Does the Ethereum Merge offer a new destination for institutional investors?

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Does the Ethereum Merge offer a new destination for institutional investors?
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Last week’s Merge was the “most significant development in the history of the Ethereum network,” according to Fidelity Digital. 

And from a purely technical standpoint, the blockchain network’s transition from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism was a marvel. Widely compared to changing a jet engine mid-flight, the software upgrade proceeded with nary a glitch on Sept. 15.

Overnight, too, Ethereum, the world’s second-largest blockchain platform, reduced its energy usage by 99.95% from a rate as high as 94 TWh per year in May — roughly equivalent to the nation-state Chile — to an almost negligible 0.01 TWh on Sept. 16, according to Digiconomist.

This should carry some weight with regulators threatening to clamp down on blockchain networks for environmental profligacy. It could also bring more institutional investors into the crypto space.

To this last point: Institutional investors like pension funds, insurance companies, foundations and others matter because they tend to be longer-term investors and are not inclined to trade on rumors or overreact to 24-hour news cycles. Broad participation from this group could help solve crypto’s persistent liquidity and volatility problems.

Yet, others believe that while the Merge offers corporations and large financial institutions a more eco-friendly platform, as well as new staking opportunities, it doesn’t yet solve one of Ethereum’s core deficits: its lack of scalability. Not yet, anyway.

“The Merge is a watershed moment for the crypto industry, but the impact to accelerate adoption by institutional investors will take more time,” Jim Kyung-Soo Liew, associate professor at Johns Hopkins University’s Carey Business School, told Cointelegraph.

“Ethereum does not have a better statement on TPS [transactions per second],” John Peurifoy, co-founder and CEO at Floating Point Group — a trading platform provider — told Cointelegraph. The Merge doesn’t increase block size or block speed. “We’re not there yet.” That will have to wait for the Surge, another Ethereum upgrade scheduled for 2023. That will implement a sharding solution that could boost network speed dramatically.

Still, solving the energy consumption problem and reducing carbon emissions are no small achievements. Ethereum’s carbon footprint, once as large as Finland’s, now compares to the Faroe Islands, said Digiconomist. Or, put another way, a single Ethereum transaction is now “equivalent to the carbon footprint of 44 Visa transactions or 3 hours of watching Youtube.”

“The bolstering of Ethereum’s environmental, social and corporate governance (ESG) credentials should be good for regulatory-driven institutions that want to start to explore the Ethereum ecosystem,” Marc Arjoon, Ethereum Research Analyst at CoinShares, told Cointelegraph, while Jack Neureuter and Daniel Gray, writing in Fidelity Digital’s Report on the Merge, added that the transition to PoS could have “a positive reinforcing effect for those who feel strongly about the environmental impact resulting from the usage of blockchains.”

Indeed, two Bank of America analysts recently suggested in a note to clients that some institutional investors who were previously “prohibited” from investing in PoW-generated tokens could now participate:

“The significant reduction in energy consumption post-Merge may enable some institutional investors to purchase the tokens that were previously prohibited from purchasing tokens that run on blockchains leveraging proof of work (PoW) consensus mechanisms.”

An increased return for Ether holders?

The Merge also introduces other potential benefits for traditional financial institutions. “Ethereum’s shift to proof-of-stake makes ether an asset which can earn interest for holders in the form of staking,” noted Fidelity Digital. This could increase the total return for Ether (ETH) holders and “may make the asset more attractive to prospective investors.”

“One reason to be excited” if you’re an institutional investor, said Peurifoy, is that you can stake your ETH as a PoS Ethereum validator and receive about a 5% annual percentage yield (APY). “That’s a pretty good rate, and it has relatively low risk associated with it.”

Staking could come at a cost, though. In a Sept. 15 article headlined “Ether’s New ‘Staking’ Model Could Draw SEC Attention,” the Wall Street Journal reported that United States SEC chief Gary Gensler recently suggested that Ethereum, with its generous new staking opportunities, could trigger the Howey test — and U.S. courts might declare Ether a security.

“Now that Ethereum more closely resembles traditional financial instruments, regulators may start to view it as such,” Arjoon told Cointelegraph. In other words, Ethereum’s new staking opportunities might bring in more traditional investors but also SEC oversight in the United States.

Is ETH becoming deflationary?

The overall supply of Ether could drop as a result of the Merge, which institutional investors might also view favorably. Pre-Merge Ethereum was paying out, creating about 13,000 ETH a day to reward its PoW miners. After the Merge, the network will pay out about 1,600 ETH a day in staking rewards, a 90% drop in new issuance, according to the Ethereum Foundation. Meanwhile, a portion of Ethereum gas fees continues to be burned or deleted, as they have since August 2021. According to the Foundation:

“At an average gas price of at least 16 gwei, at least 1,600 ETH is burned every day, which effectively brings net ETH inflation to zero or less post-merge.”

“Many people believe that ETH is becoming deflationary,” Peurifoy said, and now comparing that to the United States dollar, which is declining currently at “a pretty massive rate.” 

“Supply will not only be capped but even reduced, i.e. deflationary through reduced ETH issuance and increased burns,” noted consultant Markus Hammer, writing on LinkedIn: “ETH might therefore eventually increase in value.”

Is a flippening more likely?

Bitcoin, the first and largest blockchain network, still uses a PoW consensus mechanism, of course. Could post-Merge institutional investors now favor ETH over Bitcoin (BTC)?

“PoS and less energy-use does make Ethereum’s ETH a much more attractive investment than Bitcoin (BTC) from the ESG perspective, but it’s too early to tell if the ‘flippening’ will occur,” said Liew, further adding:

“I suspect that the diehard Bitcoin fanatics are not going to sell their positions to move into ETH just because of the Merge.”

The new Ethereum software still hasn’t been thoroughly tested at scale either, and the staking rewards come with some strings attached. When institutional investors stake their ETH, it is locked in a contract. “You will not be able to withdraw your staked ether or your rewards […] for at least 6–12 months until after the merge,” Arjoon said. “This inability to withdraw is still a risk that many institutions aren’t willing to onboard and the logistics to navigate around and manage these risks also provide a hurdle for greater adoption.”

“The institutional investors will probably take a wait and see approach,” Liew said, adding that if “the overall stock market crashes driven by fears of inflation, then those waiting for institutional investors to come save the crypto industry will be waiting a much longer time.”

“The Merge was successful but won’t necessarily mean institutional crypto adoption is on a fast track,” Edward Moya, senior market analyst at Oanda, told Cointelegraph. “The key for widespread adoption will come from future upgrades.”

Peurifoy, on the other hand, viewed last week’s events as a defining moment, especially “if we go another week and don’t see any massive forks of Ethereum come out, or technical bugs,” he told Cointelegraph, adding:

“How often do you see a decentralized rollout of something that affects millions of users that is done completely live. […] It’s a watershed because of the human collaboration involved, and because we pulled off something like this at scale with so few bugs.”



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