Ethereum MERGE — will ETH overtake Bitcoin?

The Ethereum merge, One of the most awaited events in the history of crypto is finally upon us. The transition to a proof of stake system will transform Ethereum's monetary policy. That should greatly improve the network's scalability and security.

I think Ethereum does have, just from an economic perspective and because of the effect of the supply shock, a chance to flip Bitcoin.

In this video, we talked to Ethereum researcher Vivek Raman about how the merge will change Ethereum forever and how it may lead ETH to take over Bitcoin as the leading cryptocurrency. I'm Giovanni, your host. Welcome to another Cointelegraph interview. With the merge, the Ethereum network is going to transition from a proof of work to a proof of stake consensus mechanism. What does that mean for Ethereum and what are the main improvements that the merge will bring?

Absolutely. So the Ethereum merge, I don't think it's an overstatement to say it's one of the most important and impressive engineering feats in the whole history of the blockchain movement. From the founding of Bitcoin, the founding of Ethereum, and I would say the Ethereum merge is up next. And Ethereum started, like Bitcoin, as a proof of work network with miners mining blocks and securing the blockchain that way. But unlike Bitcoin from basically very, very early in the Ethereum roadmap, Ethereum had it in its goals to transition to fully proof of stake. And there's a lot of reasons for it. The main ones are proof of stake makes Ethereum a more economically sustainable blockchain. And we can go into detail on the why it makes it a more secure blockchain. It's a higher cost to attack Ethereum under proof of stake. We can go into that detail as well. And it makes Ethereum a more sustainable blockchain, even from an environmental standpoint, because instead of having to have a hardware miner footprint, the hardwares are replaced by validators that use proof of stake. And a validator can be run by anyone with a laptop computer or any sort of computer anywhere. So it promotes more centralization of validators.

You said that Ethereum is going to become more sustainable in two ways. One, it's environmentally sustainable and the other is more like economically sustainable. Could you get a little bit deeper into the economically sustainable aspect of this whole story?

So, just from an economic standpoint, running Ethereum as a proof of stake blockchain requires less issuance to validators than proof of work would require to miners. This is really, really important because it pays less to secure the blockchain, it means it requires less inflation. Ethereum as a monetary asset, its value goes up. And if Ethereum's monetary value goes up, then in theory the security value of the entire Ethereum, the market cap of Ethereum will go up. And the higher the market cap of the base layer, the harder it is to attack the chain, the more it costs to attack the chain again. It's very, very positive feedback loop of under proof of stake issuance goes down, which means cost to attack the chain will go up. And the whole ecosystem works without the need for constant block subsidies. That's really important. That's something that proof work chains like Bitcoin don't have. Bitcoin will have to have a block subsidy basically in perpetuity until 2140.

This supply shock which is going to be a 90% or around 90% issuance reduction, what is the impact of that on the Ethereum price according to you?

So Ethereum by doing the merge is going to see the effect of three equivalent bitcoin halvings at the same time. This is just hard. It's hard to see how this will not create a structural change in Ethereum. Instead of having issuance 4.3% inflation that goes to effectively zero. With the 90% reduction in issuance that means effectively 90% less Ethereum issuance that can be sold on an everyday basis. It's hard to see economically how with a lot less selling pressure we won't see a reflection Ethereum's price to the upside. We don't know when that'll happen. Usually bitcoin have innings. When they happen, it takes six months or something for the effect of the lower inflation to kick in. Ethereum is doing three at once effectively. And I think we'll see the effect. On day one, sell pressure goes to almost zero. So in short, I'm optimistic on price. I think it's a supply shock that we've never seen before.

We saw that Bitcoin when it underwent the last bitcoin halving, then it skyrocketed to new all time highs. So I'm super excited to see something similar to happen with Ethereum too. Now I would like to actually ask you why is it taking so long? So the merge, for those who don't know, it's a process that actually started back in 2020, in December 2020 when the Bitcoin chain was created. So the bitcoin chain is the parallel shadow chain where Ethereum has been running on a Proof of stake system while the, well, the majority of the Ethereum network of course, is still running on the proof of work system. And the merge will mark the moment where the two chain, the main chain and the beacon chain will merge with each other. And so many have compared this process to changing the wheel of a car while the car is moving. So why is it taking so long? And what are the main difficulties of this whole process?

No, that's an absolutely valid question. And again, Darian's been talking about proof of stake since very shortly after its genesis. And now almost eight years later, you'd say in 2022 we're getting to the actual merge. The analogy you say about the car is valid. I would say it's even more difficult. It's like changing the engine of an airplane while the airplane's mid flight. And that right there encompasses why it has so much technical difficulty. The majority of defi runs on Ethereum, which means a tremendous amount. It's been over $100 billion of value secured on Ethereum plus the NFT world runs on Ethereum. Plus Ethereum is setting itself as the digital property rights layer, where you can basically have your property that's embedded into the blockchain that can't go down, there can't be issues with this. And when the merge, when the actual transition happens from the proof of work to proof of stake blockchain, it needs to go. So all the value secured exists and so confidence remains in the Ethereum blockchain. We can't have downtime, we can't have the blockchain be shut down. And that's a very, very big part of Ethereum ethos. So better safe than sorry in this sense. It's better to test over and over and over. And the last thing I'll say on this is Ethereum has this property called client diversity, which sets it apart from other blockchains. There's a vast amount of execution layer clients, there's a vast amount of consensus layer clients that's good for decentralization, that's good for separation of power, but what it creates is human thinking issues where all the clients have to all sync with each other and all be ready. And that's something that brings in another complexity that we've had to test over and over.

