Ether Is Falling in Crypto Selloff. 2 Ways Ethereums Merge Could Boost Prices.

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Ethereum’s long-awaited Merge upgrade should be completed within days. Barron’s Advisor; Dreamtime (2)

The price of Ether the second-largest cryptocurrency after Bitcoinwas plunging on Tuesday amid a broad selloff that has hit both digital assets and stocks. But investors shouldn’t take their eyes off the most important factor on long-term prices: the Merge.

Heralded as one of the biggest events in crypto history, the long-anticipated Merge is a critical, fundamental upgrade to the Ethereum blockchain that underpins Ether. Set to complete around Sept. 15, the Merge is designed to make the network far more climate friendly and attract investors looking to earn yield on their crypto holdings.

Interest in Ether has boomed in the months running up to the Merge, with the token far outpacing gains in Bitcoin since a dramatic selloff rocked the crypto market in mid-June. But you wouldn’t have guessed it Tuesday, with Ether prices falling 7% to outpace Bitcoins 6% decline.

Investors were flocking out of risk-sensitive assets like cryptos and stocks, with the Dow Jones Industrial Average shedding more than 875 points, or 2.7%, by midday with the S&P 500 tumbling 3.1%.

To blame is consumer price index (CPI) data showing that inflationary pressures remain salient and likely to pressure the Federal Reserve to keep tightening financial conditions, which has already rocked markets and raised the risk of recession this year.

Nevertheless, with the Merge likely just days away, there remain two key reasons to believe the upgrade will be supportive of prices, according to Will Denyer, an analyst at Gavekal Research.

The first is that the Merge will cut the carbon footprint of Ethereum dramatically, which will make the crypto network far more attractive from an environmental, social, and governance (ESG) perspective

At the heart of the upgrade is a switch from the proof of work system that underpins Bitcoin as well as Ethereum in favor of a system known as proof of stake. In proof of work, crypto miners use computers to solve complex puzzles, securing the blockchain and validating transactions while expending vast amounts of energy.

In Ethereums new proof of stake system, validators will instead lock-up or stake their Ether while this process is completed, earning yield on the tokens used as collateral in the process. It is designed to be much less energy-intensive.

The shift to proof-of-stake and the resulting cut to energy consumption could attract flows from fiat currencies and/or Bitcoin, Denyer wrote in a note Tuesday. ESG-sensitive investors, particularly institutional investors, may dabble in cryptocurrencies for the first time, or shift allocations from the more energy-intensive Bitcoin.

That is not all. The Merge is also set to slash the issuance of new Ether tokens by removing proof of workminers were rewarded with tokens for their workand change the networks monetary policy, said Denyer. Following the Merge, gross issuance of the token will fall to about 0.5% from 4.6% annually.

On the face of it, less issuance should help boost Ethers price, assuming that demand holds up, the Gavekal analyst said, however noting that much of this may already be in the price, and the fall in net issuance post-Merge will be less than expected a few months ago.

In the short term, Denyer said the outlook for Ether demand is tough to call. While a successful upgrade should attract new users, the macro environmentwhich caused Ether to sink on Tuesdayremains tough for risk-sensitive assets including cryptos.

In the longer term, the new system looks like it should create some equilibrium in the supply of Ether, bringing it closer to stable money even as the token may continue to see significant price volatility in the medium-term, according to Gavekal.

Write to Jack Denton at [email protected]

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