September 14, 2022, 9:00AM EDT · 5 min read

Hey Reader,

Note from the editor.

Welcome to Issue #11 of the keepitasatoshi.com newsletter, where we examine the top crypto asset projects and their communities.

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This week we'll be covering Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS) better known as The Merge.

The Merge is Ethereum’s most ambitious update in its history. It is arguably the biggest update in the entire history of crypto assets.

It represents more than 7 years of collective work by some of the brightest minds on the planet. A successful launch will change the industry forever.

As you know, public blockchains are simply a collection of computers usually called “nodes” running the same software. What make them different from other software is the fact they use “consensus mechanisms” to ensure every node is in sync. This is how nodes know someone hasn't already spent the bitcoin they just sent you.

Bitcoin popularized the consensus mechanism PoW. The bitcoin protocol asks a specific math question every 10 minutes or so and network participants called “miners” use their computers to brute force an answer to this question.

More specifically, bitcoin produces a target hash and miners are expected to produce a hash that is lower than or equal to the numeric value of that target hash.

But because each hash created is completely random and impossible to guess, it can take millions of guesses aka hashes before a miner finds a valid hash. This is the work in PoW.

The first miner that finds a valid hash gets the opportunity to append to the existing bitcoin blockchain and gets rewarded a certain amount of BTC for their trouble (6.25 BTC at the time of this writing).

As you can imagine thousands of miners are attempting to find a valid hash at the same time, but the moment one miner does and wins the lottery perse, all the work the other miners have done are discarded as its time to start this process over with the next block.

While clearly wasteful and incredibly slow, this is an intentional design choice as having many miners guessing hashes has a necessary side effect, it increases the security of the network. We can track the security of the blockchain via its hashrate. The higher the hashrate the harder to perform a 51% attack on the network.

Enter Proof of Stake

Ethereum has relied on PoW since genesis, but it has always made it known that a change in consensus mechanisms would be necessary for Ethereum to fully realize its goal.

Unlike Bitcoin which aims to be borderless, censorship-proof, hard money, Ethereum’s goal is to be the “World’s Computer” capable of supporting smart contracts for billions.

To make this possible, Ethereum would need to handle tens of thousands of transactions per second. A far cry from the roughly 15 per second it supports today with PoW. So Ethereum leadership started planning their move from PoW to PoS as early as 2014 before Ethereum even launched.

PoS is an alternative consensus mechanism to PoW whereby network participants called “validators” stake capital instead of electricity and mining equipment (in Ethereum’s case 32 ETH) into the protocol and are then in charge of checking that new blocks added to the blockchain are valid.

They also earn the opportunity to add new blocks themselves with yield estimates between 3-6% annually. And if they behave lazily or mischievously, they risk losing some or all the staked capital. The staked capital is the stake in Proof of Stake.

In PoW, the mining difficulty determines how quickly blocks get added to the blockchain. Bitcoin adjusts its mining difficulty every 2 weeks to ensure it remains as close to 10 minutes as possible. This prevents someone with a supercomputer from mining all the bitcoin at once.

In PoS the timing is instead fixed. Ethereum’s is divided into slots (12 seconds) and epochs (32 slots). A validator is simply randomly selected to be a block proposer in every slot. No miners expending gigawatts of energy guessing hashes needed.

In December 2020, Ethereum launched the Beacon Chain a separate PoS blockchain. The Merge represents joining the PoW Ethereum Mainnet with its new PoS Beacon Chain. Once complete, the Beacon chain will be the new engine of block production. This means mining will no longer be capable of producing valid blocks.

Ethereum will still maintain all its previous history. There is nothing for ETH holders to do. Most users won’t even notice a difference. It’s akin to replacing your Honda gas engine with a Formula E electric motor while driving 30 mph.

The Merge will happen sometime between 9/14 and 9/15 and can be monitored at https://www.ethernodes.org/merge​

Now PoS doesn't come without its share of critics. Many believe the staking requirement of PoS (32 ETH for Ethereum or roughly $50,000) mimics our existing financial system and will only further widen the gap between the rich and poor.

They also argue that eliminating miners will make it easier for centralized institutions like governments, banks and big tech to pool capital together and take over PoS blockchains for their own selfish needs.

No matter how much capital you have, accumulating the thousands of ASIC machines and the energy to run them to take over a network like bitcoin is more challenging than simply accumulating capital.

If JP Morgan became a validator, could they stop processing your transactions if you didn’t pay your mortgage? What if you sent money to your family in Russia? Will the US Government put you on the OFAC list and prevent all US validators from processing your transactions?

These are the type of concerns that will only be alleviated with time. PoW has proven to be the best choice if your enemies have unlimited resources and your blockchain’s goal is to be tamperproof hard money.

If your goal is to simply be the engine that runs billions of financial applications, maybe PoS will turn out to be good enough? Or maybe this a massive mistake and will mark the end of Ethereum.

Who knows. The important part is we are alive to witness yet another game changing technology play out.

Happy Merge Day everyone!

KB

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Network Updates:

This week will we explore Ethereum:

Ethereum

Where to buy: Gemini, Coinbase​

• As far as price action goes, the hype around the Merge has given ETH's price a nice boost from its June lows. But with global macro forces still influencing asset prices, we are skeptical this isn't a buy the rumor sell the news event.
• I wouldn’t rule out ETH dropping under $700 this year especially if the stock market drops another 30%. But regardless of the short term to mid term, ETH's long term investment potential still looks strong.

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