These common myths about Ethereum’s “Merge” can turn investors off
The highly anticipated Ethereum merger is just around the corner, and even after the many months investors have spent preparing for it, excitement in the market is still building. Excitement around the merger has increased, injecting some optimism into the market as cryptocurrencies, along with stocks, continue their rough ride for the year. Ether, the native symbol of Ethereum, is up nearly 66% since June 30, shortly after the risk asset sank to its lowest level of the year. It has outperformed bitcoin by about 63% at its peak, according to Glassnode data. And many call the merger the most important moment in crypto̵[ads1]7;s (albeit short) history. “The merger is very important, but how to justify this 63% excess return is another matter,” said Owen Lau, senior analyst at Oppenheimer. “There are a couple of misunderstandings about the merger.” The merger refers to a technical transition intended to reduce energy consumption by almost 99.95%. That alone can lower the mental barriers to keeping institutional money out of the crypto markets, and it’s something pretty much everyone in the crypto community can get behind. “It’s not the end game” The merger is also expected to pave the way for further technical upgrades that will help increase network capacity and reduce fees – two of the crypto industry’s biggest criticisms of Ethereum and the reason why alternatives like Solana and Cardano have emerged and grown in popularity . However, some investors may be getting ahead of themselves, Lau said. “People think it will significantly reduce gas taxes, the APR will go up a lot, and that it will transform into a much faster network. But the answer to that is not yet,” he said. “The merger is just part of the end game, it’s not the end game.” The merger is planned to take place 13-15. September. But as investors get ready for the big week ahead, there are some misconceptions that need to be put to rest. Ethereum is moving from an energy-intensive protocol known as proof-of-work, which requires specialized computing equipment to validate transactions, to the more energy-efficient proof-of-stake, where holders of ether perform the validation manually. Ether is the second largest cryptocurrency by market capitalization, after bitcoin. Yet it is notoriously slow and expensive to use. As a result, it is mostly used to pay for “gas fees”, tolls for transactions and processing on the Ethereum blockchain. It may remain so for some time after the merger, which is only a first step. The event will be disappointing for those expecting a shiny new platform next week. “The merger won’t do anything on its own for Ethereum’s throughput, they have other kinds of solutions in the works that are trying to address making transactions happen faster and cheaper. The merger itself isn’t really designed to solve that,” Michael Rinko , venture -employee at AscendEx. Lau echoed this sentiment and suggested investors interested in ether take a long view of the cryptocurrency. “It will only set the stage for further upgrades in 2023 and 2024, but in terms of immediate benefits, we may not feel them right after the merger,” he told CNBC. “Yes, we save a lot of energy, but for quick transactions and lower gas fees, we may not feel it right away.” In addition, there are guaranteed to be some fundamental difficulties on the way there. Many have compared potential post-merger integration problems to the Y2K computer system updates more than two decades ago. “It’s going to be, as all big transitions are, a little rocky at first,” FTX CEO Sam Bankman-Fried said on CNBC’s “Squawk Box” Friday. “There’s going to be some messy activity around when that happens — it’s kind of inevitable — but long-term, and probably even medium-term, I think it’s going to be healthy.” Return Expectations Are Too High The process of manually validating network transactions is impractical for most people, and many will likely take advantage of services offered by companies like Coinbase to participate in the network and earn rewards, or returns, for doing so. Ultimately, the return-generating opportunity, known as staking, could help push crypto further into the mainstream. While becoming a yield-generating asset may excite investors at a time of high inflation and depressed stock prices, widespread market expectations for a tripling of returns are a little high, Lau added. “The annual rate for validators is expected to increase after the merger, but it is unlikely to triple,” he said in a note this week. “Note that the increase in APR comes from the redistribution of transaction fees from miners to validators, not from new ETH issuance. The Ethereum Foundation estimates that ~10% of gas fees paid go to miners in the form of a tip, and the rest is burned.” “By extrapolating these 10% fees to average recent network activity, the Foundation estimates that the annualized compounded interest rate will increase to ~7%,” he added. (For more on how transactions are validated and how the merger will create staking opportunities for investors and revenue opportunities for exchanges, check out our previous Deep Dive here .) Supply limits will make ether more attractive In addition to higher returns, investors can expect an increase in the price of ether itself because the merger will reduce the amount released into the market, explained Rinko. Every day, new ether is released into the market, and if the demand does not match the supply level, the price goes down, he said. After the merger, there will be less supply in the market, and if demand remains constant, the price should rise. “Ethereum had this really big upgrade a few months back that burns a fraction of every transaction fee,” Rinko said. “Then lower supply is coupled with a constant burn, and many people believe that after the merger, ether will become a deflationary asset – meaning that over time the supply will begin to decrease (as opposed to increasing, as historically it always has have done. ) A deflationary asset is slightly more attractive to own for investors.” A Potential Fork and a Popular Trade Those who have seen this unfold are waiting to see if there will be a forked version of Ethereum, or several, powered by proof-of-work miners who will no longer be able to service the network after its migration to proof-of-stake. “Once it’s merged into proof-of-stake, and those people are no longer needed, they have a vested interest in moving things back to the proof-of-work model so that everything their expensive equipment can continue to make money,” Rinko said. “There’s now a big parlor game about whether or not the fork will happen and how many forks will happen,” he said. “Part of the game is trying to figure out which fork the market will coalesce around and exchanges will support post-merger.” In August, a group of miners launched a campaign to fork Ethereum to maintain the proof-of-work mechanism as a separate network and token, called ETHPoW. This means that when the merger is completed, it can v honor a forked version of Ethereum – and if you are currently an ether holder, you will automatically receive ETHPoW for free through an airdrop. Since then, traders have been betting on the fork happening by buying spot ether and shorting ether perpetual futures. “They see this as almost a type of game,” Rinko said. “So they don’t have price exposure, but with any fork that happens, they’ll get the token airdropped because they own the spot ether, and then they’ll probably immediately sell the fork and realize those gains.” Funding rates on perpetual ether futures contracts have been extremely negative recently, he added, suggesting there is strong demand to short them. Lau also highlighted the recently popular trade. “Some traders set up a strategy to buy ether going into the merger and sell futures so they can hedge the price risk of ether,” Lau said. “When they go into the merge, they get the so-called fork version of ether, and then they can stay in the market or – I think people will relax trading and you can see ether underperform bitcoin.”
