Fidelity digital said that last week’s Merge was “the most significant development in the history” of the Ethereum network.
From a technical perspective, the transition of the blockchain network from a proof–of-work (PoW), to a consensus mechanism that is proof-of–stake (PoS), was amazing. The software upgrade was swift and painless, much like a mid-flight change to a jet engine.
Digiconomist reports that Ethereum, the second-largest blockchain platform in the world, saw its energy consumption drop by 99.95% overnight. It used to consume 94 TWh per annum in May, roughly equivalent to Chile’s nation-state. This was compared to 0.01 TWh on September 16, which is almost negligible.
This is important as regulators are threatening to crack down on blockchain networks that promote environmental destruction. This could bring in more institutional investors to the crypto space.
This brings us to the last point. Institutional investors such as pension funds, insurance companies and foundations are important because they tend not to react to 24-hour news cycles or trade on rumors. This group could be a large part of solving crypto’s volatility and persistent liquidity problems.
Others believe that the Merge is a better platform for large financial institutions and corporations, but it does not solve one of Ethereum’s main problems: its inability to scale. It’s not yet.
Jim Kyung-Soo Liew (associate professor at Johns Hopkins University’s Carey Business School) stated that “The Merge” is a significant moment in the crypto industry. However, institutional investors will need to take longer to adopt the technology.
John Peurifoy (co-founder and CEO of Floating Point Group, a trading platform provider) stated to Cointelegraph that Ethereum doesn’t have a better statement about TPS [transactions/second].” The Merge does not increase block size nor block speed. “We are not there yet.” This will need to wait for the Surge upgrade, which is scheduled for 2023. This will enable a sharding solution to dramatically increase network speed.
Yet, reducing carbon emissions and solving the energy problem are not small accomplishments. According to Digiconomist, Ethereum’s carbon footprint is now comparable to that of Finland’s. A single Ethereum transaction can now be compared to 44 Visa transactions, or 3 hours of Youtube watching.
“The strengthening of Ethereum’s environmental and social governance (ESG credentials) should be beneficial for regulatory-driven institutional that want to begin exploring the Ethereum ecosystem,” Marc Arjoon told Cointelegraph. Jack Neureuter, and Daniel Gray wrote in Fidelity’s Report on the Merge that the transition from PoS could have a “positive reinforcing effect” for those who are concerned about the negative environmental impacts of blockchains.
Two Bank of America analysts suggested recently to clients that institutional investors, who had been “prohibited” previously from investing in PoW tokens could now take part.
“The substantial reduction in energy consumption after Merge could allow some institutional investors to buy tokens that are run on blockchains that leverage proof of work (PoW), consensus mechanisms.
Ether holders get a higher return
Traditional financial institutions may also be able to reap the benefits of The Merge. Fidelity Digital stated that Ethereum’s shift towards proof-of-stake makes it an asset that can earn interest for its holders through staking. This could increase Ether (ETH) holders’ total return and make the asset more appealing to potential investors.
Peurifoy stated that institutional investors should be “excited” because they can stake their ETH as PoS Ethereum validators and get a 5% annual percentage return (APY). It is a good rate and comes with low risk.
However, staking can come with a price. The Wall Street Journal published a September 15 article titled “Ether’s New Staking Model Could Draw SEC attention” in which Gary Gensler, the chief of the United States SEC, suggested that Ethereum could trigger the Howey Test — and that U.S. courts might declare Ether security.
Cointelegraph’s Arjoon said that Ethereum is now more similar to traditional financial instruments. “Regulators may begin to view it this way,” Arjoon explained. This means that Ethereum’s new staking options might attract more traditional investors, but also SEC oversight in America.
Is ETH deflationary?
Institutional investors may also be positive about the Merge’s potential drop in Ether supply. Pre-Merge Ethereum paid out about 13,000 Ethereum per day to its PoW miners. According to the Ethereum Foundation, the Merge will see the network pay out approximately 1,600 ETH per day in staking rewards. This is a drop of 90% in new issuance. A portion of Ethereum gas fees is still being burned or deleted as they have been since August 2021. According to the Foundation
“At an average gas cost of at least 16 Gwei, at most 1,600 Ethereum are burned each day. This effectively reduces net ETH inflation to zero post-merge.”
Peurifoy stated that “many people believe that ETH has become deflationary” and compared it to the United States Dollar, which is currently falling at “a pretty substantial rate”.
“Supply will be not only capped, but even decreased,” stated consultant Markus Hammer on LinkedIn. deflationary through decreased ETH issuances and increased burns,” wrote Markus Hammer, a consultant on LinkedIn. “ETH might therefore eventually rise in value.”
Are flipping more likely?
Bitcoin, the largest and most popular blockchain network, still uses a PoW consensus system. Are post-Merge institutional buyers likely to favor ETH over Bitcoin(BTC)?
“PoS and lower energy use make Ethereum’s ETH a more attractive investment than Bitcoin(BTC) from an ESG perspective,” said Liew.
“I believe that diehard Bitcoin fans will not sell their positions to get into ETH because of the Merge.”
It is still not possible to test the new Ethereum software at large scale. There are also some restrictions on the staking rewards. Institutional investors stake their ETH and it is locked in a contract. Arjoon stated that you will not be allowed to withdraw your staked Ethereum or your rewards […] until the merge. This inability to withdraw poses a risk to many institutions. The logistics required to manage and navigate these risks are also obstacles to greater adoption.
“The institutional investors will likely take a wait-and-see approach,” Liew stated, adding that if the overall stock market crashes due to fears of inflation, then those who are waiting for institutional investors in order to save the crypto sector will have to wait a longer time.”
Edward Moya (Oanda senior market analyst), said that while the Merge was a success, it won’t necessarily indicate institutional crypto adoption is on an immediate track. Future upgrades will be the key to widespread adoption.
Peurifoy on the other side, saw last week’s events in a defining moment. “If we go another week, and don’t have any major forks or technical bugs come out of Ethereum,” he said to Cointelegraph.
“How often do we see a distributed rollout that impacts millions of users and is completely live? […] This is a watershed due to the human collaboration involved and because we were able to achieve something like this at such a large scale with very few bugs.