Sell the Ethereum Merge

I don’t usually make short-term prognostications about asset prices. But occasionally financial markets lob a fat pitch.

Well-followed traders of digital assets, such as Arthur Hayes, Marc Cuban and Travis Kling, have made very public statements (e.g. here, here, and here) about how bullish the upcoming Ethereum Merge will be for the price of ETH.

I think the opposite is more likely.

The most-anticipated event in digital Assets… ever

If you’re reading this article, you’ve probably heard of the Ethereum Merge. It might be the best-telegraphed technical event in the modern history of digital assets (i.e. since the invention of Bitcoin). It’s so anticipated because:

Ether is the second-largest digital asset as measured by network value.

It is a major change to the network, with significant attendant execution risks

It has been delayed so many times that market participants have had years to analyze it.

People tend to get excited about the prospects of these sorts of widely anticipated developments and think they will usher in price gains. But such occurrences tend to be “sell the news” events.

Prior events like this include the launch of bitcoin futures on regulated U.S. exchanges, and the approval of the first bitcoin futures ETF (exchange-traded fund). Besides the fact that these events marked long-term peaks in the dollar price of Bitcoin and the prices of digital assets in general, they were widely anticipated.

But these watershed events in the development of the Bitcoin market also represented changes in the structure of the market for the asset they represented. In the case of Bitcoin futures and Bitcoin futures ETFs, a new tool was introduced for selling Bitcoin without purchasing the underlying spot asset.

The Ethereum Merge represents a similar dynamic because it changes the structure of the markets for digital assets.

Supply shock

Investors and speculators in digital assets (yes, most digital assets are pure speculations), have a number of consensus mechanisms from which to choose. But the largest by far in terms of market capitalization (and, in my opinion, the most secure) is proof of work.

Today, proof of work secures perhaps three-quarters of the market capitalization or network value of all digital assets in existence. (While this measure for asset value is imperfect, it should suffice for this analysis).

But if Ethereum switches to proof of stake, then roughly a fifth of the total network value of proof-of-work digital assets will change to proof-of-stake digital assets.

Don’t get me wrong – BTC and ETH are very different beasts. To me, ETH is no more a substitute for BTC than Facebook stock is a substitute for gold. They are both assets, but they are very different.

However, it would be naive to assume that there isn’t a large contingent of participants in the markets for digital assets who see some similarities between BTC and ETH that effectively make them partial substitutes in the portfolios of those investors/speculators.

But ether changing to proof of stake will reduce ETH’s similarity to (and substitutability for) BTC, while simultaneously increasing its similarity to (and substitutability for) various major proof-of-stake assets such as Cardano, Solana, Tron, Avalanche, Algorand and others.

So the Merge will amount to a decrease in total supply of proof-of-work assets and an increase in supply for proof-of-stake assets. All else equal, a reduction in supply for proof-of-work assets implies an increase in the price of the remaining proof-of-work assets (primarily bitcoin) and an increase in the supply of proof-of-stake assets implies a decrease in the price of proof-of-stake assets. Based on current capitalization, the biggest proof of stake asset will be ether.

Heads you lose, tails you lose

The Merge has two possible outcomes: Either it works or it doesn’t. If the merge doesn’t work, that seems unlikely to be good for the price of ether. But if it does work, that also seems unlikely to be good for the price of ETH because a proof-of-stake-based ETH will now directly compete for investor/speculator market share against the panoply of other major proof-of-stake-based digital assets.

I have no idea whether the dollar price of ether will go up or down between now and when the Merge happens. And I have no idea whether the Merge will happen at all, considering that it’s been delayed for so many years. But if I read the news one day and it says the Merge has happened, I expect that news to be sellable.


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