The Merge

Earlier this month, a major event happened in the cryptocurrency space called the ‘Merge’. In this event, the ethereum blockchain changed the way it achieves consensus – from using a proof-of-work mechanism to a proof-of-stake mechanism.

A blockchain is a spreadsheet that maintains a record of all the transactions between users using the same blockchain. Every user on a blockchain basically possesses an up-to-date copy of that spreadsheet and helps validate others’ transactions on the blockchain. The rewards that the blockchain produces for desirable user behaviour are called its tokens. For example, tokens on the ethereum blockchain are called ether and those on the bitcoin blockchain are called… well, bitcoins. This is what the users also transact with on the blockchain.

(See here for a more thorough yet accessible intro to blockchains and NFTs.)

As a result of the ‘Merge’, according to the foundation that manages the cryptocurrency, the blockchain’s energy consumption dropped by 99.95%.

The blockchain on which users transact ethereum tokens plus the network is called the ethereum mainnet. During the ‘Merge’, the existing mainnet was replaced with another called the Beacon Chain.

Imagine the blockchain to be a bridge that moves traffic across a river. Ahead of the ‘Merge’, operators erected a parallel bridge and allowed traffic over it as well. Then, on September 15, 2022, they merged traffic from the first bridge with the traffic on the new one. Once all the vehicles were off the old bridge, it was destroyed.

Each of the vehicles here was an ethereum transaction. During the ‘Merge’, the operators had to ensure that all the vehicles continued to move, none got hijacked and none of them broke down.

(Sharding – which is expected to roll out in 2023 – is the act of splitting the blockchain up into multiple pieces that different parts of the network use. This way, each part will require fewer resources to use the blockchain even as the network as a whole will be using the blockchain as a whole.)

Blockchains like those of bitcoin and ethereum need a ‘proof of x’ because they are decentralised: they have no central authority that decides whether a transaction is legitimate. Instead, the validation mechanisms are baked into the processes by which users mine and exchange the coins. Proof-of-work and proof-of-stake are two flavours of one such mechanism. To understand what it does, let’s consider one of the problems it protects a blockchain against: double-spending.

Say Selvi wants to send 100 rupees to Gokul. Double-spending is the threat of sending the same 100 rupees to Gokul twice, thus converting 100 rupees to 200 rupees. When Selvi uses a bank: she logs into her netbanking account and transfers the funds or she withdraws some cash from the ATM and gives Gokul the notes. Either way, once she’s withdrawn the money from her account, the bank records it and she can’t withdraw the same funds again.

When she takes the cryptocurrency route: Selvi transfers some ethereum tokens to Gokul over the blockchain. Here, the blockchain requires some way to verify and record the transaction so that it doesn’t recur. If it used proof-of-work, it would require users on the network to share their computing power to solve a complex mathematical problem. The operation produces a numeric result that uniquely identifies the transaction as well as appends the transaction’s details to the blockchain. A copy of the updated blockchain is shared with all the users so that they are all on the same page. If Selvi tries to spend the same coins again – to transfer it to someone else, say – she won’t be able to: the blockchain ‘knows’ now that Selvi no longer has the funds in her wallet.

The demand for computing power to acknowledge a transaction and add it to the blockchain constitutes proof-of-work: when you supply that power, which is used to do work, you have provided that proof. In exchange, the blockchain rewards you with a coin. (If many people provided computing power, they split the coins released by the blockchain.)

The reason the Ethereum folks claim their post-Merge blockchain consumes 99.95% less energy is because it doesn’t use proof-of-work to verify transactions. Instead, it uses proof-of-stake: users stake their ethereum tokens for each transaction. Put another way, proof-of-work requires users to prove they have computing power to lose; proof-of-stake requires users to prove they have coins – or wealth – to lose.

Before each transaction, a validator places some coins as collateral in a ‘smart contract’. This is essentially an algorithm that will not return the coins to the validator if they don’t perform their task properly. Right now, aspiring validators need to deposit 32 ethereum tokens to qualify and join a queue. The network limits the rate at which new validators are added to the network.

Once a validator is admitted, they are allotted blocks (transactions to be verified) at regular intervals. If a block checks out, the validator casts a vote in favour of that block that is transmitted across the network. Once every 12 seconds, the network randomly chooses a group of validators whose votes are used to make a final determination on whether a block is valid.

Proof-of-stake is less energy-intensive than proof-of-work but it keeps the ethereum blockchain tethered to the same requirement: the proof of preexisting wealth. In the new paradigm, the blockchain releases new coins as reward when transactions are verified, and those who have staked more stand to gain more – i.e. the rich get richer.

Note that when the blockchain used the proof-of-work consensus mechanism, a big problem was that a very small number of users provided a very large fraction of the computing power (contrary to cryptocurrencies’ promise to decentralise finance). Proof-of-stake is expected to increase this centralisation of validatory power because the blockchain now favours validators who have more to stake, and rewards them more. Over time, as richer validators stake more, the cost of validating a transaction will also go up – and the ‘poorer’ validators will be forced to drop out.

Second, the proof-of-stake system requires problematic transactions to be flagged when the validators have staked their ethereum. Once they have withdrawn their stakes, they can’t be penalised. This in turn revives the risk of the double-spending problem, as set out in some detail here.

The energy consumption of cryptocurrency transactions was and remains a major bit of criticism against this newfangled technological solution to a problem that the world doesn’t have – and that’s the point that sticks with me. The ‘Merge’ was laudable to the extent that it reduced the consumption of energy and mining hardware in a time when the wealthy desperately need to reduce all forms of consumption, but while the ‘cons’ column is one row shorter, the ‘pros’ column remains just as empty.