Ethereum Merge giving new areas for institutional investors?
Technically speaking, the blockchain network’s switch on September 15 from a proof-of-work (PoW) (1) consensus process to a proof-of-stake (PoS) (2) consensus mechanism was a wonder that has been compared to replacing an aircraft engine in mid-flight.
The second-largest blockchain platform in the world, Ethereum (3), cut its energy consumption by 99.95% overnight from a rate as high as 94 TWh per year, or roughly equivalent to the nation-state Chile, to a very microscopic 0.01 TWh on September 16.
As regulators threaten to stifle the blockchain network for environmental profligacy, this will carry weight and may encourage more institutional investors to enter the cryptocurrency market. Institutional investors, such as pension funds, foundations, and insurance companies, matter because they tend to be longer-term investors and are less likely to trade on rumors or overreact to 24-hour news cycles.
While some think the Merge provides businesses and significant financial institutions with a more environmentally friendly platform and new staking options, it hasn’t yet addressed one of Ethereum’s main problems, which is its inability to scale. The Merge is regarded as a turning point for the cryptocurrency market, although it has delayed institutional investors’ embrace of cryptocurrencies.
As the Merge does not increase the block size or speed, users will have to wait for the Surge, another Ethereum upgrade that is scheduled for 2023, to implement a sharding solution to significantly increase the network speed. Currently, Ethereum does not have a better statement on TPS (transactions per second) (4).
The carbon footprint of Ethereum, which was once as large as Finland’s, is now comparable to the Faroe Islands, or, put another way, one Ethereum transaction now has a carbon footprint equal to 44 Visa transactions or three hours of watching YouTube. Solving the energy consumption issue and reducing carbon emissions are not small accomplishments.
For regulatory-driven institutions interested in learning more about the Ethereum ecosystem, it would be better to strengthen Ethereum’s ESG (5), or environmental, social, and corporate governance credentials. This is because the switch to PoS could have a positive reinforcing effect on those who are concerned strongly about the environmental impact and consequences of the use of blockchains.
Due to the significant decrease in energy consumption following the Merge, some institutional investors who were previously prohibited from investing in tokens generated by proof-of-work (PoW) may now be able to do so. Before the Merge, institutional investors were not allowed to buy tokens generated by the proof-of-work consensus mechanism on blockchains.
The switch to proof-of-stake transformed ether into an asset that can earn interest for owners in the form of staking, which could also increase the total return for Ether ETH holders and make the asset a more appealing prospect for investors. These additional benefits for traditional financial institutions were also introduced by the merger.
“Institutional investors can stake their ETH as a PoS Ethereum validator and earn roughly 5% APY annually, with only a minimal amount of risk involved,” -Peurifoy
Even so, staking might not be free since Ether’s new staking model might attract SEC (6) attention due to its generous new staking options, which might cause the Howey test to be triggered and result in a U.S. court designating Ether as a security. Regulators may begin to see Ethereum as being similar to conventional financial instruments since its increased staking options may attract more conventional investors while also bringing SEC oversight to the US.
The network paid out 1,600 ETH per day in staking rewards after the Merge, with a 90% decrease in new issuance. The pre-Merge Ethereum was paying out and creating around 13,000 ETH per day for rewarding PoW miners, which can be advantageous for institutional investors. The overall supply of Ether may decrease as a result of the Merge. The gas fees associated with Ethereum continued to be destroyed or eliminated as they have done since August 2021.
“At least 1,600 ETH are burned per day on an average gas price of at least 16 gwei, bringing net ETH inflation to zero or less post-merge.”
The supply will not only be limited but even reduced, which is deflationary through lower ETH issuance and greater burns where ETH might gain in value, even though many believe that ETH is becoming deflationary and that compared to the US Dollar it is decreasing at a large rate.
Although institutional investors may now prefer ETH following the Merge, Bitcoin is still the first and largest blockchain network to use the PoW consensus technique. From an ESG viewpoint, Ethereum’s ETH is a more appealing investment than Bitcoin due to PoS and less energy use, although it is still too early to predict if this will happen sooner or later.
The staking rewards come with conditions where institutional investors stake their ETH and are locked in a contract wherein a user will not be free to withdraw the staked ether or the incentives for at least 6 to 12 months up until after the merge. The new Ethereum software has also not yet been tested at scale. Many institutions are still reluctant to accept the risk of inability to withdraw, and the logistics of avoiding and managing these risks act as a barrier to wider adoption.
Institutional investors are likely to adopt a wait-and-see strategy because those who are waiting for institutional investors to step in and save the cryptocurrency business would have to wait a lot longer if the general stock market crashes and is driven by inflationary fears. The Merge was successful, but that doesn’t always mean institutional crypto adoption is moving along more quickly. Instead, future enhancements will be crucial for wide-scale adoption.