#35 Who cares about The Merge?
The most important effects of Ethereum's Merge will only be perceived in the long term (no simple numba go up today). Also, Tornado Cash reloaded, intellectual property licenses for NFTs, & Sudoswap
Who cares about The Merge?
The Merge is one of the most relevant milestones in crypto’s evolution, and it will probably have a nice place in the annals of crypto history. We’ve written about it in the past (#33, #30, #19), and everyone’s writing about it these days, as the estimated culmination date approaches. But to be honest, besides the minority of people who have swallowed the red pill, the world probably doesn’t really care about The Merge. Why should they?
The current context is messy. Prices of BTC and ETH slumped twice this year (following the Terra and the Celsius/3AC crises) and show no symptoms of long-lasting recovery (yet). Trading volume on top NFT marketplace OpenSea down 99% in USD from May peak, and DeFi is going through an identity crisis after the Tornado Cash case (more on this later), the most notable example of the increasing regulatory pressure coming from a dozen angles. And all of this within a backdrop of global financial crisis and stagnation. Suppose you’re not heavily invested in crypto, financially or intellectually. In that case, the old reasons to be looking at it -like price rollercoasters or delirious NFT sales- are no longer flashing in front of your eyes. But The Merge is indeed a big thing.
Let’s take a minute first to introduce it to the blue-pillers:
The Merge is a technical upgrade in the Ethereum blockchain (the second most noteworthy blockchain in the crypto ecosystem, home to the second most remarkable asset, Ether).
The Merge will finalize Ethereum’s transition from a Proof of Work (PoW) to a Proof of Stake (PoS) validation protocol. A quick refresher:
Validation protocols are the mechanisms by which transactions are validated and added to blocks on the blockchain by a distributed community of participants (miners/validators), who in turn get rewarded.
Proof of Work involves miners running expensive machines 24/7 and consuming tremendous amounts of energy to validate blocks.
Proof of Stake, instead, uses financial incentives: miners (now called validators) stake their funds in the protocol in exchange for an opportunity to be randomly assigned block validation. If it sounds like a raffle (where you get more chances to win if you buy more tickets), it’s because that’s mainly what it is.
The arrival of PoS to the Ethereum blockchain brings a drastic change in the financial incentives and supply mechanics. Less Ether will be issued, and more Ether will be proportionately burnt in every block. As a result, supply is likely to shrink, and you probably know what scarcity translates into in investment.
Most people only care about crypto when the price goes up, and it excites the gold fever in everyone. But the potential positive effect of The Merge in Ether’s price is, firstly, muffled by the general context, and secondly, still in question. Many people are still wary of the change: there are concerns that the transition will not be as smooth as desired, and there are also many questions regarding what will happen to the deprecated Proof of Work blockchain. Investors are watching from the sidelines, and price action is subsequently dull.
So, back to the original question: if The Merge is not going to get us our Lambos, why should anyone care about it?
The effects of The Merge will be profound and will set the baseline for creating a solid crypto and Web 3 ecosystem. But they can probably only be evaluated in the long term.
The transition from PoW to PoS had a clear goal: to make Ethereum more energy efficient and sustainable. The Merge will decrease energy use by 99.95%. There are planetary reasons why this is a good idea. Besides, sustainability can potentially restrain some regulatory urges (opening the doors to mainstream investment) and lure good actors into adding value to the ecosystem.
The Merge has another side effect: increased decentralization. Reducing the size of validators to secure the network is a critical element of Ethereum’s roadmap. How decentralized is a network where only a few people can mine? The Merge will kick off other efforts to reduce the cost of validation, which means a safer, more resilient blockchain. Decentralization is the most powerful philosophical disruption brought by crypto. It is the key to the disintermediation of whole industries, starting with the financial industry.
And finally, as soon as The Merge is live and people are done celebrating, developers will move on to their next task. One that will make degens happier: the following stage of Ethereum’s development, The Surge, has scalability as its primary goal. Transaction time and costs are in the crosshairs. Cheap transactions open the floodgates to infinite new use cases for crypto (think of fully on-chain gaming experiences).
Sustainability, decentralization, and a baby step towards scalability are why everyone should care about The Merge.
⬡ Six Angles
We select six topics to illustrate the very different angles crypto can be approached from. We could choose dozens, but six is the atomic number of carbon… and otherwise we’d be writing for ages.
1. Regulation | Tornado Cash
Previously, on Tornado Cash…
The OFAC, the financial police force at the service of the USA’s foreign policy, added some Ethereum addresses, wallets, and smart contracts related to Tornado Cash, to their SDN list: a black list of individuals, groups, and entities, such as terrorists and narcotics traffickers, who the OFAC identifies as conducting operations harmful to the national security. Once the addresses were included in that list, any individual or company that transacted with them was legally liable and could face harsh sanctions.
The industry is full of good actors willing to play by the rules and cooperate with regulators for purposes like prosecuting international criminals. Still, the OFAC’s methods seem clumsy and lack the nuance crypto deserves.
