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Has the Onset of the ETH Merge Driven Institutional Adoption of Ether?
October 26, 2022

With the ETH Merge almost a month in the rearview mirror, the real questions emerging are about the institutional adoption of Ether. Will it happen? What was their perspective before and has anything changed?

To be clear, it is too early to tell if there has been an injection of funds into the ETH ecosystem. ETH miners selling, macroeconomic chaos, and a volatile market make it difficult to discern what has happened. However, there are many reasons to expect it, and that’s what we’re going to outline today.

The 99.95% decrease in network energy consumption is a start, and other economic factors like staking rewards and negligible supply inflation will also make ETH more attractive to these investors. Most of all, there is a clear change in motivations in the sector that will help give crypto a much-needed makeover.

Speculation was the first step function of usage for Ethereum, and DeFi was the second. With the lowering of fees post-merge, we expect to see another step function in transaction volume that will increase usage by a significant amount.

The ESG Barrier is Gone

The last five years brought the rise of ESG (environmental, social, and governance) standards in investing. This is when investment funds use socially conscious values to filter their investments. Social and governance aspects are focused around how employee compensation, management compensation, and other internal controls work, and it is the environmental aspect that is relevant to the Ethereum network.

Most institutional investors don’t understand the intricacies of crypto technology, but they do know there is reputational risk from investing in Proof-of-Work assets. This changes that. There will always be investors who are skeptical of cryptocurrencies, but this does remove one major “con” in their eyes and attracts the marginal investor.

As Bank of America recently reported, funds that were previously prohibited from buying Proof-of-Work cryptocurrencies because of their investment mandate are now open to invest in Ethereum and protocols on the Ethereum network.

Increasingly, brokerage houses, robo-advisors, and mutual funds provide investment solutions that follow ESG principles. For these funds to maintain their ESG mandates and invest in cryptocurrency, they must avoid Proof-of-Work cryptocurrencies that use excessive amounts of energy.

More recently, there has been pushback against ESG mandates because of inefficiencies in disclosures that somehow oil giant ExxonMobil made the ESG approval list but Tesla didn’t. However, BlackRock, the largest investment manager in the world with over $8.5 trillion of assets under management, is still moving forward with ESG mandates at full speed.

Ethereum’s merge makes it ESG-friendly, and we’ll soon see if that means more money will be flowing into the network in the coming months.

The Right Kind of Investors

In order to succeed, crypto needs long-term investors who aren’t going to enter and exit on a whim. That’s where pension funds, insurance companies, and other big funds can make a huge difference to the sector, and why the ETH Merge is so important.

For a long time, crypto’s volatility problem has scared off potential investors, but a perceived change in the market could be what it takes to get the big money involved permanently. Fidelity Digital has already referred to the ETH merge as “the most significant development in the history of the Ethereum network”, which indicates positive sentiments.

Scaling of the network will be handled in future upgrades, like the aptly named “ETH Surge”, but with this highly technical upgrade underway, investors have more trust in the future of the network.

Macroeconomics play into this as well. With the Fed continuing to raise interest rates and the worldwide economy looking very precarious, there isn’t much “risk-on” money floating around right now. Knowing that, the effects of the merge may take a long time to manifest in the market while investors wait for the economy to recover.

Other Economic Factors of Interest

There are 2 other factors to consider in the future of ETH:

  1. Shrinking supply
  2. Staking rewards

Right now, ETH rewards are more than the amount being burned. However, this could change quickly, and the supply growth is around a 0.07% increase on an annualized basis right now. Investors love this because it is like there are built-in buybacks that will increase the value of their investment.

Staking rewards are an appealing aspect to the network, and investors love the proposition of being able to own more of the network over time. 5% returns look very appealing when combined with the prospect of capital appreciation that would initially draw in an investor. Below is a chart of the estimated ETH staking yields.

We think a floor of 4.5% yield is attractive for institutions given the risk-profile of staking & high yield compared to traditional assets.

These staking rewards can be a double-edged sword. It will take at least 6 months before sufficient upgrades have been done to the network to allow for withdrawals from the staking contract, and that could take up to 12 months.

Plus, there is some potential risk that staking ETH is treated like a bond because of the interest payments on it, but this risk remains small since you have to opt in to receive the interest.

Recent comments from SEC Chief Gary Gensler suggest this may be the case since it is then in a “gray zone” of the Howey Test.

The Merge May Represent a Strategic Win For Crypto

The big question now is whether the ETH Merge has changed the institutional perspective on ETH. We haven’t seen the money flow in just yet, but the optics of an ETH investment have improved considerably.

Even if you just look at the technical coordination required to facilitate this, the merge displays a lot of cohesion in the community. This is demonstrated in the participation rate shown below.
Maintaining a 98.5-99.5 participation rate almost immediately after the merge is perceived as being very important, given the logistical difficulties. This isn’t necessarily an improvement vs pre-merge status of the chain, but shows there hasn’t been post-merge issues that are hurting the chain.

Plus, a 99.95% reduction in energy consumption overnight is nothing to scoff at. With regulators threatening to go after cryptocurrency mining as scapegoats for the current energy crisis, this news innoculates Ethereum from future issues on this front.

This “wait and see” phase will end soon, but until then, these are the core narratives we’re watching to see how institutions react to the ETH Merge.

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