Post Merge Stress Disorder
The Ethereum Merge was uneventful - congratulations to the developers, node operators, miners, and users involved! A non-event was possibly the best outcome in my mind, because anything else might’ve meant billions of dollars of value were at risk. Now that the crypto-event of the year has passed, what does the future hold for ETH? I’m not macroeconomic expert, but I do have a few ideas…
Are there any immediately obvious catalysts for ETH to appreciate in value significantly over the next few months? Personally, I don’t think so. (Again, nothing I say here is investment advice, because just by writing that I’m “protected” - right?) Of course, there are still reasons why ETH might appreciate over the next 6-12 months, but those reasons involve more “if” statements than most investors are comfortable with.
Either way, I’m going to explore the positives and negatives that Ethereum will be forced to navigate over the 3-9 months. I’m personally bullish on Ethereum in the medium-term, but there are a lot of reasons to be wary in the short-term. (My thoughts on the long-term case for Ethereum are best summed up here.) Let’s dive into this ape’s thoughts…
Disclaimer: This ape is long crypto and might open new positions in the future. Nothing in this post should be considered investment advice, only the ramblings of an ape.
Number Go Up
Ethereum is the largest smart contract platform for a reason. Besides its first-mover advantage, it hasn’t had any catastrophic failures in its 6+ years of operation. Solana is another layer one (L1) network that’s grown significantly this past cycle, but has suffered a series of outages in 2022 - for a variety of reasons. Solana’s technology might be great someday, but many users have indicated a preference for consistency and reliability when playing around on the blockchain.
As a result, much of the NFT and DeFi activity is likely to stay on (or at least connected to) Ethereum. More users on the network suggests that Ethereum’s gas prices will rise. (With more users comes more competition for block space.) Higher gas fees are a huge benefit to Ethereum after the Merge, as it helps move the needle from ETH inflation to deflation.
In other words, the more user activity on the Ethereum network, the more Ethereum is burned thanks to its newly adopted proof-of-stake system. If more Ethereum is burned than generated, then ETH becomes “deflationary” and it’s reasonable to suggest that the price of ETH will rise. More dollars chasing fewer tokens.
This is the extent of my optimism in the short-term. There are plenty of great NFT projects coming up (like Art Gobblers, which I’m very excited to participate in), but it’s not clear that NFT activity alone will be enough to sustain ETH prices given the bleak macroeconomic environment. As for DeFi, I am concerned that regulators are out for blood and that a lot of DeFi activity in major markets will dry up. It’s a bumpy road ahead to say the least.
Number Go Down
Currently, any ETH staked is locked in a contract and cannot be transferred or sold until the “Shanghai” upgrade that’s slated for early 2023. This means that nearly 15 million Ethereum, over $20 billion USD, is effectively frozen until the next phase of the Merge. (There are staking derivative tokens that act as IOUs for staked Ethereum and allow for immediate liquidity, but those carry various degrees of risk.)
Operating under the assumption that the next phase goes as well as the initial phase of the Merge, there are three effects to the price of Ethereum after the Shanghai upgrade:
No price reaction
The simplest answer is the least likely in my opinion. When $20 billion dollars worth of risk-on capital are all unlocked, at once, amidst macroeconomic turbulence, I am not confident that “nothing will happen.”
Price goes up
When things go according to plan, the market might reduce hedge exposure. Hedges are for uncertainty, and a good outcome to the Shanghai upgrade might lead some participants to reduce downward-price pressure positions. Alternatively, it might boost the confidence of other market participants to deploy cash, and who were only comfortable staking Ethereum after the ability to withdraw it was introduced. I don’t feel that this is a likely outcome at this time.
Price goes down
About 12% of Ethereum’s entire market capitalization will be unlocked after the Shanghai upgrade. I don’t know what percentage of the initial cohort of Ethereum stakers were unsophisticated players that were seeking simple “yield” by staking as soon as possible. I don’t know what percentage are determined builders that are invested in Ethereum for the long-haul. I don’t know what percentage are relentless trading junkies that temporarily rotated to Ethereum staking as a “safe” crypto play given the state of the wider crypto market. But it’s safe to say that there’s a bit of each group currently staking Ethereum.
The unsophisticated players are likely to abandon their Ethereum positions as soon as they can, in an effort to salvage whatever capital they initially invested. Regardless of your economic position in life, Ethereum is a high-risk, high-reward play that thrives in conditions diametrically opposed to the market’s current view of the future.
The determined builders with deep convictions of Ethereum are unlikely to radically change their exposure, but they may withdraw some staked Ethereum to pay for expenses, build new protocols, or interact more with the network.
The trading junkies might leverage (or further leverage) their staked Ethereum positions in order to fuel their “next big trade.” Oftentimes these individuals lack the discipline to treat leverage with respect and blow up their positions - which, in this case, might force lenders to liquidate the Ethereum used as collateral. Alternatively, these trading junkies might sell their Ethereum to fuel the latest DeFi protocol that’s ripe for exploitation. Regardless, it’s unlikely they will be happy with Ethereum’s current 4% annualized staking yield and will find something else to invest in.
Number Go More Down
The other possibility is that the Shanghai upgrade doesn’t happen on time or complete successfully. If it doesn’t happen in time, there’s a chance that some Ethereum holders will lose confidence in the development team and sell their stakes. I feel that this is the lesser concern, especially considering that the Merge had been teased for years before actually happening in 2022.
The greater concern is that the Shanghai upgrade breaks the network in any way. Tens of billions of dollars can be wiped out in an instant, over a simple coding error or some unforeseen circumstance. It’s difficult to imagine specifically what might break, but if any functionality were to be compromised - from simple withdrawals of staked ETH to the locking more ETH for staking - would have devastating effects.
If withdrawals were to break in any way, billions of dollars of Ethereum might be sold instantly - and any staked Ethereum could become worthless. DeFi, which uses staked Ethereum derivatives, would suffer a cascade of liquidations and a fast-evaporating pool of liquidity for stablecoins/Ethereum as users rush for the exits. I wouldn’t place odds on the likelihood of this happening, but I would never discount it as a complete impossibility.
Not Tomorrow, Not Next Quarter, Maybe in Two Years
I’m a crypto optimist. I think blockchain technology will have a net positive effect on the way the world interfaces with digital mediums. I also doubt that it will be “easy” to make money in the industry for the foreseeable future. In 2021 one could buy practically any NFT or token and flip it within 24 hours for a profit, but I don’t think that will be the case for the remainder of 2022 and most of 2023.
Given what we know today about the world economy, I don’t see an easy upside to any cryptocurrency other than Bitcoin and its “digital gold” theory. Ethereum’s growth requires more users, activity, and investment. Zealots will cite Ethereum as a “deflationary” token, indicating that price should rise as token supplies are burned and fewer new tokens are issued. However, I don’t think price will go up if demand falls faster than supply…
In an ironic turn of events, one of the most publicly ridiculed use cases for Ethereum might actually end up being its saving grace: NFTs. I participated in the rise and fall of DeFi, when excitement for the next food-based yield farm waxed and waned. I also participated in NFT-mania, where pictures of anime-inspired mekabots went from values of $1,800,000 to average sales of $420 over a 6-month period. The biggest difference between DeFi and NFTs has been community development.
DeFi was predicated upon getting in and out fast to make money. NFTs have been building stalwart fans that have a genuine passion for the art, community, and project. My initial impression of NFTs was wrong: The expensive monkey pictures aren’t a waste of Ethereum network’s potential, but potentially a last line of defense for its survival.