- Ahead of a years-in-the-making upgrade to the ethereum blockchain, the token ether has been outperforming bitcoin in 2022 by a wide margin.
- The so-called merge will result in much more energy-efficient transactions.
- Some market experts say the real upside price momentum is set to come after the merge.
It's time for the "merge."
The years-in-the-making, systemwide upgrade to the ethereum blockchain is set to roll out on Wednesday, marking one of the crypto sector's most historic events to date. Leading up to the overhaul, investors have been jumping into ether, the native token to ethereum.
In the past three months, ether has jumped 32%, dramatically outperforming bitcoin, which has dropped 9%. While analysts say that anticipation around the merge has helped pump up the price, some experts see the real upside coming after the merge takes place.
"We believe post-merge the bull case for ethereum is going to be a lot stronger for a number of reasons," said Katie Talati, head of research at asset management firm Arca. The main factor, she says, is that supply is going to come way down, creating scarcity.
The hallmark of ethereum's big makeover is that it will take a lot less energy to verify transactions, which has long been a major problem for the crypto industry. The proof-of-stake model, which is replacing the proof-of-work model, requires validators on the network to put up their ether tokens, or "stake" them, essentially pulling them out of circulation for an extended period of time, in order to secure the network.
"For probably six to 12 months — there's no defined guidance yet from developers on ethereum — you will not be able to withdraw your ethereum once you've staked it to validate the network," Talati said.
Slashing energy consumption by more than 99% will also go a long way toward lowering the barrier to entry for institutional investors, who have been battling the optics of contributing to the climate crisis. The White House last week released a report warning that proof-of-work mining operations could get in the way of efforts to mitigate climate change.
Still, some skepticism has been creeping into the market.
Ether is down around 6% in the last 24 hours following the latest official read on inflation in the U.S., which punished risky assets on Tuesday and drove tech stocks to their worst day in over two years.
Whether to buy now or wait and see how the merge goes depends on an investor's time horizon for holding the coins, said Jaydeep Korde, CEO of ethereum infrastructure builder Launchnodes. Korde tells CNBC that traders who plan to sit on their stake for the long term — in the range of two to three years — should be in good shape.
"If you're looking in the shorter-term horizon in terms of trading, I think that it's much more volatile," Korde said. He cited global economic conditions, geopolitics and inflation as playing into the immediate risk.
"Ethereum will suffer the challenges of that volatility, like every other asset class," Korde said.
With the upgrade, ethereum won't become faster, cheaper or more scalable. One developer even told CNBC that if the user experience feels the same, that will be one sign that the merge was a total success.
The real investor draw is the slashing of energy usage, especially as bitcoin mining continues to face blowback for its growing power consumption.
Since its creation almost a decade ago, ether has — similar to bitcoin — been mined through a proof-of-work model. It involves complex math equations that massive numbers of machines race to solve, and it uses an abundance of energy.
The new proof-of-stake method requires users to leverage their existing cache of ether as a means to verify transactions and secure the network.
According to one estimate on the Ethereum Foundation's blog, the merge will result in a reduction of at least 99.95% in total energy use.
Bank of America said in a note on Sept. 9, that the significant reduction in energy consumption post-merge "may enable some institutional investors to purchase the token that were previously prohibited from purchasing tokens that run on blockchains leveraging proof of work (PoW) consensus mechanisms."
Institutional money is key to the maturation of digital assets. Research firm Fundstrat wrote in a note that a successful merge would cement ethereum as the "premier blockchain network."
Ethereum has set itself apart from rival chains, as more of an operating system for the industry. The vast majority of apps are built on top of ethereum, and the merge is the first in a series of planned upgrades that should ultimately result in faster and cheaper transactions.
The reduced supply of the cryptocurrency, which some investors say could be a boon to the price, is the result of a new verification model that replaces miners with "validators."
The rewards for validators are much smaller than those that went to proof-of-work miners, meaning that less ether will be minted as a result of this upgrade.
Additionally, as part of an upgrade that went into effect last August, the network is already "burning," or permanently destroying, a portion of the digital currency that would otherwise be recycled back into circulation.
Talati says that people may look back in three to six months and say, "That was the inflection point and the turning point for ethereum."
The bitcoin network experiences a similar type of supply reduction roughly every four years.
Bitcoin's production declines exponentially over time, thanks to something called "the halvening" or "the halving," when the size of the prize for miners is cut in half. The halving was built into bitcoin's code by its pseudonymous founder, Satoshi Nakamoto, as a way to stave off inflation of the cryptocurrency.
"Bitcoin can't issue any more shares," Fundstrat's Tom Lee previously told CNBC. "It doesn't do stock splits or dividends, so the only way to increase the network value of bitcoin is for the unit price to go up."
There have been three halvings of bitcoin, to date. The last one, in May 2020, preceded a steep rally that continued through late 2021, before the crypto "winter" began.
For ether, the website for Ultrasound Money has simulated the forthcoming supply changes. In its model, the annual issuance drops from 5.5 million tokens to 600,000 and estimates that the supply growth drops to 0.1% from 4.1%.
Regardless of the changing dynamics that come with the merge, the crypto market is likely to still be driven in part by a hefty dose of pure speculation and events that have nothing to do with the fundamentals of the tokens or blockchain networks.
The steep selloff this year — ether is down 56% even after the recent rally — is tied to rising interest rates and the Federal Reserve's effort to tamp down inflation.
Investors have been rotating out of risky assets, even those that are supposed to act as a hedge against inflation, so the merge may not immediately change investor sentiment.