Ethereum merge

Last week, the Ethereum foundation confirmed that the merge will commence on the 15th or 16th of September.

Is Proof of Stake better for the environment than PoW?

Some of the main proponents of Proof of Stake are often bashing Proof of Work for its energy consumption, and claims that Proof of Work is destroying the environment or uses more electricity than XYZ country.

It is true that Proof of Work mining uses energy, and that not all of this energy is renewable (although thanks to the Bitcoin Mining Council, we know that 57% of this energy is renewable).

However, there are also ways in which Proof of Work mining is hugely beneficial to the environment.

Firstly, as Alex Epstein and Saifedean Ammous often argue, the utilisation of energy resources within a society is hugely beneficial for the growth of that society.

In fact, there is a huge correlation between the amount of energy that a country uses and the quality of life within that country. As people use more fossil fuels and become larger consumers of energy they are free to use more tools that make life enjoyable.

There are already many examples of cases in which Bitcoin mining has been hugely beneficial for the environment. Last year, during the floods in Texas, there were huge problems with their energy grid as companies weren’t producing enough surplus energy to be able to fix the issue, and tens of thousands of people were left without electricity.

Bitcoin miners decided to simply plug into the energy grid and share the energy that they were exerting, creating a favourable political environment for Proof of Work mining and safeguarding the energy grid.

In a world in which energy prices are notoriously volatile (even before the cost of living crisis, oil prices have gone parabolic and even fallen into negative prices), this sort of stability is hugely important for the environment.

Moreover, Bitcoin miners are incentivised to use energy that is the cheapest that can be found. In this way, they adopt a mercenary attitude to find appropriate jurisdictions where the politics and the geography are favourable.

As well as the geographical component ensuring that mining is more decentralised than in Proof of Stake, where one only need to have a lot of money, this means that energy companies are incentivised to start mining Bitcoin with zero marginal cost.

Thanks to the energy that a lot of oil and gas companies waste each year (since energy can’t be stored), there is no extra cost to simply burning waste fuels (that would have been burned anyway) in order to mine Bitcoin.

In this way, Bitcoin mining is brilliant for the environment in that it converts energy that would otherwise have been wasted into value. The ramifications for such a development are extreme, in that it means that Bitcoin can function as a way for energy companies to operate ventures such as wind farms and hydroelectric power regardless of demand and without government subsidies.

Proof of Stake, by contrast, does not use up all the energy that Bitcoin uses, but this means that it loses a lot of the benefits that Bitcoin has.

Proof of Stake may not be so damaging in the first instance, thanks to the fact that it simply uses less energy than Bitcoin.

Nevertheless, by not using energy PoS also loses a lot of advantages that would be conferred to it if PoW were used.

Is the merge going to damage Ethereum’s reputation?

The merge has already exposed Ethereum as being extremely centralised, and there doesn’t appear to be a way in which this can be remedied.

First of all, the centralisation of Ethereum staking thanks to liquid staking services such as Lido has meant that there are very few people who exert disproportionate control over Ethereum validators. Not only this, but people who have staked their ETH with Lido cannot unstake until after the merge, which means that there is no mechanism for rectifying this situation until after the merge.

Some, such as Dylan Leclair, have advocated that Ethereum ought to consider delaying the merge further in order to first rectify the centralisation of validator nodes, because without doing this there is clear risk to using Ethereum.

The ramifications for such centralisation is extreme: in a worst case scenario, Ethereum validators could choose to cooperate with law enforcement agencies to censor transactions on the protocol level.

Miner Extractable Value (MEV) has long been an issue for Ethereum, in that miners can extract value by frontrunning transactions that been broadcast to the mempool. This means that if someone broadcasts their Internet to make a swap on Uniswap, miners have the opportunity to jump in front of them and arbitrage the price difference caused by the slippage.

In PoS, this concept still exists except that it is known as Maximum Extractable Value, and represents a huge problem for Ethereum, given the power that it confers to those who hold the most ETH: unlike Bitcoin, where all participants are treated equally, MEV gives ETH validators an uneven playing field versus the hoi polloi.

The worst thing about such a large change in Ethereum’s consensus, which required Vitalik and the EF exerting so much influence and control over the network that they killed the entire Ethereum mining industry, is that it exposes the extreme degree of power that lies in just a few hands and makes it difficult for long term investors to trust that there will stability in the consensus over time – after all, Ethereum has a track record when it comes to PoW, but Ethereum on PoS is not so well-tested.

