Are Institutions Underpricing the Merge?
Katie Talati, the director of research at investment firm Arca, thinks traditional finance institutions are at risk of missing out on a once-in-a-decade trade. Right now, she said, ether (ETH) is woefully underpriced and there’s a catalyst around the corner. Next month, Ethereum will have billions of dollars worth of cryptocurrencies, millions of users and thousands of apps transferring to a new and improved blockchain. This follows years of R&D that will culminate in the so-called Merge, the actual technical deployment of Ethereum’s proof-of-stake chain. “This is an event that a lot of people are undercounting, especially based on current price appreciation” of ether, said Talanti, who also leads Arca’s investment research. “We're gonna look back on this in a year from now and [realize] we were at the [market] bottom there.” Of course, this is just Talanti’s opinion. But it’s an opinion widely shared widely among industry insiders. The Merge has market upside potential at a time when most headlines spell risk and not reward for crypto holders. From Arca’s perch, Talanti has observed increased retail interest in crypto in the past few weeks. Yet, “there aren't new institutions coming in,” she said. “Those will be the much more important and larger buyers of [ether].” There are structural reasons why one might expect ETH’s price to appreciate post-Merge, Talanti said. “From a financial standpoint, the net issuance of [ether’s] supply is going to be net negative,” she said. In other words, there’s hope ETH could become a deflationary asset, making it more valuable to hold over time. This is the result of an Ethereum Improvement Proposal, specifically EIP-1559, instituted last year that burns ETH as part of every successful transaction and a change in Ethereum’s issuance, post-Merge. For at least six months after Ethereum ditches proof-of-work, users who stake their assets will not be immediately able to withdraw their assets. This creates a “supply sink” that essentially caps the issuance of new ETH entering into circulation, she said.
Add the fact that there will now be an incentive for people to lock up their ETH on Ethereum, to earn a staking reward. “You will see the circulating supply of [ether] increase with staking, but it won't actually be available for individuals to sell,” Talanti said. Some people have referred to this as Ethereum’s “thirdening,” a reference to Bitcoin’s “halvening” or the cyclical decrease in new bitcoin (BTC) issuance every four years. These programmatic cuts to supply are sometimes thought to drive up prices, (or at least drive awareness to crypto markets). Risks Still, there are risks to the trade. First, Ethereum’s Merge could be delayed – which would send a “negative signal” to the markets, at least in the short term, Talanti said. Then there’s the prospect that something could go wildly wrong during or after deployment, a risk that’s hard to calculate given all the moving parts that could break. (Ethereum upgrades have been delayed before, and several times.) Another risk are all the planned and possible Ethereum forks that will keep the proof-of-work algorithm. This will fracture the market, Talanti said. Some prominent crypto firms have already pledged to support some PoW forks, like ETHPOW, which prominent miner and investor Chandler Guo has backed. There’s also the possible sell pressure on ETH, once people will be able unlock their coins. Some people have locked their ETH for nearly two years, ever since the so-called Ethereum 2.0 deposit contract went live with the experimental Beacon Chain. They’ve also earned returns on their capital in the form of staking rewards that could be sold for cash or reinvested. “It's kind of hard to predict that behavior,” Talanti said, adding that many early stakers are likely long-term supporters of Ethereum who would be less inclined to sell. It’s worth adding that much of Ethereum’s issuance schedule could change. There is no guarantee that ETH will become deflationary, a major selling point for institutions, which depends on high levels of Ethereum use (and thus high levels of burnt ETH). So considering the financial, technical and other unpredictable risks of the largest blockchain upgrade in history, is there a way to hedge your bets? Investors seem to be aware of the downside risk. Put options, or contracts that allow people the option to sell an asset, for ETH are “really expensive in the current market,” Talanti said. – D.K. | 