Dear Investors,
A historic event is coming later this year that could provide a positive catalyst similar to the Bitcoin halving events, which have historically determined crypto’s 4-year cycles.
Ethereum will be the first crypto asset ever to switch consensus mechanisms from Proof-of-Work (PoW) to Proof-of-Stake (PoS).
In the process, ETH is expected to switch from a structural supply asset to a structural demand asset.
Oh, and ETH will be reducing its energy usage by ~99.95%.
Supply / Demand TL;DR:
At a distinct moment in time (likely September / October ‘22) The Merge will forever shift the supply/demand dynamics for Ether…
Structural sell pressure (miners selling their ETH issuance) will be reduced by ~90%
Structural buy pressure (users buying back ETH spent to utilize the network) will likely remain steady / grow with the network
Recurring discretionary buy pressure (DCA investors/users making automated, indiscriminate purchases) will likely remain steady
Non-recurring discretionary buy pressure (new investors attracted by ETH staking rewards, institutions attracted by the improved ESG narrative, etc.) may increase while the bulk of discretionary sell pressure may be behind us after Q2’s wave of forced deleveraging (3AC, Celsius, Voyager, etc.).
Rather than requiring millions of dollars of new money flowing in on a daily basis to maintain current prices, massive outflows from current holders would be required every day just to keep the price of ETH from going up.
Structural Supply
Pre Merge…
ETH PoW miners are rewarded ~14k tokens/day (~$15m USD/day) for securing the network.
Annualized, the inflation rate of PoW Ether is ~4%. For reference, BTC’s is currently 1.7%, and gold’s is 4.6%
As IRL businesses, miners have to sell the majority of this ETH to cover their USD denominated expenses (ie. hardware, rent, energy, etc.). On average, it is estimated that miners sell 80-90% of the issuance that they receive.
PoW Miners = Structural Sellers
Assuming they sell 80% on average would = ~$12m sell pressure/day that needs to consistently be offset by an equal or greater amount of buy pressure in order for the price of ETH to remain stable or rise.
Post Merge…
ETH issuance will be reduced by ~90%. 100% of issuance will flow to stakers, who have significantly lower fiat-denominated expenses (motivation to sell) associated with each unit of network security that they provide relative to PoW miners.
At equilibrium, gross issuance may only be reduced by ~70-80% as staking participation is likely to continue increasing from today’s ~10%…
However, given that…
a) stakers will likely sell closer to 10% of their rewards on average (vs 80% for PoW miners)
b) staked ETH and all accrued ETH issuance will remain illiquid for another ~6 months after the merge
…I believe it’s fair to anticipate a 90%+ reduction in structural sell pressure in the months following the merge, despite gross issuance increasing slightly from increased staking participation.
Structural Demand
ETH’s high fees can be thought of as a source of structural demand as users need to periodically buy back a comparable amount of ETH in order to continue using the network (Gaming, NFTs, DeFi, etc.) / maintain their ETH allocation.
Due to EIP-1559, 70% of fees are burned and forever removed from the float (currently ~$3m/day) - this can be thought of as an automated stock buyback.
As use-cases for ETH continue to expand and adoption grows, so too will structural demand.
ESG Narrative
While I believe that the ESG concerns around Bitcoin’s use of PoW may be overblown - ETH dropping its energy usage by ~99.95% post merge will likely attract ESG-minded institutional investors.
Timeline
Yesterday, Ethereum completed the second of three major tests of The Merge - the Sepolia testnet merge.
Goerli - the third and final testnet - is expected to be merged in mid August. Assuming that test run also goes smoothly, The Merge would likely be slated for late September / early October.
Conclusion
There is still plenty that needs to go right. However, the success of the Ropsten test merge in June and Sepolia test merge yesterday have provided confidence that ETH’s long awaited switch to PoS is within reach.
When it happens, it should be like an athlete removing a heavy weight vest for the first time.
Cheers,
Mac
DISCLAIMER: I hold ETH. Investing in digital assets is extremely risky. Personal opinions only - NFA.