The Ethereum (ETH-X) community – and market – have reached a fever pitch in anticipation of the long-awaited “Merge” update in September. 

However, despite the tremendous excitement surrounding the event, there are critics who would hardly call it an “upgrade.” 

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Among them is James Check – the lead on-chain analyst for Glassnode, a blockchain intelligence provider. 

On August 7, the analyst unveiled a video presentation calling the protocol change a “monumental blunder”. He outlined how the merge will create systemic risks that, until now, Ethereum developers have refused to deeply consider or discuss.

The following is a full breakdown of what the merge is, what came before it, and why Check believes it’s far too risky to follow through with. We will also cover the nervous response he’s received from the Ethereum community, its developers, and its figureheads. 

What is The Merge?

The Merge – previously known as Ethereum 2.0 – is the upgrade that will transition Ethereum’s consensus mechanism from proof of work (POW) to proof of stake (POS).

Specifically, it will “merge” Ethereum’s execution layer (the mainnet) with its new, proof of stake consensus layer (the beacon chain). 

The beacon chain launched in December 2020 as a separate blockchain and de facto testnet for POS on Ethereum. It has since successfully merged with multiple other testnets, and will begin processing real Ethereum transactions starting in mid-September. 

There are two primary justifications for the merge. Firstly it is expected to reduce Ethereum’s energy usage by 99.95%. Secondly, it will pave the way for sharding – Ethereum’s scaling solution that will exponentially increase its transaction throughput later on.

While there are no guarantees, the merge itself is not expected to be dangerous. The Ethereum Foundation has clarified that Ethereum’s entire chain history will remain intact. ETH holders and stakers will keep their funds, there will be no downtime, and most users need not do anything to prepare.

Nevertheless, the devil lies with its more technical details.

Proof of Stake (POS) VS Proof of Work (POW)

The beacon chain’s POS mechanism requires nodes to stake a minimum of 32 ETH to propose a block. The more ETH they stake, the higher their block’s odds of being added to the blockchain by the system. 

If the user proposes a valid block that’s accepted by nodes, he will receive a block subsidy denominated in ETH as a reward. Conversely, if the block breaks consensus rules, the proposer will receive no subsidy, and his stake will be slashed. 

Therefore, users are rewarded financially for honest behavior, and punished for dishonest behavior.

POW – Ethereum’s legacy system – operates a bit differently. Like Bitcoin, it requires nodes to harness computer power in a race to create the next block by solving a complex mathematical problem. The first to solve the problem creates the next block and earns its associated block reward.

Like POS, users that propose invalid blocks will not earn a block subsidy. Meanwhile, their dishonest behavior is implicitly punished through the energy cost of creating the block. 

Both systems classify as “consensus mechanisms” – allowing decentralized users to reach a consensus about the state of the blockchain’s ledger. 

Under POS, the ledger with the most significant stake behind it is deemed by nodes to be the canonical chain. Under POW, the canonical chain is that with the most collective “work” behind it, aka the “longest chain.”

As of late, businesses and regulators often deem POS a superior system to POW. On the surface, it appears to achieve all of the same security guarantees, but with virtually zero carbon footprint. 

However, its subtle differences from POW create incentives that risk opening Ethereum to a hostile takeover by centralized forces. 

How The Merge Risks Centralizing Ethereum Forever

In his video on Sunday, Glassnode analyst James Check broke down how the merge could be Ethereum’s final nail in the coffin. 

“I’m a little bit skeptical of the merge. In fact, I think it’s one of the biggest blunders the Ethereum project is gonna make,” he said.

The analyst highlights 5 primary risks surrounding the upgrade.3 are related to flaws in its code and economic structure, while 2 are related to the regulatory context in which it’s being launched.

Check then synthesizes these risks to forecast Ethereum’s socio-political fate.

Risk 1: The EIP-1559 Contradiction

Ethereum’s EIP-1559 upgrade permanently burns network transaction fees rather than rewarding them to miners. As Check explains, this creates contradictory incentives within the Ethereum ecosystem. 

