What Is The Merge and How Will It Impact NFTs?

Jason Bales explains Ethereum’s latest upgrade and how it impacts NFTs.

By Jason_Bales Aug 25, 2022, 8:39am PDT

This article originally appeared on Lucky Trader: What Is The Merge and How Will It Impact NFTs?

Ethereum’s latest upgrade, aptly named “The Merge,” is a transition from the blockchain’s current proof-of-work (PoW) execution layer to its new proof-of-stake (PoS) consensus layer. In layman’s terms, Ethereum is swapping from a slower, older way of processing transactions to a faster, newer technology.

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The Current Proof-of-Work (PoW) Model

Currently, Ethereum’s Mainnet uses a PoW cryptographic proof to confirm or reject the validity of each transaction on its blockchain. It operates through a process known as “mining.” Miners validate “blocks,” or permanently recorded data structures, with energy intensive computations. The miners are then rewarded for adding validated blocks to the blockchain via transactions fees, and if malicious blocks are added, they’re punished.

It’s complicated, but think of it like building a house with 1,000 pound bricks. Each brick needs to be added to the appropriate place for the structure to remain sturdy, but people can’t lift 1,000 pounds. Enter expensive machines that do the work for us. They move the bricks around and are rewarded for each structurally-sound house that’s built. If a house is built incorrectly and falls over, they’re punished.

But there are only so many machines, and each machine is too costly for average-income people to afford. They’re also big and bulky and finding safe storage for them is a hassle. And they use too much precious energy. These are the problems that PoS hopes to solve.

The New Proof-of-Stake (PoS) Model

Under the PoW model, Ethereum is limited to processing seven to 15 transactions per second, an insufficient number when compared to a payment processing platform like Visa, which can process up to 65,000 transactions per second according to its fact sheet (actual number closer to 1,700 in practice).

PoW, as mentioned, is also energy intensive and costly, which limits the number of people who can participate in validating the network and makes the network less secure. Most notably, it opens Ethereum to a 51 percent attack, a takeover of the blockchain by a group of miners who control a majority of the network.

Under the new PoS model, Ethereum replaces competitive block mining with a new consensus mechanism for block validation. Proof-of-stake makes it easier to process transactions. Willing participants can run a node, or a computer that supports a specific blockchain network, from a laptop or phone. And staking, a process in which miners loan the network a significant amount of Ether (ETH) or another native network cryptocurrency to participate in the mining process, keeps bad actors from validating malicious blocks.

Going back to the house analogy, PoS uses new five pound bricks. Anyone can pick up the bricks and build a house without needing expensive, energy intensive machinery. But before you’re allowed to enter the building zone, you have to provide the gatekeeper with $1,000. If you build the houses correctly, you get the $1,000 back and extra. If you build the houses incorrectly, you lose the money you provided to enter.

How Is Ethereum Going to Switch From PoW to PoS?

The Merge is a highly technical and complicated process that has to be accomplished with zero downtime for the Ethereum blockchain. It’s like swapping an old jet engine for a new one mid-flight. And if the jet is landed, it could have a disastrous impact on DeFi (decentralized finance) protocols, NFT marketplaces, and more.

The first step to swapping out a jet engine mid-flight is to build the new one. Ethereum already accomplished that task in December 2020 when it launched Beacon Chain, a new consensus engine that will replace proof-of-work mining. The Beacon Chain consensus layer is already built and working side-by-side with the Ethereum Mainnet execution layer. It has been tested for over a year and a half.

Following the final Goerli testnet merge, which was completed on Aug. 10, 2022, the Beacon Chain and Mainnet will merge together, replacing the PoW algorithm with the new Beacon Chain PoS algorithm. There will be no downtime and nothing will change for users (node operators and dapp developers should check to see if there are action items to adhere to). Ethereum’s entire transaction history will migrate seamlessly during The Merge.

When Will The Merge Happen?

The Merge is expected to happen on Sep. 15 or 16, according to estimates from bordel.wtf.

The exact date is unknown because The Merge has been scheduled to execute at the terminal total difficulty of 58750000000000000000000, according to Ethereum founder Vitalik Buterin, and precise timing for when that will occur is difficult to accurately predict.

How Will The Merge Impact NFTs?

The Merge is an attempt to solve three major areas of concern for Ethereum: sustainability, scalability and security. Solving these problems is also good for the network’s NFT community. But with all major technical upgrades, there will likely be scams, hacks, volatility, and confusion.

Here are the good, bad, and confusing market responses to The Merge that could impact NFTs.

