Countdown to the Ethereum Merge: Mechanics and Implications
Note: My views. Not investment advice.
In this article, I discuss the Ethereum Merge, what it is, how it is expected to play out, and why it could be one of the more significant events to occur in the cryptocurrency ecosystem.
Ethereum was first conceived of in 2013 by Vitalik Buterin, Gavin Wood, Joseph Lubin, and Charles Hoskinson. The network went live in 2015.
In comparison to the Bitcoin network which was primarily designed to be used as a store of value and digital currency, the Ethereum network was to be used as the base layer for which all decentralized applications would be built upon in addition to having its own currency (Eth), which many investors and traders have bought and sold.
Bitcoin has a fixed supply of 21 million. Currently, both cryptocurrencies are mined through a proof-of-work (POW) model, but Ethereum is transitioning to proof-of-stake (POS), which has been dubbed, the “Merge”.
Ethereum is advantageous compared to Bitcoin since it can process a greater number of transactions per second (tps) — (14–45 versus 5 tps).
However, as it currently stands, this is slow in comparison to the Visa and Mastercard networks which can handle 1000’s of transactions per second.
After Ethereum became the de facto network where an influx of developers, coders, and programmers were creating, the network became congested, and gas fees (fees which are paid to miners to process the transactions) became prohibitively high. Reports of gas fees in the thousands of dollars during popular NFT mints including Yuga Labs selling Otherside NFT’s.
In order for Ethereum to be the base application layer for the decentralized internet, it has to solve the problem of scalability in addition to being truly decentralized and secure (trilemma of crypto), while being both cost and energy efficient.
In order to remedy this problem, Ethereum is undergoing an upgrade from Ethereum 1.0 to 2.0, called the “Merge”, which is a transition from proof-of-work to proof-of-stake consensus mechanism.
This will change how the current paradigm of how Ethereum is generated. It will move away from requiring large mining computational power to a mechanism where network participants “stake” their Eth in return for a percentage yield. The staked Eth then becomes “locked” for a period of time, thus making the network more scalable, while still securing the network.
The Merge has been years in the making with multiple testing and development phases since 2017. Recently, developers have completed multiple testing phases, with the Merge scheduled for September 2022.
Financial Implications of the Merge (Bullish Case for Eth):
The Merge will significantly shift the supply-demand dynamics of Ethereum, creating unique properties that will make Ethereum attractive as a digital asset, and thus creating an extremely bullish case for Ethereum in the long term.
Supply side shock —it is estimated that approximately 9% of the circulating supply of Eth is staked, with yields between 3–6%. After the Merge, staking yields are expected to be 6–12%. As a result of this attractive yield, more and more investors will be staking their Eth in return for yield, which is predicted to be 30% of all of the circulating supply of Eth expected to be staked, and thus out of the circulating supply. Lower supply, means higher prices.
Significantly increased demand — with the Merge, the properties of Ethereum lend itself to very unique characteristics, which have the potential to be extremely attractive from an investment standpoint.
For the first time in history, Ethereum will be a digital asset that behaves like:
- Tech-growth stock
2. A value asset with dividends and buybacks-similar to the equities market
3. Bond — Ethereum has been labeled as the “internet finance bond”
A single digital asset will possess all of these unique characteristics. This, in turn will significantly drive up demand because institutions, corporations, and investors will seek out Eth in order to gain upside price exposure in order to diversify their portfolios, and seek additional returns outside of traditional investments.
Investors will always seek out greater returns, which can be seen in with real estate, hedge funds, private equity, and venture capital. Ethereum will be no stranger to this phenomenon.
Remember — everything of value, investments included, are based on consensus (gold, equities, currencies, art, precious metals, commodities, real estate, and companies). In this case, the consensus will not be from government decree (fiat), but from network effects.
In summary, the Merge will improve the Ethereum network from a cost, efficiency, scalability, and security standpoint, all done with the aid of smart contracts in an ESG-friendly manner, while reducing supply and increasing demand.
This is extremely powerful, and why I am bullish on Ethereum as a long-term investment in the digital asset space.
About: Dr. Christopher Loo is a physician who became financially free at the age of 29, and retired early at the age of 38, as a result of making strategic investments after the 2008 financial crisis. A graduate of the MD-PhD program offered jointly through the Baylor College of Medicine and Department of Bioengineering at Rice University, he is the author of “How I Quit My Lucrative Career and Achieved Financial Freedom Using Real Estate”, and is the host of the Financial Freedom for Physicians Podcast. He is a regular contributor to KevinMD and has spoken about the importance of financial literacy for Passive Income MD, the White Coat Investor, Board Vitals, SEAK Non-Clinical Careers, SoMe Docs, Doximity, Medpage Today, FinCon, and other high-profile financial brands geared towards high-income professionals. He is passionate about the role that crypto, fintech, and innovation will play in enabling financial freedom, economic inclusion, access and opportunity for the entire world in the upcoming decades.