Original Author: @korpi
Original Compilation: Deep Tide Techflow intern
The Merge - This is the most important upgrade Ethereum has ever seen. Big events like this are often just short-lived "hype", some people say that $ETH will be the same, but I disagree. This article will explain why $ETH changed its face after the merger.
This merger removes the proof-of-work (PoW) consensus mechanism in Ethereum and replaces it with the proof-of-stake (PoS) consensus mechanism. But in this article we ignore the technical details and focus only on the price of $ETH. The price of every asset is determined by the forces of supply and demand. What factors will change the supply and demand dynamics of $ETH post-merger?
Triple the amount in half;
ETH staking Annualized Rate of Return (APR);
ETH (unlocked) locked position;
institutional needs;
1. Triple the amount in half
Through PoS, the issuance of $ETH is reduced by 90%: this is the amount of BTC that needs to be halved three times to produce the same specification of supply reduction. What Bitcoin can do in 12 years, Ethereum has done it in one breath this year. But it's not just about reducing selling pressure by 90%, it means more.
In PoW, additional $ETH is issued to miners running high-cost businesses. They were forced to sell large amounts of ETH to pay high electricity bills.
In PoS, new ETH flows to validators who only need to care about the lowest cost of electricity and hardware, they are no longer sellers who are forced to sell.
Also, Bitcoin miners don't have to be BTC longs, they invest in hardware and electricity to mine, not Bitcoin. Instead, Ethereum validators must stake $ETH, so they are usually long-term holders. Why are they selling their staking rewards if they see the price of ETH go up?
2. ETH Pledge Annualized Rate of Return (APR)
There are currently $11.4 million in ETH pledged, with an annualized rate of return of 4.6%. This ETH-denominated yield comes only from staking rewards. In PoS, stakers will also receive gas fees that now belong to miners, which will increase APR by 2x or more.
Staking annualized rate of return (APR) can be considered as a nearly risk-free return on $ETH. When it rises, it will attract more ETH to be pledged, because it becomes an attractive alternative to other earning opportunities in DeFi. More ETH pledged means less supply on the market and even triggers panic buying.
3. ETH (un)locking
Staking $ETH is currently a one-way operation, as stakers cannot withdraw their ETH and rewards. Many seem to believe that the ethereum merger will enable withdrawals and that "when the 12 million staked ETH is unlocked, there will be a massive sell off of ETH". I noticed that some people think that the merger is a negative price catalyst, ETH is unlocked, flooding the market, this view is completely wrong.
(1) Pledged ETH will not be unlocked when merged
ETH merges will not make withdrawals happen. This is another planned Ethereum upgrade that will take place 6-12 months after the merger. In other words, neither the pledged $ETH nor the pledged rewards will enter the circulation state for a long time. When the withdrawal is finally enabled, only 30k ETH can be withdrawn per day, and there will not be a large amount of unlocking.
(2) The unlocked ETH will be released slowly
Even with withdrawals enabled, all staked $ETH is not immediately available. It will introduce an exit queuing mechanism, which may take more than a year in the worst case and several months in the normal case. To withdraw $ETH, a validator must withdraw from the set of active validators, but there is a limit to the number of validators that can withdraw per epoch. There are currently 395k validators (active + pending) and it will take 424 days for all of them to quit if no new ones are built (highly unlikely).
(3) The pledged ETH is usually a stack that is never sold
Who would voluntarily lock $ETH for months without even knowing when they can withdraw? Without a doubt, the most bullish on ETH. Most ETH stakers are long-term investors. They're not interested in selling, especially not at current prices. Short-term $ETH stakers would rather use liquid staking options (like @LidoFinance) so they can sell their tokenized stake at any time.
I used Nansen and Etherscan to see the distribution of staked ETH by stake type: liquid stakes are only 35%.
Additionally, 30% of staked $ETH came from addresses not labeled as exchanges or staking pools. It may represent validators running separately. Running a validator is not an easy task, and as such, is usually only done by true ETH believers. They won't sell it, will they?
All in all, I don't believe there will be any exaggerated sell-offs due to $ETH unlocking. It will take place and release slowly over the course of a few months, and many stakers won't be selling anyway.
4. Institutional needs
Why is the PoS transition sparking institutional interest?
DCF model (discounted free cash flow model) will be applied to value $ETH, which shows that the value of ETH is undervalued;
ETH as an "internet bond" will become a substitute for US treasury bonds;
ETH is green, which is a good narrative;
EIP-1559 burns $ETH on every transaction;
(1) DCF model valuation $ETH
The DCF model is a popular valuation method in TradFi. It has been used by institutions that manipulate trillions of dollars of global wealth for decades. PoS will use the DCF model for valuation and eventually apply to the value of $ETH. Why is it so important?
By predicting future cash flows, it is possible to assess the fair value of $ETH, which is required for institutional investors to approve multi-million dollar investments. And, as you may have guessed by now, ETH is massively undervalued. Because based on DCF and P/E valuation techniques, the fair value of $ETH is definitely higher than $10,000. After the successful transition of PoS, institutional investors will become interested in ETH. And now we can preemptively run these mechanisms by purchasing ETH.
(2) Convert $ETH into internet bonds
Staking proceeds converts $ETH into internet bonds - a viable alternative to US Treasuries. Even though ETH is more volatile than bonds, it promises a higher yield, and if the ETH price doesn't crash, the real return would still be better.
(3) ETH environmental protection narrative
Transitioning to PoS will reduce the energy usage of the Ethereum network by 99.98%. Energy-intensive PoW gets a lot of hate eyes when the issue of climate change is prevalent. Whether this criticism is justified is irrelevant; the narrative is what matters. While $BTC proponents will have to fight back against the ongoing PoW attacks and go to great lengths to justify the energy consumption of the Bitcoin network, $ETH holders will be basking in the new narrative of an environmentally friendly blockchain. Changing the narrative is easier than winning a war.
(4) EIP-1559 burning $ETH
In short, institutional demand will explode. And if that wasn't enough, we also have EIP-1559 burning $ETH on every transaction! So far, it has burned more than 2 million ETH in 8 months. That's almost 6 ETH/minute! At this burn rate, the supply of ETH will decrease by 2.2% per year. ETH = money that keeps increasing in value!
Everyone is talking about $ETH being burned. Indeed, it's exciting. Is ETH Already Deflationary? No, it has a lower inflation rate. Will there be deflation? I'm pretty sure it will. Let me share some helpful resources to track ETH as a valuable currency. We don't even need a bull run to make ETH deflationary after the merger. Gas prices have been extremely low throughout the recent bear market. However, EIP-1559 will still burn more ETH than if it were merged. The consolidation will mark the peak in ETH supply.
We don't need a degree in economics to understand the principle of what happens to the price of an asset if its supply decreases and demand increases. Yes, the numbers go up. In my opinion, this is exactly what will happen to the $ETH price after the merger (long-term trajectory). Maybe you will say "But, everything is already priced!" Is it? Crypto markets are extremely inefficient. I even feel like "very few people understand" all the above dynamics. Remember when EIP-1559 started burning a lot of $ETH and everyone was surprised? They'll be surprised again after the merger.
Furthermore, institutional demand has yet to reach robust levels. Many corporate risk committees will not approve an investment in an asset that has "substantial execution risk" to the future - PoS transition is often described as such. Only after the merger will $ETH become an investable asset. Bears now control the market and price action completely ignores fundamentals.
In summary:
The consolidation has not yet been priced into;
We can purchase $ETH to run the Pos mechanism in advance of the institution;
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