So a lot of people are waiting for these new technological advancements as a path to see Ethereum finally scale and become a truly global network that can onboard much more users and much more activity. On the other hand, you pointed out in a recent Twitter thread That this is a very big misconception. So that the merge is not going to tackle this scalability problem. It's not going to bring the fees of the Ethereum network down. So can you clarify this common misconception? And if the merge is not going to do anything about fees, then how is it going to make Ethereum more scalable?

That's a great question. It's a very important question and it shows that Ethereum needs to continue educating and showing what its value is versus where the scaling is actually going to be. And the short answer is Ethereum has identified as blockchains evolved that there's effectively a scalability trilemma. And it means that blockchains can either be very decentralized, very secure, or very scalable and fast. And between those three, blockchains have to pick two. It's basically architecturally impossible to do all three correctly. Ethereum has chosen that, you know what, let's actually separate, have separation of powers and separation of duties and let's have Ethereum be a settlement and security layer that's very, very secure, incredibly neutral and can't be tampered with by third central parties. And let's make it decentralized by having hundreds of thousands of validator nodes and by making it very, very easy to run a node. Hardware requirements are very, I can run a network, I can run a validator. That's something that other LLMs can't do, but that comes at the cost of not being able to scale up the base layer. And you know what, that's actually okay because Ethereum has chosen what they've called a roll up roadmap where it's outsourced the execution, which is the scalability to a series of rollups that are known as layer two. And the funny part is rollups are already live, scaling is already here. There's already environments to have very, very low fees, very very fast execution on Ethereum. Scaling's here. Apps exist on scaling. What needs to now change is that users need to learn that all of their activities should be on layer 2. And then the layer 2s ultimately will use Ethereum as a base layer 1 for settlement, security and decentralization.

So some people say that these layer two solutions, that will be the only way Ethereum can, will be able to scale, will acquire more value proposition than Ethereum itself and it will kind of suck out from eth, all the value or part of the value. So what would be your counter argument?

So that's a very common criticism and I would sort of Point out that that criticism's sort of very zero sum game. It's a very zero sum game mentality where saying that either Ethereum can win or roll ups can win if rollups get more users, and that's bad for Ethereum, if we are bringing on hundreds of millions of new users onto rollups, then I would argue that everyone wins. There's no roll ups win and Ethereum loses. Because ultimately roll ups can't function without Ethereum as the settlement security layer. That's the trade off rollups made. Just like we were talking about the scalability dilemma. Because rollups takes execution, they are not taking security and decentralization as a base player, they're outsourcing that to Ethereum. So as rollups grow, rollups will need to pay fees for settlement and security to Ethereum as the base layer. And 100 million more users onto rollups will mean more fees paid from rollups to Ethereum, which increases Ethereum security and keeps that flywheel going very positively.

Critics of the merge says that it will lead to because while miners in a proof of work system usually have to sell a part of their rewards in order to fund their operations, the validators in a proof of stake system are incentivized to accumulate more and more ETH in this case. And that would mean that more and more ETH will be basically accumulated in the hands of these validators. So what would be your response to this argument?

So that's one of the most common criticisms of proof of stake by proof of work players. And I would counter that these are two very different complementary consensus mechanisms and there's trade offs to both. Could proof of stake be more centralizing because it has less sell pressure, no miners and no sell pressure miners, but validators could potentially hold. Yes it could, but that's assuming that everyone is only profit maximizing for staking. The whole point of the Ethereum economy is it creates use cases and creates a velocity of money. I mean, Ethereum really is the money that's used across the entire Ethereum EcoSystem to buy NFTs with collateral and defi to pay for gas in a bunch of use cases that we probably haven't even invented yet. The point is keep recycling money so there will be validator selling and that will create more redistribution into the ecosystem. Validator rewards are taxable, so that will already create, if you assume the 50% tax rate, that'll already create a 50% sell pressure from validators over the long run to pay taxes. So there are still decentralizing methods will it be everything sold from validators versus miners need to sell everything. Not as much. But let's turn to the flip side too. Let's turn to the mine, to the mining front. And I think Bitcoin's a fantastic technology. I think Ethereum and Bitcoin will be very complementary and people who want proof of work exposure will have Bitcoin. People that want exposure to digital economy will have Ethereum. But on the bitcoin side, mining is also fairly centralized. Mining operates with scale, so it scales the better operate the larger players or the larger pools are going to have better economics and are going to scale their operations better. Especially nowadays with power prices going through the roof, it's harder for smaller individual miners to set up their own operations. So you could actually argue the same phenomenon could happen with large miners that can happen with validators because the large miners could also accumulate Bitcoin and hold onto it as an investment. So this is just a long winded way of saying there are trade offs to both.

