The merge was a long-awaited upgrade to the Ethereum network, seeking to make it more scalable and energy efficient. Now that it is complete, Ethereum’s proof-of-work consensus mechanism has been replaced by a proof-of-stake one. PoS consensus uses significantly fewer resources than PoW, making it more sustainable, as well as providing several other benefits.
To combat scalability issues, the upgrade integrates the two previously separate chains: the execution layer and the consensus layer. The Ethereum mainnet (the PoW chain) and the beacon chain (the PoS chain) used to operate in parallel. The first part of the merge, the Bellatrix update for the beacon chain, completed on 6 September, ensured that validators are producing updated beacon chain blocks ahead of the merge.
The second and final stage of the update, the execution layer’s Paris update, was completed early on 15 September. Although the merge has had a bumpy rollout, extensive testing on public sandboxes and bug bounties helped ensure a safe transition to proof-of-stake.
Foremost among the questions consuming institutional users is how the merge will impact pricing and volatility. This is a major concern. Based on possible outcomes of the Ethereum 2.0 rollout, there could be crucial pricing implications for Ether, the network’s native cryptocurrency, and the entire market. However, institutions looking to participate in the market now that Paris is implemented would be wise to prepare for other roadblocks. As was seen with the Luna crash and subsequent hard fork, significant events in the crypto space can introduce enormous challenges to trading activities, data operations, reporting and compliance.
The impact on trading, for example, is not limited to price actions around Ether. As in 2016, when Ethereum and Ethereum Classic split, the market could potentially see the launch of a new asset. If a segment of the market supports a ‘new’ PoW asset, trading exchanges will scramble to determine whether they should list it. Some have already announced their support for such an asset; others will perform due diligence as it launches.
If it does appear, traders will have to quickly integrate information for the new asset into their data stacks. Consumers, like index providers, will have to determine how it will fit into their compliance frameworks. Additionally, tokenised assets in the Ethereum ecosystem (of which there are tens of thousands) may choose to move operations to either chain in the case of a split. The need for data standardisation and reliable information on asset characteristics will be critical in this case.
The confusion doesn’t end with a potential new Ether competitor. Many venues have already listed new financial instruments related to the event, such as the ‘potential forked’ Ether tokens listed on Poloniex, which allow traders to swap their existing ether into I-owe-you assets. As Poloniex announced, ‘ETHS (ETH2, Ethereum PoS) represents the token for the new PoS chain, and ETHW (ETH1, Ethereum PoW) represents the token for the PoW chain that will potentially continue to exist’ in the event of a contentious hard fork.
However, neither of these assets are a consistent representation of the Ether currently known to the market – the ticker conventions presented by Poloniex may change based on the event. ETHW is more of a placeholder, it does not carry the characteristics of potential new proof-of-work Ether assets, which will have to be evaluated by market participants if the new asset enters the market. Poloniex is also just one venue – Lukka has identified over other 50 trading venues that have announced operational changes related to the event.
For traders looking to navigate new tokens, advanced futures instruments and ticker updates quickly, the release of Ethereum 2.0 introduces potential for errors and missed opportunities due to operational downtime. Institutions looking to integrate new asset information introduced by the event or handle reporting on financial activities following the merge will require significant resources and expertise to standardise all of the data changes presented by the market.
There are also new research factors to consider for participants interested in environmental, social and governance criteria in the crypto space, such as how the shift to PoS impacts the environmental footprint of Ethereum and how that might compare to a forked PoW version. To handle these challenges and questions, institutions should work with a trusted data provider to timeline events, standardise historical data and streamline operations.
The benefits of this upgrade are extensive and many institutions, including Lukka, support it. However, all organisations must have an understanding of any of the resulting complications as they manage the risks associated with the merge.
Adam Katt is Data Product Manager and Chris Muoghalo is Data Product Specialist at Lukka.