Global DeFi app store DappRadar and other stakeholders have expressed concern over Ethereum’s imminent “merger” as it could negatively impact or destabilize several decentralized applications on the ETH blockchain network during the upgrade process.
In a report titled ‘DeFi’s Stablecoins Battle Fallout’ on August 27, DappRadar highlighted that it is one of the most anticipated events in the crypto industry as it could potentially destabilize stablecoins.
Crypto investment firm Grayscale expresses similar views on Twitter that the ETH merger could affect the native tokens on the Ethereum blockchain.
Ethereum is currently the dominant blockchain network on which DeFi protocols and other applications operate. That’s one of the reasons why the “merger” has been viewed with a grain of salt.
Grayscale data shows that blockchain-based stablecoins such as Tether (USDT) make up 28 percent of Ethereum’s total market capitalization. Also, according to crypto market data provider Coinmetrics, the value locked in various Ethereum-based DeFi smart contracts is around $40 billion.
Grayscale tweeted that “Issuers such as Tether and CirclePay have already stated that post-fork, only tokens on the PoS (proof of stake) network will be redeemable.”
Therefore, Grayscale said, if the PoS-based Ethereum fork goes “live with a parallel DeFi ecosystem, secured by irredeemable stablecoins, users and smart contracts may attempt to liquidate positions on the new chain, contributing to selling pressure on it new token.”
Pedro Herrera, data analyst at DappRadar, said in an interview with CoinDesk, “If the merger fails to launch, we will have delays on DeFi protocols that will affect stablecoins. But from the perspective of supply dynamics, this could also take a toll on how stablecoins will be used for liquidity pools, in the DeFi space and beyond.”
The relationship between Stablecoins and DeFi
According to DappRadar, “Stablecoins are central to the function of DeFi, as they are often used in DeFi events to facilitate trading or as collateral for lending and borrowing.”
Stablecoins, it said, are an asset in a pair of digital assets and are often used in automated market maker (AMM) schemes. “AMM is designed to create liquidity for others who wish to execute trades,” said DappRadar.
Citing another example, DappRadar said, “Stablecoins are often ‘locked’ in DeFi schemes to obtain returns from interest payments paid by others who borrow these stablecoins from the scheme for leveraged trading or other activities.”
The Impact of Ethereum Merger
The crypto market and its stakeholders worry that the impending Ethereum (ETH) merger could negatively impact stablecoins and DeFi applications on the network.
Still, Circle’s USDC, the largest dollar-backed stablecoin on the Ethereum blockchain and whose audited reserves are held at BlackRock, a US-based financial institution, said it will support the upcoming event. Tether (USDT), another stablecoin provider, has also pledged its support.
On the other hand, MakerDAO (MKR), the builder of stablecoin DAI, expressed concern on Twitter, stressing that “the merger could lead to perpetual contract backlog and negative funding” and “potentially trigger cross-chain selling pressure” on ETH proof-of-work. MKR believes that the possibility of assets becoming worthless on staked Ethereum assets cannot be ruled out.
“Staked Ethereum will likely become worthless on any PoW Ethereum fork. This is because additional chain upgrades will be required to unlock ETH from the staking contract, and there is arguably little financial incentive for the fork chain to accommodate this,” MKR said on Twitter .
Lately, there has been an increasing focus on conceivable PoW post-merger Ethereum forks.
If these forks take place, what are the potential risks Maker faces?
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— Maker (@MakerDAO) 5 August 2022
In response to MKR’s comments, DappRadar added that the risk of the lending protocol could become higher due to the increase in “ETH deposit rates and liquidity due to the merger fork.”
“There is also the potential for network downtime because not all Ethereum-based protocols will transition to proof-of-stake with the Ethereum chain. Maker noted that this could affect both users and transactions. Likewise, a replay attack on the DAI fork was not or MKR fork omitted from the options,” DappRadar said in the report.
According to Grayscale, the merger may produce unexpected, unfavorable outcomes. Shades of Gray also expressed concern that the event could trigger panic selling.
Also, “the merger could create a scenario where stablecoins and tokens locked in smart contracts may not be redeemable,” the DappRadar report said.
In closing remarks, DappRadar noted that the concerns of Grayscale and MakerDAO are genuine; however, “Ethereum developers have probably taken them into consideration. ‘Merge’ will presumably transmit proof of Ethereum data and serve as a handover. A parallel chain will inevitably result in duplication. But the strategy and measures to address such concerns remain. »
