Ethereum’s transition from Proof of Work (PoW) to Proof of Stake (PoS), more popularly known as The Merge, continues to dominate crypto narrative. The price for Ethereum’s ether, which had been on a tear in recent weeks, fell this morning. Like most things crypto, it is difficult to pinpoint an exact reason.
While Bitcoin’s price is influenced by global macroeconomic factors, the catalysts for ether’s price – at least in the current rally – are supposed to be related to the fundamentals of its network – user activity, network statistics, and, most importantly, its transition from an energy intensive consensus mechanism to one that slashes its energy consumption by slightly more than 99%.
Then, why did its price decline in the week that the Merge is supposed to happen?
Observers ascribe the development to a return of fear to the markets and unwinding of trades related to ether. The Merge is expected to occur later this week, meaning we might see a positive news bump if things go well. An expected interest rate hike from the Fed might also play into investor thinking for crypto markets and influence prices. In the end, though, these are all theories and it remains almost impossible to forecast ether’s price trajectory.
Staking Ether: A Good Trade?
An anticipated increase in the yields for Ethereum’s ether has resulted in a race among platforms to offer the cryptocurrency as a staking option. Put simply, staking is similar to a certificate of deposit i.e., locking up your cryptocurrency for a specified period of time in exchange for periodic or annual yields from the provider. According to one report, Binance – the world’s biggest crypto exchange by trading volume – is offering annualized yields for staking ether starting at 6%.
The activity currently yields between 3% to 4% at various services. For example, Coinbase offers 3.25% annual yield for staked ether while BlockFi will give you 4% on an annual basis. Of course, these yields depend on the amount of ether staked and the duration for which it is staked. For context, staking ether was supposed to have offered annual yields of 11.25% in January 2021, according to a report by Staked.us.
The catch here is that the staking period for the coins is undetermined. Most services are offering these staking services for the duration of Ethereum’s upgrade from PoW to PoS.
The time period for that event is not clear. The Merge will be followed by a Shanghai Upgrade that will make Ethereum scalable by partitioning databases used to store its transactions and enabling thin clients or nodes that do not store the full state relating to a transaction to participate in its network. The upgrade is expected to occur in the next “six to twelve months”.
The Trade’s Logistics
Is staking ether a good trade?
The answer to that question depends on your investment goals, timeframes, and risk tolerance. It is an uncertain trade in the near term because ether’s future yield is a function of its performance as a blockchain.
Based on cursory research, the cryptocurrency’s yield is determined by block rewards, miner extractable value (MEV), and user tips. The last two depend on user transactions on Ethereum’s blockchain.
For most of its short history, Ethereum has been infamous for its high gas fees. The fee amount will need to decline significantly for users to transact more on its platform. But the Merge is not expected to make a difference to its gas fees. It will also not solve the problem of congestion on Ethereum’s network and make it scalable to handle more transactions on its network.
About the only positive development that will occur immediately in the aftermath of The Merge is a reduction in ether supply. According to the Ethereum Improvement Proposal (EIP) 1559, a portion of gas fees will be burned to reduce supply, thereby reducing the amount of ether in circulation. A scarce asset can potentially become a profitable asset when demand for it is sustained or increases. But the only certainty for increased ether demand is staking because of the promised high yields. Staking itself could concentrate ownership and result in another risk to its platform.
The Existential Threat of Regulation
More than a decade after Bitcoin was introduced to the world, the regulatory uncertainty around crypto still looms as an existential threat. For staked ether, this uncertainty might presage questions about its status as a commodity. Crypto purists insist that Ethereum is decentralized enough to qualify as one. But the shift to PoS might sully their argument. Already, just four staking providers – decentralized platform Lido, Kraken, Coinbase, and Binance – control two-thirds of staked ethereum. If regulatory agencies come after them using the Howey Test, it might inflate staking costs and eat into the generous yields being offered at crypto platforms.