
The dream of Satoshi Nakamoto, the anonymous inventor of Bitcoin, was for ordinary people to use their home computers to help secure a ledger and receive the native token, bitcoin, as a reward for their efforts. Within a few years, application-specific integrated chips (ASICs) appeared on the scene, making the involvement of home computer mining no longer viable. The original hardware was replaced by data centers and specialized computers that consumed excessive amounts of energy.
Ethereum entered the arena a few years later with its novel smart contract platform (and the ability to schedule assets) and followed in bitcoin’s footsteps by also using PoW.
But early on, another idea called staking was put forward that could, in theory, one day replace the energy-intensive PoW mining process and maintain network integrity. This new solution would not only significantly reduce power usage, but democratize the validation process by giving token holders the ability to approve transactions with fewer hardware requirements.
In Ethereum’s Proof of Stake (PoS), users can become validators and lock (stake) their Ether, similar to entering a link to the protocol. They then take turns approving transactions and receive newly created ether (staking rewards) in exchange for helping to protect the network. Under this new system design, access to specialized computer chips or electricity would no longer be required, meaning more involvement from everyday users and less pressure on the environment.
Since its launch, Ethereum has grown from a novelty toy to a $200 billion platform, with an additional $300 billion in assets and applications depending on its uptime and functionality. For the past seven years, researchers and developers have tried to fulfill this initial promise.
Various proposals have been proposed for the correct technical implementation, but the developers found themselves back on the drawing board, continually delaying the update. Investors and community members even began to doubt that it would ever come to fruition.
In 2020, a consensus began to form around the technical standards that would make it appropriate to release this new and improved version of Ethereum. Given the high stakes on the size of the project, the new platform was launched in pseudo-incognito mode with limited functionality.
A year and a half later, it was time to marry the two networks and transition the combined value of $500 billion to this new implementation. Everything leading up to this moment would happen in 12 seconds and with no visible change to the end user. No pause in regular activity, downtime or broken interfaces.
Some have described the event as driving a car at 100 km/h and swapping the combustion engine for an electric battery without even slowing down or the driver noticing that anything had changed.
Fortunately, the merger went smoothly. Just before 3am ET on September 15th, we bid farewell to Ethereum mining and ushered in a new era, one without specialized computing hardware and electricity requirements like those of small countries.
The merger marks one of the biggest turning points for Ethereum and the web, setting the stage for the next iteration of the internet. If we are to believe in a future where trillions of dollars worth of assets and activities will exist on a blockchain, a system like proof of stake will be required to remain stable and secure.
This new system also creates new opportunities. There is now an incentive for retail and institutional investors to fall back on an asset that aligns with environmental, social and corporate governance (ESG) mandates.
To top it off, invested capital of any size can generate the same return and economies of scale have become irrelevant. This could be the catalyst our pension funds need to enter the sector and trust that this innovation is built to last.
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New lines of business have also begun to emerge. Local digital asset exchanges will have new product lines to offer their clients and to support this, specialized staking infrastructure companies will be formed. Figment Networks Inc., a Toronto-based company, has become one of the world’s largest and most recognized staking providers for both institutional clients and retail platforms. Businesses like Figment weren’t possible just a few years ago.
But the Ethereum upgrade is not complete. In the coming years, several technical updates will be implemented, significantly reducing transaction fees that have historically reached up to US$50 per transaction, the price of users and the reduction of value activity. This activity has felt stranded, with no other blockchain to move to without serious security compromises.
In addition, the network will be able to process 1,000 times more transactions per second. A successful blockchain of the future will need to handle various spectrums of activity in terms of value and performance to truly become a global settlement layer.
The launch of proof of stake is one of the most impressive computing feats to date, and it was all developed by a decentralized group of participants. This is the beginning of the next frontier for blockchains and the right move for a tech group that is aware of the ongoing climate crisis and can envision a world where people have transparency and autonomy over their finances.
Brian Mosoff is CEO of Ether Capital.