What is the Ethereum blockchain trying to ‘merge’?

One of the major news before last week was the expected completion of a major software upgrade of the Ethereum blockchain called “The Merge” by Sep 15.

In this newsletter we would be discussing cryptocurrency and blockchain in simple terms for someone completely new to this world. Given the multiple jargon and complexity associated with them, there is no easy way around it, but let us give it a shot.

Visualize a ₹ 2000 currency note from your wallet. It has an alpha-numeric code – OBQ545781 as the serial number. You are giving me this currency note with a defined serial number as a paid annual subscription to this newsletter. Similarly, there are five hundred other subscribers to this newsletter who would hand me the same INR 2000 denomination notes. Each with their respective serial numbers.

In the world we operate, the responsibility of not having a fake note rests with the RBI. In other words, the repository of valid codes or serial numbers, on the currency notes in circulation, rests with the central bank of the issuing country. In our case, the Reserve Bank of India.

But now think of a different world.

Imagine the crisp currency note OBQ545781 in your wallet to be fragmented into 500 pieces of a jigsaw puzzle and each of the 500 subscribers has one. You have one piece too. Similarly, there would be 499 pieces or jigsaw puzzles of other subscribers’ currency notes in your wallet, assuming each one has ₹2000 in their account.

Visualize further, you wish to take an annual subscription of this newsletter and have to pay me. To do so, 500 jigsaw puzzle fragments magically come out of the 500 subscriber wallets and instantly reassemble to form a Rs 2000 note with OBQ545781 serial number, ready to be posted to me. In this way, the collective network of this newsletter’s subscribers have authorized a transaction between you and me.

In other words, the repository of valid serial numbers on the currency notes in circulation is decentralized. You don’t own it. I don’t own it. No one person holds it. No one bank holds it. No central bank holds it.

This is what blockchain is. The underlying database (repository of information) which is stored across all the nodes of the network. For our example, each of the 500 subscribers is a node in this imaginary ‘Venture pulse newsletter network’, where ‘blocks’ (jigsaw puzzle pieces of your 2000 note) are added and updated to authorize a transaction, resulting in a chain of blocks. Hence, the name blockchain.

A currency like ₹ or $ serves as a medium of exchange. Bitcoin is the oldest currency based on the blockchain technology. Just like a regular currency note has a host of security/authentication marks embedded in it, the digital currency has security/authentication codes (read algorithmic problems) embedded, which are encrypted. At the time of a transaction (such as you paying for this newsletter) these codes would be decrypted, updated and encrypted again, to reflect the latest transaction exchange, across the whole network. Hence, it is called crypto-currency. But Bitcoin, rather than becoming a widely accepted transactional currency, evolved into a speculative commodity. Maybe we would delve into reasons for it in another issue of this newsletter.

Like Bitcoin, Ether is a crypto currency on the Ethereum blockchain. Ethereum blockchain went a step further than Bitcoin and created a platform.

Recall the fragmented 500 jigsaw pieces of the ₹2000 currency note in your wallet. Can we replace the currency note with land records, insurance policy, health card, degree certificates? Obviously, we can. In other words, the application of blockchain can go beyond recording currency transactions. That’s what Ethereum enables users to do in the web3 space.

Seems surreal? It surely is! But as you might have guessed, there are quite a few challenges with blockchain and crypto applications built over it.

One of the challenges, ethereum seems to have solved with what it calls “the merge”. Hence, it was in the news. Let us look at their solution.

Recalling our thought experiment – the magical reassembly of a ₹ 2000 note to authorize and process the transaction between you & me. This is known as ‘validating a transaction on blockchain’. Some or the other computing machine actually has to do this task in the background. In crypto parlance it is known as ‘mining’ or ‘proof of work’. In ethereum lingo it is called ‘gas fees’. The term is inspired from gas, American for fuel, which is required for a car to run. Similarly, ethereum requires fuel to run i.e. to make transactions.

Simplistically, till now, this task can be understood to be performed by someone on the blockchain network who volunteers for it. E.g. You are paying me for the subscription, this is validated by another Mr ABC on the venture pulse subscriber network, who opts to do so, and earns INR 50 for it. This process is time consuming and has become computationally expensive. Rs 50 as ‘gas fees’, at times could become Rs 500 or more which was unsustainable and the reason for less adoption of the Ethereum platform.

Ethereum has switched the validation process on their platform from ‘proof of work’ to ‘proof of stake’ model.

Ethereum argues this is cost effective as it is not dependent on existing computing infrastructure or ‘miners’. Instead, the transactions would be validated by people who stake their existing ether coins, and get rewarded with more coins.

Continuing with our example, It is like saying, HDFC Bank is one of our newsletter subscribers and it assures us that let them handle the subscription transactions for all of us in crypto since that’s what they efficiently do in other currencies. They are pledging an initial sum of 10 lacs and would bring down the transaction cost (gas fees) from Rs 50 to Rs 15 or even lower.

Decentralized blockchain makes way for decentralized finance. This move would help existing ethereum owners to use their coins and earn returns on it. Second, it would allow finance professionals to compare crypto assets with traditional assets.

In a way it should be viewed as Ethereum trying to create a link between the old established financial world and the new one which is yet to shape up. Hence the name of the software upgrade – ‘the merge’.

Ecosystem Ventures This Week

Key Highlights – Events

We are happy to share that Mr. Shailesh Jain (Vice President) and Mr. Kinjalk Pancholi (Associate) have represented Ecosystem Ventures being a part of the judging panel at AvantGarde business plan competition organized by IPM students, held at IIM Indore.

Startup Funding Summary

Zopper, a Noida-based insuretech startup, has raised $75 Mn in Series C funding from Creaegis, ICICI Venture, Blume Ventures, Tiger Global and Bessemer Venture Partners – Read More

Light Microfinance, a Ahmedabad-based microfinance company, has raised $26 Mn in Series B funding from British International Investment, Nordic Microfinance Initiative, Triple Jump BV and Incofin IM – Read More

Join Ventures, a Mumbai-based house of D2C brands, has raised $24 Mn in Series B funding from MO Alternate Investment Advisors, Convivialité Ventures, DSG Consumer Partners, Venture Catalysts, ZNL Growth and other HNIs – Read More

KukuFM, a Mumbai-based Audio platform, has raised $22 Mn in funding from The Fundamentum Partnership Paramark, KRAFTON Inc, 3one4 Capital, Vertex, Verlinvest and FounderBank Capital – Read More

Bhanzu, a Hyderabad-based math learning platform, has raised $15 Mn in Series A funding from Eight Roads Ventures and B Capital – Read More

M&A Snippets

Mumbai-based green energy business Reliance Industries will acquire minority stake in US-based research and development firm Caelux Corporation for $12 Mn – Read More

Mumbai-based ecommerce furniture company Pepperfry has aqui-hired Mumbai-based architecture and planning firm Brandmakerr for an undisclosed amount – Read More