The Merge: What effects will it have on ETH?

At some point in Q3 or Q4 of 2022, Ethereum will make the transition to be fully secured by PoS instead of PoW. The Merge is a melding of the Beacon chain (consensus layer) with the current PoW chain (execution layer). None of the transaction data executed on the Ethereum network since its inception will be lost as a result of The Merge. PoS proponents argue that The Merge will make Ethereum more scalable, decentralized, sustainable, and efficient.

PoW to PoS

Miners in a PoW consensus blockchain compete against one another using dedicated hardware for the chance to produce the next block and cryptographically prove that computational "work" has been exerted. As the token goes up in value, more miners join the network — because the incentives to do so are greater — and results in higher security for the network.

Validators in Ethereum’s PoS Beacon chain are required to stake ETH as collateral in order to propose or attest to new blocks in the chain. Malicious validators that don’t play by the rules risk having their collateral “slashed”, or taken offline. The amount at stake is what ensures a PoS network’s economic security, as opposed to power-guzzling computations in a PoW system.

With a PoW consensus mechanism, all block rewards, tips, and Maximal Extractable Value (MEV) go to the miners. In a PoS network, all of this revenue will instead be transferred to stakers. MEV is earned by miners/validators as a result of reordering transactions within blocks, typically related to token swap arbitrage, in order to generate additional profits. MEV earned by miners has averaged 325 ETH per day according to data from Flashbots, which is commonly referred to as a lower bound estimate. Tips are additional ETH paid by users trying to ensure their transactions are included in a block. Since the implementation of EIP-1559, tips paid to miners have averaged 1,410 ETH per day.

Running a validator on the Beacon chain requires 32 ETH, operational expertise, and expensive hardware, but far less energy spend than operating a miner in a PoW network. Marathon Digital Holdings, one of the largest BTC (which uses PoW consensus) miners in North America, spent $33.7 million on cohosting fees, electricity, depreciation and amortization of miners and patents throughout 2021. Block rewards are often sold to cover the high overhead costs associated with running a PoW mining operation. The Merge will likely alleviate this inherent sell pressure as a result of lower operational costs.

A less energy intensive network also plays nicely into the environmentally friendly narrative that many professional money managers need to be mindful of when allocating capital. It is also fair to assume that, due to the high upfront costs of running a validator, those who elect to do so believe in the long term investment thesis behind ETH and would opt against selling their yield as it accrues.