What are the risks associated with the Ethereum Merge?

With each passing day, the long-awaited consensus shift from Ethereum to Proof of Stake is drawing closer. If everything goes according to plan, most ETH developers are currently assuming that the merge will take place on September 19th. The last major testnet “Görli” has already been successfully placed on the new consensus mechanism – BTC-ECHO reported.

Never before has such a switch been made on such a large blockchain project. It is therefore clear that there are also some risks associated with the upgrade.

The upgrade will shift the consensus mechanism of the Ethereum blockchain from Proof of Work (PoW) to Proof of Stake (PoS). In short: The ETH network will in future be secured by investors and their capital in Ethereum instead of miners. From this point on, it is no longer miners, but validators who confirm transactions, process them in blocks and attach them to the ETH blockchain.

To the detriment of many ether miners, the merger threatens to end a multi-billion dollar industry.

However, it is unrealistic for miners to go out of business without a fight. They will fork Ethereum (copy blockchain) and advocate for an alternative Ethereum blockchain still based on Proof of Work.

There are already Ethereum miners who are looking for an alternative ETH PoW Blockchain (ETHPOW) make strong. Additionally, crypto exchanges like Bitmex or Poloniex already tradable futures contracts for ETHPOW. This gives investors the opportunity to speculate on the future price of these potential forks.

Whether the Ethereum PoW Forks are ultimately valuable or not is an open question. However, it is likely that these forks could create confusion for the ETH ecosystem in the short term. In addition to possible technical difficulties, forks could also become a problem for a successful introduction of the ETH PoS Blockchain.

Danger from Ethereum Forks

Forks are not uncommon in the crypto world. However, they can cause complications. Bitcoin also experienced a large number of forks in 2017. At the time, large parts of the Bitcoin community did not agree with the so-called SegWit upgrade. As a result, the Bitcoin blockchain was forked and BTC holders received tokens at a 1:1 ratio on each forked blockchain (BCH for Bitcoin Cash, BCD for Bitcoin Diamond, BSV for Bitcoin Satoshi Vision, etc).

While most of these forks have since faded into obscurity, many had multi-billion dollar market caps at their peak. Bitcoin Cash (BCH) has a market cap of over $2.6 billion as of today.

Many investors received new BTC tokens that had a market value through the forks at that time. They faced the choice of getting rid of their freshly forked tokens for more BTC or keeping them in line with the vision of the new blockchains. The question that now arises: does Ethereum face the same fate?

Just as with Bitcoin in 2017, it is already clear that there will be ETH forks. Each Ether holder will therefore receive ETHPOW tokens at a 1:1 ratio. However, there is a key difference between Ethereum and Bitcoin. With a Bitcoin fork, only the native token, BTC, has to be forked. With Ethereum, on the other hand, miners can theoretically fork an entire ecosystem of tokens and decentralized applications.

Should miners decide to hard fork, it means that all these tokens and protocols technically also exist on the new PoW blockchain. For some, this could cause confusion. It is therefore likely that the merge will cause increased market volatility until a new consensus is established.

As already mentioned, with a fork, miners can do everything on the current ETH Copy blockchain. But that doesn’t mean that every asset, protocol or piece of infrastructure is supported by every entity behind it on all Ethereum versions (ETH PoS, ETHPOW, etc). What a fork does not do is that things that are outside of the blockchain can be duplicated. What does that mean?

Consequences for stablecoins and DeFi protocols

For example, the value of stablecoins such as USDT or USDC cannot be copied one-to-one to another blockchain. This is because the capital backing these stablecoins is not on the blockchain, but resides in the bank accounts of the companies behind these stablecoins.

Just because tokens exist on a forked version of Ethereum doesn’t mean they have the same value as the tokens on the Ethereum PoS blockchain.

For example, Circle, the company behind USDC, already has announced, that it will only support the Ethereum PoS blockchain. Conversely, this means that any USDC on possible ETH PoW forks will be worthless.

Another question that arises: what is the value of a non-fungible token (NFT) on an ETHPOW blockchain versus the NFT on the PoS-based blockchain? The merge also raises a number of questions for many DeFi protocols. Which DeFi protocols support ETH PoW and which only support Ethereum PoS?

Many DeFi projects, including Chainlink, for example, have announced that they will exclusively support the PoS Ethereum blockchain. For the PoW ETH forks, this means that many of their possible forked DeFi protocols are dysfunctional, as they lack sufficient liquidity and the necessary oracle infrastructure. It is therefore likely that forked tokens on ETH PoW forks will fall towards zero in value.

One thing is therefore already certain: the hours before and after the merge will point the way for the future of the ETH PoS blockchain. There will be chaos in the DeFi ecosystem for a short time while hundreds of billions of dollars in capital fall to zero on one Ethereum fork and not on the PoS version.

Vitalik Buterin remains optimistic

Ethereum founder Vitalik Buterin is nevertheless convinced that such Ethereum forks will not have any negative effects on Ethereum PoS in the long term. At an Ethereum conference in South Korea in July explained Buterinthat the majority of the Ethereum ecosystem is behind ETH PoS:

My impression from pretty much everyone I’ve spoken to in the Ethereum ecosystem is that they fully support the move to Proof of Stake

According to Buterin most ETHPOW projects are usually just “a few misfits” looking to make a quick buck.

Despite this, the Ethereum mastermind noted that there could be complications if Ethereum PoW forks gain significant acceptance in a short period of time and the ETH PoS blockchain fails to function as planned.

Conclusion

The Ethereum Merge represents a unique event in the history of the crypto world. Never before has such a large blockchain switched from PoW to PoS. It is normal that such a complex project can cause confusion. Therefore, it is likely that volatility in the Ethereum ecosystem will increase for a short period before and after the merge before a new equilibrium is established.

As a user, you can still remain relaxed. The merge is coming and users don’t have to take any further steps to initiate it. The majority of ETH projects, crypto exchanges and institutional investors rely on ETH PoS.

It is therefore unlikely that any of the potential Ethereum PoW forks will pose serious competition for the Ethereum Proof of Stake blockchain. Still, it might be wise to keep your feet still and not take speculative trades during the merge due to increased volatility.