20th May 2022 > > The Merge again.

tl;dr

Tom Head gives us the lowdown on the Merge, so I get a day off.

Market Snap (at time of writing)

Market Wrap

I think I saw a reference that analysts at J.P. Morgan think we have reached the wides for US treasuries, which seems a bold call as inflation hurtles furiously into double figures. I guess what they are saying is that a long and deep recession is almost upon us.

We haven’t seen one of those for a while, the last one officially ending in the US in June 2009, just 6 months after the first BTC block was mined. I am not convinced a recession will be positive for crypto prices.

Occasional Series – The Milk Road

The Milk Road daily newsletter is just so much more entertaining than my scribbling.

This cartoon has been shamelessly stolen from them:

If you want more fun than I can give you, check it out:

https://www.milkroad.com/subscribe?ref=o5CmCFhBAK

ht Susan from Dr. Chloe’s very excellent Crypto Chitter Chatter WhatsApp group. If you want to be involved let me know and I will ask Chloe very politely if you can join us.

Curious Cryptos’ Commentary – The Merge

On the 17th March 2022 we had a brief look at the Merge and sharding, and the potential timescales for both events.

In response Tom Head, founder of crypto research and insights company https://www.comparative-linguistics.com/ and long-standing supporter of the CCC, sent me this podcast:

https://open.spotify.com/episode/7DSzHIgvPsPEj4Y2jxke0S?si=Xo_7sKZpTnGNreTU93jn6Q&nd=1

I don’t know about you, but my heart sinks when I see something is going to run for 1 hour and 39 minutes. Lacking the patience to listen for myself, I made the obvious decision to ask Tom to do it for me, and to summarise the creator’s thinking.

Over to you Tom:

The podcast is titled: Betting the fund on the merge and it's the thesis of Hal Press from North Rock Digital

Headline: The merge represents the best opportunity in crypto for significant upside and is currently not priced in.

Background: This guy Hal Press comes across as an intelligent seasoned investor. I don't know his track record, but he has thought a lot about the ETH merge potential and has some very interesting ways to look at it.

The Merge Opportunity Thesis

As has been written about within the CCC emails recently the merge is going to change Ethereum from proof of work (like Bitcoin) to proof of stake. This means that the network is going to be secured by people holding ETH who stake and then become validators (they check and approve blocks and get rewarded in ETH for doing so). If you're interested you need 32 ETH to run a staking pool yourself, if you don't have 32 ETH you can join an existing pool on Lido, Rocketpool, Stakewise, or others.

Hal has been sitting on the open Ethereum developer calls, which anyone can listen into, and using those to not only understand where the merge is at but also the type of culture and decision making that is within Ethereum. His view is that the Ethereum environment is very positive and promotes a longer term view for the greater good of the network which is a plus for him. He also thinks we are very close to the final tests being complete on the merge and a possible go live date would be August this year.

The core of his thesis is based around supply and demand: Currently Ethereum issues around 4m ETH each year to miners, which could be thought of as its expenses if it were a company. This is because there is sell pressure on miners due to the fact they need cashflow to keep their mining businesses going. So, they must sell some (or all) of the ETH that they are rewarded for validating blocks. When Ethereum moves to proof of stake the holders of ETH who decide to stake then get the rewards for validating blocks. If you believe that holders of ETH who stake are less likely to sell than miners (who are running a business) then the sell pressure drops and that could be significant for creating upward price movement.

To put it another way Ethereum is in a state of equilibrium right now, yes the price goes up and down but essentially we have constant flows of buyers and sellers. And if you remove a portion of the sellers but keep the same number of buyers then the price will appreciate.

This is alongside EIP 1559, an update that burns part of the gas fees each time there's a transaction, which hopes to make Ethereum a deflationary asset.

Currently there is about a 10% staking rate - that is around 10% of all Ethereum holders stake their ETH. You get around 4.8% for staking right now but post merge that should be 7% plus.

The staking rate is seemingly quite low because there's so much other stuff going on that you can use your ETH for - there is high utility across the whole ecosystem. Yields, lending, borrowing, NFTs etc. And any other application that uses ETH or any pairs that are bound to ETH.

Price narratives: Crypto has themes or narratives that drive cycles within cycles. His view is the price is the leading indicator and narratives follow. We essentially create a narrative to fit the price action. And with the sell pressure removed due to the move to proof of stake a very compelling merge narrative will play out with lots of people ploughing their money in.

There is more in the podcast, but you could summarise it as:

· Decreased sell pressure - moving to proof of stake.

· Increase buy pressure - attractive staking rewards and deflationary asset.

He is going to trade this in the following way:

1. Long ETH - Buy and hold ETH.

2. Buy staking tokens - Lido (LDO), Rocketpool (RPL), Stakewise (SWISE).

3. ETH upside calls - due to the fact they are not pricing in any event risk around the Merge - December £5k strike, $8k call spread - can be purchased for $70 and pays out 41x return if ETH closes above $8k before the end of the year.

I think it's a compelling case, but my questions and concerns are as follows:

If you remove the sell pressure from miners, then I get that it creates price movement upward if the number of buyers stays the same. But if the total miner rewards per year are 4m ETH that equates to $8B (at $2k per ETH). The daily volume on Ethereum is $14.1B according to Coinbase. So, will removing this have much of an effect on the sell pressure?

Secondly there is the macro environment and of course that could have a big impact, however nobody really knows what's going to happen there. The main question would be is there enough capital that could flow into Ethereum to create a significant price movement, and would that signal the end of the bear market, or would ETH move away and flip Bitcoin?

…

More of Tom’s work can be seen here, as the host of a weekly youtube show:

https://www.youtube.com/watch?v=6ibnkDzrch4&t=621s