During these last few weeks, interest in investing in cryptocurrencies has been reborn again. Specifically, the token Ethereum It has risen three times more than bitcoin since mid-June, skyrocketing its value by 85%. This could have something to do with the fact that the network is eliminating mining entirely on September 12, moving from a proof-of-work (PoW) to a proof-of-stake (PoS) blockchain. The event dubbed The Merge (or "the merger" in Spanish) will be one of the largest ever seen in the cryptocurrency sector, but we are all asking the same question... What effect will it have on the price of investing in cryptocurrencies?
What exactly is Merge?
Ethereum currently uses a proof-of-work (PoW) system, in which miners compete to solve complex cryptographic puzzles to secure the network and add transaction blocks to the blockchain. As a reward for solving each puzzle, the winning miner takes the newly mined ETH, which is added to the total coin supply. Miners also generate profits from transaction fees for each block they mine.
Differences between PoW and PoS. Source: Blockgeeks
But this is going to change with the Merge, when Ethereum is expected to become a PoS blockchain. When the upgrade is complete, the Ethereum PoS Beacon Chain will merge with the current PoW chain. Miners will be replaced by “validators,” who will confirm transaction blocks based on the amount of ETH they have locked in Ethereum. That is, the amount they put up as collateral will define how much ETH they earn for the privilege.
Why the merger could help the price of ether?✅
1. PoS will limit the supply of ETH
Miners have large costs to maintain (electricity and equipment), which they cover by exchanging part of the ETH they earn into fiat currencies. This is not the case for validators, who simply stake their investment in cryptocurrencies to generate rewards. In other words, they don't need as much ETH as miners to make profits, meaning they create ETH more slowly and keep the supply lower for longer. Add in the fact that validators are less likely to sell their ETH to pay their bills, and the PoS model should see less downward pressure on the price of cryptocurrency investment.
Deflationary projection of ETH after the Merge. Source: Finbold
2. US institutional investors will be able to participate
Coinbase recently launched Coinbase Prime, an institutional custody platform that allows US-based hedge funds and asset managers to lock in their cryptocurrency investment and generate passive income. And because it is protected by a regulated company, they will be better able to address the compliance challenges of securing and storing the tokens themselves. This should encourage more major US investors to buy and hold their investment in cryptocurrencies, which could give a big boost to its price. One of the big deals they have made is with the investment fund Blackrock (BLK), which catapulted the price of Coinbase (COIN) shares by 40% in one day.
3. Proof-of-stake is a greener alternative♻️
It is no secret that mining uses large amounts of electricity, which can be a major deterrent to large institutional investors with mandates requiring them to hold green investments. But PoS should use about 99% less electricity than PoW, so it stands to reason that more institutional investors will be willing to make their cryptocurrency investment in ETH as a result.
Comparison of electricity consumption between Bitcoin, Ethereum PoW and Ethereum PoS. Source: Ethereum Foundation Blog
Why the merger could hinder the price of ether?❌
1. The merger could be a “buy the rumor and sell the news” event
Cryptocurrency investment prices tend to rise before a big event as investors jump on the bandwagon, only to have the price drop sharply when the event occurs and they close positions. We have seen this exact scenario on several occasions recently, such as when CME Group announced the launch of bitcoin futures products in 2017 or Coinbase listed on the US stock market in 2021.
The launch of BTC futures on the CME Group could have been the catalyst for the big drop. Source: CryptoFXStreet
In other words, investors may not be interested in whether the merger will be positive or negative for the price of ether. They are simply interested in the fact that there is a major event that moves the market. So if a significant portion of these investors sell when the merger hits, all previous gains in ETH could disappear in one fell swoop.
2. There are signs that enthusiasm for the merger is reaching its peak
Ethereum activity has skyrocketed recently, with transactions from Ethereum wallet addresses growing 75% on July 26 from the previous day. It's not clear what exactly caused this (the enthusiasm for the merge might have something to do with it), but that's almost irrelevant. The thing is, we have seen similar spikes in the past, and they have almost always represented a spike in the price of ETH. Therefore, if history is anything to go by, the price of ETH must take a turn sooner or later.
The largest spikes in activity in Ethereum wallet addresses (blue) have preceded large drops in the price of ETH (gray). Source: Glassnode.
3. Ethereum miners might not turn off their machines
The original PoW blockchain will not instantly cease to exist when the merger occurs. So to discourage miners from using it, what is known as a “difficulty bomb” has been written into the code, which makes mining puzzles so complicated that it would not be profitable to continue using the blockchain.
Explaining the 2016 hard fork where Ethereum Classic (ETC) was born. Source: Trading Education.
But in theory, miners could continue mining on it anyway, meaning Ethereum “forks” into two separate chains. And since forks create a lot of uncertainty, this could weigh on the price of ETH. An example: Ethereum forked into two separate blockchains (Ethereum and Ethereum Classic) in July 2016, and the price of ETH rose in the lead-up to the event. However, it took a while for Ethereum to become the dominant blockchain after the fork, and the price of ETH trended lower in the meantime.
So, will Merge drive crypto investment towards ETH?
Assuming things go as planned, Ethereum's move to PoS could be a major driver for ETH's price in the long term. But things are less clear in the short term. If it is true that the price of ETH could rise even further as we get closer to the September merger, it could stall or investors could lose faith completely.
In any case, the price of ETH has been on such an uproar that now is probably not the best time to go all in. The most sensible thing would be to follow the strategy we tried of averaging our inflows, investing in ETH periodically with small portions of our cryptocurrency investment. This way, we could still have some advantages if this rally has more gas in the tank, but we won't be over-invested if it blows up closer to the event.