What the Ethereum merge will mean for payments

What the Ethereum merge will mean for payments

Ethereum, the second biggest cryptocurrency after bitcoin, is significantly reducing its energy consumption through a change in how it validates transactions on its blockchain. But what will the Ethereum merge mean for payments?

The Ethereum merge could increase the use of the cryptocurrency in payments

One of the biggest events in the crypto calendar has finally arrived. With the Ethereum merge, the Ethereum blockchain has moved from a proof-of-work to a proof-of-stake methodology for validation – a move that will have wide-ranging implications for the crypto community, as well as for merchants, exchanges and processors. 

Following the merge, crypto miners will no longer validate new blocks of transactions, added to the chain through a computational process known as proof-of-work. Instead, new blocks in the chain will be validated via proof-of-stake. This will mean that those wanting to make new instances of Ethereum’s token Ether (ETH) will use existing ETH as a stake, with the recipients selected at random. A higher stake gives a higher chance of being selected, meaning large amounts of ETH replace the high-powered computers formerly used by miners to grow their holdings.

Not only will the merge lay the groundwork for significantly faster transactions, but it will also have notable environmental benefits, with the Ethereum Foundation predicting energy usage across the system could be reduced by an amount equivalent to the output of a small country. 

However, for payments, the Ethereum merge represents a potential opportunity for merchants, processors and the wider industry.


What is the Ethereum merge? 

The merge will see the existing execution layer of Ethereum joined with a new proof-of-stake consensus layer, called the Beacon Chain. This chain has existed for some time, and has been running parallel to the Ethereum mainnet – the main Ethereum blockchain. 

Until now, transactions, accounts and balances on the Ethereum blockchain have been secured and validated by proof-of-work. This refers to the process whereby miners race to solve complex mathematical challenges, with the victor being given the opportunity to validate new blocks for the blockchain and receive crypto as a reward. 

Now, however, the Beacon chain and mainnet are being merged together, permanently replacing proof-of-work with a proof-of-stake methodology, which it expects to dramatically reduce emissions and also prepare the blockchain for future scaling upgrades that will boost its capacity and, eventually, transaction speeds. 

The merge officially began on 6 September and was completed on 15 September.

How will the merge change payments using Ethereum? 

The change to the Ethereum blockchain won’t immediately have a sizeable impact on transaction speeds, but it could lay the groundwork for significant speed increases in the future.

When the Ethereum network sees an increase in use, transactions can become slow and unwieldy, causing a rise in gas prices (i.e. the costs necessary to perform a transaction on the network). This is what happened when the Ethereum blockchain saw a sharp uptick in users in 2021. With capacity demand increasing, Ethereum needed to scale up.

The expectation is that, following the merge, the new network could be further enhanced with sharding – a process whereby the existing data across the network is split up into more manageable chunks that are spread across the network. Bolstering this process will be the addition of layer 2 solutions, which extend the underlying base layer of the existing blockchain (i.e. layer 1).

The most talked-about layer 2 solution currently is a rollup, which bundles lots of transactions together, distributing transaction fees across everyone included in the rollup while increasing capacity as well as, theoretically, transaction speed. Loopring, an organisation focused on crypto payments, believes its rollup layer 2 solution will be able to increase its transaction capacity to 2,025 trades a second. However, Ethereum co-founder Vitalik Buterin has said that improvements could eventually enable 100,000 transactions to be made per second on the Ethereum blockchain.

This would be a much larger number than the current Visa network, which can handle a maximum of 65,000 transactions per second. Based on total annual transactions for FY21, Visa actually handled 5,223 transactions per second on average during the fiscal year, while Mastercard handled 3,555 per second on average.

If Buterin’s figure were realised, it would significantly increase the utility of Ethereum for payments. The present limit on transactions per second presents a major limitation on how much any payments-related projects can be scaled. However, by opening this up to levels that rival fiat-based networks, it would become possible for a wide range of payment applications to run on Ethereum – from retail-based and P2P payments through to, potentially, more unorthodox solutions such as payment streaming.

However, it’s important to stress that there’s no certainty yet about the speeds that payment transactions on Ethereum could eventually reach. It’s hard to estimate the exact capacity of networks after the merge, because layer 2 solutions are being developed by third parties outside the Ethereum foundation, so beyond Buterin’s words there aren’t a known roadmap. Some layer 2 solutions are also based on technology such as zero-knowledge proofs, which are still under development.

For the moment, the existing merge is only likely to increase the transaction speed and capacity of the network by a small amount. The actual increase of the speed – so that it could compete with the capacity of Visa’s VisaNet network, for example – will come from later upgrades. 

Who is currently accepting Ethereum payments?

While retail and ecommerce-based Ethereum payments currently remain niche, there are some companies that have begun supporting them.

A number of ecommerce companies have already begun accepting payments in Ethereum. Luxury/fashion brands such as Gucci, Bitdial and Balienciaga are trying to boost their appeal to wealthy crypto owners by accepting the currency. Travel also appears to be a hotspot, with Traval, CheapAir.co, Destinia and Trippki all accepting Ethereum payments. 

