Ethereum is Proof-of-Stake. Now what?

Amid the rapid news cycle of this month — the passing of Her Majesty The Queen Elizabeth II, rapidly growing inflation, deteriorating cost of living crisis and energy crisis and the dangerous escalation possibilities in the war in Ukraine — one positive news that likely went unnoticed for many people not actively engaged in the crypto world is that Ethereum is now a Proof-of-Stake blockchain. Ethereum is one of the most important (some may argue the most important) blockchain out there, and this shift should not be underestimated; it is perhaps the most important event in the history of crypto. So, Ethereum is now Proof-of-Stake. What does that mean in practice for Ethereum and why does that concern Sedition?

Before diving in, a quick backstory on Ethereum. Ethereum is a blockchain first proposed in 2013 and launched in 2015 by a Russian-born Canadian programmer Vitalik Buterin. Other founders of Ethereum included Gavin Wood, Charles Hoskinson, Anthony Di Iorio and Joseph Lubin. The idea behind Ethereum was to further unlock the potential of the blockchain technology — not only the payments use case. When understanding Ethereum, a key concept to grasp is smart contracts. They are essentially pieces of computer code that operate independently from any centralized party and execute according to the pre-written rules. Ethereum’s smart contracts allow for an array of various use-cases, including lending and borrowing, exchanging between different cryptocurrencies as well as non-fungible tokens, also known as NFTs. This is obviously a very light touch overview of Ethereum, so if you want to know more about it, check out this video where our Director Rory walks you through Ethereum, why it’s important and what you can do with it.

Until 15 September 2022, Ethereum was operating on a Proof-of-Work consensus algorithm. This meant that transactions on the network were validated by miners, whose computers were solving complex mathematical problems. The Ethereum team had long been planning to upgrade the cryptocurrency as part of their roadmap, and in December 2020 the Beacon chain was launched, which supported a new consensus algorithm — Proof-of-Stake. Ethereum holders could stake ether, the native currency of the blockchain, and become validators. They would then start receiving rewards based on the amount of coins staked, or locked. Ethereum wanted to wait for a sufficient number of stakers to come to the Beacon chain before making it the whole network’s consensus algorithm. After a series of delays and following thorough testing on testnets (essentially, staging environment for Ethereum), on 15 September 2022, Ethereum pulled off what many considered impossible months or even days before the shift — the miners-powered Proof-of-Work was replaced by Proof-of-Stake. Essentially, the Beacon chain was merged with the Ethereum mainnet, thus the event was called “the Merge”. Changing the consensus algorithm of a major blockchain carrying over a million transactions a day was considered as difficult a feat as changing an engine of a commercial jetliner mid-flight. So now that it is done, what has actually been achieved?

For many, the most important change that came after the Merge is that Ethereum is now far more environmentally friendly than it used to be. Proof-of-Work took an immense amount of computing power, which caused a great deal of emissions — as the energy required to produce all that power has not always originated from the carbon-neutral sources. Shift to Proof-of-Stake is estimated to have reduced Ethereum’s energy consumption by about 99.95%. During the current energy crisis, wasting so much energy in order to operate a blockchain is prodigal — and should make users of other blockchains which are currently Proof-of-Work think twice.

In addition, not having to pay miner rewards makes a great deal of financial sense for the network. Issuing new ethers for the miners to compensate for their efforts dilutes the value of existing ethers in circulation if the usage of ether doesn’t rise — in a phenomenon known as inflation. Rewards for staking can be substantially smaller since stakers do not need to pay for all the energy required to produce computing power for mining. Finally, combining this with Ethereum destroying a fraction of each transaction, Ethereum becomes either almost inflation-free or possibly even deflationary — depending on the usage of the network. In fact, during the first two weeks after the Merge, according to the website ultrasound.money, only 8775 ethers net entered into circulation (with over 120 million already in circulation), which corresponds to an annual inflation rate of 0.17 percent a year. Compare that to an inflation rate had the Merge not happened — which is estimated to would’ve been 3.76% per year. 0.17% per year is significantly less than the 8–10% inflation rates currently common with the majority of fiat currencies across the world, such as the United States dollar, euro and British pound sterling and is less than many other cryptocurrencies, especially those operating on Proof-of-Work.

However, despite the many overwhelmingly positive aspects of the transition to Proof-of-Stake, critics of Ethereum have been fast to point out possible weaknesses. Firstly, they claim that Ethereum’s ability to change monetary policy on a whim is a sign of centralization and should not be tolerated for a decentralized blockchain. Secondly, they claim that shifting to Proof-of-Stake makes it easier for governments to censor illegal transactions on the network due to a smaller number of large validators. Finally, they argue that staking just makes the already rich richer and perfectly reproduces the fiat system of money that exists. Do these arguments hold under scrutiny? Let’s take a closer look at them one by one.

First of all, one can argue that Ethereum has a certain degree of centralization, but it is worth noting that the Ethereum foundation does not, despite the name, run Ethereum. It is just one of the foundations supporting the development of the blockchain. Without foundations in place it becomes tricky to compensate developers, organize events and hackathons, and indeed, make any progress with anything at all. A certain degree of centralization is a fair trade-off for progress.

Secondly, it is indeed possible that the Proof-of-Stake algorithm may make it easier for governments to censor illicit transactions. However, is this such a bad thing? Should proceeds of crimes be easier to launder? Should it be easy to buy illicit goods on the dark web? Should war criminals have easy access to cash? Typically, the answer to all of these questions depends on one’s political views and moral compass. Usually, only a hard-core anarchist or a person with nefarious ideas would answer yes to any of these.

Finally, related to Proof-of-Stake making the rich richer and reproducing the fiat system, few things are further from the truth. In fact, it’s the Proof-of-Work algorithm that ensures that the rich will keep getting richer. When mining, you would have a very different strategy if you have 10 thousand dollars to start mining, 100 thousand, a million or 10 million (since you can afford vastly different equipment) — and your financial returns would be vastly different in return. With Ethereum staking, while there is a minimum requirement of 32 ethers to become a validator — easily a yearly salary in a lot of Western countries, making such an investment unfathomable for many — there are both pools of people who can stake and earn together, as well as centralized exchanges which allow staking from even the smallest amount. All in all, you can view the Merge as a great equalizer more than anything else.

At Sedition, we are ecstatic that Ethereum is now a Proof-of-Stake blockchain. We believe that the pros far outweigh the alleged cons of this transition and for us, and our community, the aspect of not being wasteful with energy and not being a polluter is very important, especially in these difficult times. At Sedition we very deliberately held back from making many artworks on our platform NFTs. Now that Ethereum is Proof-of-Stake, this will change and regular announcements will be made in our Discord server. Finally, it makes it easier for many of our artists to release their artworks as NFTs now that the shift to Proof-of-Stake is here. Amid a somber month full of sorrow, it is great to stop and celebrate this rather more positive news.