What investors need to know about ‘Dencun,’ Ethereum’s next big tech upgrade

Published Tue, Mar 12 20244:42 PM EDT

Ethereum is on its way to being a faster and cheaper network to use. The widely anticipated technological upgrade, dubbed "Dencun," is scheduled to take place Wednesday, and is meant to increase efficiency and reduce network fees for users of Ethereum – particularly traders who use decentralized finance (DeFi) protocols. In the long-term, the upgrade and any that follow it should make the price of ether more attractive, but short-term traders should consider a potential lull or pullback in the weeks ahead. "Following previous upgrades, ETH price action is rather weak (outright and versus BTC) for the first 30 days before turning more positive," Citi analyst Alex Saunders said in a recent note. "ETH has rallied into the day of the upgrade … followed by 30 days of subdued price action and then a rally (topping out above 25% in the median case) in the ensuing 20 days." Relative to bitcoin , the initial price action following the upgrade is even weaker historically, with ether underperforming 80% of the time in the first 20 days, Saunders added. "Past upgrades … saw buying pressure leading up to the event and sell-the-news profit-taking shortly afterward, leading prices to drop in the short-term before resuming upward momentum not long after," said Philipp Zentner, CEO at crypto infrastructure protocol LI.FI. The price of ether has gained 16% in the past week and 50% in the past month, according to Coin Metrics. On Monday it briefly topped $4,000 for the first time since December 2021. Saunders warned, however, that the trading environment for crypto is different today than it was during previous Ethereum network upgrades. That's largely thanks to a strong setup for the crypto market's flagship asset, bitcoin – particularly the introduction of spot bitcoin ETFs in the U.S., which is serving pent-up demand from institutional investors and bracing for an expected supply shock following the upcoming Bitcoin halving in April. Plus, leverage in the crypto market is through the roof as of late. Additionally, investors are watching the Securities and Exchange Commission, which is expected to approve or deny the trading of the first spot ether ETFs in the U.S. in May. The scalability problem Dencun follows the "Shapella" upgrade from almost a year ago, which allowed investors to withdraw their staked ether from the network for the first time. There also was the 2022 "Merge," which transitioned Ethereum from a proof-of-work to a proof-of-stake protocol, making it more environmentally friendly. This upgrade is focused on the longer-term goal of enhancing Ethereum's ability to handle more activity and transactions as the network grows. "One of the most anticipated features of the new upgrade is the introduction of 'proto-danksharding … a process which aims to increase transaction throughput and scalability, in addition to dramatically cutting transaction costs by deleting data blocks after a certain time period instead of storing them indefinitely," Duncan Ash, head of strategy at Coincover, explained. "This will reduce costs for layer 2 blockchains, which will likely trickle down to users in the form of lower fees," he added. That would "increase Ethereum's attractiveness as an investment" and cause its price to climb. Layer 2 blockchains – such as Polygon , Arbitrum or Optimism – are secondary layers that do the heavy lifting of processing transactions and keep costs low for the base layer, or Layer 1 networks. Layer 1 blockchains, like Ethereum or Bitcoin, provide the basic infrastructure and security. "Given the Ethereum network's role as a host for many decentralized applications, its scalability is crucial to … DeFi's technological development and, therefore, to garnering a larger, more sustainable user base," Saunders said. "The Dencun upgrade serves as an important step in addressing this congestion, which hurts users and developers alike." —CNBC's Michael Bloom contributed reporting.