This article was originally posted in German for MoneyToday on August 29, 2022
After years of anticipation, the Ethereum Merge is finally upon us. It’s one of the biggest events in crypto history and in fintech and everyone is eagerly waiting to see if the Ethereum team can pull it off.
What is the biggest financial challenger company in the industry? Most people would opt for large fintech companies such as Revolut, Stripe or Klarna. Any of these are good guesses, but the real answer requires you to think outside the box. The biggest challenger is neither a public nor a private company. It’s a network that can’t be defined by the rules of traditional finance. It's also one that dwarfs its fintech competitors.
The Ethereum network, founded by Vitalik Buterin, is about 10 times bigger than the most valuable fintech companies. Its native digital token Ether (ETH) reached USD 560 billion market capitalization last year, about 17 times the size of Revolut, one of the most valuable challenger banks and 10 times the size of UBS today.
But, in just a few weeks, this financial giant is set to undergo a remarkable transformation. Ethereum is about to reincarnate as a proof-of-stake blockchain in a process called The Merge. In technical terms, it means that Ethereum protocol (code) switches from Proof-of-Work (PoW) to Proof-of-Stake (PoS). This has big implications for the blockchain itself and is something that has never been done before. It’s called the Merge because two independent blockchains will ‘merge’ together for the first time, transforming how its native token Ether is issued and how the network is maintained. It will also have a big impact on the amount of ETH supply.
So why, after becoming the biggest financial ecosystem in crypto and building an economy worth billions on a PoW blockchain is the Ethereum Foundation ripping up the rulebook? And, more importantly, what does it mean for investors? Let’s find out.
The man behind the Merge
I've known Vitalik Buterin, the founder and the public face of Ethereum since he landed here in the Swiss Crypto Valley, Kanton Zug, in 2014. Many of us are now used to seeing Vitalik jumping around on stage or wearing his famous cat jumpers. But, back then, Vitalik was shy, almost fragile.
“Smart contracts are pretty dumb today”, he told me. But we knew that one day they would become very powerful. And so they did. What started as an idea grew into an enormous financial ecosystem and his rise to super stardom happened at lightspeed. Just four years later we toasted his honorary doctorate in Basel. In 6 years, Vitalik became a living legend.
But even back then, one thing was already clear. Vitalik and the other co-founders of Ethereum had conceived something truly revolutionary and completely different from Bitcoin, the only other asset back then. The Bitcoin blockchain rightly has the reputation of being a tried and tested transaction processing protocol. But Ethereum took things to another level. These two blockchain networks didn’t just reimagine a different way of understanding money. They made it fully programmable. Over the last years, Ethereum has consistently proven to be home to some of the most remarkable innovations in the digital asset industry, a trend which continues to this day.
Since then, we’ve seen the arrival of many so-called Ethereum challengers. Some have survived and many more have since faded away. But one thing’s for certain: none of them has ever come close to replacing it.
Why the Merge is a Big Deal
For most of the history of the crypto industry, blockchains have been Proof-of-Work. The native blockchain of the second biggest cryptocurrency by market cap subsequently changing to PoS is a huge shift for the industry. Here’s why:
No blockchain has ever switched from Proof-of-Work to Proof-of-Stake with such a large economy ($203 billion assets locked) built on top of it.
Ethereum is the biggest financial ecosystem in the industry and everything, from security, to the maintenance of the network will change as a result of the Merge.
So why are the Foundation making this enormous change?
If you’ve just started hearing about the Merge, this isn’t actually a surprise to much of the industry. It was part of the original roadmap for Ethereum before the network even went live. The main aims of the Merge are to make Ethereum energy efficient, Secure and Scalable.
But beyond the goals that the Ethereum Foundation have for the network itself, the Merge will set in motion a series of consequences that will have an impact on investors of all kinds.
Proof-of-Stake beats crypto’s energy problem
Ethereum’s shift to Proof-of-Stake will change the conversation about cryptocurrency and energy forever. Under the existing PoW system, so-called miners (people or companies) maintain the network with powerful, expensive computers that “creates conditions for an arms race with miners acquiring increasingly power-hungry mining equipment.” (source: https://ethereum.org/en/energy-consumption/ )
Miners need this thirsty equipment so they can earn their Ether reward from solving complex mathematical puzzles and recording transaction data. But as more computers compete to solve the puzzle, the more complex the puzzle becomes. All this requires a whole lot of energy. This system means that Ethereum currently consumes as much power per year as Finland and has a carbon footprint equal to Switzerland.
Proof-of-Stake will do away with mining altogether. Instead of solving the math puzzle, the people who maintain the network will need to own and stake Ether. This will be enough to run the node and become a validator of transactions on the network. Staking Ethereum tokens instead of mining it will reduce ETH’s energy consumption by around 99.95%. That means that Prof-of-Stake is about 2000 times more energy efficient than Proof-of-Work. According to the Ethereum Foundation, the energy cost of being a validator on the network would be equal to running a laptop.
