Explained: Ethereum Is Upgrading and It Could Change Crypto's Future

The upgrade could reduce Ethereum's energy consumption by as much as 99.95 percent.

For the last couple of weeks, Ether has been outperforming Bitcoin on the cryptocurrency market.

(Photo: The Quint)

For the last couple of weeks, Ether has been outperforming Bitcoin on the cryptocurrency market. Climbing out of its month-long slump, Ether grew about 24 percent since 11 March, while Bitcoin gained only about 16 percent.

The catalyst for this growth appears to be an upcoming upgrade that will overhaul how the Ethereum blockchain works, and, in the process, make it "more scalable, more secure, and more sustainable."

A researcher at the Ethereum Foundation estimated that this could reduce energy consumption by as much as 99.95 percent.

While this upgrade has been in the works for a while, on 15 March Ethereum successfully finished a critical test which puts it right before the finish line. Investors are hopeful that there will soon be a wave of new adopters.

Here's all you need to know about what this upgrade is and how it could change crypto's future.

But First, What Is Ethereum?

Ethereum is a programmable blockchain – a system which maintains a publicly accessible record of transactions using several computers across the world.

You can use it to send cryptocurrency to anyone for a fee (called gas) towards computation and storage. You can also use it to make and access different types of financial products.

Ethereum, notably, allows for the creation of unique tokens called non-fungible tokens (NFTs) which can be used to prove ownership of digital files.

It also supports smart contracts, which are programs that run on the blockchain. These contracts can define rules and automatically enforce them, which means users can interact with them to execute certain types of transactions.

Smart contracts are also used to build decentralised applications (Dapps) on the Ethereum blockchain including games and exchanges for .

Why Is It Upgrading?

Since blockchains are decentralised, no single entity is responsible for updating the shared ledger. Instead, they rely on a network of computers to record transactions, cross-reference them, and reach a common consensus.

This means that a majority of the decentralised network needs to agree to a transaction for it to be recorded on the distributed ledger, making the system tamper resistant.

There are several mechanisms to achieve consensus.

The one built into Ethereum is called 'Proof of Work' (PoW). It requires members of a network (crypto miners) to use large amounts of computational power to solve an arbitrary mathematical puzzle.

The computer which can solve the puzzle fastest creates a new block of processed transactions, which has a cryptographic link with the previous block, making it very difficult to make any alterations.

However, the proof of work system requires high amounts of energy to be spent in solving these puzzles, which raises serious environmental concerns. As more and more users join the system, the amount of computational power and energy required will continue to grow.

"Ethereum's current energy expenditure with proof-of-work is too high and unsustainable," it says. That's why it wants to switch to a new mechanism called proof of stake (PoS).

PoS has other drawbacks such as a high transaction fee (required to compensate the miners) and much slower processing speeds due to all the work involved.

How Will the New System Work?

Proof of stake is a consensus mechanism in which users will need to stake their cryptocurrency to become 'validators' in the network, who are then selected randomly to to create blocks and check the blocks they don't create.

The staked currency is held as collateral to safeguard against tampering or malicious behaviour. If you validate a block that you shouldn't, you stand to lose the crypto you have staked.

Instead of a race for the finish line, like in PoW, the randomised selection process for PoS discourages massive, power-hungry mining farms since they no longer give you an advantage.

Ethereum is already testing the PoS system on a separate blockchain called The Beacon Chain which it plans to merge with the Ethereum blockchain, sometime this year.

After switching to PoS, it also plans to split Ethereum into 64 'shards' or sub-chains, to allow for parallel processing and to make it more scalable.

Users will need to stake 32 Ether (ETH) to become a validator, and at least 128 randomly-chosen validators will be required to attest to each shard-block of transactions for it to go on the blockchain.

How It Could Change Crypto’s Future

Ethereum is huge. With a market cap of more than $ 378 billion, it is second only to Bitcoin, which has a market cap of $847 billion. It's also the dominant blockchain in the NFT and decentralised finance (DeFi) space by far.

Proponents pitch crypto as a viable alternative to the traditional financial system, since it is highly transparent, secure, easily accessible and ensures anonymity.

However, both of these blockchain flagbearers – Bitcoin and Ethereum – use proof of work, which raises questions about the sustainability and scalability of cryptocurrency in the future.

Here are some staggering figures:

• Currently, Ethereum is estimated to use about 112 terawatt-hours of electricity per year, which is comparable to that of Netherlands and more than what Philippines or Pakistan use.

• A single transaction on Ethereum is quivalent to the power consumption of an average US household over 9 days.

• A single Ethereum transaction also equals the energy consumption of more than 1,50,000 VISA card transactions.

• The yearly carbon footprint of Ethereum is comparable to that of Switzerland and on a daily basis it is equivalent to the carbon footprint of 327,642 VISA transactions or 24,638 hours of watching Youtube.

• Bitcoin is worse. It consumes about 137 terawatt-hours of electricity per year.

When China banned cryptocurrencies last year, it said it was especially concerned about crypto mining’s effect on the environment as well as its use for fraud and money laundering.

However, Ethereum's shift to proof of stake will put an end to crypto mining on its blockchain and is expected to reduce energy consumption by as much as 99.95 percent.

The second biggest cryptocurrency and the biggest player in NFTs and DeFi cutting its energy consumption by 99 percent would certainly warrant a more optimistic re-evaluation of the environmental cost of crypto and its feasibility as a worldwide financial system.

It could cause environment watchdogs, companies (some of which are already working on the Ethereum blockchain) and even governments to look at crypto more favourably in the future.

End of profitable ETH mining will mean anyone currently mining ETH will either have to transition to a different PoW coin or sell their graphics cards and use the money to stake.

This could lead to a much needed reduction in GPU prices which have been soaring since last year due to the global chip shortage.

There's another possibility on the horizon. Since August 2021, Ethereum has burned (destroyed) the equivalent of $5.8 billion in ETH according to data dashboard Watch the Burn, leading to an increase in the value.

After the upgrade, the amount of ETH issued is projected to drop drastically which could make it a deflationary asset, which restricts supply as time passes, leading to a rise in value, like bitcoin.

It could pave the way for Ethereum to steal Bitcoin's crown and become the most valuable currency – an event referred to as "The Flippening".