On one hand, it rewards existing ETH holders by creating a source of consistent supply deflation. On the other, that deflation comes at the expense of actual transactors and users, who are arbitrarily punished for spending. 

Under Ethereum’s current POW model, EIP-1559 primarily benefits ETH holders, while slightly hurting users and miners. However, under POS, ETH holders and miners effectively become one, serving as “validators” for the network.

This model accrues wealth in the hands of validators through both explicit block subsidies, and deflationary economics. Meanwhile, users must uphold stakers’ rewards through transaction fees, disincentivizing them from actually transacting on the network.

Celebrity investor Mark Cuban has also recognized this internal conflict and pointed out how it hurts Ethereum’s value proposition as “digital oil.” Instead, the overwhelming incentive for ETH holders post-merge is to horde and stake – leading to the next risk. 

Risk 2: The Stake Congregation

While staking ETH is tempting, it’s very difficult for average users to actually do it on their own.

Becoming a solo validator requires a minimum of 32 ETH – worth over $57,000 at the time of writing. It’s also technically difficult to run a validator node and can take over a year to be approved for the validator pool. 

By comparison, it’s far easier for users to stake their cryptocurrency with a centralized staking service/pool. It takes the responsibility and technical know-how for staking off of their shoulders, and allows them to start earning yield immediately. 

At the moment, over 10% of all ETH has been locked away and staked on the Ethereum Beacon Chain. Of that ETH, over 60% of it is being staked by 4 large, centralized, regulated staking providers. These include Lido, Coinbase, Kraken, and Binance. When including the next 7 largest stakers, that total rises to 68.9%.

For context, the Ethereum POS attack threshold at which the network can be controlled by stakers is 67% to 68% of the stake. 

If these entities conspired to do so, they could technically overtake the consensus of the Ethereum chain using their stake. Thus, they could censor blocks that include transactions that they don’t like. This is commonly known as a 51% attack, variations of which exist on both POW and POS chains. 

A 51% attack would undermine the decentralization and censorship resistance that Bitcoin, Ethereum, and other distributed ledgers were designed for. But would staking providers actually try something like that?

Risk 3: The Tornado Cash Precedent

On August 8 2022, the US Treasury Department’s Office of Foreign Assets Control (OFAC) sanctioned Tornado Cash, an Ethereum mixing tool. The sanctions marked an unprecedented move by the government to sanction the use and arrest of a developer of open-source code.

However, the fallout from the event may have been more revealing than the sanctions themselves. After the sanctions were implemented, a slew of major US-based Ethereum companies and infrastructure providers were forced to comply. 

For instance, the Ethereum wallet MetaMask and its associated API provider Infura have blocked users’ access to Tornado Cash wallet addresses. Defi services like Aave have blacklisted addresses receiving funds from Tornado Cash from using their front-end. 

Most concernedly, Circle – the issuer of USDC stablecoins – used its authority to programmatically freeze all USDC locked inside Tornado Cash.  

In a vacuum, these events don’t mean that Tornado Cash is entirely unusable, or that the Ethereum network is captured. However, they show that many of the U.S. companies that make Ethereum rich and valuable will bow to state authority when called upon.

Risk 4: The Stablecoin Veto

In early August, Ethereum co-creator Vitalik Buterin warned that centralized stablecoins could have an outsized influence over future protocol hard forks. 

That’s because, for a stablecoin to function, the issuer can only respect fiat redeemability on one chain. Any tokens circulating on the other chain will lose their peg to the dollar. 

For example, stablecoin issuers Circle and Tether stated last week that they will only respect Ethereum’s POS merge in September. They will not offer redemptions for any speculative offshoot chains (ex. chains that continue using POW).

As Check argues, such an event will destroy the economy of all non-serviceable forks. Liquidations will activate across the network, DAI stablecoins ill destabilize, and DeFi abstraction layers would need to integrate alternative stablecoins. 

While agreeing to the merge, there’s no guarantee that entities like Circle will follow community consensus in the future. This is especially likely if their hand is forced by the government to refrain from servicing a particular fork. 

Circle has already demonstrated that it will comply with government regulations in a heartbeat. If the government compels Circle to refrain from servicing a particular Ethereum upgrade or fork attempt, its reasonable to expect that the company may obey. 