You said that Ethereum and Bitcoin will be largely complementary. But on the other hand on your Twitter handle, you said recently that Ethereum with the merge has all the chances to take on Bitcoin's throne. So that sounds more of a, not a complementary sort of relationship, but more of a basically the flippening. Right. So Ethereum kind of gaining more value proposition than Bitcoin. Why do you think so?

So I don't think those are contradictory statements at all. I mean complementary doesn't necessarily mean that they're equal. Market cap or the market cap stay the same. Gold and tech companies are complementary store of value. Some pension funds will put money into gold, others will put money into Apple stock and they're all part of a balanced portfolio. I think in that same sense, Bitcoin, Ethereum have very different use cases. People that want an immutable source of money that doesn't have velocity but has the proof of work, the proven whatever, there's 13 years of proof of work backing it will pick, will pick Bitcoin and keep some money in there and it'll be effectively digital gold. But the adoption space for Ethereum is much larger for a lot of reasons. One, Ethereum has a staking yield. So institutions that want yield can express that view. With Ethereum they can stake their Ethereum, they can earn validator rewards and be part of a digital economy. Also as a store of value, you want the monetary policy to be as strong as possible. After the merge, Ethereum will have lower inflation than Bitcoin especially with fee burns, Ethereum will be deflationary while Bitcoin will always be inflationary, although every happening that inflation rate does go down. So in terms of market cap, I think Ethereum does have, just from an economic perspective and because of the effect of the supply shock, a chance to flip Bitcoin.

You said that Bitcoin is supposed to, in this scenario is supposed to retain the role of digital gold. But on the other hand, in this scenario it seems to kind of lose to Ethereum the, the role of the best digital money. So it seems that you kind of foresee that Ethereum will sort of take on at least part of the Bitcoin narrative here.

I do. It's a personal view. Again, this is just a personal opinion, but based on use cases, based on the fact that Ethereum can have an economy running on top of it. It's program, it's the design space to program on top of the Ethereum blockchain is basically infinite and the base layer has lower issuance. I think proof of stake will end up being a more sustainable consensus mechanism and proof of work over the long run. And there's more velocity to it. I think the one part that is not too debatable is Bitcoin doesn't really move. Bitcoin has a culture of people hodling and that's totally okay. I mean, gold doesn't really move either. But today do we see gold being used as money or do we see other more portable forms of money being used as mediums of exchanges? And I would argue Ethereum is going to fall in that latter camp and Bitcoin is going to fall in the former camp.

I would say that Bitcoin has still this, as you said, reputation for being basically immutable in the sense that the supply is set in stone. That's probably one of the main selling point of Bitcoin that Bitcoin will still preserve in the face of Ethereum's improvements.

That's fair. That's fair. I mean, there's counters to that too in my view. In the view of blockchain design, you want the blockchain to be sustainable and supported by its own economic activity. Ethereum has a tremendous amount of transaction fees and the transaction fees are what cause Ethereum's monetary policy to ultimately be deflationary because 80% to 85% of all transactions fees are. And that creates a deflationary effect to counter the issuance from the block subsidies to validators. Bitcoin in theory, after 2140, after a lot of happenings will have an inflation rate close to zero. But you still need something to pay miners to incentivize them to secure the blockchain. When that goes away, the question is what will happen? Incentivize miners to continue spending all the money on electricity to secure the block. And that's. That question has been hand waved away. A lot of time saying that in 2140 we'll figure it out or the transaction fees on Bitcoin will be high enough to secure miners. I would argue that if the whole point of Bitcoin is to hodl it and to keep it as a as in a vault, as a form of digital gold, transaction fees are never going to really be higher. And we've seen that over time Bitcoin transaction fees are a fraction of what Ethereum's transaction fees are. So there is a structural issue. Long term, I think maybe it'll get kicked, the can will get kicked down the road. But Bitcoin can't have a fixed supply cap and low transaction fees and no real utility other than hodling for the long term unless there's some change to the protocol. So we'll see what happens there as well. But Ethereum is tackling that up front and has economic sustainability from its transaction fees, from its economy, from all the applications that are built on top of it that we haven't yet seen in Bitcoin. Again, I welcome competition. Maybe we'll have a robust layer 2 ecosystem on top of Bitcoin. Maybe we'll have a lot more smart contracts and functionality, but so far we haven't seen it yet and Ethereum has taken that place. So it's food for thought.

Yeah, that's definitely food for thought. Thanks a lot Vivek for coming on our show.

Thank you for having me. Fingers crossed for a successful Goerli merge. Fingers crossed for the actual successful mainnet merge and excited to see how this all plays out.