The Ethereum Merge Is Finally Here: What You Need To Know

eBitcoinics   14 Sep, 2022   Views: 1778

The Ethereum Merge is finally here, tentatively scheduled for September 15th or 16th.

The Ethereum (ETH-USD) Merge has been tentatively scheduled for September 15th-16th. The Merge is Ethereum's consensus mechanism transition from proof-of-work to proof-of-stake. We believe proof-of-work blockchains like Bitcoin (BTC-USD) and proof-of-stake blockchains like the future Ethereum can coexist, so we will not focus on the merits of each consensus mechanism in this article. Just understand that "miners" are associated with proof-of-work, and "validators" are associated with proof-of-stake. Instead, we will focus on providing information on what the merge is, what the merge is not, and practical investment implications. You can find more details on the upcoming merge from those directly involved here.

First, let's quickly cover the recent ETHPoW Hard Fork controversy.

Is The ETHPoW Hard Fork A Concern?

Some in the Ethereum community, mainly miners who will no longer be securing the current Ethereum proof-of-work blockchain and therefore no longer receiving rewards for their expensive computational power they are providing, are planning to create ETHPoW, a hard fork of Ethereum that will continue as a proof-of-work blockchain. Hard forks rarely survive, but one such instance is Ethereum Classic, which is already an Ethereum proof-of-work blockchain with a niche but established community. ETHPoW may draw away a small fraction of Ethereum's current market cap, but we don't believe it to be any real threat to Ethereum over the long term, but we are monitoring it just in case.

What The Merge Is

The merge will make the Ethereum network dramatically more energy efficient by approximately 99.95% from its current proof-of-work state, according to The Ethereum Foundation. This is because proof-of-work blockchains like Bitcoin require computers to solve incredibly complex math puzzles, where in Ethereum's proof-of-stake the math problems can be far simpler because validators are required to stake 32 ETH and risk getting that amount "slashed" for bad behavior. Given the heightened regulatory scrutiny that crypto already faces broadly and crypto energy consumption increasingly becoming a political talking point, it is a significant move by Ethereum to reduce at least one aspect of regulatory risk moving forward by resolving the energy consumption concerns.

The tokenomics of Ethereum are already some of the strongest in the crypto space, particularly after the implementation of EIP-1559, which resulted in a portion of ETH being "burned" in every transaction. After the merge, validators will replace miners to propose blocks and secure the network. In order to run a validator, 32 ETH are required as a "stake". This locks up 32 ETH for every validator. Once the merge occurs, rewards that were previously given to miners will now go to validators, incentivizing more folks to run validators and thus, more Ethereum locked in validators and less in circulation. Less supply means higher price, benefiting all Ethereum token holders. Furthermore, miners have high OpEx (facility rent/upkeep, utilities, etc.) and CapEx (physical mining rigs), meaning most of the ETH rewarded to miners end up on exchanges as daily sell pressure to cover their mining expenses. On the other hand, stakers have negligible expenses to validate the Ethereum network, are philosophically aligned as "long-term holders", and therefore can be expected to hold the ETH they are rewarded from securing the network. In short, structural sell pressure is eliminated from the market, replaced by structural buy pressure.

What The Merge Is Not

Sadly, the Ethereum merge will not reduce gas fees. The Merge is one step on a long road map laid out by Vitalik Buterin and the Ethereum foundation to scale Ethereum. Currently, and part of the long-term vision of Ethereum, are layer 2 solutions that significantly reduce Ethereum fees like Polygon (MATIC-USD), Arbitrum, Optimism, zkSync, etc. The other change that will reduce fees over time is sharding the Ethereum blockchain.

The Ethereum merge will also not improve transaction speeds, this will come with the later Ethereum scaling solutions as well.

Key Investor Takeaways

The Merge has taken forever but it appears to finally be here. There has been a rally in Ethereum price that has a lot to do with the Merge, but the rally also coincides with an overall growth rally that may be losing steam. Combine this with what very much feels like a "buy the rumor, sell the news" type of event as there appears to be more downside risk from the merge than upside. For example, If the merge occurs without issue we believe that is exactly what is being priced into the market and upside beyond that in the short term may be limited. On the flip side, if the merge has any issues, becomes further delayed, or investors were expecting gas fees to dramatically reduce or transactions speeds to increase post-merge only to be disappointed, that may negatively impact the price. While we are regularly dollar-cost averaging into Ethereum, we're expecting a price pullback around the merge event and plan to be more aggressive with our Ethereum purchases if this thesis becomes reality.

In the 2017/2018 crypto cycle, Ethereum reached an all-time high of around $1,400. We believe this is a significant price point. If Ethereum falls below $1,400 we plan to increase our dollar-cost average purchase quantities.

Quick Reminder Of Our Longstanding Ethereum Conviction

While blockchain technologies can be incredibly complex, investing in crypto is much easier once you've made all the mistakes in crypto and therefore are reminded time and time again to focus on quality and basic fundamentals; user growth, revenue growth, total value locked, developer activity, user experience, adoption, etc.

A very high-level reminder of why we believe always building an Ethereum position in your crypto portfolio has the highest probability of success in the crypto space long term.

Total Value Locked (TVL)

Ethereum dominates the field when it comes to total value locked in DeFi protocols, see the charts below. TVL is a good but not great metric because networks can artificially create TVL adoption (and artificially pull demand away from Ethereum). Take Tron for example, which in the chart on the far right shows a 9% market share of TVL, number two behind Ethereum. However, Tron is artificially creating this demand by stealing a page right from Terra Luna (LUNC-USD) (LUNA-USD) and offering an unsustainable high yield to draw stablecoin liquidity into their ecosystem. Couple this with the fact that Ethereum layer 2 solutions make up three of the top ten blockchain networks by TVL (Polygon, Arbitrum, and Optimism), it is fair to say that Ethereum has the most robust Defi ecosystem, always has, and it has never really been close.

Defi Llamas measure of Defi total value locked showing Ethereum dominates TVL market share

Defi Total Value Locked (Defi Llama)

User Adoption (Measured By User Address Growth)

Ethereum has continued to steadily grow their network, and because of how they've designed their tokenomics the greater the network demand the more ETH is burned over time, providing price support. This stresses the importance of network effects, which we'll provide greater detail in future "Ethereum Papers".

Etherscans measure of unique addresses showing Ethereum has steadily added Addresses and grown their network since inception

Ethereum Unique Addresses (Etherscan)

Selling Blockspace At A Premium

Lastly and most importantly, blockchains are in the business of selling blockspace, and Ethereum executes this better than any other chain in the ecosystem.

Token Terminal chart showing Ethereums dominance of protocol revenue

Protocol Revenue (Token Terminal)

This chart truly speaks for itself. All three charts all go to serve as a great reminder that, in our opinion, it is never a bad idea to buy some Ethereum.

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