The crypto community is waiting for The Merge event on September 15 - the final transition of the Ethereum blockchain from the PoW (Proof of Work) algorithm to PoS (Proof of Stake). However, many doubt that this will benefit the cryptocurrency. PoS simplifies network scaling, speeds up transactions and makes it energy efficient, but threatens to increase centralization, which is especially unpleasant for DeFi ecosystems on this blockchain. Part of the community opposes the transition and intends to support its PoW forks: the old Ethereum Classic (ETC) and the new Ethereum PoW (ETHW or ETH1). It is on them that most miners will probably transfer their power, since PoS-ether will not need them. What fate awaits the split blockchain? Will at least one of the forks hold the second line of capitalization? Andjei Korotkewič, CEO of the ASTL investment project, gives the main arguments for and against the renewal of the Ethereum cryptocurrency network.
The transition of Ethereum from the PoW (Proof of Work) algorithm to PoS (Proof of Stake) is close to completion. Among the possible threats is not only the loss of a large army of miners (who will be forced to support some other project), but also an increase in the centralization of the network. According to the so-called blockchain trilemma, while maintaining the same security, the acceleration of transactions (provided by PoS) should increase the centralization of the project. At the same time, in practice, all currently existing PoS projects with a claim to decentralization (like Cardano) are far behind in popularity both from slower PoW projects (Bitcoin) and from fast, but strictly centralized projects (for example, USDT and Ripple) .
Will Ethereum be able to break this pattern and create a truly decentralized and popular PoS project? This is still not very clear, because "maximum decentralization vs maximum scalability": these are two extremes with both advantages and disadvantages.
According to the blockchain trilemma, the network can only fully perform two of the three functions: decentralization, security, scalability (closely related to the speed and ease of network management). Most successful projects are very careful about the issue of security, so the "pull of the blanket" is mainly between two alternatives - decentralization and scalability.
Classic cryptocurrencies that use the PoW principle with mining on computing power - Bitcoin, Litecoin, Dogecoin, the current version of Ethereum and others - put decentralization at the forefront, but have repeatedly had problems with speed and in general with scalability. The most famous example is the multi-day BTC transaction times in 2017, which necessitated an urgent reform of the network. It was then that compromise technologies SegWit and Lightning Network were introduced into BTC, deviating from Satoshi's original principles of recording all transactions in the blockchain.
A reverse example of currencies with a high transaction speed, but without decentralization, are digital assets issued by specific corporations (and not by a “swarm” of miners around the world). For example, the Ripple (XRP) interbank system from Ripple Inc, the USDT stablecoin from Tether Ltd (both use the PoS principle instead of PoW, which we will discuss below), the unlaunched Libra project from Facebook, as well as central bank digital currencies (CBDCs) being developed today, such as digital yuan.
These designs have two related drawbacks. The first drawback is the vulnerability of issuing companies to the repressive actions of national governments. Tether has been repeatedly accused of the opacity of reserve funds, and Ripple is at the center of disputes over the status of the XRP token as a security.
Perhaps, over time, the legal status of such blockchain companies will be settled and they will simply take their place among other officially registered payment systems. State stablecoins have a good chance of displacing conventional national currencies in the future. However, all of them fundamentally cannot compete with bitcoin and other decentralized systems where it is important for users to be independent from emission centers. Centralized digital assets do not fulfill the original purpose of cryptocurrencies and cannot replace them for the same reasons that national currencies or private securities cannot replace gold. This is their second and key drawback.
Is decentralized PoS an attempt to sit on two chairs? Naturally - yes. But there is a nuance. Technologies like SegWit, although they violate the ideals of Satoshi, do not encroach on the central principle - the development of the network is regulated by the vote of the miners. Only those who single-handedly collect energy sources sufficient to power an average European country can gain control over it. The current BTC can be considered completely decentralized, and it cannot be destroyed by the bankruptcy of one or even many companies associated with it. At least in a number of countries, miners will continue to support the network.
As a proposed alternative, a more radical solution to the problem of decentralized network scalability is the transition from the PoW principle to the PoS principle, but without a central issuing company. In PoS, there are no miners as such, but there is a staking mechanism. The validator allocates a certain number of coins, which are blocked, and he receives rewards for confirming transactions. Validators, like miners, vote for certain initiatives to develop the network.
