CrypTalk ep 7 – What will happen to Ethereum after the merge, and ISIS NFTs

In this episode of CrypTalk, BizNews’ Ross Sinclair speak to Gaurav Nair of Jaltech about the coming Ethereum merge, its economic implications and the likelihood of success, as well as the recent scandal surrounding an ISIS sympathiser creating an NFT to potentially fund the terrorist organisation.

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Excerpts from the video discussion with Jaltech’s Gaurav Nair

Gaurav Nair on what the Ethereum merge entails

Well, to understand that, we need to understand the ways that blockchains work and the two major ways blockchains work is there’s either something called mining, which is known as proof of work. Or there’s another way to run a blockchain, which is called proof of stake. And without getting into what makes these two different, the key difference is that mining takes a lot of energy in order to run the blockchains, whereas proof of stake doesn’t take much energy at all. In fact, it uses 99.9% less energy to run the blockchain. So the merge is that Ethereum – the second biggest blockchain by market capitalisation and the biggest blockchain by activity – actually, it’s even more active than the Bitcoin blockchain has been running on proof of work (mining) the same way the Bitcoin blockchain runs. And from the very beginning, the intention was to change over Ethereum to run on this new method. Proof of stake. There are other blockchains out there that run on proof of stake. So we do know it works. But at the time Ethereum was conceived, it seemed too risky really to try and run it on proof of stake. There was more research that needed to be done and development, so it ran on proof of work mining. And in parallel, many researchers and programmers, developers out there have been working on trying to convert Ethereum to proof of stake. And the analogy that’s often drawn is that these developers are trying to change the engine of a flying plane while in flight. So they’re not stopping the blockchain for a few minutes or hours and then changing it and then restarting it. Instead, the blockchain is going to continue running the entire time. Now the reason it’s called the merge is that I think about two years ago they started a parallel chain called the Beacon Chain. And that chain has been running on proof of stake this entire time. What’s going to happen is the existing Etherium chain and the Beacon chain are going to merge into one and then mining is going to get turned off. And the Ethereum chain will continue using the proof of stake system that the Beacon Chain is using. So that’s the merge.

On how the merge is technically being implemented 

The way they set it up is something called the difficulty bomb. And the difficulty bomb is going to make mining much, much harder to do. And so that has been built into Ethereum a long time ago. It was foreseen that when Ethereum swapped over to proof of stake that this difficulty bomb would go off. And so there would be no incentive to continue mining. Simultaneously, they’ve been upgrading both chains to actually implement this automatically. And what they’ve done is they have chosen a metric. And when that metric is passed, then the chain will automatically merge. It’ll swap over to proof of stake. Now, this metric isn’t a time. It is, in fact, one of the metrics that that you can measure in a blockchain, which is the difficulty of mining the chain and that the difficulty keeps moving. So they’ve chosen a total difficulty. And so we have an approximate time. It’s likely to be on Thursday morning in South Africa when this difficulty is reached and the merge happens. And the reason they choose this kind of esoteric metric is because it’s very difficult to fake it. However, if the mining activity changes on the chain, it could happen sooner than Thursday morning or it could happen later. So that’s why we kind of have a window and an approximate time of when the merge is likely to happen.

