ESG Impact of The Merge

The Merge, the Ethereum network’s transition to a proof-of-stake (PoS) consensus mechanism from a proof-of-work (PoW) model, is set to have major implications on ESG. ESG—Environmental, Social, and Governance—is a set of standards measuring a business’s impact on society and the environment and how transparently it carries out operations. Specifically, The Merge will reduce the energy consumption of the Ethereum network by 99.95%.

A proof-of-work consensus mechanism rewards miners for undertaking complex computational work. The hardware required uses a significant amount of electricity—a single transaction on Ethereum is equivalent to the power consumption of an average US household over 9 days. Additionally, using proof-of-work, the price of ETH and the hashrate—the measure of the computational power per second used when mining—are positively correlated. Therefore, as the price of ETH increases, so too does the power consumed by the network proportionally.

Once The Merge happens, staking will replace mining to verify Ethereum transactions.Using proof-of-stake, as the price of ETH increases, so too does the security of the network, but the energy required to sustain the network does not change. There are no rewards involved; each block is determined by the wealth it holds. Miners are paid in “gas,” fees on Ethereum transactions. Proof-of-stake doesn’t consume any more energy than running a laptop.

“If you value blockchains as nations, Ethereum will become the greenest digital or physical nation in existence after the move from proof-of-work to proof-of-stake,” said Paul Farella, Managing Director of Willow Crypto, an ESG-focused digital asset advisory firm.

According to the Confederation of British Industry, more than two-thirds of investors consider ESG factors when considering investing in a company. Additionally, ESG mandates can serve as a major barrier to large investments. The transition to proof-of-stake will give Ethereum the ESG stamp of approval, removing one of the biggest impediments to Ethereum’s mainstream adoption and encouraging new institutional investments in the asset.

Many environmentally-conscious investors consider blockchains that use a proof-of-work consensus mechanism, like Bitcoin or pre-Merge Ethereum, to be too energy-intensive. The Bitcoin network, for example, consumes 835.4 kilowatts of energy per year, which is about the yearly consumption of 675 American homes or more than the annual energy consumption of Argentina.

“[The proof-of-work blockchain industry] is spending no less than 0.3 percent of all electrical power on mining. Therefore it is accordingly responsible for the proportional amount of harmful atmosphere pollution,” argues Dmitry Pluschevsky, Founder and CEO of GoldMint. “It is unacceptable for electronic technology of the 21st century.”

The Merge puts an end to mining and the electricity required to do so, making Ethereum 7000x more efficient than Bitcoin. To demonstrate the ESG effects of The Merge, examine the comparison between the previous proof-of-work consensus mechanism and the new proof-of-stake model below.

“Surface-level, the transition in consensus mechanisms is not difficult to understand. Bitcoin burns energy to provide security for the Bitcoin network by using proof-of-work. Proof-of-stake replaces energy with money. Instead of burning electricity for security, you can put your assets on the line and stake them to secure the blockchain,” said Farella.

This improvement in energy efficiency has been a long time coming. Ethereum’s transition from proof-of-work to proof-of-stake began on December 1, 2020 and is due to be completed within the next month. Investors are excited about Ethereum’s progressive decision to join blockchains like Avalanche, Cardano, and Solana in energy efficiency through proof-of-stake.

“On the demand side, a proof-of-work protocol’s ability to scale will be limited by the public’s willingness to tolerate fossil fuel-driven, proof-of-work protocols in general and preference for the growing availability of carbon-negative alternatives,” said Staci Warden, CEO of the Algorand Foundation.

By reducing energy usage by 99.95%, The Merge marks a significant commitment of the Ethereum network to ESG standards. Investors should be excited not only about the Ethereum network’s decrease in energy consumption but also about the signal this sends to the digital asset ecosystem about the prioritization of sustainable energy use. Proof-of-stake promises a much greener future for digital assets.

“Ethereum’s power-hungry days are numbered, and I hope that’s true for the rest of the industry too,” said Carl Beekhuizen of the Ethereum Foundation.

What is Index Coop?

Index Coop is a decentralized autonomous organization (DAO) that powers structured decentralized finance (DeFi) products and strategy tokens using smart contracts on the blockchain. We offer a suite of sector structured products, leverage and inverse products, and yield-generating products. We aim to create products that are simple to use, accessible to everyone and secure. Our products are built on Set Protocol, a twice-audited, self-custodial DeFi tool that allows for the creation and management of Ethereum-based (or ERC-20) tokens. Among users, partner protocols, and our composable products, Index Coop maintains one of the largest partnership networks in the DeFi ecosystem.