Article | The Merge and Ethereum - what you need to know

14 September 2022

We are about to see, arguably, cryptos most ambitious project yet – the so-called Merge. This refers to the moment when the Ethereum (“ETH")’s mainnet will merge with the so-called Beacon Chain. With this merger, the Ethereum network will complete its transition from a Proof-of-Work network (whereby new ETH coins are mined by solving complex computing problems to validate on-chain transactions) to a Proof-of-Stake network (a more energy-efficient consensus mechanism whereby holders of ETH who “stake” their coins validate on-chain transactions).

Proof-of-work has become synonymous with cryptocurrencies, with the world’s oldest and most-famous one (Bitcoin) using a blockchain based on proof-of-work. The system entails powerful computers competing with one another to solve mathematical calculations to validate a new block of transactions. While this system has been praised for its ability to ensure no individual can corrupt the blockchain, it requires a large amount of energy to run.

So what is Proof-of-Stake, the new system?

The first concept to understand is that Ethereum blockchain is a distributed database (“distributed ledger technology”). Computes across the globe host a copy of the entire Ethereum blockchain and its ledger of transactions – essentially a record of who owns what on the blockchain. To update this record, a majority of participants have to agree on the so-called golden copy of the ledger.

To achieve this update, there must be a consensus mechanism, such as PoW or PoS. When Ethereum moves to PoS, the network will no longer rely on mining (which in cryptocurrencies refers to the tasks of solving complex mathematical calculations to verify new transactions). Instead, the blockchain will be updated by validators that are picked at random.

To be eligible for selection, validators must post collateral of at least 32 Ether coins, currently worth around $50k. This should ensure that participants have a reasonable economic stake in the Ethereum network succeeding – hence proof of stake. Acting maliciously or inappropriately will result in punishment for validators such as ‘slashing', whereby validators lose a portion of their active ETH stake. Validators receive Ether in return for validating new transactions.

Miners of Ether wish for Ether to keep using PoW. To mine Ethereum (or any Proof-of-Work coin), a miner has to invest heavily into specialised processing power (such as GPUs). Given the amount of IT infrastructure miners have built around their operations, they have a motivation to keep a PoW chain alive. As a result, with the Merge Ethereum will undergo two main changes:

(i) the mainnet ETH will become a PoS chain,

(ii) while it simultaneously “splits off” a PoW chain, which will be known as ETHW.

Such a split is called a “hard fork” in blockchain terms. Hard forks have occurred in the past (this will be the second hard fork of the ETH net for example, the last major one happened in 2016 resulting in the current ETH network and its predecessor Ethereum Classic under the ETHC ticker). Hard forks function similar to equity share splits; a holder of ETH before the hard fork will be a holder of ETH and a holder of ETHW after the event (a so called “airdrop” in blockchain lingo).

HANetf’s partner, ETC Group, issues ETHetc - ETC Group Physical Ethereum (ZETH). We wish to ensure investors in ZETH receive the benefits of the fork and so ETC Group will issue a new ETP identical to ZETH but which will be based on airdropped ETHW. This ETC will be referred to as ZETW.

If investors hold ZETH at the time of the Merge, they will not only continue to keep their ZETH, but will also receive free tokens on a 1:1 basis that represent a stake in the Proof of Work Ethereum chain. ETC Group has launched an ETP called ZETW, tradable on all the same exchanges as ZETH, to represent this stake. Hence, if an investor holds 1,000 units of ZETH, they will receive 1,000 units of ZETW in their accounts post-Merge.

Additionally, ETC Group has produced a landmark 40-page research report — available for free here — that details everything investors need to know about the Ethereum Merge in granular detail.

HANetf and ETC Group are committed to transparency ensuring investors get the proceeds of the fork. We believe ETCs should be run with the same stringent requirements as UCITS ETFs.

 

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