On what the economic impacts of this merge are likely to be

So typically for running a blockchain, the miner is spending money on capital and then they’re spending money on energy and they’re doing the work of running the chain. And as a reward, every time they mine a block, they get some Ethereum issued to them as a reward. So when Ethereum moves over to proof of stake, it becomes much, much cheaper to run the chain. Because you’re no longer mining. You’re instead doing something called validating. And since it’s much, much cheaper, the person that’s validating doesn’t need as big a reward in order for it to be a worthwhile activity to validate the chain. And so instead of issuing the same amount of Ether per block. The issuance becomes much less, it’s dropping by 90%. Now whether it’s Ethereum or Bitcoin or any other blockchain, whenever they issue currency, it’s inflationary. And that reduces the value of all the other coins out there. By reducing the inflation of Ethereum because less ether is issued per block, this means that the value of the coins will reduce by less on an ongoing basis. So economically it’s quite good, while still being worthwhile to validate the chain and run the chain. But separately, when those coins are received by a miner validator, if they’re miner, they typically sell the coins quite soon because they need to pay energy costs and replace the equipment that they’re using. Compared to the validator, they don’t have as much of a need to sell because they don’t have as heavy a cost structure. But even if they sold everything they received in terms of that issuance, there’s much less, only 10% of it that they’re selling. So what this means is there is less new supply of Etherium that’s going to be coming on the market. And if you consider the price of any other commodity to be the interaction between demand and supply, when supply drops, that should result in the price increasing. So we’re going to see less supply coming onto the market, and that’s how the economics will change.

On what happened with the ISIS NFT and what it means for the future of crypto 

I guess most people don’t want terrorist organisations to be funded. And if we also consider the case of North Korea, they don’t necessarily want another country to have nuclear weapons and so they don’t want to then fund North Korea to be able to do that. The question, though, is whether this means that we shouldn’t have technology which can be used in that way. Now, most terrorist funding and funding of a pariah states actually happens in cash because cash is the most untraceable thing. This doesn’t mean that cash should be banned. I think what a lot of level-headed people want is good technology. They want privacy. But they also want law enforcement to catch the bad guys. Now, where blockchain currently is is that it’s a totally new technology. And because of that, law enforcement don’t yet know how to police it well and how to trace flows and catch criminals, including terrorists. And so you have these criminal elements that are using the various blockchains, and some of these blockchains are, in fact, much more traceable than cash. So if you consider Bitcoin and Ethereum, the blockchain is actually a history of every single transaction. So once law enforcement knows a terrorist organisation’s wallet, they can actually see the history of all the transactions they’ve done and follow it. However, there are also tools out there to try and obscure this. That’s why law enforcement recently also banned tornado cash, which is a privacy tool. So what happened here is that it seems like, as you said, an ISIS sympathiser listed nfts that look like photographs or digital art that support ISIS or have ISIS messages. So we can’t even say, in fact, who this was that listed this. It could even just be someone playing a prank. However, what it appears to be is that it’s a sympathiser that is testing the ability now to sell these NFTs to other sympathisers and hence raise money. Now most of the NFT marketplaces have companies behind them that control what is listed on there. And so if this person tried to list on these other marketplaces, it was either very quickly removed or they were unsuccessful, unable to do so. However, there are also decentralised ways to list these NFTs. Three of them were listed on one of these decentralised platforms, and it’s very difficult to remove it from there. So what this means is that there’s fear that there’ll be a new way for people to send money, in essence, to terrorist organisations, either by buying these NFTs or in fact even just sending directly using cryptocurrency and that these organisations will then carry out their acts of terror. Or, in the case of North Korea, build nuclear weapons.

How can the funding of criminals be prevented? 

Very much like the analogy with cash: the way that regulators stop cash from being used for all kinds of criminal activities is by regulating it as it touches the banking system or a lot of other institutions, financial services and institutions. And they require these companies to know the person they’re transacting with. KYC (know your customer.) They require these institutions to understand who they are transacting with and where they get their money from. And a similar approach could be taken when it comes to cryptocurrency. And we call the way that you get into cryptocurrency and out of it back into normal money, we call those on ramps and off ramps. And so one approach that has been suggested is for regulators to regulate the on and off ramps. The exchanges that change cryptocurrencies into cash could be regulated. And so if a terrorist organisation tries to change the ether back into dollars, when they try and sell the ether on an exchange, that exchange could then carry out KYC procedures to understand who it is and ask them for their source of funds. Where did they actually get this ether from? And then at that point, if the person can’t provide sufficient information, not allow them to interact on that exchange.

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