Why Ethereum Merge is changing the game for DeFi and crypto investing

Ethereum’s big upgrade taking place this week, known as “The Merge”, is creating a lot of excitement in the crypto market – and for good reason. It will likely be looked back on not only as the most important industry event of 2022, but as a major turning point in blockchain history.

Ethereum Merge refers to the merging of Ethereum’s mainnet, the execution layer currently secured by an energy-intensive proof-of-work system, with the Beacon Chain, a separate consensus layer based on a proof-of-stake mechanism. Once completed, blocks of transactions will be added to the Ethereum blockchain exclusively via proof-of-stake verification, eliminating the role of Ethereum miners and their heavy carbon footprint. There are many different aspects of the Ethereum Merge that touch all different parts of the crypto world, and it is only the first step in a detailed roadmap for Ethereum described in shorthand as “Merge, Surge, Verge, Purge and Splurge.” The result is that these changes will massively expand the scalability of the Ethereum ecosystem.

As with any major event that drives the crypto narrative, there has been price action in ETH on many exchanges as the expected completion date in mid-September is fast approaching. ETH holders must understand that this is not just a turnkey upgrade, but the beginning of a long-term process. That said, one important result is that there will likely be more interest in Ethereum from the financial sector.

The first major reason is ESG — environmental, social and governance. The shift from an energy-intensive asset to an energy-neutral one is a big deal for institutional investors, who are more focused than ever before on ESG factors, with environmental impact foremost. Concerns about the carbon footprint of proof-of-work-based cryptocurrencies (which notably include Bitcoin) have been one of the main obstacles to large institutions deploying more capital in the space. The merger means that, at least as far as Ethereum is concerned, that particular objection will be completely neutralized.

Second, the nature of the proof-of-stake mechanism will significantly improve ETH’s attractiveness to large financial investors by introducing a return-like property to ETH holdings.

To understand why, you need to know a little about how proof-of-stake works, and how it will be implemented on the Ethereum blockchain going forward. After merging, Ethereum transactions will not be verified by miners who perform calculations, but by validators who unlock (put) their own money (in ETH form) as collateral to ensure that they perform the verification diligently and honestly. In return, validators who successfully add blocks to the blockchain earn monetary rewards for their work. In the context of Ethereum, running a validation node would require staking 32 ETH – over US$50,000 at current prices – although the creation of staking pools also allows smaller ETH holders to participate collectively.

This new system therefore creates the opportunity to earn direct and secure returns on ETH holdings. This is a big deal for investors, and it can prove attractive to money managers whose main concern is to generate stable returns with good upside.

Finally, ETH stakes will also give a boost to the entire decentralized finance (DeFi) space. The size and credibility of the Ethereum network will make it almost like the crypto world’s equivalent of the US Treasury bond market. ETH staking will become a de facto “risk-free” rate for crypto, serving as an underlying rate against which all sorts of DeFi return-generating projects can be measured.

The Ethereum Merge and future Ethereum upgrades, combined with the development of layer-2 blockchains that enable massive scale-up while inheriting the base layer’s security guarantees, will result in a proliferation of infrastructure built on top of the new proof-of-stake-based Ethereum. .

Based on the combination of all these factors, it is no wonder that many are bullish on Ethereum and its ecosystem, and even more so on DeFi. The merger is about long-term value, not short-term price increases.

A classic Wall Street maxim instructs traders to buy the rumor and sell the news. But investors should be cautious about seeking short-term profits around this week’s Ethereum Merge event.

It’s worth thinking back to another significant crypto market event, the recent Bitcoin “halving”. Every four years, the reward for mining Bitcoin is halved. The third case occurred in May 2020 and was accompanied by much discussion about how the price would be affected. As it happened, the price of Bitcoin didn’t change much in the run-up to BTC’s halving. It was several months later that the next Bitcoin bull run started, fueled by a narrative of Bitcoin as digital gold.

Similar dynamics may be at play with Ethereum. The merger is not about the chance of a one-off event-driven price increase. Instead, it’s about understanding the fact that it’s the first in a long line of improvements that will upgrade the network and allow players in the ecosystem to unlock enormous value by building on top of it. It will take some time for the narrative to catch up with events on the ground, and then for meaningful inflow of capital into this asset. But I am convinced that the future is bright for the ecosystem as a whole.

The content of this article is not investment advice and does not constitute an offer or solicitation to offer or recommend any investment product. It is for general purposes only and does not take into account your individual needs, investment goals and specific financial circumstances. Investment involves risk.