As we inch closer to a highly anticipated protocol development for Ethereum, some big institutional players may wonder what “the Merge” could mean for them.
The system upgrade, set for September 15, plans to reduce the second-largest blockchain's energy consumption by about 99% by moving away from proof-of-work, which relies on crypto miners using tons of computing energy to validate transactions, to proof-of-stake, which uses an algorithmic lottery to determine future validators from a pool of “stakers” who lock up funds to secure the network.
After the Merge, the reward subsidy for miners will be reduced by about 90%. At the moment, about 13,000 ETH is mined a day, but after the Merge, it’s expected that only about 1,600 ETH will be issued daily, according to the Ethereum Foundation.
“I think institutional adoption is the next big wave,” Nikos Andrikogiannopoulos, CEO of Metrika, said to technewss. “Back in 2018 when the previous crypto winter happened, a number of VCs were in the wave at that time, but this time financial institutions are riding the wave this crypto winter.”
Basically, Andrikogiannopoulos said he sees these institutions maintaining their faith in Ethereum after the Merge, rain or shine.
The reduction of Ethereum's carbon footprint will be one of the potential appealing factors for investors looking to meet ESG mandates in their portfolios, according to a report on the impact of the Ethereum system upgrade by MetaMask Institutional and ConsenSys' Cryptoeconomic Research Team. But some are saying the environmental shift isn't the only appealing factor.
The Ethereum Merge may allow for far more applications to be built upon its network, opening up innovation and bringing on new financial institutions, Andrikogiannopoulos said.
“In the short term, the new economics and monetary policy of Ethereum could serve as perhaps the biggest catalyst of institutional adoption,” David Shuttleworth, senior DeFi economist at ConsenSys, said to technewss. “Under these new economics, Ethereum becomes decidedly deflationary.”
The possibility of positive real yield generation through staking (the way Ethereum’s token is used to stake the new proof system post-Merge) can also help drive institutional adoption, “particularly given the current macro climate of negative real yields,” Shuttleworth said. “Institutions will now have a way to earn passive rewards on their Ethereum investments while simultaneously helping to secure the network through staking. Collectively, these factors could play a significant role in the overall growth of the ecosystem.”
Ethereum post-Merge can be thought of as an asset that will become significantly more scarce in a relatively short amount of time, Shuttleworth said. At least 1,600 ETH will be burned every day, which effectively brings net ETH inflation to zero or less post-Merge, the Ethereum Foundation said.
“To put things in perspective, it would take Bitcoin 12 years to achieve the same level of net issuance as Ethereum is about to undergo with the Merge,” Shuttleworth said. “The Merge will reduce new ETH issuance by 90%; it takes Bitcoin three years to undergo a halving and reduce BTC issuance by 50%. This could be an extremely attractive value proposition to any institution. The reduction in the total new issuance of ETH also creates a store-of-value element in Ethereum, adding to its intrinsic appeal.”
Generally speaking, the Merge may facilitate continued adoption from both retail and institutions, Shuttleworth said.
“The largest tier 1 financial institutions have already done a lot of great work in the space,” Andrikogiannopoulos said. “I think there's zero doubt from financial institutions' perspective that they need to enter this space. They will be testing the waters more and more after the Merge.”
As Ethereum leaves the proof-of-concept stage where it focused on experimentation, it's now ready to scale, Andrikogiannopoulos noted.
“Financial institutions have every incentive to consolidate or provide access [to crypto] through existing customer relationships,” Andrikogiannopoulos said. “There's a two-way street from the crypto world to the financial institutions and somewhere between is stablecoins, but I think they can bring crypto assets to the traditional financial system and they can also take traditional assets like stocks, bonds and other derivative products and make them available on public blockchain networks.”
“The network will become more performant and more secure,” Shuttleworth argued. “Participants will no longer be required to own expensive pieces of mining equipment, which in turn require access to resources and a certain level of technical wherewithal to operate.”
But “the Merge will not fix everything,” Shuttleworth noted. “It's important to temper expectations and understand exactly what this transition entails and how it fits into the long-term road map of Ethereum.”
Six challenges
The ConsenSys report said there are six key challenges for institutions looking to enter the Ethereum ecosystem: security, pre-trade compliance, access, monitoring, reporting and research.
Institutions of all shapes and sizes must consider risk management when engaging with web3 both directly and indirectly, Shuttleworth said. Additionally, institutions must track risks and have the depth and breadth required to engage with decentralized finance pools' transfers and transactions, he added.
Oftentimes, institutions also execute trades from the walled garden of their custodian, Shuttleworth noted. “As institutions leave these walled gardens, they will need to ensure that they are able to track their assets, yields, attribution of annual percentage yields (APY) and risk management around their positions.”
Institutions need to better understand and filter the nuances and opportunities within the DeFi ecosystem, Shuttleworth said. “In order for institutions to safely and effectively engage with DeFi, it is crucial that each of the six challenges above are addressed and investment processes are made secure, compliant and efficient.”
In the long term, the Merge is just the first step in solving Ethereum's scalability issues and creating a more efficient system.
“In the eyes of the financial institutions, the open finance world experiment has succeeded and now they need to find a way to embrace it and make it compliant with the traditional financial world they transact in,” Andrikogiannopoulos said.
Ethereum transaction fees will still be relatively high in comparison to competing layer-1 blockchain networks, Shuttleworth said. Many of the solutions to these bumps will be addressed later on, and an instant fix for these problems isn't on the near horizon.
“It is important to remember that the Merge is just one of many upcoming improvements to Ethereum and will serve as the foundational layer for what's to come,” Shuttleworth said.