The Good

The Merge positively impacts NFTs in at least three major ways: the greenification of the space, paving the way for lower gas fees via sharding, and network security.

Greenification

NFTs on proof-of-work are significantly worse for the environment than NFTs on proof-of-stake. It has been a major point of contention for NFT antagonists, who claim NFTs and blockchain technology are quickly ruining the planet.

NFT Club estimates that for every NFT added to the Ethereum blockchain, it takes 1.38 trees to offset the 83kg of C02 released into the atmosphere. For new bids on NFTs, it’s 0.38 trees (23kg of C02). For transfers, it’s 0.5 trees (30kg of C02). For secondary sales, it’s 1.35 trees (81kg of C02). That means an acre of forest can only account for the carbon emissions of 1,764 NFTs, which is typically one-fifth the total collection size of a standard 10k pfp project, and more than 1.3 million trees would have to be planted per 1 millions NFTs added to the blockchain.

The worst offenders throughout Ethereum’s history have been: CryptoKitties (239.8 million kg of C02), Axie Infinity (27.7 million kg), Art Blocks (23.1 million kg), The Sandbox (11.5 million kg), and Decentraland (11 million kg). Axie Infinity saved more than 25 million trees by switching to the Ronin blockchain, according to NFT Club.

Enter proof-of-stake, which will reduce NFTs carbon footprint by up to 99 percent, according to Digiconomist estimates. Ethereum, and by extension NFTs on the Ethereum blockchain, will be much greener following The Merge. This is good for both outsider public perception and convincing new environmentally-conscious artists to enter the space.

Sharding (Lower Fees)

Another frequent complaint about Ethereum’s NFT economy is that gas fees are too expensive, which makes it impossible to build out high-transaction gaming ecosystems that still benefit from the blockchain’s top-level security. With proof-of-stake, the path is set to lower gas fees, but it won’t happen immediately.

Vitalik Buterin and other Ethereum developers made it abundantly clear that The Merge will not lower gas fees. The consensus layer is changing, but this upgrade will not expand the network’s capacity, and gas fees will remain mostly unchanged. But it is a crucial first step to sharding, or a way to break up a blockchain into smaller partitions and spread out computational and storage workload across a peer-to-peer network.

Sharding, which was originally being worked on in conjunction with The Merge, took a backseat with the success of alternative layer 2 (L2) technologies and rollups that have helped Ethereum scale transaction execution. It is now expected to arrive in 2023.

Sharding will reduce points of failure for the network, increase transaction speeds, reduce network congestion, and ultimately, lower transaction fees.

This is good for NFT ecosystems, as it keeps more money inside the ecosystem when less money is flowing out to block miners. It creates an even more efficient and active secondary marketplace for projects and helps high-transaction gaming economies grow on Ethereum, especially since sharding will work synergistically with layer 2 solutions and rollups.

Security and Decentralization

Technical-level analysis of on-chain security and decentralization pros and cons is beyond the scope of this article. But Vitalik Buterin outlines three main reasons why PoS is a superior blockchain security mechanism when compared to PoW: it costs more to attack the network, attacks are easier to recover from when they do happen, and PoS is more decentralized than PoW.

The Bad

It’s impossible to predict all of the repercussions that The Merge might have on the NFT space, but two areas of concern include: potential scams and hacks on unsuspecting network participants and unintentionally vampire attacking alternative blockchains’ NFT collections.

Beware of Hacks and Scams

It is worth mentioning again that Ethereum has stated there will be no downtime during The Merge and network users will not have to do anything to transfer over their assets, including both cryptocurrencies and NFTs. Do not fall for hacks and scams that are bound to pop up prior to The Merge.

During highly-technical and important web3 events, hackers and scammers target unsuspecting and uninformed users. Beware of requests to migrate your cryptocurrencies or NFTs. Never click on suspicious links.

Beyond standard security and safety best practices, do not interact with the potential PoW fork unless you’re technically skilled enough to do so. Buying, selling, or transferring assets could result in a loss of assets on the PoS chain, according to certain network participants.

“Remember that transactions are just messages - signed with your private key - that define an action,” 0xquit wrote on Twitter. “That signature is encoded with the transaction data, transaction nonce, your private key, etc.”

“That means that if you submit a transaction on ETH PoW, the transaction could be re-broadcast to ETH PoS, and it may be valid,” he continued. “This is called a replay attack. The easy advice is to just not use the grifter chain that will be ETH PoW. If you don’t use it, you can rest easy.”

