Will The Transition To Proof-Of-Stake Help Or Hinder Ether’s Price?

Will The Transition To Proof-Of-Stake Help Or Hinder Ether’s Price?
Jonathan Hobbs, CFA

over 1 year ago5 mins

  • Ethereum’s transition to a proof-of-stake blockchain is expected to happen on September 12th, meaning the blockchain will be run by validators instead of miners.

  • The move will limit the supply of ether, as well as make it easier and more appealing for institutional investors to buy in.

  • In the long run, the merge could boost the price of ether. But its price right now may be factoring in a fair amount of hype.

Ethereum’s transition to a proof-of-stake blockchain is expected to happen on September 12th, meaning the blockchain will be run by validators instead of miners.

The move will limit the supply of ether, as well as make it easier and more appealing for institutional investors to buy in.

In the long run, the merge could boost the price of ether. But its price right now may be factoring in a fair amount of hype.

Ether has rallied three times as much as bitcoin since mid-June, shooting up 85% in value. That might have something to do with the fact that the network is doing away with mining altogether on September 12th, going from a proof-of-work (PoW) blockchain to a proof-of-stake (PoS) one. The event – dubbed “the merge” – will be one of the biggest ever seen in crypto, but a big question remains: what effect will it have on the cryptocurrency’s price?

What is the merge exactly?

Ethereum currently uses a proof-of-work (PoW) system, where miners compete to solve complex cryptographic puzzles to secure the network and attach blocks of transactions to the blockchain. As a reward for solving each puzzle, the victorious miner wins freshly minted ether, which are then added to the total coin supply. Miners also earn transaction fees for each block they mine.

But that’s set to change come the merge, when Ethereum is expected to become a PoS blockchain. At that point, Ethereum’s PoS “Beacon Chain” – a kind of initial testing ground for PoS – will merge with the current PoW chain. Miners will then be replaced with “validators”, who will confirm transaction blocks depending on how much ether they “stake” – that is, how much they put up as collateral – and earn ether for the privilege.

Why might the merge help ether’s price?

1. PoS will limit ether’s supply.

Miners have huge costs in the form of electricity and equipment, which they cover by exchanging some of the ether they earn into fiat currencies. That’s not the case for validators, who simply stake their ether to earn rewards. In other words, they don’t need as much ether as miners do to turn a profit, meaning they create ether more slowly and keep supply lower for longer. Throw in the fact that validators are less likely to sell their ether to pay their bills, and the PoS model should see less downside pressure on the crypto’s price.

2. US institutional investors will be able to get involved.

Coinbase's institutional custody platform, Coinbase Prime, are now allowing US-based hedge funds and asset managers to stake ether and earn passive income. And since it’s safeguarded by a regulated company, they’ll better be able to navigate the compliance-related challenges of securing and storing ether themselves. That should encourage more major US investors to buy and hold ether, which could give its price a serious boost.

3. Proof-of-stake is a greener alternative.

It’s no secret that mining uses obscene amounts of electricity, which can be a big deterrent for large institutional investors with mandates that require them to hold green investments. But PoS should use around 99% less electricity than PoW, so it stands to reason that more institutional investors will be keen to buy, hold, and stake ether as a result.

Why might the merge hinder ether’s price?

1. The merge could be a “buy the rumor, sell the news” event.

Crypto prices tend to rally before a big event as traders board the bandwagon, only to drop hard when the event plays out and they take their profit. We’ve seen this exact scenario play out a few times recently – most notably when CME Group announced the launch of bitcoin futures products in 2017, and when Coinbase listed on the US stock market in 2021.

In other words, investors might not actually be interested in whether the merge will be positive or negative for ether’s price. Instead, they’re interested simply in the fact that there’s a major market-moving event at all. So if a significant portion of these investors sell up when the merge arrives, all ether’s prior gains could be wiped out in one fell swoop.

2. There are signs merge excitement is peaking.

Ethereum activity has jumped recently, with transactions from Ethereum wallet addresses rising 75% on July 26th from the day before. It’s not clear exactly what brought this about (excitement around the merge might have had something to do with it), but that’s almost beside the point. The point is that we’ve seen similar spikes in the past, and they’ve almost always represented a peak in ether’s price. So if history is anything to go by, ether’s price is due a turnaround sooner or later.

Major spikes in Ethereum wallet addresses activity (blue) have preceded big drops in the ether price (gray). Source: Glassnode.
Major spikes in Ethereum wallet addresses activity (blue) have preceded big drops in the ether price (gray). Source: Glassnode.

3. Ethereum miners might not switch off their machines.

The original PoW blockchain won’t instantly cease to exist when the merge occurs. So to deter miners from using it, what’s known as a “difficulty bomb” has been written into the code, making the mining puzzles so tricky that it wouldn’t be profitable to keep using the blockchain.

But miners could theoretically keep mining on it anyway, meaning Ethereum would effectively be “forked” into two separate chains. And since forks create a lot of uncertainty, it could weigh on ether’s price. Case in point: Ethereum forked into two separate blockchains – Ethereum and Ethereum Classic (ETC) – back in July 2016, with ether’s price climbing in the run-up to the event. But it took a while for Ethereum to emerge as the dominant blockchain after the fork, and ether’s price trended downward in the meantime.

So will the merge help or hinder ether’s price?

Assuming things go to plan, Ethereum’s move to PoS could be a major driver for ether’s price in the long term. But things are less clear in the short term: ether could climb even higher as we draw closer to the September merge, it could stall, or investors could lose faith altogether.

In any case, ether’s price has been on such a rampage that now probably isn’t the best time to go all in. The wiser move would be to stick with the tried-and-tested strategy of dollar-cost averaging, investing in ether periodically with smaller chunks of your total investment. That way, you might still get some upside if this rally has more gas in the tank, but you won’t be over-invested if it blows up closer to the event.

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