As such, the OFAC may theoretically be able to influence the direction of Ethereum’s roadmap, by leveraging regulatory action against Circle. This premise is crucial for understanding the final risk.

Risk 5: The Weak Subjectivity Fallacy

Before observing the final risk, lets recap the previous four points:

1. ETH holders have an overwhelming incentive to stake due to the economics of EIP-1559. 
2. This stake naturally concentrates with centralized, regulated staking providers due to the ease and accessibility of custodied staking. Collectively, staking providers already own enough stake to collude and compromise the network.
3. Fallout from OFAC sanctions against Tornado Cash proved that U.S. crypto companies will hurriedly obey the law.
4. Stablecoin issuers like Circle and Tether effectively dictate Ethereum’s roadmap surrounding hard forks. 

Given these premises, Check ultimately argues that the Merge will expose Ethereum to regulatory capture by the OFAC. The government need only issue an order to centralized staking providers to no longer attest to blocks that include sanctioned transactions. 

Since the top 11 staking providers already hold two-thirds of all ETH, the takeover would be both possible and feasible to coordinate. As U.S.-regulated entities, the stakers will likely follow through.

ETH users would have little choice in the matter. Unlike mining pools in POW, staking pools prevent holders from withdrawing their stake without permission from the compromised entity. Once the centralized body has stake control, its game over.

According to Ethereum’s website, POS proponents do possess a kill switch in the event of a majority stake attack. It states that honest validators can “decide to forcibly remove the attacker from the network and destroy their staked ether.”

According to Vitalik, a level of social consensus would be required to select a minority block on which the new fork will be built. He and Ethereum developers consider this a tolerable level of “weak subjectivity” present in POS systems and forks.

However, Check highlights the impracticality of this method due to the need for OFAC-compliant ecosystem participants to agree to service the new chain. After all, if Circle backs out of the forked chain, the entire ecosystem collapses.

Furthermore, stake held with centralized staking providers represents the savings of thousands of smaller ETH holders. Slashing those staking providers amounts to slashing those customers’ holdings, who never personally consented to censorship.

For these reasons, “weak subjectivity” would likely not be effective to coordinate a fork. The economic fallout it creates would be far too contentious and could cause the forked ecosystem to collapse. Failing to gain traction, the OFAC-compliant Ethereum would likely remain the canonical chain. 

The Result: Ethereum Sells its Soul

In conclusion, Check believes that the Ethereum Merge will hand over Ethereum’s final bastion of decentralization to U.S. authorities. 

The U.S. government already controls Ethereum’s infrastructure (via Infura), the DeFi ecosystem’s stability (via stablecoins), and Ethereum’s fork choice. Transitioning to proof of stake will, at last, give the government control of consensus and block production as well.

“The Merge is the line where Ethereum has sold its soul,” he said. “I don’t personally believe there’s any way to get it back once this happens. They’ve just created a fiat system, they’ve handed over the keys to traditional finance, and new bankers are just like the old ones.”

Unfortunately, Check doubts that the community and developers will turn back on the Merge within the next month. Sunk costs, years of promises, and an established narrative against POW would make the reversal politically unpalatable.

It would also crush investor excitement over Ethereum’s transition to a deflationary economic structure that incentivizes HODLing. After all, it could be Ethereum’s one chance at pumping its price high enough to flip Bitcoin. 

“If you want that tradeoff, then the number will go up,” said Check. “But you are gonna sell your soul.”

What Does the Ethereum Community Think?

The analyst’s video has sparked vigorous debate on Twitter among Ethereum community influencers, developers, and figureheads. Generally speaking, the conversation centered around the likelihood of – and potential response to – a 51% attack on Ethereum, post-merge.

Here are some of the counter-arguments, critiques, and solutions they had to offer. 

Vitalik Buterin

Vitalik did not respond directly respond to the video, but briefly chimed in on one of the related conversations that emerged from its release. 