The Decline of Alt Chain NFTs

This is long-term speculation, but alternative blockchains that separate themselves from Ethereum via lower transaction fees and quicker transactions could fade into irrelevance if Ethereum successfully solves these problems.

Innovation is spurred from competition, and it is bad for the entire space if Ethereum becomes the only place to buy, sell, and trade NFTs. The potential upside here is that alternative chains will have to find new, unique ways to separate themselves from Ethereum.

The Confusing

The Merge will introduce new questions and considerations into the Ethereum ecosystem. Three unpredictable and confusing possible happenings include: the proof-of-work blockchain fork, the pre-versus-post merge NFT distinction, and volatile ETH prices.

PoW Fork

Not everyone is looking forward to The Merge, and when a community disagrees on the path forward for a blockchain, forks happen. A fork is when a single blockchain, like Ethereum, splits into two separate blockchains. This is how Ethereum Classic was born in 2015.

Certain network participants (mainly miners) want Ethereum to remain proof-of-work, which will result in the blockchain splitting again; this time into ETH PoS and ETH PoW.

When the merge happens and [Ethereum] transitions to [proof-of-stake], there will be two chains: proof-of-work and proof-of-stake,” Olimpio explains. “[Block] miners will try and get the last breath of value before selling their hardware, [and] they will keep [proof-of-work] Ethereum alive, effectively hard-forking the blockchain.”

But what does this mean for NFTs and DeFi protocols?

“Everything you had before the chain split will now be in the new [proof-of-stake] chain, and in the existing [proof-of-work] chain,” Olimpio continues. “NFTs and assets in wallets, liquidity provided (Uniswap, etc.), lending and borrowing (Aave, Compound positions), your on-chain assets will duplicate.”

This means CryptoPunks on PoW and PoS, Bored Ape Yacht Club on PoW and PoS, and so on, and how that will impact the market is currently unknown. Will the proof-of-work NFTs hold value? Will secondary marketplaces like OpenSea and LooksRare allow both versions of NFTs to be listed? Does this impact historical NFT collections more than utility-based NFT collections?

Prior to moving into pre- and post-merge NFTs, it is worth noting that stablecoins backed 1:1 with the U.S. dollars like USDC and USDT have been clear about supporting only the new Ethereum PoS blockchain. It is unlikely that the Ethereum PoW blockchain gains traction after The Merge, but value will depend on community and market reactions to the event.

Pre and Post Merge NFTs

The Merge, regardless of the possible fork, is a major event in Ethereum’s history. It will mark the NFT projects that were built on the proof-of-work blockchain prior to The Merge and those that are built on the proof-of-stake blockchain. The question is: does it matter?

The answer: probably not, but maybe. Historically-relevant NFT collections tend to trade at a premium. In many years from now, this event could make all NFT projects built on Ethereum up to this point historically relevant to a certain degree. These are pre-Merge collections.

The ETH PoW fork could also make the argument that the PoW NFT collections are the originals, and for certain historical collections like CryptoPunks, this might convince some market participants. Ultimately, the blockchain that wins in popularity (highly likely to be ETH PoS) should also win NFTs. But the market will have its say after the event takes place.

Be careful trading for ETH PoW NFTs, as proof-of-work is expensive to maintain and the fork could eventually fade into nothingness. If no one is maintaining the blockchain, all NFTs on that blockchain will also fade into nothingness.

Volatile ETH Price

Market participants are making big bets in both directions regarding ETH value predictions prior to and after The Merge. This will likely lead to major swings in price. If The Merge is smooth and transitions without any issues, price could swing up. If the Merge runs into a major problem, the price could swing down.

ETH’s price volatility will likely impact the NFT market. Whether or not that is in a positive or negative direction is difficult to know.

It is worth mentioning, however, that ETH is a veblen money-good, according to Vance Spencer of Framework Ventures. This means that as the value of ETH increases, the desire to spend ETH increases. And one of the most popular places to spend ETH is on NFTs.

What’s Next?

After The Merge is successfully completed, Ethereum will add new features not included in the transition, including the ability to withdraw staked ETH. This is called the Shanghai upgrade. There is no scheduled date for the Shanghai upgrade at the moment.

The Merge also paves the way for sharding, which will decrease network congestion and lower transaction fees. Sharding is a multi-phase plan that Ethereum expects to start in 2023. It will work in conjunction with layer 2 solutions and rollups and is a big part of solving Ethereum’s scalability problem.

Disclaimer: The author or members of the Lucky Trader staff may own NFTs discussed in this post. Furthermore, the information contained on this website or the Lucky Trader mobile application is not intended as, and shall not be understood or construed as financial advice.

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