What is "The Merge" and its effect on Ethereum’s price?

I) Ethereum is preparing to upgrade its PoW consensus to PoS.

II) It is one of many changes Ethereum has undergone over the years, and there will be more to come.

III) It will have a significant effect on the value of ether as well as offering new possibilities in terms of passive returns.

IV) All that glitters is not gold: some negative effects for Ethereum.


It has been years since it was first announced that Ethereum was going to move from a Proof of Work to a Proof of Stake consensus. Or at least that was the intention, based on benefits such as reduced energy costs, to justify the change. Since then, a multitude of obstacles have prevented this significant improvement from being implemented. Ethereum's own developers were the first to recognise the difficulty of the process, even going so far as to "underestimate" the enormous task involved.

But last week, Ethereum's testnet Kiln had succeeded in making the switch to Proof of Stake for good. This event is known as “The Merge” and according to the Ethereum Foundation is already scheduled for the main Ethereum network sometime in Q2 this year.

This is obviously a very significant event not only for Ethereum but potentially for the entire cryptoverse. Ethereum is the foundation for much of the ecosystem, whether as the cornerstone of decentralized finance (DeFi) or as the basis for a myriad of ERC-20 tokens. Therefore, The Merge will profoundly alter Ethereum, but its effects will be felt throughout the crypto world.

Let's take a closer look at what the consensus change actually entails (both the good and the bad) as well as break down the multiple updates Ethereum has had and is going to have.

I) Before switching to Proof of Stake

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Despite the impact this update will have, it is by no means an isolated event. Ethereum has already undergone several changes that have introduced significant shifts in the way it operates.

For example, last summer IEP-1559 was activated, which adjusted the transaction fee system but also added a deflationary mechanics for ether. The consequences were more far-reaching than they appeared at first glance.

Even earlier, in December 2020, the first step towards Proof of Stake had already been implemented. Indeed, Ethereum's PoS chain has been active for about a year and a half, although its use is limited to validating blocks, rather than encompassing all the functions of a blockchain. Hence the next step is now being taken with The Merge, which will open the doors to the full range of its purpose.


This is why the term "merge" is used to describe this event. It is not something that requires adopting a new process from scratch (as was the case in EIP-1559), but rather bringing together two pieces of an existing puzzle. The Beacon Chain, the Proof of Stake chain, will come to incorporate all activities on the Ethereum blockchain, while the Proof of Work chain will simply cease to perform its functions and become obsolete.

The changes planned for mid-year can therefore be seen as a stepping stone on Ethereum's long journey towards its final form.

II) After switching to Proof of Stake

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Ethereum still has a number of issues to resolve. Moving to Proof of Stake is obviously an important step, but it will not have an impact on its most glaring problem: transaction fees.

Transaction fees are undoubtedly its Achilles' heel, the most vehement criticism it constantly faces. Whether an obstacle for users with fewer resources or the degree of manipulation it lends itself to with Maximal Extractable Value, Ethereum has long struggled with this problem.

Meanwhile, other blockchains have taken advantage of this efficiency gap to grab a notable share of the market, but almost always at the expense of decentralization. Within the Trilemma of the blockchain world - Security, Scalability, Decentralization - the latter seems to be the least relevant as we further notice many Layer 1 projects gaining prominence in the crypto ecosystem. Developers and the average user seem to value much more the possibility to make large-scale transactions for (almost) nothing. In most cases this is understandable given that these projects tend to be centralized, with companies and private investors sharing the biggest slice of the cake, even if they try to justify this with the option to join the network as an independent validator or other rationalizations that give a slight DeFi and Web3 feel. In such cases, throwing decentralization out the window is logical, though perhaps questionable given the founding ethos of cryptocurrencies.

Ethereum is not exempt from these practices, especially now that it is moving to Proof of Stake, although it is trying to hold on to some extent to the concept of decentralization. This could explain why it has not implemented a quick solution to its scalability, and therefore to the cost of transactions. We know that there are so-called Layer 2 solutions (parallel networks that offload the amount of transactions from the main Ethereum network) with projects such as zkSync, Arbitrum or Optimism, which progressively allow more functionality in Ethereum at low cost. It is a slow process that will require time for full integration, even though it has been mentioned for years.

However, the next step after The Merge would be to find a way to increase scalability without necessarily compromising decentralization. The solution would be “sharding”, an internal division of the blockchain into several “shards” capable of processing data faster and more efficiently than if they were grouped together. In principle, this would allow practically infinite scalability without affecting the ability to maintain decentralized validators. But this will have to wait until 2023 at the earliest, relying on Layer 2 solutions to keep transaction costs down.

III) The effect on Ethereum's price

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But what does all this mean for the price of Ethereum? There are several points to consider.

