Ethereum Merge: What to Expect on D-Day

This post first appeared on Hackernoon.

With all of the excitement around the upcoming Ethereum Merge, it can be hard to know what is hype and what is real alpha. We've pulled out a short summary here.

Issuance Tanks

Ethereum issuance will now go to stakers and not miners. This represents a large removal of supply from the market. Miners will no longer receive ETH rewards that they have to sell to finance their operational costs. This means over 10,000 eth in daily sell pressure could disappear over night. Instead the ETH issuance will go to stakers and won't be available for withdraw for at least six months.

Merge Won't Lower Gas Prices or Turn ETH Deflationary

Ethereum transaction fee costs are already at lows for the year, but it bears repeating that the Merge shouldn't change much about gas prices. If gas prices remain this low, the ETH burned per day won't surpass issuance and ETH will remain inflationary. However, around 15-20 gwei ETH burned should be more than ETH issued and it becomes deflationary. There could be any number of catalysts for this, but crypto continues to develop products and attract users.

As more users come in either through DeFi or other avenues like NFTs, usage of blockspace increases, which pushes burned ETH higher. I think L2s will also contribute, as they store more data on chain from larger user volumes.

What will the merge look like for end users?

To prepare for the merge, most DeFi users won't need to do much. The chain should switch over from Proof of Work to Proof of Stake mechanisms without a disruption for Defi protocols. The merge is just a change in the execution layer, not state or consensus, so DeFi will continue as before. If everything goes smoothly, DeFi users won't even notice a difference.

Developers and DeFi builders also shouldn't notice much of a change. There are a few minor differences between execution, but most dapps should continue working without big upgrades. For developers who want to learn more about the changes, the Ethereum Foundation has published an extensive review for buidlers.

There are some big changes coming though for other members of the Ethereum community.

Miners will be immediately removed from the system upon the switch to proof of stake. This has lead to a lot of speculation on where this hash rate will go. One of the more popular options is for miners to create a hard fork and continue mining. This will bring chaos on the PoW chain's DeFi market as oracles fail, lending protocols go insolvent, and users rush back to the native ETH asset. However, it could open up interesting ways to make money as users find they suddenly have two copies of other assets like NFTs and ETH.

Since there is potential money to be made, there is a lot of positioning going on in the market, and a tentative date for the merge coming from the EF makes it even more interesting.

Who will win the liquid staking wars?

It is clear that liquid staking derivatives are have achieved product market fit. Lido already controls one of the largest stakes in the network. Their size has raised questions about staking concentration and what happens with a highly concentrated monopoly staking company gaining even more share.

Competitors are also coming from all sides. There are the DeFi native options like Rocket Pool and Stakewise. But there are also meaningful offerings from the centralized exchanges. Coinbase has just launched a cbETH token, representing 1:1 ETH that they have as part of their staking product. Similar to a USDC, but for staked ETH, the Coinbase cbETH can be used throughout DeFi.

Post-merge, liquid staking derivatives will retain their importance. The ETH unlock from the beacon chain will become the next major milestone for Ethereum's roadmap. It will require further network upgrades and another hard fork, but should come within a year after the merge. However, lots of stakers looking to unlock could mean withdraw queues of months. Users who look to seamlessly enter and exit staked ETH positions will rely on liquid staking derivatives. They will also have continued use throughout DeFi.

What could go wrong?

There are still lots of open questions around how the PoS network will work in practice. Some of these won't be known until the network has been running for some time.

For example, it remains to be seen if there will be meaningful attempts to censor transactions or disrupt the network. The question has come to forefront in the aftermath of OFAC sanctioning the Tornado Cash contracts. Will some validators, especially those under US jurisdiction, look to exclude "problematic" transactions?

https://x.com/BitMEXResearch/status/1560619907565252609

There could also be a bug in one of the clients, or other issue with the network execution. While there has been thorough testing on multiple testnets in the lead up to the Merge, new technology always contains bugs. Just this week, one of the main Ethereum clients geth found and triaged a critical bug in their database code. While we expect minimal issues any bugs to get quickly fixed, everyone's eyes will be on the network health post merge.

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