Last update, we had just witnessed one aggressive liquidation cascade caused by the Terra/UST collapse, to soon be followed by a second, equally aggressive move lower as 3 Arrows Capital imploded as a secondary result. Now “The Merge is here” and I’m not sure the hype is unwarranted.
At the root level, the change from Proof of Work (Pow) to Proof of Stake should make Ethereum simultaneously more secure AND more efficient. There has been hours of blogs written on the upcoming impacts so I won’t try to summarize other than to say go check Hal Press’s excellent post and recent follow up on the subject, plus Justin Drake discussing the Merge on the Defiant.
But what does the merge mean for the market in general?
The most significant effect of the change from PoW to PoS is the potential for the staking rewards for ETH2.0 to essentially create a risk-free rate for the crypto markets. As the second largest blockchain by market cap (soon to be largest?) and the leader in other important metrics like developer activity, total value locked, and user adoption by number of wallets, Ethereum is well established.
“As long as Ethereum continues to offer the highest quality block space it will likely capture the majority of high value transactions.” — @NorthRockLP https://link.medium.com/i1EYhfXmzsb
Most importantly, the staking yield provided by the merge stands out amongst other chains when viewed in real terms. The efficiency gains in a PoS model for ETH are so significant that after accounting for gas/fee burn, Ethereum will likely be a deflationary asset, potentially creating a real yield of over 5%. (For more on this, see the above linked post from Hal Press). As the below chart from staked.com shows, this compares favorably against other large layer 1 chains:
Setting a benchmark interest rate for DeFi provides the market a new way to price risk and creates a benchmark for other protocols. It may even bring in new money from institutions with yield requirements that are currently sidelined by the volatile, or even negative, real yields from other chains.
It’s always interesting to see how predictions play out, and last post I went over BTC, ETHBTC and DXY. ETHBTC has respected it’s long term range while BTC and DXY have continued their trends as the Fed continues to combat consistently strong inflation.
BTC is sitting right at the December 2017 high.
DXY pulled back for a brief period after hitting the January 2017 high, but ripped through resistance and took out the high set back in October 2002. Eventually the trend should pause as the global demand for dollars (or, rather, squeeze) starts to fade, but as long as the dollar and US yields are bid, and financial conditions continue to tighten in the US, BTC will have challenges going forward.
Finally, something fun to think about. Coinbase staked ETH (cbETH) and Lido staked ETH (stETH), are trading at a discount to ETH, while RocketPool’s version (rETH) has traded at a consistent premium to ETH over the last few weeks. Once Beacon chain staking withdrawals are enabled, all three should converge to 1.00, provided no other frictions are present. However, the mechanics of each of the three tokens provides some insights for the current differences. From Galaxy Research:
“Since Coinbase’s launch of its liquid staking derivative ETH token (cbETH) several weeks ago, cbETH has widened its discount to ETH, now trading nearly 10% below ETHUSD. While stETH operates on a rebase model, where tokens held or staked at participating venues have their supplies adjusted upwards on a daily basis to account for reward accrual, cbETH follows an accrual model pioneered by Compound in which each cbETH token represents a claim on underlying principal + rewards - slashing/penalties, such that cbETH supply held does not alter but instead represents a claim on growing collateral. This is like rETH’s value accrual method where, as each rETH token represents a claim on a growing amount of collateral, cTokens with value accrual should should trade as a premium to the tracked asset (i.e., ETH), yet, Coinbase’s cbETH trades at a significant discount while rETH trades at a premium. This dynamic is likely due to the simplicity of redeeming rETH vs. cbETH, with the latter requiring KYC and account signup at Coinbase. Another reason for the cbETH dicsount, which we discussed in a prior newsletter, is that Coinbase’s larger regulatory footprint increases cbETH’s counterparty risk profile.”
