The Merge: Ethereum is shifting from Proof of Work to Proof of Stake – what does it mean?

After much delay, the major update on the Ethereum blockchain called the Merge seems to finally happen this month (September 2022). 

A key part of the Merge is Ethereum’s switch from the Proof of Work (PoW) consensus mechanism to Proof of Stake (PoS).

Ethereum is not the first blockchain to adopt the PoS mechanism. There are quite a number of other blockchains such as Solana, Cardona, etc. that employ alternate consensus mechanisms including  Proof of Stake but also Proof of History, etc.

However, it is worth noting none of these blockchains have the same width and depth of applications and value hosted as Ethereum does. Ethereum is also the first blockchain that is transitioning from an existing PoW consensus mechanism to another (PoS) mechanism. No other blockchain in the world has attempted such a feat before, switching from one mechanism to another. 

So, what actually is PoW?

Why is Ethereum taking so much effort to move from PoW to PoS to validate transactions on the blockchain? 

Let’s start by understanding what is Proof of Work (PoW) and Proof of State (PoS).

Proof of Work (PoW)

When you’re transacting cryptocurrency, every transaction you do needs to be validated to be entered into the blockchain. In PoW, a group of miners solve intense, complicated puzzles (which require a lot of computational power) to validate a transaction on the blockchain. Miners who succeed in validating a transaction are awarded cryptocurrencies.

 

An example: Bitcoin’s Consensus Mechanism

Bitcoin uses Proof of Work (PoW). PoW is a validation mechanism that required miners: people who dedicate a large amount of computational power to verify a transaction through complex cryptographic hashing algorithms. Hackers must represent 51% of all computing power on the network to exploit the blockchain – not an easy feat to achieve. 

As time went on, cryptocurrencies began to improve upon Bitcoin’s PoW mechanisms.

Why? 

The PoW consensus mechanism is very energy intensive and is not environmentally (or more importantly, economically) sustainable. These high energy requirements combined with the increasing competition in mining reduce scalability. Moreover, the rewards in crypto mining have also reduced significantly. All of these factors have weakened the blockchain’s stability.  

This led to the creation of different “proofing” methods such as Proof of Stake (PoS), which required user capital to validate transactions, Proof of History, which verified the passage of time, or other methods that offer varying levels of asset liquidity and currency delegation.

Proof of Stake (PoS) 

In a PoS consensus mechanism, validation of transactions on the blockchain doesn’t depend on how much computing power you have, but rather on the risk you’re willing to take. Here, the miners/validators stake a certain amount of crypto they own to validate transactions, and the validation is chosen randomly. 

This PoS is more energy efficient and increases the accessibility for many people to become validators on the blockchain because you don’t need high computing power anymore. People who risk their capital to validate transactions are in turn rewarded. Blockchains that adopt the PoS mechanism are more scalable and accessible.

Ethereum 2.0

Owing to several issues with PoW, Vitalik Buterin, the founder of Ethereum, envisioned Ethereum 2.0 with PoS, which was set to be launched in 2016 but it faced numerous challenges and delays. Introducing these changes concurrently on a network with thousands of running applications proved to be overly ambitious, especially given the irreversible nature of network protocol change, leading to multiple delays and a change of plans. 

However, finally, the first step towards Ethereum 2.0 – The Merge seems to be finally taking place.

Despite possessing a first-mover advantage, there is no guarantee that Ethereum will maintain its competitive advantage. Other blockchains such as Solana and Cardona have, and will continue to, improve upon the issues of Ethereum’s blockchain, but they are currently nowhere as popular.

If Ethereum’s future development plans succeed, it is poised to become the backbone of the future Web3 ecosystem, serving as the primary blockchain for more exciting decentralised applications to come.

In summary … 

If you would like to know more about Ethereum and the Merge, read our report on “The Future of Ethereum” here.