On the one hand, PoS provides a number of obvious advantages. In addition to allowing you to make transactions very quickly, it is environmentally friendly. A PoS blockchain can consume orders of magnitude less electricity than PoW. However, the downside of this simplicity is the threat of losing decentralization.
In PoW blockchains, the largest coin holders (whales) do not have to be the largest miners. The power over the development of the blockchain does not belong to those who have more coins, but to those who have provided the network with more computing power. In PoS, however, the power is in the hands of the largest validators who have staked as many coins as possible. In other words, whales decide everything, and in order to gain influence and income on the network, one must strive to own the maximum number of coins. Therefore, despite the initially decentralized mechanism, such blockchains are prone to increased centralization.
For example, in the currently most popular non-corporate PoS blockchains Cardano (ADA) and Solana (SOL), only a few dozen of the largest wallets contain 50% of the total money supply, which is not even close to BTC. Moreover, a significant place among them is occupied by wallets of centralized crypto exchanges.
Does the market trust decentralized PoS blockchains? As current practice shows - not especially. By itself, the concentration of control over the network in the hands of dozens of the largest whales does not yet turn it into a centralized one. However, it also hurts security by increasing the likelihood of a 51% attack when one user (or coordinated group) gains control of the network and can single-handedly control it, committing theft and other destructive actions. Theoretically, dozens of the largest ADA or SOL whales could conspire and carry out such an attack. In practice, this is unprofitable for them, since the likely gain does not cover the negative from discrediting the blockchain. Because of this, ceteris paribus, a 51% attack is less likely in PoS than in PoW. But in reality, the conditions are unequal, and in PoS the technical possibility of collusion is higher due to the concentration of capital.
For this or some other reason, but the popularity of decentralized PoS in the modern crypto market is not great. In the top ten capitalization, the vast majority of the market is occupied by PoW blockchains - bitcoin, the current ether and Dogecoin. Their total capitalization is $580 billion, that is, 59% of the market. In second place are stablecoins and other centralized projects of corporations, such as XRP, BNB, USDT. Their capitalization is $ 200 billion - almost 20% of the market. As for decentralized PoS blockchains, there are only two of them in the top ten - Cardano (ADA) and Solana (SOL). They occupy 8th-9th places with a total capitalization of $36 billion, that is, less than 4% of the market. And this is despite their widely "promoted" environmental friendliness.
Perhaps the absence of powerful leaders among decentralized PoS is only due to the expectations that ETH2 will become such a leader, and so far there is no point in competing with it. But perhaps the market is still afraid of the concentration of capital in a small number of people and does not believe in the ability of such projects to satisfactorily solve the blockchain trilemma. It cannot be ruled out that in the historical perspective, decentralized PoS does not have much prospects. For reliable decentralization, the market prefers PoW projects, and for the speed and flexibility of the system, centralized systems such as BNB.
After the transition of ether to PoS, we should expect a particularly high concentration of capital on crypto exchanges that will organize staking for users. At the same time, the largest centralized exchanges are officially registered with financial regulators, and if necessary, the state can put pressure on them. A very significant part of the Ethereum coins and power over the entire network may end up with centralized players. As a result, ETH2 may lose popularity among DeFi projects, the main feature of which is the decentralization of everything and everything. A significant portion of DeFi projects may choose to continue collaborating with PoW networks, and Ethereum Classic (ETC) and PoW (ETHW) forks of Ethereum can be especially useful here.
Why, in fact, are some so afraid of the transition of Ethereum to PoS? Above, I directly indicated what concerns the Ethereum (ETH) community has about its transition to the PoS principle (we will conditionally denote the new version of ETH2). First of all, people are afraid of the likely increase in the centralization of the project, and in the future - the fall in capitalization. Today, the most popular decentralized PoS blockchain - Cardano (ADA) - occupies only the 8th line in the capitalization rating. At the same time, the degree of its decentralization is low: 50% of all coins belong to several dozen whales, between which collusion is possible. More popular PoS blockchains like Binance Coin (BNB) are completely centralized, as they are tied to specific issuing companies (for example, to the Binance exchange).
The new ETH2 PoS Ethereum claims to outperform all of these projects by retaining the #2 market capitalization while maintaining high decentralization. In September, according to research by Glassnode, market participants expect the price of ether to rise to $2.2-5 thousand. However, will ETH2 maintain such indicators in the future?