Does the merge prove that Ethereum is a security?

According to the SEC, a cryptocurrency would be defined as a security if it was sold at an ICO or distributed with a future expectation of profit.

Ethereum meets both of these criteria, given that they conducted an ICO with a 70% premine and there were clear expectations of profit from Vitalik’s early speeches in which he discusses the marketing department and “fleshing out the business model”.

Furthemore, one of the reasons that Bitcoin is classed as a commodity rather than a security is thanks to the nature of PoW itself; thanks to PoW everyone is treated exactly the same, wherees in PoS there is a clear bifurcation between those with 32 ETH and those without: the ability to be a validator and earn higher rates of interest (those with less do have the chance to pool) than those lower down the totem pole is not an even playing ground.

What other competition does Ethereum have?

There are other Turing complete blockchains that also have a lot of promise. Avalanche founder and Ava Labs CEO Emin Gun Sirer has repeated numerous times that he doesn’t believe Ethereum will achieve what they hope to with ETH 2.0.

Vitalik and the team at the Ethereum Foundation have tried a range of cryptographic solutions until now including VRFs, plasma, rollups, sharding, etc.

Many of these ideas, such as plasma and VRFs, have largely since been abandoned. Solutions such as rollups and sharding also come with risks, and solutions like sidechains aren’t really solutions at all since they allow for other EVM-compatible blockchains to capture a lot of Ethereum’s value.

Ethereum has competition from its own side chains such as Polygon, it has competition from far better funded companies like Binance with their BNB, and it has competition from new consensus models such as the Avalanche, which have already addressed a lot of the issues Ethereum will have after the merge.

For example, Avalanche has a structure of standardised sub-sampling that allows the blockchain to scale without compromising on the “Blockchain Trilemma”.

Proof of stake is haram

“Those who consume interest cannot stand [on the Day of Resurrection] except as one stands who is being beaten by Satan into insanity. That is because they say, “Trade is [just] like interest.” But Allah has permitted trade and has forbidden interest.”

Surah Baqarah, 275

Some of the largest sovereign wealth funds in the world have invested in cryptocurrency and crypto companies, either directly or indirectly.

A direct example of buying cryptocurrencies would be to simply go to Binance and buy BTC or ETH.

An indirect example of a sovereign wealth fund owning BTC would include via ownership in an ETF. For example, when the Norwegian sovereign wealth fund buys into the Nasdaq they have exposure to Microstrategy, a stock which has now become something of a Bitcoin derivative.

Many of the largest sovereign wealth funds, and many of the wealthiest people in the world, are in the Middle East.

Islamic finance is very different to western finance in that there are particular laws and guidance that must be followed to comply with the Quran. The most well-known of these is that Muslims are not allowed to charge or earn interest.

Ethereum staking is thus a controversial issue, since the way that the network is secured is by providing interest, and the way that new ETH is “mined” is not through the toil of one’s labour but by already being wealthy.

Whilst there is some debate over whether Ethereum staking constitutes a “certificate of deposit” for helping to validate the network rather than an interest-bearing asset, there is little difference to the investor.

Some experts in the world of Islamic finance have contended that Bitcoin is a commodity like gold, and its PoW architecture is very similar to gold’s. This means that there is no contradiction whatsoever with what is already permitted under Islamic Law with Bitcoin. Harris Irfan, an expert on both Islamic finance and Bitcoin, has explained his view that Bitcoin has the potential to make the world economy more equity based rather than debt based, and is therefore far more halal and compliant with the Quran.

Ethereum, however, is far more contentious and far more likely to be an example of Riba.

With a market cap almost half the size of Bitcoin’s, a history that already excludes it from being a commodity and a roadmap that will aim to exclude if further from some of the largest pools of capital in the world, Ethereum appears to be overvalued going into the merge – certainly when compared with Bitcoin.

A lot of the optimism surrounding Ethereum being “ultra sound money” and highly deflationary neglects the fact that Ethereum is principally used for paying gas fees within its own dApp ecosyste, and is therefore more akin to a a currency within its own digitally-native ecosystem.

It does not mean that Ethereum isn’t a security, isn’t centralised, could have any benefit for the environment, or can even guarantee a high degree of transaction finality after the merge.

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