MakerDAO and the Ethereum Merge

The blockchain space, like any emerging technology, is constantly evolving. Just as the Android operating system began with version 1.0 and has since matured, Ethereum, a foundational layer of DeFi, is about to undergo its own significant evolution. The move from Proof of Work (PoW) to Proof of Stake (PoS) marks a pivotal shift not only in the Ethereum network but also in the entire ecosystem that relies on it.

For years, Ethereum's Proof of Work consensus mechanism has been both its backbone and its limitation. While it ensures the integrity of transactions, it does so at a staggering energy cost. The University of Cambridge estimates that Bitcoin alone consumes about 39% of the world's annual electricity—a staggering figure that's impossible to ignore. Ethereum's PoW mechanism isn't far behind, leading to mounting concerns about sustainability.

Beyond energy consumption, PoW has made Ethereum struggle with scalability. As the network processes more distributed apps (dApps) and DeFi projects, it has become congested, driving up gas fees. Earlier this year, gas fees peaked at $50 per transaction, creating barriers for innovation and accessibility, particularly for smaller projects. For a blockchain network that hosts billions of dollars in value, these challenges have become increasingly pressing. The Ethereum network needs to grow with its ecosystem.

The Merge is Ethereum's answer to these growing pains. It's a long-awaited upgrade that will transition the network from PoW to PoS, promising not just sustainability but scalability, security, and efficiency. By switching to PoS, Ethereum is expected to cut its energy consumption by a massive 99.5%. For a network supporting DeFi projects worth over $100 billion in total value locked (TVL), this isn't just an environmental win—it's the future of decentralized finance itself.

While the Merge brings optimism, it also introduces new risks that projects on the network, including MakerDAO, must navigate. MakerDAO, as one of Ethereum’s flagship DeFi platforms, is committed to embracing Ethereum 2.0. However, we're aware that the road ahead is fraught with challenges, and we’re prepared to address them.

One risk Maker faces post-Merge is future backwardation and negative funding. Due to the fork, spot ETH holders will receive PoW tokens, but those holding ETH perpetual contracts will not. This imbalance could pressure Maker’s vaults, leading to a decline in the cost of leverage through futures contracts. We plan to stay competitive by adjusting our rates to avoid losing volume.

Another issue is the potential devaluation of staked Ethereum (stETH). Since stETH will remain locked until further upgrades, its liquidity could suffer. This, combined with the speculative nature of the forked PoW ETH, could result in volatility and liquidity risks. MakerDAO is committed to closely monitoring stETH liquidity, adjusting our stability fees or liquidation ratios as needed, and keeping our rates competitive across DeFi lending platforms.

With the Merge, externally-backed assets, such as centralized stablecoins and real-world assets, may recognize Ethereum forks. This poses a risk to Maker’s collateral assets, as their value could fluctuate based on the fork’s adoption. To mitigate this, we are working closely with key external asset providers to ensure they support the Merge and the PoS Ethereum.

Oracle networks and price indices also face risks if a PoW fork gains traction. Outlier data could be fed into these systems, causing market disruptions. We are engaging with centralized exchanges to confirm their stance on the PoW fork and ensuring we have clear strategies to prevent bad data from affecting Maker’s protocol.

While the Merge offers a promising future for Ethereum and DeFi, it is not without its complexities. MakerDAO is prepared to navigate these challenges, ensuring the stability and sustainability of our protocol in this new era.

The Ethereum Merge is not the end, but merely a new chapter in the blockchain’s journey. As Ethereum continues to evolve, so too will the decentralized applications, protocols, and communities that build on it.

Stay tuned for more updates. Together, we’re shaping the future of finance.