(Source: Ethereum Foundation)
This is obviously amazing news for the environment, but it’s also an important signal to the broad spectrum of institutional investors that desperately wanted to get in on such an innovative asset but couldn’t touch it for ESG (Environment, Social, Governance) reasons. After the merge, Ethereum will take its place among the greener digital asset investment options which will lead to institutional investors taking out larger positions.
Thematic investment is also a growing trend because many people like to invest according to their passions and beliefs. Cryptocurrency was a tricky inclusion in these portfolios because many younger, eco-conscious investors struggled to weigh up their belief in the potential of crypto against its alleged impact on the environment. After the merge, we will likely see ETH included in a wider range of thematic investment options.
Supply will change forever
Fewer Ether tokens will be available on the market. Previously, miners received Ether for maintaining the network and recording transactions. There was strong sell pressure in order to pay for electricity, property and equipment costs. As a result, miners usually sold around 90% of their ETH rewards.
After the Merge, there will be much more ETH locked up in the blockchain and less on the market available for trading. This is because validators are incentivised to hold them, in order to earn an ETH reward from staking. But that’s not the only impact on supply.
ETH issuance – that means new ETH created that didn’t exist before – will reduce ten times, from a rate of 4.3% to 0.43%. Post Merge less ETH will be created with every block. Additionally, Ethereum recently introduced a burn mechanism. Ether tokens rewards sent to miners are now being burned, which means permanently destroyed and taken out of circulation. Combine all of this and you receive a deflationary cryptocurrency, where available supply reduces by as much as 2% per year, according to some estimates1.
The combination of all these factors could point to a bullish outlook for ETH, with fewer tokens available on the market and more investors looking to stake their assets. On the other side, the Ethereum blockchain shows no sign of slowing down the pace of innovation. More updates are scheduled in the future which would bring transaction costs down and speed up. This means the Merge and following upgrades will lead to even bigger utilization of Ethereum and even greater demand on the investor side with an ultimately positive implication on the long term Ethereum price.
Ether becoming the ultimate benchmark for yield
The Merge is going to open up a whole load of new opportunities for earning yield. For starters, the shift to Proof-of-Stake means that maintaining the network becomes pure yield because validators no longer have the overheads of needing a physical site to store their mining machinery, as well as the associated operational costs.
Anyone who owns 32 ETH, the minimum stake, can use them to help secure the network and earn yield on their assets for this work. The rewards are weighted towards being higher when there is less Ether staked to encourage participation.
Many people are wary of yield opportunities in crypto after the collapse of large DeFi lenders like Celsius. There’s a good reason for that. These companies and networks offered unsustainable yields and weren’t open about where they were getting the money and what they were doing with it. The Merge will offer people a transparent and compliant way to earn from their crypto assets.
Until now, staking had always played second fiddle to lending and mining when investors wanted to earn yield on their assets. But now that such a huge financial network is switching to Proof-of-Stake, we could see how this will develop into alternative yield mechanisms. Staking rewards could also represent a solid anti-inflationary option for protecting assets in a challenging macroeconomic environment.
Even though the Merge is no surprise to anyone that’s been in the industry for a long time, it still feels like a big moment to me. While it won’t solve every critic’s issue with Ethereum or digital assets in general, it does signify a real effort to make the sector more sustainable, accessible and secure. Maintaining the network is no longer a monopoly for those that can afford expensive machinery and the cost of running them.
Solving Ethereum’s energy problem opens the door to much wider adoption, both among institutional investors and climate-conscious millennials. Supply will also decline after The Merge but this won’t stop ETH being an asset associated with continual evolution, innovation and a commitment to a concrete set of values, all of which make it even more attractive to investors of all kinds. But most of all, this is a testament to the long-term vision of the Ethereum Foundation that had the boldness to conceive a project so gargantuan in scale and actually deliver results after nearly a decade of work.
From a handful of dreamers that found themselves in Switzerland to one of the most formidable financial ecosystems in the world, the team deserve nothing but congratulations. I can’t wait to see what they do next.
SMART VALOR is trailblazing the way for the Ethereum Merge by launching staking on its platform on the 22nd of August. Now anybody can earn a passive income by buying and staking Ether in a secure and easy way on the only European digital asset exchange from Switzerland, listed on Nasdaq. Join the innovation today
Legal Disclaimer:
Disclaimer: The data provided in this blog is for information purposes only and should not be construed as investment or tax advice nor as a recommendation to buy, sell, or hold any particular security. SMART VALOR believes the data in this blog is accurate, but does not verify its accuracy independently and does not warrant or guarantee that it is accurate or complete. SMART VALOR has no obligation to provide any updates or changes to the data. No investment decisions should be made using this data.
Risk Disclosure: Cryptocurrencies can fluctuate widely in prices and incur the permanent loss of capital and are therefore not appropriate for all investors. Trading cryptocurrencies is not supervised by any EU regulatory framework. Past performance does not guarantee future results. The trading history presented is less than 5 years and may not suffice as a basis for investment decisions. More information is available under Risk Disclosure.