The hotly anticipated "merge" by Ethereum (or The Merge) has finally happened. The net result is that Ethereum has changed from "Proof of Work" mining to "Proof of Stake" validation, as its consensus mechanism to verify new transactions, add them to the blockchain, and create new tokens. This is a win for sustainability because of the significant energy reduction in Proof of Stake compared with Proof of Work. For global organisations who are looking to take action on sustainability as well as tip their toes into the growing DeFi space, this can only be a welcome move.

It is still early days though. As with any major software upgrade, perhaps more so because of the potential economic effects of distributed networks to transfer stores of value, the implications need to be worked through and understood.

A few thoughts:

  1. Bitcoin is now the only major blockchain network (the largest by market capitalization) operating on Proof of Work mining, known for its high energy requirements.
  2. The academic research to date on energy consumption in cryptocurrencies has largely focused on Proof of Work, given that, until The Merge, it was the most prevalent consensus mechanism (used by both Ethereum and Bitcoin). More research is needed on establishing indices for Proof of Stake cryptocurrencies, although estimates point to a 99% reduction in energy consumption in Proof of Stake networks compared with Proof of Work. Calculating the range between maximum and minimum energy consumed is more difficult in Proof of Stake and there is likely to be a much larger range between maximum and minimum numbers.
  3. Regulators were already focused on the sustainability issues in Proof of Work before The Merge. It is likely that this will only intensify now that Ethereum, the second largest cryptocurrency by market capitalization, has successfully moved to Proof of Stake, and shown that it is technically possible to make the change. Regulatory interest has also been piqued by certain features of Proof of Stake and possible similarity with features of investment contracts.
  4. Some criticisms of staking are of a possible creep toward centralization. This is not an insignificant point given that consensus is critical to maintain the security and integrity of the network.
  5. Additional flow of effects of The Merge also point to likely heightened interest by regulators who are already concerned about staking effects, and this is likely to increase.

Therefore, whilst the improvement on sustainability with Ethereum's change to Proof Stake is to be celebrated, we are likely to see increased regulatory focus in this space.

There is some concern of a creep towards centralization over the longer term because of the effects of staking pools, such as the big exchanges, that control most of the resources required to secure the network. ... We have seen first-hand in a number of jurisdictions some of the regulatory challenges that arise from the provision of staking services, and, we expect that the transition of the world's second largest cryptoasset by market capitalization to a proof of stake model is only likely to increase regulatory focus in this area in the coming months and years.

www.insidetechlaw.com/...

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.