Uniswap’s case is a good example: Uniswap is a DeFi protocol, a piece of software that runs autonomously on a blockchain. Uniswap Labs, on the other hand, is a company in charge of developing and maintaining the frontend: the web application that people use to interact with the protocol. So Uniswap Labs can decide to comply, even though the OFAC applies to American citizens, and they could legally choose to navigate the gray areas. And so they did: they removed any possibility of transacting with sanctioned addresses from their frontend. In the meantime, the protocol continues to run immutably on a blockchain. And people with enough technical knowledge (who don’t need to interact with a sleek frontend interface) can’t be stopped from anonymously operating at their own risk.
2. Intellectual Property | NFT licenses
Use, distribute, reproduce, display, perform, modify, and create derivative works are the verbs described in Intellectual Property law. Add “own” and “contemplate,” and you get all the actions one can perform on/with the different forms of IP, like artistic expression. Probably all of these have been fundamentally disrupted by the arrival of decentralized digital assets. Intellectual property rights need an update.
The first copyright laws came from colonial times in the United States. So it is easy to understand why such ancient rules would not apply to the current creative environment. But Creative Commons licenses are just a bit over 20 years old and struggling to adapt.
Venture Capital firm and web 3 capital fountain Andreessen Horowitz have recently published their take on what IP licensing in NFT-land could look like in the future. A new set of licenses, based on Creative Commons, collectively called “Can’t Be Evil,” that leverage some of crypto’s key features and adapt to the new characteristics of digital art.
The licenses are freely available for use by the community and serve three goals: (1) to help NFT creators protect (or release) their intellectual property (IP) rights; (2) to grant NFT holders a baseline of rights that are irrevocable, enforceable, and easy to understand; and (3) to help creators, holders, and their communities unleash the creative and economic potential of their projects with a clear understanding of the IP framework in which they can work.
3. Stablecoins | DAI might become an unstablecoin
MakerDAO, the DAO behind the stablecoin DAI, has been featured prominently in at least three of our latest newsletters. They quickly reacted to the UST crisis, showing themselves as the most trustworthy of the algorithmic decentralized stablecoins. They displayed boldness by incorporating real-world assets as collateral in a move meant to fight the negative momentum dragging DeFi.
Today they make the news again for another debate that seems, once again, potentially transformational.
MakerDAO reacted to the threat embedded in the OFAC’s sanction. The ban on Tornado Cash demonstrated the power of regulators over USDC. With one single move, Circle’s stablecoin was frozen in the blacklisted accounts. It became pretty notorious then how easy it is for regulators to choke virtually anything in crypto. Just add pressure on USDC.
With more than 50% of their DAI backed by USDC, MakerDAO got rightfully scared of the potential threat. But, unknowingly (?), MakerDAO had made DAI centralized through its dependence on USDC.
The solution? De-peg the stablecoin. Break the ties with real-world denominated assets and let DAI price float instead of moving in sync with the dollar.
The move would depeg the currently stable DAI token from the U.S. dollar and prevent holders from redeeming it on a one-to-one basis for other stablecoins. It would also do away with one of DAI’s core value propositions and could result in the token trading below the dollar. Christensen Calls For MakerDAO to Float Stablecoin.
4. Regulation | Combatting fraud
The House Committee on Oversight and Reform has asked four US agencies and five crypto exchanges to detail how they combat fraud and scams. Among those receiving letters from the House were US Treasury, Securities, and Exchange Commission (SEC), Commodity Futures Trading Commission, Federal Trade Commission, Binance.US, Coinbase, FTX, Kraken, and KuCoin. These organizations were requested to provide documentation on their mechanisms to identify frauds such as commodity scams, fraudulent coin offerings, and sham investment platforms.
Regulators are trying to make crypto a safer place for investors, asking industry participants to up their game in areas beyond the “code is law” mantra: through self-regulating, performing due diligence, and doing their best to educate consumers.
5. NFT + DeFi | Sudoswap
Sudoswap is a breath of fresh air in these times. A tiny bit of creative thinking in the space was very much needed. The “build” in “bear times are build times.”
Sudoswap is a decentralized NFT marketplace. It is no coincidence that it rhymes with Uniswap because what Sudoswap brings is Automated Market Making to NFT trading. This means that NFT trades can happen in liquidity pools, like altcoin trades happen on Uniswap: async, disintermediated, liquid trades.
The DeFi-zation of NFTs was bound to happen (actually, mark these words, everything will be DeFi-ized in a decade), and it seems like Sudoswap is here to kick off the race. They are one of the fastest growing projects lately, regardless of the general context, and they’ve gone as far as launching an airdrop that’s shaking crypto.
UK | New Prime Minister
Boris Johnson is out the door, and in comes Liz Truss, his successor as the leader of the Conservative Party and, therefore, Prime Minister of the UK. Truss beat Rishi Sunak, former head of the Treasury, and reported crypto curious. Sunak had promoted the idea of making the UK a crypto-friendly tech hub and was pushing towards stablecoin regulation.
The election of Truss is still not bad news for crypto. The new Prime Minister is no stranger to crypto, though; she has expressed the widespread stance of handling regulation with care so as not to break anything in the process.
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