By transitioning to proof-of-stake, Ethereum has secured the largest catalyst for long-term growth

The second largest blockchain in the world launched its long-awaited update known as the merge on Thursday morning, switching the network from a proof-of-work to a proof-of-stake consensus algorithm. Ethereum developers celebrated the upgrade alongside other prominent community members via a live video stream. Over 40,000 people watched the live stream. Ethereum co-founder Vitalik Buterin marked the event on Twitter, stating that it is a 'big moment for the Ethereum ecosystem.

The update, known as Paris, followed last week’s Bellatrix upgrade, which prepared Ethereum’s consensus layer for the main event. From one block to another, Ethereum’s proof-of-work mainnet 'merged' with its proof-of-stake beacon chain.

The event was described as the equivalent of an airplane changing its engine mid-flight.

As of today, Ethereum will now rely on validators who 'stake' to achieve consensus and secure the network. Proof-of-Stake is expected to bring several significant changes to Ethereum. Perhaps the most notable of these changes is the estimated reduction in energy consumption by 99,95 percent. Since Ethereum will no longer rely on miners operating energy-intensive hardware, it will become much more efficient. Ethereum Foundation researcher Justin Drake stated that this move will reduce global electricity consumption by 0.2 percent during the live stream. Additionally, the network will stop paying ether to miners, leading to a reduction in issuance by about 90 percent. Previously, 13,000 ethers were produced daily, but now validators will only be paid around 1,600 ethers.

The merge is a significant event not only for the Ethereum community but also for the crypto community as a whole. Never before has a blockchain as large as Ethereum made such a type of transition.

Buterin has been discussing proof-of-stake since 2014, and it has been in development for years. It has suffered several delays until the Ethereum Foundation committed to launching it in 2022.

– Proof-of-stake has been the dream of the Ethereum ecosystem since almost the beginning – Buterin said during the live stream.

However, while most Ethereum enthusiasts anticipated the event, the merge was also a contentious topic among Ethereum miners as it essentially rendered them obsolete. Therefore, a group of proof-of-work advocates gathered over the summer to preserve a new version of the network called EthereumPOW. The PoW chain is expected to begin an airdrop for Ethereum holders within the next 24 hours.

Concerns about censorship resistance

Ahead of the merge, many advocates of crypto content within and outside the Ethereum ecosystem expressed concerns about the network’s ability to avoid censorship in light of U.S. Treasury sanctions against Tornado Cash. There are fears that Ethereum proof-of-stake could be easier to censor than the proof-of-work network because many validators of large networks like Coinbase are based in the U.S. To support Ethereum’s decentralization, these validators should process all transactions assigned to them, even if they are not in compliance with sanctions. Validators could theoretically decide not to process certain transactions to comply with sanctions, which could lead to censorship at the base layer.

Coinbase CEO Brian Armstrong commented on this issue when discussions about the network’s censorship resistance raged last month, stating that the crypto exchange would rather give up staking than engage in censorship. Vitalik Buterin confirmed in a tweet that he would consider censorship an attack on the network and advocate for slashing, a process in which stakers lose ether as a penalty for misbehavior or failing to validate transactions as needed.

What’s next for Ethereum?

Ahead of the merge, much of the community’s attention was focused on what the update could mean for Ethereum’s native asset, ether. The second-largest cryptocurrency has risen more than 100 percent from its June lows over the summer, driven by growing anticipation for today’s launch. Several tokens associated with Ethereum in the ecosystem, such as Lido’s LDO and Ethereum Classic, have also seen gains. Ether briefly surpassed $2,000 but has since retreated.

Ether showed renewed strength last week when it reached its highest level in 2022 against Bitcoin, fueling hopes among Ethereum enthusiasts for a possible 'flippening' where Ethereum surpasses Bitcoin’s market capitalization. However, it exceeded the ratio of 0.085 and has since struggled to maintain momentum. Ether took a significant hit on Tuesday when CPI data came in higher than expected at 8.3 percent.

Macro environment

There are some who believe that the merge could be a 'sell the news' event, likely because it has generated enormous hype and such scenarios are common in crypto. Moreover, the current macroeconomic landscape paints a grim picture for risk assets like cryptocurrencies, regardless of promising updates or major launches.

With inflation rising worldwide, the Federal Reserve is expected to announce new interest rate hikes. Some have predicted that it could double its 'hawkish' stance with a rate increase of 100 basis points, which would likely shake global markets. Fed Chairman Jerome Powell has repeatedly indicated that the U.S. central bank is committed to combating inflation. He reiterated in Jackson Hole last month that the Fed is targeting a rate of 2 percent, which is still far from today’s price growth.

Aside from the macro picture, crypto has been in a bear market for nearly a year, seeing its market capitalization fall from $3 trillion to around $1 trillion. Even if the Fed becomes less restrictive next week, retail investor interest in digital assets has taken a hit compared to this time last year, and crypto has few catalysts currently up its sleeve.

Deflationary asset

Despite clear arguments for a bearish stance, the merge is likely the largest catalyst for long-term growth that Ethereum has ever seen. As the network reduces its issuance by 90 percent, ether is likely to become the first major deflationary cryptocurrency if demand for using the network remains constant. The Ethereum blockchain burns ether with every transaction since the EIP-1559 upgrade, increasing the scarcity of the asset as more people use the network. According to data from ultrasound.money, the supply of ether will peak at 120.5 million and decrease by about one million annually.

Crypto commentators have debated both sides of the argument in recent weeks as the merge hype has grown. BitMEX co-founder Arthur Hayes, for example, stated on the Bankless podcast that the merge could be a 'sell the news' event, but that he views ether as a 'no brainer trade' due to its limited supply.

Aside from ether itself, a broader question is whether Ethereum’s transition to proof-of-stake will lead to increased public interest in blockchain. The cryptocurrency has occasionally been under scrutiny in the mainstream, often due to mining impacts in 2021 and more recently because of NFTs, which have received fierce criticism in the mainstream world, but the environmental arguments made by detractors are anything but irrelevant now that the network uses proof-of-stake. If the public becomes accustomed to the idea of an energy-efficient Ethereum, it will undoubtedly raise questions about Bitcoin and its reliance on proof-of-work.

Ether is currently trading at around $1,606, putting Ethereum’s market capitalization at about $194 billion.