Will the Ethereum merger provide a new destination for institutional investors?


Last week’s Merge was the “most significant development in the history of the Ethereum network,” according to Fidelity Digital.

And from a purely technical standpoint, the transition of the blockchain network from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism was a miracle. Broadly compared to replacing a jet engine in flight, the software upgrade went through on September 15 without any glitches.

Also overnight, Ethereum, the world’s second largest blockchain platform, reduced its energy consumption by 99.95% from a rate of a staggering 94 TWh per year in May — roughly equivalent to the nation-state of Chile — to an almost negligible 0.01 TWh on Sept. 16, according to Digiconomist.

This should carry some weight with regulators threatening to curtail blockchain networks due to environmental pollution. It could also bring more institutional investors into the crypto space.

On this last point, institutional investors such as pension funds, insurance companies, foundations, and others matter because they tend to be long-term investors and tend not to trade on rumors or overreact to 24-hour news cycles. Broad participation from this group could help solve crypto’s lingering liquidity and volatility problems.

Others, however, believe that while the merger provides companies and major financial institutions with a more environmentally friendly platform, as well as new staking options, it still doesn’t solve one of Ethereum’s main shortcomings: its lack of scalability. Not yet anyway.

“The merger is a turning point for the crypto industry, but the impact to accelerate adoption by institutional investors will take more time,” Jim Kyung-Soo Liew, an associate professor at Johns Hopkins University’s Carey Business School, told TBEN .

“Ethereum has no better statement about TPS [transactions per second]John Peurifoy, co-founder and CEO of Floating Point Group – a trading platform provider – told TBEN. Merging does not increase block size or block speed. “We’re not there yet.” That will have to wait for the Surge, another Ethereum upgrade slated for 2023. That will implement a sharding solution that could dramatically increase network speed.

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Yet solving the energy consumption problem and reducing CO2 emissions are no small feat. Ethereum’s carbon footprint, once as large as Finland’s, now compares to that of the Faroe Islands, Digiconomist said. Or, to put it another way, a single Ethereum transaction is now “equivalent to the carbon footprint of 44 Visa transactions or 3 hours of YouTube watching”.

“Strengthening Ethereum’s environmental, social and corporate governance (ESG) credentials should be good for regulatory institutions looking to start exploring the Ethereum ecosystem,” Marc Arjoon, Ethereum Research Analyst at CoinShares, told TBEN, while Jack Neureuter and Writing in Fidelity Digital’s Report on the Merge, Daniel Gray added that the move to PoS “could positively empower those who feel strongly about the environmental impact of using blockchains.”

Indeed, two Bank of America analysts recently suggested in a note to clients that some institutional investors previously “banned” from investing in PoW-generated tokens could now participate:

“The significant reduction in energy consumption after the merger may allow some institutional investors to purchase tokens that were previously prohibited from purchasing tokens running on blockchains, using Proof of Work (PoW) consensus mechanisms.

An increased return for Ether holders?

The Merger also introduces other potential benefits to traditional financial institutions. “Ethereum’s shift to proof-of-stake makes ether an asset that can earn interest for holders in the form of staking,” noted Fidelity Digital. This could increase the total return for Ether (ETH) holders and “make the asset more attractive to potential investors.”

“One reason to be excited” if you’re an institutional investor, Peurifoy said, is that you can stake your ETH as a PoS Ethereum validator and receive about 5% annual return (APY). “That’s a pretty good rate, and there’s relatively low risk involved.”

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However, strikes may incur costs. In a Sept. 15 article headlined “Ether’s New ‘Staking’ Model Could Get SEC Attention,” the Wall Street Journal reported that US SEC chief Gary Gensler recently suggested that Ethereum, with its generous new staking options , could trigger the Howey test — and US courts could declare Ether a security.

“Now that Ethereum is more like traditional financial instruments, regulators may begin to see it as such,” Arjoon told TBEN. In other words, Ethereum’s new staking opportunities could bring in more traditional investors, but also SEC oversight in the United States.

Is ETH becoming deflationary?

The total supply of Ether could decline as a result of the Merger, which could also be viewed favorably by institutional investors. Pre-Merge Ethereum paid out and created about 13,000 ETH per day to reward its PoW miners. After the merger, the network will pay out approximately 1,600 ETH per day in strike rewards, a 90% drop in new issuance, according to the Ethereum Foundation. Meanwhile, some of the Ethereum gas fees are still being burned or removed, as it has been since August 2021. According to the Foundation:

“At an average gas price of at least 16 gwei, at least 1,600 ETH is burned each day, effectively bringing net ETH inflation to zero or less after the merger.”

“A lot of people believe that ETH is going to be deflationary,” Peurifoy said, now comparing that to the US dollar, which is currently declining “at a pretty huge pace.”

“The supply will not only be capped, but actually reduced, i.e. deflationary due to reduced ETH release and more burns,” noted consultant Markus Hammer, writing on LinkedIn, “ETH could therefore eventually appreciate in value.”

Is a flipping more likely?

Bitcoin, the first and largest blockchain network, of course still uses a PoW consensus mechanism. Can Institutional Investors Now Prefer ETH Over Bitcoin (BTC) After the Merger?

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“PoS and less power consumption make Ethereum’s ETH a much more attractive investment than Bitcoin (BTC) from the ESG perspective, but it’s too early to say whether the ‘flipping’ will happen,” said Liew, adding:

“I suspect the diehard Bitcoin fanatics will not sell their positions to move to ETH just because of the merger.”

The new Ethereum software has also still not been thoroughly tested at scale and the wagering rewards are subject to certain conditions. When institutional investors stake their ETH, it is locked into a contract. “You cannot withdraw your deployed ether or your rewards […] for at least 6-12 months until after the merger,” said Arjoon. “This inability to back out is still a risk that many institutions are unwilling to accept, and the logistics of circumventing and managing these risks is also a hurdle to greater adoption.”

“Institutional investors are likely to take a wait-and-see attitude,” said Liew, adding that if “the overall stock market crashes, driven by inflation fears, those waiting for institutional investors to bail out the crypto industry will wait much longer. ” time.”

“The merger was successful, but does not necessarily mean institutional crypto adoption is on a fast track,” Edward Moya, senior market analyst at Oanda, told TBEN. “The key to widespread adoption will come from future upgrades.”

Peurifoy, on the other hand, viewed last week’s events as a defining moment, especially “if we go another week and don’t see massive forks of Ethereum or technical bugs coming out,” he told TBEN, adding:

“How often do you see a decentralized rollout of something that affects millions of users, done completely live. […] It’s a turning point because of the human collaboration involved, and because we’ve accomplished something like this on a large scale with so few bugs.”