Clanzenomics: Ethereum Merge, energy consumptions, proof-of-stake and proof-of-work

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In this week's market wrap for Friday, September 16, Dr. Michael Kollo discusses the Ethereum Merge.


Hi, everybody. This is Michael Kollo from Clanz coming to you on the 16th of September, 2022. And yesterday was a massive day for blockchain and Ethereum plans worldwide, where finally, we had the Merge. So, what we have done, is we have transitioned essentially Ethereum from a proof-of-work to a proof-of-stake.

If you want an analogy for this, it's a little bit like replacing the base level of a massive skyscraper in the middle of a city without moving the skyscraper around. I really liked that analogy. I picked it up from the Internet, thought that was very, very fitting.

So on this wonderful day, people had all kinds of forecasts. Ethereum is going to double, triple, is going to crash. It's going to move up and down, left and right. And that's the first slide for today shows nothing much happened. Actually, it was a pretty smooth event so far, at least. What we've seen is the transition come and go. We're seeing Ethereum come down again and again.

We were talking a little bit about the idea that people buying the rumor. And in fact, in those situations, you often end up selling the news, which basically means the price is a great run-up and then once something has happened, the price will come down again. So I think that was very much the case here. Ethereum is down, I think about 9% over the last week. And we've seen a whole bunch of weakness across the crypto. A couple of single digit kind of numbers zig-zagging around as we have seen for a while. On the other hand, some good news, the hash rate went up for bunch of other cryptos where a lot of the miners that had previously been working Ethereum went over and started working for other proof-of-work chains, like, Ethereum Classic. Where you saw the hash rate really, really go up. And so these at least in the short run will benefit a great deal from increased security and the benefits of that hash rates. But, ultimately I think it's a whole new era that's beginning. And that's really the subject of today, the whole new era of proof-of-stake and what this means more generally for the crypto community and what this kind of divide will mean going forward as well.

So to start with one of the big benefits of a proof-of-stake is really the energy consumption. So if you look at the total energy consumption in the US, it's about 23,000 terawatt hours per year. And really what you've seen, is Ethereum say, that by changing from one method to another, they're going to reduce the energy consumption by 99.95%. And that's because they're going to eliminate the need for all these computers to compete with each other as proof-of-work and they just kind of rely upon people having essentially Ether. This is a subject we covered in one of our previous weekly updates. But who actually has the Ether, but we're going to leave that to the side for the moment and focus on this energy impact. So that basically means that estimated 80, but I've seen some numbers that are more like a 100 terawatt hours of annual consumption basically being eliminated, which is not a small number. It's about 0.3% of global electric demand. Although, I'm pretty sure that it would be something similar for the US as well. And that's equivalent to something like, Finland dropping off the planet as well. So that's quite an interesting kind of analogy of what a country does. In other big components of this electricity usage I found this slide quite interesting. So it talks about YouTube's annual consumption, obviously huge amounts of videos. Gold mining, I thought it was quite an interesting one, I thought that was a funny one to put on here, because it wasn't quite a techie one. But then have a look at the third one, so that is Bitcoin right there at 200 ETH and its previous version of proof-of-work was about 112 in the previous slide, you saw it being a bit less than that at 80, essentially somewhere around that, then you saw Netflix. Gaming, that's a pretty wide kind of concept. And the idea is that with PoS kind of structure — ETH is now 0.01. So again, massive elimination brings it all the way down. So that's wonderful, and I think from the environmental perspective, it now makes Ethereum a lot more green and it's certainly features in our Green Metaverse portfolio as an example.

But there's an interesting question about what happens to the rest of the coins that are sitting on proof-of-work. And in fact, if this is going to create a precedent for those coins, to start transitioning to proof-of-stake because of the environmental impacts. The number one and the biggest by far is obviously Bitcoin. And so the question becomes, shall we change the code, not the climate, and is there any effect that we can have on Bitcoin to start transitioning? And why would Bitcoin want to, or not want to transition? The answer is not what you may expect.

So, the articles around the subject really talk about how unlikely it is for Bitcoin to change has been very little talk about it. There's very little action on it. Whereas Ethereum is really been preparing for quite a while. And it is while there's a lot of lobbying there's not really many people on the ground doing this stuff. You might ask "why?" Why is staking or the use of staking such a difficult thing to do or to adopt.

So on the first hand, and what most people would talk about is this idea of decentralization. Decentralization with proof-of-work is deemed to be the most important feature so that the freedom to allow anybody to enter conceptually with computers, CPU power, and to become a node, to provide power into the network is limitless. And so anybody can theoretically come in, you don't need to hold a lot of Bitcoin to do so. Whereas proof-of-stake, the idea is that the major holders of the underlying currency are the ones who are contributing and controlling that system. So it's seen as democraticization. It seemed that everybody could have incentives as well. Of course the realities are slightly different. Because in order for you to compete effectively, you do need to have a lot of rigs, need to have a lot of power and that takes money, that takes resources. So in a sense, anybody can provide those power resources, but in the same kind of way anybody can buy Ethereum if they chose to as well and become proof-of-stake. So I've seen this argument. I don't really buy it. I think it's not the best. The fear of security, certainly this idea of centralization, that proof-of-stake has more centralization elements, has lower securities, more vulnerable to these kinds of attacks, central forms of attacks. Again, the idea being is that if you can take over a smaller number of high Ethereum owners, and validators, that maybe you can influence the system much better than proof-of-work. Certainly there's some analogies here of Solana and some other systems that have these types of vulnerabilities and have been exploited in different ways. But again, it's hard to link that directly with the idea that one is proof-of-stake and one is proof-of-work.

I think there is, however, a very interesting and very real emergence about the way that things are going to be regulated, which I think will really determine how cryptocurrencies stay as proof-of-work or indeed, transition to proof-of-stake. And really early on, in fact just today, there was an interesting report that was released from the Wall Street Journal. Which was really talking about the SECs treatment of cryptocurrencies based upon whether they are proof-of-stake or proof-of-work. And it really does come back to this idea decentralization and centralization, this is a continuum, don't think about is very discreet. And so most things were falling into some region of that. While some element of the crypto may be decentralized, the idea that you're dealing with a central agency to access that as an exchange, or as we saw in some of the DeFi protocols or central banks. Will mean that they might still be underneath what's called a common enterprise, a kind of a framework and therefore be treated as securities and the securities or regulation.

So one of the interesting things that the impact of this kind of tech upgrade is not just about environment or technology it's about potentially the legal treatment and therefore the regulatory treatment of a cryptocurrency. While Bitcoin is firmly as treated as a commodity, and it's been confirmed by federal regulators as a commodity. The conversation now about proof-of-stake very well places that into much more of a securities regulation, financial securities. So you can start to see the division happening here, and this is what we wanted to illustrate here, is whereas Ethereum and Bitcoin are really the two of the major cryptocurrencies, is really the vastly dominant cryptocurrencies, that so far have walked together in terms of their, I suppose, their approach and their regulatory treatment in terms of their environmental impact. With this particular difference we may see more than just an environmental divergence. We might have started to see a very meaningful regulatory divergence in the way that these two cryptos are treated. And so therefore we'll probably start to see again coins that are more favoring investment and even types of solutions, outcomes, and therefore regulation and commodities and commodity types that might end up falling, much more to the left.

So really what I wanted to kind of highlight you today is we've had the Ethereum merge. It's happened in the short run, there's been a little bit of price weakness, in the medium to long run what we're starting to see is a very meaningful, potentially divergence between the way that these cryptos are regulated and their environmental footprint.

Thanks for listening.

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