A pessimistic scenario cannot be ruled out: ETH2 “hypanet” only at first, while those who wish will be purchased in the hope of becoming validators (for this, the more coins, the better), but this process will lead to a concentration of capital among a small number of people and a loss of confidence in the project. The new ether will no longer be a serious competitor to BTC and will fall to lower positions with other PoS projects.
The main and most vital question - will the place of the main PoW competitor of bitcoin remain empty? For many years, Ethereum has been ranked second in the capitalization rating. This means that the first two lines, covering most of the market capitalization (today - 59%), are occupied by PoW projects. All these years, ether has acted as a “younger but promising” brother of bitcoin. If the PoS version of the ETH2 Ethereum retains the second line of capitalization, then an unusual situation will arise for the market: BTC will remain essentially the only popular PoW project. Most of the other first lines will remain with PoS projects, including centralized USDT, BNB, XRP. Considering that a significant part of crypto enthusiasts do not consider them to be full-fledged cryptocurrencies, the crypto market for them will turn into a market for the “only real” bitcoin and projects that “adjoin” it, far removed from Satoshi’s principles.
On the one hand, this situation will strengthen the position of BTC as the main "digital gold". On the other hand, it is unlikely that the “holy place” of the second PoW blockchain will remain empty. Moreover, the ether has a huge army of miners, most of which, for technical reasons, cannot switch to BTC. Probably most of them will support other projects on the ethash algorithm, among which are PoW forks of Ethereum. Already, many miners from the “main” ether (ETH) are migrating to Ethereum Classic (ETC). This fork appeared in 2016. Then the cooperation of ETH with the DAO fund led to a major theft of funds by a hacker. Observers have spoken about the insufficient development of the fund's security system before, but the community relied on "maybe". As a result, the ether was divided into two new PoW branches: ETH, where the blockchain events were “returned” to the past at the moment before the theft, and ETC, “classic ether”, where the theft was not “cut out of history”. Miner voting over time has shown that ETH is much more popular than ETC. However, now the upcoming ETH abandonment of mining encourages miners to switch to ETC, adding weight to the network and increasing its protection against 51% attacks (which used to happen due to the lack of popularity of the coin).
Another alternative to ETH2 PoS Ethereum could be the latest ETHW PoW fork proposed by Chandler Goh. If we compare two PoW forks, ETC and ETHW, then the second one has the advantage of having all the system improvements from 2016 to 2022 up to the London fork. ETC does not have them. On the other hand, ETHW, as a “pirated” blockchain, may face hostility from influential supporters of ETH2. Already, for example, the largest ethereum pool, Ethermine, has announced that it will not support new PoW forks, while ETC support will continue.
So far, in the polls, about half of the community members prefer one fork, and the other half prefer the other. However, after September 15, this parity is unlikely to continue. The future of the market after The Merge remains not very predictable. How much support for miners will raise the popularity of ETC and ETHW? Is the ether development team in danger of splitting? Will PoW forks be able to gather really strong teams? What versions of Ethereum will the DeFi sector prefer? How will Bitcoin show itself, having lost its main PoW competitor?
Probably, until September 15, the capitalization of ETH will grow due to the hope of investors for a short-term increase in the ETH2 rate immediately after the reform, as well as for the possible free receipt of ETHW fork coins. The capitalization of ETH will grow especially noticeably compared to the capitalization of BTC, which we are already seeing (now their ratio is only 38:20%). However, in the medium term, a reverse strengthening of BTC is very likely. Indeed, for some time (until it is not clear which of the forks of the ether will win), it will remain for investors the only recognized “ground under their feet”.
Of the Ethereum PoW forks, only one is likely to win - the one that puts together a more successful team and gives miners a higher profitability. Whether it will be ETC or ETHW, it has a good chance to take a high line in the capitalization rating in any case - as the most popular competitor of bitcoin with support for smart contracts. As for the PoS version of ETH2, it is around it that high uncertainty can persist for many months. This fork already has a good team led by Vitalik Buterin. At the same time, the support of miners is not important to him. But DeFi developers will still have their say here. Some projects may prefer the speed of PoS, others the “proper” decentralization of PoW. This is what will largely determine the balance of power between PoS and PoW versions of the second market cryptocurrency.