Ethereum is penetrating online marketplaces too, if not always to the same extent. Overstock.com has teamed up with crypto exchange ShapeShift to facilitate crypto payments across Ethereum, as well as other coins including Litecoin, Dash and Bitcoin Cash. Meanwhile, Amazon is still not directly accepting cryptocurrencies as payment, although companies such as BitPay and Purse claim to enable this by offering Amazon gift cards, purchasable with crypto through their apps.

Although cryptocurrencies aren’t the default payment method for consumers, many merchants are considering the benefits that crypto advocates propose. It is claimed that transactions can be more secure and eliminate the potential for chargebacks. This means merchants don’t have to front the cost of the reversed transaction, which otherwise creates additional costs and makes them susceptible to scams. 

Transaction processing costs can also be lower for merchants compared to debit and cards. Of the examples we’ve looked at, costs are between 0.5% and 1% of transaction fees – lower than average interchange fees in the US but higher than those in Europe. 

There is also the potential to reach different customers globally, in particular those that don’t have access to conventional cross-border payment methods, which in some cases can include the underbanked.

At present, while there are merchants across a range of product groups, the selection does speak to a customer base similar to that of the average crypto-holder – young and male. Over time, if Ethereum becomes more commonplace after the merge and can handle growing numbers of transactions, we may see this group of potential users for payments widen.

Ecommerce sites that accept payments in Ethereum
Breaking down websites that accept payments in Ethereum by category

How will payment processors be affected by the merge?

Payment processors in the Ethereum space span a variety of focuses, with some of them offering merchant payment acceptance services alongside personal crypto wallet and trading solutions. While not all have commented on the merge, some have blogged about its potential impact and what it might mean for merchant and business customers.

Coinbase said of its Coinbase Commerce segment that it would be temporarily pausing the ability to process payments during the merge, but apart from that there would be no impact and users would not need to take any action. It said its role was “to protect users’ assets and help ensure a seamless transition across Coinbase products”. It added that should an Ethereum proof-of-work fork arise after the merge, it would review this in line with other assets on its exchange. 

Bitpay also said that it would disable invoice payments and merchant acceptance due to the merge, and no longer support Ethereum proof-of-work chains. It also said that it wasn’t expecting transaction fees to be immediately lower after the change, but believes gas fees could be reduced in the future. 

Meanwhile, NOWPayments said that it believed Ethereum Classic (ETC) – the coin that many miners are expected to shift to in the wake of the merge – could end up being a better choice for “blockchain idealists who believe in the ledger and the mandate to not tamper with it”. Having said that, it said that it believes ETH could end up offering more functionality and faster transaction speeds. It therefore suggested ETC could become less popular as the blockchain moves away from proof-of-work. 

Environmental benefits of the Ethereum merge

Increased scalability aside, the headline advantage of Ethereum’s move towards proof-of-stake is that it will save vast amounts of energy, reducing Ethereum’s significant environmental impact. According to the Ethereum Energy Consumption Index, each Ethereum transaction consumes as much energy as an average US household uses in a week and has the carbon footprint of 263,000 Visa transactions.

With proof-of-stake, the method of validation requires validators to have a high enough stake in Ethereum to secure and validate blocks, rather than miners expending very large amounts of energy racing to solve mathematical problems. According to the Ethereum Foundation, the merge will reduce Ethereum’s energy consumption by around 99.95%.

It is notable that the foundation is focusing far more on this benefit than it was when the merge was first being discussed. The significant energy consumption of crypto as a whole has seen greater scrutiny over the past few years, and has been a notable driver of negative sentiment around the industry, particularly as climate change concerns continue to grow. 

As a result, it suggests that Ethereum is being reframed as being better than alternatives such as bitcoin, due to its now significantly lower levels of energy consumption.

A widening gap in the crypto community

This has potentially significant implications for its adoption by mainstream financial services companies, including those in the payments space, as it comes as environmental, social and governance (ESG) issues have become an increasingly significant concern. For those looking to utilise crypto, Ethereum is simply going to make for a much better ESG report than bitcoin. 

This also brings Ethereum across the growing divide between crypto products and organisations that are acceptable for mainstream financial services to work with – compared to those that more purely align with the original libertarian goals of the crypto landscape.

The growing crypto divide
Entities prioritising original crypto values vs catering to FS needs

The merge could also represent a move towards cryptocurrency being less decentralised, which may have already upset many miners who benefit from the proof-of-work system, but be more in line with the demands of mainstream finance. Arguably, Binance’s recent move to convert its customers’ currencies from stablecoins (including USDC) into its own token is an example of this shift.  

“Crypto mining for proof-of-work tends to consolidate over time due to economies of scale on the hardware and energy needed,” explains Cameron Graham, Product Lead, FXC Intelligence.

“In theory you may just be shifting the ownership from large mining groups to large holders of the currency (which are typically exchanges).”

The shift away from rewarding miners may play into a wider trend of the crypto space splitting into two camps – one that favours the decentralised nature of blockchain but comes with the potential for more volatility, and another that sacrifices the freedom of the network to (ostensibly) offer more stability.

Time will tell if the merge creates an impact, and if it will eventually live up to expectations with regards to transfer speeds in payment processing. FXC Intelligence has already begun monitoring crypto, and will be tracking all the key developments and how they affect payments moving forward. 

Learn more about FXC Intelligence’s cryptocurrency pricing and market data

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