Investors in trade finance will love Ethereum's Merge

Unless you've been living under a crypto rock, you know that Ethereum is about to switch from a proof-of-work consensus mechanism to a proof-of-stake consensus mechanism this month.

The Merge is the most important change to a blockchain protocol that has ever happened in the history of cryptocurrencies. Investors want to know if the price of ether, Ethereum's native token, reflects this huge change.

I think it's not, mostly because "Ethereum 2.0" will have value for institutional investors in the long run. (Note: Just because I think the price of ether will go up doesn't mean that Ethereum 2.0 will follow the purest principles of decentralization. They are not the same thing.)

Before we talk about that, let's look at what caused ether's price to drop over the past two weeks, which took away a short-lived premium caused by Merge. That should help us figure out what the bears are saying.

Toàn cảnh sự kiện The Merge của Ethereum

Factor #1: Doubt

Like the people in Aesop's story "The Boy Who Cried Wolf," investors in Ethereum have a lot of reasons to doubt that this project will work.

Even if the Merge does happen, there is a high chance that there will be problems and failures during this very complicated and inherently tense change. DappRadar has warned that if this happens, it could hurt protocols for decentralized finance (DeFi) and other systems built on top of Ethereum.

But while we should respect the wisdom of the crowd, there is one group whose opinions matter the most: the large Ethereum developer community, which has been testing this project for years. And Bankless founder David Hoffman pointed out in a response to a post on that media outlet's service from Jordi Alexander this week that "the people who are experts on the details of the Merge are more optimistic about its success than the [broad community of] people responding to [Twitter polls on the matter]."

You could even say that all the failed attempts make the chances of success now even better. Developers are very careful and afraid of taking risks, which is why the proof-of-stake switch has been delayed so many times before. Since they're moving forward now, it means that a very high level of quality control has been done.

Factor #2: Regulatory risks

The decision by the U.S. Treasury Department on August 8 to shut down the Tornado Cash mixing service has caused a lot of worry in the Ethereum community. Companies and nonprofits that ran Ethereum-based services moved quickly to block wallets that had access to tokens that had gone through Tornado Cash.

The response has made people worry that corporate providers of staking pool services will also be pressured by regulators to leave tainted on-chain transactions out of blocks. This would mean the end of censorship-resistance, which is a very important principle.

These are important and real worries. (That's why I said earlier that prices and principles are different.) But putting limits on tokens that have been used to break sanctions could be a reason for compliance-focused institutional investors to buy ether. And for the many people who have a right to privacy in their financial dealings, the Treasury Department's move will just make it easier for all kinds of other solutions to pop up.

Factor #3: Macro conditions

The main reason why ether has gone down over the past two weeks is not related to Ethereum. It's because Federal Reserve Chair Jerome Powell said that people should expect interest rates to go up for longer than they thought. That made investors sell off all "risk assets," which is what they now think of cryptocurrency as.

But if you want a story about how ether doesn't get pulled down by macro factors like other assets do, The Merge has one.

Traditional financial (TradFi) institutions are where this story begins. These are the people whose "risk-off" instincts led them to sell digital assets in response to tighter monetary policy, which made the current crypto winter worse. The same guys will help us get ready for spring.

We know that many hedge funds, family offices, venture funds, and even pension funds and endowments are looking at the long-term benefits of including crypto in their portfolios. This is true even though the markets aren't moving much. I'll explain why they might want to get a lot of post-Merge ether in the future.

Analyst Warns Ethereum Merge Mania Is Blinding Crypto Traders, Says Hammer Set to Drop on Unsuspecting Investors - The Daily Hodl

The institutional case

ESG compliance: Look, as I’ve frequently stated, I think the anti-Bitcoin spin among many environmentalists wildly misses the opportunities for promoters of renewable energy to partner with miners to fund and build demand-response solutions that help make grids greener. But the reality is that until those solutions become ubiquitous, Bitcoin’s proof-of-work system will continue to produce a massive carbon footprint, making it a pariah among entities looking to meet environmental, social and governance (ESG) standards. Major institutions will be constrained from investing in bitcoin by their internal investment committees and, soon, by regulations coming from the Securities and Exchange Commission. Ethereum’s shift to a massively less energy-intensive proof-of-stake mechanism will make ether, by comparison, much more attractive.
Staking as “fixed” income. Proof-of-stake systems allow holders of the token to passively and predictably earn additional tokens by participating in blockchain validation. Although the dollar value of ether will continue to swing, that income model looks a lot like the fixed-income patterns of bonds, an asset class on which institutions are steeped. With sophisticated DeFi hedging and stablecoin solutions coming, institutions will likely avail themselves of some unique new financial instruments that bring reliable returns to their portfolios. The staking boom is coming.
Scarcity function. According to the current Ethereum 2.0 specifications, the Merge comes with a significant, multi-year phased reduction in the rate of new ether issuance. This will make ether comparatively scarcer than it was and, by extension, underpin its market value. Institutions are going to like the long-term outlook in that.
Positive narrative. There’s a can-do aspect to all this that can’t be overstated. It is truly impressive that a hurly-burly, disparate community of open-source developers could pull this off while a blockchain supporting around $200 billion in total value continued to operate. It’s a grossly underappreciated example of humanity’s capacity for innovation and collaboration. That’s a positive story (assuming the Merge goes ahead as planned) that will boost confidence in Ethereum and, by extension, attract new and old investors.

Could the bears show me that I'm wrong? Of course. And, as I said, the bull case I made comes with problems for decentralization and proves that the ESG reasons for supporting proof-of-stake over proof-of-work are wrong. But I don't think the Merge is factored into the price.