A Financial Advisor’s View of The Merge

The Merge is a really exciting time for those of us that are immersed in the decentralized finance space. As a financial advisor, I’m excited at the prospect of a proof-of-stake Ethereum, and all the scalability and security that may be developed as a result. I am keeping an eye on risks related to the implementation of The Merge, too, though. When investing in digital assets, as with most investing, there is always the possibility that an investor could lose some or all of their investment, and it’s important to always be mindful of the risks.

What most excites me about The Merge is that many of the changes will make ETH more investable to my mind and less speculative. When we look to invest, rather than speculate, in any asset, we carefully weigh the risks versus rewards. With the post-merge version of Ethereum it will be easier to do just that.

In this article, I’ll go over the potential upsides to The Merge as well as potential risks.  If you aren’t already familiar with The Merge, I recommend this explainer video from Finematics.

5 things that will make ETH more investable after The Merge

1. A new issuance policy could make ETH deflationary.

The new issuance policy of Ether, coupled with EIP1559, which took effect in mid-2021, can make Ether deflationary, or at least disinflationary.  

What does that mean?

It means that with each block processed, there will be less ETH created than the amount of ETH burned.  Therefore, we will consistently see the supply of ETH decreasing after The Merge.  This is significant from an investment perspective as the value is really based on supply and demand, and this tackles the supply side.

Before EIP1559, there was an unlimited supply of ETH to be created and rewarded.  It would have been difficult for demand to keep up with the supply.

Now, with some ETH being burned in each block, plus much less created, we see the supply lowering consistently.  All things being equal, a decreasing supply of an asset should increase the value.

2. It may be easier to value ETH more accurately.

This new monetary/issuance policy also makes possible more traditional valuation techniques like Discounted Cash flows. Since we will have a much better idea of the issuance and burning of ETH, we can forecast demand, and determine how much each ETH should be worth.

This issuance system and ability to better value ETH also sets it up to possibly decouple from bitcoin.  As we know, BTC and ETH have been very correlated in value recently, regardless of the fact the use cases for the networks, and the assets have different value and price structures.  This could be the moment that we finally start to see more cryptoassets priced in closer accordance to their value proposition, rather than through pure speculation.

We have already seen the growth in institutional interest in ETH lately. This is due in part to the interest in the use of the underlying network, but mainly to the upcoming Merge.

3. Energy consumption will be reduced after The Merge.

The Merge will reduce the energy necessary to run the Ethereum network by up to 99.95%.  This turns ETH into a very environmentally friendly investment, which is obviously popular.  It also clears the way for Ethereum to replace part of the current financial system.  Making a more secure, transparent, inclusive system, at a fraction of the energy outlay, will bring more players to the field.

4. Staking may become more lucrative.

One aspect of The Merge is that investors will be able to stake ETH, and earn interest in the form of staking rewards on their asset. Based on an investors assessment of the future value of ETH, that investor could earn even more ETH simply for holding and staking.  

5. The Merge could increase demand for Ethereum.

As an advisor, I’m also interested in what The Merge means to the future of Ethereum, and how that can impact the value. The value of ETH is based on the adoption of the Ethereum network, which is based on the development of useful applications.

The Merge, when successful, is the first step in the path that makes Ethereum more scalable and secure. That scalability will lead to more development, more adoption, and even more development. Since we spoke of the supply side earlier, here is where we discuss the demand side of the equation.  

The success of The Merge gives more direction to the developers, possibly increasing demand.  This demand can give investors better data from which to derive value based on traditional or even non-traditional methods. Increasing demand with decreasing supply should also result in a higher price.

I’ve mentioned also in this post, the ability to better derive a value for ETH turns it into more of an investment and less of a speculation. If investors can see usage, growth, decreasing supply, they can feel more comfortable with ETH occupying a different part of their portfolio.

Last topic for the impact of the The Merge on the growth of the Ethereum network, is to look at the potential of other tokens and protocols that operate mainly or fully on Ethereum.  When they feel more comfortable with the path of Ethereum, they will ramp up production and adoption. So the next phase after The Merge will be the scaling, lower fees, higher throughput, and all the tools, protocols, projects, and apps that go with it.

Risk factors during and after The Merge

As an advisor, I also need to be thinking about the risks of any investment. For this article, however, I will steer clear of subjects like custodial risk, private keys, etc., and focus on the value of ETH as an asset.

There could be problems with the implementation of The Merge itself

The first risk I’m considering is The Merge itself. When that moment comes to switch from the PoW chain to the PoS chain, what will happen? We know it has been tested on three testnets.  However, to make that switch with transactions running, and billions of dollars in value moving around, is a little unnerving.  

My biggest fear is that there is some decimal error and suddenly 1 million ETH are minted. Next is that there is some code that is exploitable and gives the ability to drain wallets, alter the chain, etc. Given this uncertainty, however small, investing in ETH up until The Merge does have some risk..

Long-term we haven’t seen a proof-of-stake blockchain operate at this scale

The next risk for me is the ongoing security and viability of Ethereum. Many of us have discussed the virtues of a proof-of-stake blockchain, and have even seen them operate on a much smaller scale. However, we haven’t seen a network the size of Ethereum, with the value locked, and the number of transactions, operate via PoS.  

There is a risk that the incentive mechanism can be gamed, or that it becomes just as centralized as the TradFi system, or even moreso. While we’ve tried to run through all the scenarios, we won’t really find out how resilient and secure the PoS network is until it starts running, and has billions of dollars locked.

We still don’t know how regulators are going to handle ETH

One last risk that is especially concerning as a financial advisor stems from the ability to now stake ETH. There is the worry that it is considered a security by the SEC in the US, and has to be delisted from major exchanges here. As of now, I see this as a remote possibility, but certainly more viable than pre-Merge.

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