Eric Wall – researcher and Chief Investment Officer of Arcane Assets – polled the Ethereum community on Monday about how they would react if centralized entities commenced a 51% attack on Ethereum. When given the option to either fork and burn the attacker’s stake, or to tolerate the censorship, Vitalik voted for the former. 

Vitalik also supported taking such measures in a 2016 blog post defending POS design philosophy. 

“Two days later, the blockchain and community are back on track, attackers are $50 million poorer, and the rest of the community is likely richer since the attack will have caused the value of the token to go up due to the ensuing supply crunch,” he argued.

Lane Rettig

Lane Rettig is a former developer for the Ethereum Foundation. He later left the organization after concluding that Ethereum’s governance had “failed.”

Rettig has been highly vocal since the video dropped, emphasizing that Ethereum’s censorship resistance hangs in the balance. 

“Ethereum is truly on the verge and I don’t think enough people are paying attention,” he tweeted on Tuesday.

Explaining himself further, Rettig acknowledged that there is a likely possibility of staking providers like Coinbase censoring the Ethereum protocol under OFAC order. Should this happen, at that point, the Ethereum community may have to accept the OFAC-compliant chain, meaning it has “lost the war.”

The developer added that it’s “conceivable and plausible” that the community coordinates a UASF to remove Coinbase from the network. However, he believes this would certainly lead to a contentious hard-forked blockchain that stablecoins and much of DeFi would be barred from servicing. 

Tim Beiko

Tim Beiko is an active developer who has been closely involved with Ethereum’s move toward the merge. He was the first to reveal that the upgrade would take place in mid-September.

Beiko watched Check’s entire video, and was highly critical, maintaining that POS will be a net good for Ethereum’s security.

Specifically, he claimed that miners can be regulated just as easily as validators can. In other words, staying with POW doesn’t make much difference from the perspective of censorship resistance. 

He also disagreed that stablecoin issuers can control fork choice in Ethereum, given that many other entities also have a say. 

Beiko agreed that staking pools are “stickier” to withdraw from than mining pools, and that its questionable whether large entities can actually be slashed. Nevertheless, he believes the former issue will be somewhat remedied once staking withdrawals are enabled, and personally thinks a coordinated fork can be executed. 

Ryan Sean Adams

Ryan Sean Adams is the founder of Bankless – a media organization providing coverage and education of the crypto industry. He and his organization take an especially strong interest in Ethereum and are supportive of the merge. 

Check directly asked Bankless to allow him to discuss his views about the merge on their program. Adams was not impressed with Check’s video.

“I love good ETH critiques. Unfortunately, this was not one,” Adams tweeted on Thursday. “We’ve covered all this, I don’t think a debate would be productive.”

Then, in a Bankless podcast episode on Friday, Adams expressed confidence that a community hard fork attempt would successfully remedy a 51% attack. 

“I think, in every single case, as long as we have a social layer around Ethereum… the non-censorable version of Ethereum will win in the end.”

Check also discussed matters with Bankless co-owner David Hoffman, who accused the analyst of being “intellectually malicious” and “concern trolling.” 

Brian Armstrong

Finally, there’s Brian Armstrong – the CEO of Coinbase, which is one of the large and regulated staking providers the community is worried about.

Armstrong and other exchange leaders were asked by Ethereum developer Lefteris Karapetsas how they will react under OFAC pressure. Will they use their stake to censor the protocol, or shut down their staking service to preserve network integrity?

The CEO personally attested that, if his company had to choose, he “thinks” they would pick the latter option. 

“It’s a hypothetical we hopefully won’t actually face,” he tweeted on Wednesday. “There may be some better option (C) or a legal challenge as well that could help reach a better outcome.”

While there is some doubt as to whether the company will actually do this, Lane Rettig believes it could be the “most likely outcome that’s not a complete and total disaster.”

Conclusion: Is Ethereum Doomed?

The merge is still a month away, and there are countless variables at play. As such, it’s impossible to predict how the upgrade will affect the future of the network. 

Nevertheless, arguments presented by James Check are gaining steam across the crypto community, indicating that he may be on to something. In fact, Ethereum core developers recently discussed how the merge, in its current implementation, could amount to “censorship software.”

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