Talk of Ethereum Blockchain merge has been going on for quite some time now in the Crypto circles and it has been highly anticipated for several reasons and one of them is the reduction in gas fees for transactions. Use of ether has been wide especially when it comes to smart contracts.
What is the merge all about? Ethereum merge is the point at which the network plans to move off Proof of Work (PoW) and transition to Proof of Stake (PoS). Ever since Ethereum was created by Vitalik Buterin, it has been using Proof of Work (PoW) protocol to mine, Ether (ETH). But due to reservations on the amount of energy, carbon footprint, PoW uses to update and validate the blockchain, Ethereum has been trying to move to Proof of Stake.
In the PoW mining protocol, the miner creating the cryptocurrency has to show how much work went into solving the puzzle, nonce, in order to create the cryptocurrency. A nonce is an arbitrary number that is used in PoW consensus algorithm.
The nonce is the number that blockchain miners solve to receive the block reward. Topic for another day I guess. This work involves expending a considerable amount of electrical.
Proof of Stake (PoS) meanwhile uses little power in order to mine or create more coins. What is Proof of Stake (PoS)? It is a consensus mechanism for blockchains that work by selecting validators of the Blockchain in proportion to their quantity of holdings in the associated cryptocurrency.
Basically what makes you be able to make decisions on the particular Blockchain is the amount of the crypto you have staked and what you stand to lose if a wrong decision was made by you. You would work in the interest of the Blockchain because it is in your interest too.
Now that we have broken down what PoW and PoS is, it goes without saying the reason why Ethereum is changing from one consensus mechanism to the other. Energy consumption, carbon footprint. One of the reasons people who are not pro Bitcoin use against it is it's high use of energy in the Proof of Work consensus protocol.
A Possible Split After Merge is Possible
The merge will come with many advantages other than the power consumption reduction but miners who used to make huge profits from the PoW consensus protocols are not happy with the movement to the PoS consensus protocol. It means loss of on rewards and huge transaction fees called gas. This could lead to a possible a split in the Blockchain called a fork.
A fork occurs when the software of different miners become misaligned. It's up to miners to decide which blockchain to continue using. If there isn't a unanimous decision, then this can result in the creation of two versions of the blockchain.
Hard forks and soft forks are essentially the same in the sense that when a cryptocurrency platform's existing code is changed, an old version remains on the network while the new version is created. In a soft fork, only one blockchain will remain valid as users adopt the update. But in a hard fork Blockchains continue operating separately. This has happened before with Bitcoin and Bitcoin cash.
Hard Fork Blues
Other than the volatility which comes with such forks there are normally some consequences for tax. Other income received in cryptocurrency including salaries are all treated as ordinary income and taxed. The controversy though comes when there is a hard fork .
In a hard fork, you pay tax at ordinary income rates and current price of the token but what happens normally is the newly created token or cryptocurrency will lose value because of too much liquidity meaning a loss to you since you paid tax on a higher price.
Everyone is looking forward to the merge for opportunity abounds to the people with knowledge.
Written by:
Blockchain and Cryptocurrency Enthusiast.
United Africa Blockchain Association-Zambia Chapter Chairperson.