Mail merge

Does the Ethereum merger offer a new destination for institutional investors?

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

And from a purely technical standpoint, the transition of the blockchain network from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) consensus mechanism was a marvel. Widely compared to changing a jet engine in mid-flight, the software upgrade went smoothly on September 15th.

Also overnight, Ethereum, the world’s second-largest blockchain platform, reduced its power consumption by 99.95%, from as high as 94 TWh per year in May – to just nearly equivalent to the nation-state Chile – at an almost negligible rate of 0.01 TWh on September 16 according at Digiconomist.

This should carry some weight, with regulators threatening to crack down on blockchain networks for environmental debauchery. It could also attract more institutional investors to the crypto space.

On that last point: institutional investors such as pension funds, insurance companies, foundations and the like are important because they tend to be longer-term investors and are not inclined to trade on rumors or to overreact to 24-hour news cycles. Broad participation from this group could help solve the crypto’s lingering liquidity and volatility issues.

Yet others believe that while the merger provides corporations and large financial institutions with a more environmentally friendly platform, as well as new staking opportunities, it still does not address one of the major deficits of Ethereum: its lack of scalability. Not yet anyway.

“The merger is a watershed moment for the crypto industry, but the impact to accelerate adoption by institutional investors will take longer,” said Jim Kyung-Soo Liew, associate professor at the Carey Business School of Johns Hopkins University, at Cointelegraph.

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

Yet solving the problem of energy consumption and reducing carbon emissions are no mean feats. Ethereum’s carbon footprint, once as large as Finland’s, is now compared in 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 viewing.”

“The strengthening of Ethereum’s environmental, social, and corporate governance (ESG) credentials should be good for regulatory-focused institutions that want to start exploring the Ethereum ecosystem,” said Marc Arjoon, Ethereum Research Analyst. at CoinShares, at Cointelegraph, while Jack Neureuter and Daniel Gray, writing in Fidelity Digital’s report on the merger, added that the transition to PoS could have “a positive reinforcement effect for those who are strongly concerned about the environmental impact resulting from the use of blockchains”.

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

“The significant reduction in energy consumption post-merger may allow some institutional investors to buy the tokens that were previously prohibited from buying tokens running on blockchains by leveraging proof-of-work consensus mechanisms (PoW).”

Increased yield for Ether holders?

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

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

Staking could, however, come at a cost. In a September 15 article titled “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 opportunities, could trigger the Howey test – and US courts could declare Ether a security.

“Now that Ethereum looks more like traditional financial instruments, regulators can start to view it as such,” Arjoon told Cointelegraph. In other words, new Ethereum staking opportunities could attract more traditional investors, but also SEC oversight in the United States.

Is ETH going deflationary?

The overall supply of Ether could fall as a result of the merger, which institutional investors may also welcome. Before the merger, Ethereum was paying, creating around 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 staking rewards, a 90% drop in new issuances, according at the Ethereum Foundation. Meanwhile, a portion of Ethereum gas fees continue to be burned or removed, as has been the case since August 2021. According to the Foundation:

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

“A lot of people think ETH is getting deflationary,” Peurifoy said, and now compares that to the US dollar, which is currently falling at “a pretty massive rate.”

“Supply will not only be capped but even reduced, i.e. deflationary through reduced ETH issuance and increased burns,” Noted consultant Markus Hammer, writing on LinkedIn: “ETH could therefore possibly increase in value.”

Is a reversal more likely?

Bitcoin, the first and largest blockchain network, still uses a PoW consensus mechanism, of course. Could post-merger institutional investors now favor ETH over Bitcoin (BTC)?

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

“I suspect diehard Bitcoin fanatics aren’t going to sell their positions to move into ETH just because of the meltdown.”

The new Ethereum software still hasn’t been tested on a large scale either, and staking rewards come with some strings attached. When institutional investors stake their ETH, it is locked into a contract. “You will not be able to withdraw your staked ether or rewards […] for at least 6-12 months until after the merger,” Arjoon said. “This inability to exit is always a risk that many institutions are unwilling to embrace and the logistics of navigating and managing these risks also pose a barrier to greater adoption.”

“Institutional investors are likely to take a wait-and-see approach,” Liew said, adding that if “the global stock market crash is driven by inflation fears, then those waiting for institutional investors to come save the industry from cryptography 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 Cointelegraph. “The key to widespread adoption will come from future upgrades.”

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

“How often do you see a decentralized deployment of something that affects millions of users that is done entirely live. […] It’s a milestone because of the human collaboration involved and because we managed something like this at scale with so few bugs.