The ETH Merge : Five things you (probably) don’t know
We are at the gates of the Ethereum Merge, just hours from it, and the clock is ticking.
At this crucial moment, BlockZero brings to our clients an essential piece of analysis of what could be expected for ETH in the first hours after the Merge.
Hopefully, all will turn out impeccable and the crypto world emerges as a better, more attractive place for its users. In this case, and with some caveats (see below), a more energy efficient ETH blockchain that (hopefully) will meet future regulatory requirements, with increased network security, and positioned for future improvements and upgrades.
We recommend listening to this video that summarizes well The Merge of Ethereum, and why it’s happening:
However, (crypto) life is not all peaches and cream. There are risks looming ahead of the Merge that could sour all the joy. It is our responsibility to put in front of you the sour and the sweet, for forewarned is forearmed.
In particular, we want to bring forth and explain the factors that could move the ETH price up or down in the short term.
This, we think, is one of the most sought-after info pieces on the verge of such a breakthrough and stirring moment as the forthcoming.
The (bullish-)expectations
The market is reading The Merge as a positive step and that has been reflected in the price lifting of ETH around a favorable announcement. ETH prices jumped almost 40 percent back in July after the mere announcement of the potential date for The Merge. Another 25 percent increase took place when Vitalik Buterin, Ethereum co-founder, announced on Twitter that The Merge will move forward 4 days to September 15.
And there is a huge demand for future purchases of ETHs (i.e., call options), which is overwhelmingly larger than the future selling alternative (put options), which defines a bullish expectation.
Therefore, this factor alone will push prices up, as long as everything goes well, or as economists love to put it, ceteris paribus.
On another note, there has been a lot of speculation in the last few days that Ethereum Classic (ETC) could regain significance and its price could be positively impacted by The Merge. Indeed, several miners are making the transition from ETH to ETC which consequently has significantly increased the hash rate of ETC, which has reached an all-time high.
The Triple Halving
This is another positive factor for prices. The triple halving of Ethereum is made up of (not surprisingly) three parts: exponential decrease in distribution, EIP-1559: Burn after sending, and lock-up duration. The three elements will have a direct impact on the supply (issuance) of ETH, reducing its growth rate to almost zero or even into negative (deflation) rates.
This is going to create a relative scarcity of ETHs which will shoot prices upwards. On top of that, if the merge happens well, and users are satisfied with the upgrade, the demand would have a push upwards too, reinforcing the relative scarcity loop, so prices of ETH would be positively impacted.
Volatility is probably going to be high
Whether positive or negative the outcome of The Merge (and the other factors here mentioned) you have to be prepared mentally for a first day (hours?) of chaos in terms of transactions. A whole gamut of stakeholders will be up and running, buying or selling that day, including whales and miners.
And with high volatility the probability of exchange outages increases, or, if things go catastrophic, DeFis could pause transactions, which is a hard lesson learned this year with the crash of Terra, and the collapse of Celsius, to name the most prominent ones.
The Tornado Cash sanctions and its fallout
Many are concerned that The Merge could bring censorship following the Tornado Cash sanctions. Remember that on the 8th of August 2022, the U.S. Department of Treasury’s Office of Foreign Asset Controls (OFAC) sanctioned Tornado Cash, a virtual currency mixer tool, along with Ethereum wallet addresses associated with the mixer tool (See last month newsletter for more information).
When the transition for Proof-of-Work to Proof-of-Stake is done, many validators will be centralized exchanges. For instance, as of September 13, four centralized crypto exchanges hold more than 60% of the staked ETH: Lido (30.2%), Coinbase (14.5%), Kraken (8.3%), and Binance (6.6%).
Now, the problem is that several of these crypto exchanges are based in the United States and will have to determine if they are going to censor any transactions related to a sanctioned address related to Tornado Cash, or potentially face OFAC and be fined or put in jail. Indeed between a rock and a hard place situation.
Many users consider that the main value of blockchain technology is its resistance to censorship. So, if Ethereum chooses to impose censorship, many users could abandon the project completely, or, the validators doing censorship may face consequences, such as getting slashed or banned. At the moment, key validators are still not decided on whether to censor or not.
How big this turmoil could become and how fast? It is hard to say, but we will keep an eye on this because of its potential influence on ETH prices.
Finally, (although unlikely) something could come out bad and The Merge might fail
In order to prevent and mitigate the risk of The Merge failing, Ethereum developers have conducted several tests, including Shadow Forks (testing mechanisms) on TestNets (alternative blockchains used for testing). So far, there has been no major problem, and Ethereum is ready for the official transition, and we consider it highly unlikely to witness a failure of The Merge.
However, there is no such thing as zero risk software upgrade and there could be potential issues with this transition. For instance, in the recent Bellatrix update, the update to the Ethereum Virtual Machine, almost 10% of the blocks were missing for a short time. Not dramatic, but a bug anyway, and such a snag during The Merge would have fast consequences for the close to 200 billion dollars market cap of ETHs.
We truly believe and hope that this info would enrich your ETH big picture and would solidify your strategy for the crucial upcoming days.
Want to learn more about how we could support you? Write to us at info@blockzero.ca.
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About BlockZero
BlockZero is a boutique consulting firm specializing in the evolution of the financial infrastructure through digital assets, digital currency, stablecoins and Central Bank Digital Currency (CBDC).
BlockZero advises global financial institutions, central banks and financial technology companies in the exploration, experimentation, technical implementation and rolling out of digital asset-based infrastructure.
BlockZero offers market intelligence services that can be tailored based on the clients needs and contexts to help inform decision-making. In addition, once a month our team summarizes through our Monthly Newsletter the market movements and what we have been following for our client and ourselves. We issue Thought Leaderships on specific topics that discuss topics and issues that are relevant to our clients in this rapidly evolving space.
Disclaimer
The content of this newsletter is provided as general information only and should not be taken as investment advice. All discussion content shall not be construed as a recommendation to buy or sell any crypto asset, security or financial product, or to participate in any particular trading or investment strategy. Furthermore, the reader should note that BlockZero does not claim this analysis to be exhaustive nor complete. The analysis contained herein relies on public sources of information and insights from the BlockZero team. The reader should also note that BlockZero did not conduct any interviews with the organizations mentioned in this discussion paper to validate the information presented.