Since the formulation of Bitcoin in 2009, the ground-breaking idea of using blockchain to generate what is now known as “cryptocurrency” has attained a level of popularity, even in the face of tremendous volatility, that detractors could never have imagined. Ethereum was first conceptualised in 2013 and brought to life in 2014 by programmer Vitalik Buterin. The cryptocurrency was founded not as a currency in itself, but as a platform with a goal to fully decentralise the internet. Since its formation, Ethereum has grown to earn its position as the second-largest cryptocurrency in the world with a current market cap of $163.28bn, despite a recent but steady fall in price of 66% from annual highs.
Although Bitcoin and Ethereum are quite different with regards to their structure and capabilities, they have faced common criticisms by both observers and users alike. “Proof-of-work” is the decentralised mechanism used by both whereby members of a network solve arbitrary mathematical problems that use massive amounts of computing power for mining new tokens and validating transactions. The total consumption of energy needed to fuel this computing power has been condemned. According to estimates, Bitcoin alone consumes as much energy as Poland. In the face of climate change and energy shortages, there has been increased pressure on governments and corporations to disincentivise the growth of such cryptocurrencies based on the system of proof-of-work. The White House proposed restrictions on proof-of-work mining earlier this month as a way to reduce energy consumption.
These problems prompted Ethereum developers to reconsider the “proof-of-work” system and led to the proposal of a “proof-of-stake” upgrade to underwrite Ethereum. This project eventually led to the “Merge” that took place last Thursday, 15th September which went off without a hitch. The proof-of stake mechanism is based on the work of “validators” rather than “miners”. These validators are compensated modestly in return for their validation of transactions and collateralize their own cryptocurrency which deters dishonest or lazy work. Over 100 developers worked on the upgrade for years to ensure minimal risks for bugs and the new mechanism is estimated to cut energy consumption by the cryptocurrency by roughly 99.95%.
The upgrade will significantly reduce the quantity of Ether (Ethereum’s token) coming into circulation which may allow it to serve as a deflationary currency in the coming months. Ethereum may well become more accessible for institutional investors as corporations can no longer use the wasteful use of energy as an excuse to ban its use in portfolios. Institutions such as Bank of America have recently indicated that the upgrade may ease their current restrictive policy on Ethereum. Cryptocurrency advocates say the transition marks a turning point in the future of digital assets while critics argue that a number of challenges remain. While the “Merge” will accelerate the process of introducing upgrades and make Ethereum more efficient, it will still face the inherited problems of congestion and very high transaction costs. The proof-of-stake upgrade represents more than just a change in operating system. Proof-of-stake has now been proven to be a suitable mechanism for operating blockchain technology and will have broad implications for the innovation of digital assets in the future.