To begin with, the shift to Proof of Stake consensus introduces a crucial element: the production of ether per block is going to be reduced by around 90%. If Bitcoin's Halvening (50% reduction) is a substantial factor for its parabolic rises every 4 years, we can deduce that The Merge will be an amplified version for Ethereum. Supply increase will shrink to only a tenth of what it used to be. As long as demand stays the same or increases, this will result in a strong appreciation of ether by pure supply/demand mechanics. Even if demand falls it could increase in price as the reduction in supply is staggering. Still, the effect of this amplified Halving is unlikely to be immediate. As with Bitcoin, it usually takes several months before we see a noticeable impact on the price as there must be a shortage of supply, and therefore sellers' reserves must first be depleted.

Another factor to consider is that miners will be replaced by validators. Therefore, the profits previously associated with Ethereum mining will now be entirely in the hands of anyone who validates the network. To be a full-fledged validator, you will have to stake a minimum of 32 Eth. This was already a possibility since the Beacon Chain was activated in 2020, giving staking returns close to 5% per year. But after the Proof of Work chain is deactivated, all transaction fees will be passed on to validators.


In anticipation of the juicy benefits of being a validator on Ethereum, we observe that the number of validators is growing steadily, with a slight intensification in the last month.

Similarly, another graph that illustrates this trend is the amount of Eth deposited in the Beacon Chain. Since the possible date of the Merge was announced, we have seen the largest spike in deposits since the Beacon Chain was launched in 2020, with more than 215,000 Eth on 15/03.


The benefits of the Ethereum switch will not only be linked to the very likely increase in its fiat value, but in that anyone with some ether will be able to accumulate more and receive part of the transaction fees without the need for all the logistics and infrastructure required by Proof of Work mining.

What if I don't have 32 Eth? The barrier in terms of the amount needed to be an independent validator is out of reach for many users (over 100,000 USD at the moment), although until not so long ago it was only a few thousand dollars. But the crypto world always tends to overcome all obstacles, or at least tries to. As such, there are solutions that allow everyone to benefit from staking Ethereum with really low amounts (0.01 Eth), by joining staking pools with other users such as Rocket Pool.

To answer the initial question of the effect of this update on the price of Ethereum, it can be stated that the upward pressure will be very strong due to the drastic reduction of ether production. In addition, the ease of receiving validator benefits, rather than mining infrastructure, is a further factor to imcrease demand. The logical conclusion is that Ethereum will increase in price over time, once The Merge is completed. But along with the very likely appreciation of ether, there is also the possibility of earning ether through transaction fees, which may be even more advantageous.

IV) The downside of Proof of Stake

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It is impossible to conclude this article without mentioning some negative aspects, as not everything is positive, even if the effects of the Merge may appear to be so.

As mentioned previously, the move to Proof of Stake accentuates the problem of many blockchains: centralization. While many may see this as insignificant or simply a lesser evil, the reality is that Proof of Work consensus further secures one of the fundamental pillars on which cryptocurrencies and blockchain technology are based. By separating the production of new coins from the amount held by users, a blockchain like Bitcoin can ensure a certain level of independence between those who work for its operation and security (the miners) and the users themselves who make use of the network and hold coins. This means that no matter how many Bitcoin a particular wallet holds, it cannot influence the security of the network in any way as long as it does not contribute through Proof of Work. By default, the Proof of Work will always guarantee a decoupling between the blockchain and the holders of the token associated with the blockchain.

Moreover, since the contribution to Proof of Work has no fixed limit, there will always be competition under the same rules when it comes to adding a block to the chain. The design of the blockchain forces those who want to reap the fruits of their labor to be efficient and outperform those competing for the right to produce a new block. Nothing prevents a new entrant from competing with an established miner as long as it brings considerable computational power, which ultimately benefits the security of the blockchain.

Proof of Stake consensus cannot make the same case. It has other considerable qualities, such as the enormous reduction in energy costs, but at the expense of the “equitable” design of Proof of Work consensus. Indeed, in the case of Proof of Stake, the production of blocks is closely linked to the amount of coins that a validator has, since it is necessary to deposit these coins in order to produce blocks and receive rewards in exchange (staking). There is then a compounding interest effect where those with higher stakes will receive progressively more, and nothing can prevent it.

This may be particularly worrying considering that Proof of Stake projects as a whole are usually launched by entities that distribute most of the coins internally, either among the team, the legal structure or private investors. They are therefore securing control of the blockchain and the benefits that come with it, by design.

We are facing a full-blown Cantillon Effect. The monetary policy behind a blockchain with a Proof of Stake consensus will always favor those who designed it or who ensure that they own a disproportionate share of the coins in circulation. To some extent this may seem reasonable since these are private for-profit entities, but ultimately, it is no different from the nefarious fiat financial system in terms of its principles. And yet, the creation and development of the crypto world seeks not only to replace the obsolete fiat order, but to improve it too.

The Merge is a big step forward for an improved version of Ethereum, but a step backwards for its core principle of decentralization.



Author: Gate.io Researcher: Bernabé L.
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