The shift in ethereum from proof-of-work to proof-of-stake will take place in the second quarter of the year.In a new note, Matt Hougan, the CIO of crypto asset manager, Bitwise, breaks down the impact of “the merge”.He shares how it could bring 2 halvings in one as well as 12% returns.Last year, Matt Hougan, the chief investment officer of Bitwise Asset Management referred to ethereum’s London hard fork upgrade , also known as EIP-1559, as “one of the biggest crypto stories of this year.”
The upgrade made ether, ethereum’s native token, a deflationary asset, thanks to a certain percentage of tokens being pulled out of circulation through the “burning” of fees.
This upgrade has been just one step in ethereum’s transition from a proof-of-work to proof-of-stake consensus mechanism.It’s a change that’s set to reduce the network’s energy usage and make it more efficient and cheaper.
The next step in ethereum’s transition from proof-of-work to proof-of-stake is expected to take place in the second quarter of this year.
It’s known as “the merge”.It will be “a blink and you miss it event”, according to Simon Morris, the head of strategy at ConsenSys , the blockchain technology company founded by ethereum co-founder Joseph Lubin.
The event is simply a switch-over where the block production will be redirected from one source to another, Morris said in a recent interview .After the switch, ethereum will start using a proof-of-stake consensus mechanism and rely on the Beacon Chain, which has already been in production for over a year, he added.
Bitwise’s Hougan is just as bullish for “the merge” as he was for the hard fork, according to a new note.
Over the past year, as of February 28, one of Bitwise’s top performing funds was the single entity tracking ether’s price, returning 92% .
The firm’s flagship fund, which provides exposure to the 10 most highly valued crypto assets, has over $819 million under management and returned 0.90% in the past year .
Bitwise manages a total of $1.2 billion in assets as of March 31.
“The merge will fundamentally transform ethereum and its native coin ETH, making them (we believe) significantly more appealing to a wide swath of institutional investors,” Hougan said in an April 5 investor letter .
If the merge successfully takes place, he’s confident that it will have three primary impacts.
“It is hard to overstate the importance of this development,” Hougan said.
1) Attract more institutional investors The shift to proof-of-stake should cut ethereum’s energy usage by more than 99%, according to the note.This is a big improvement compared to the energy intensive proof-of-work consensus mechanism .
The improvement of ethereum’s environmental footprint could attract more institutional investors, particularly those with strict ESG investment management mandates, Hougan said.
The switch to a new consensus mechanism means investors might look at ethereum now as a diversification option in addition to bitcoin.
Other blockchains use proof-of-stake, but none are as big as the ethereum network, Hougan said.
“In other words, the merge could be the event that brings institutions into the crypto market beyond bitcoin,” Hougan said.
2) Replicating the halving cycle and reducing issuance Currently, the ethereum blockchain token issuance rate is over 4% per year, according to the note.
With proof-of-stake, the validation of transactions occurs at a much lower cost, which means fewer ether tokens are needed to compensate validators relative to mining, according to the note.Hougan expects “the merge” to reduce issuance by 75-90%.
“History suggests that a sharp reduction in new issuance could have a significant impact.Every four years, for instance, the rate of new bitcoin issuance is cut in half in closely monitored events called ‘halvings,'” Hougan said.”Many investors attribute bitcoin’s cyclical bull markets to this halving effect.”
“The merge is like two halvings at once,” he added.
3) A new yield opportunity By participating in the proof-of-stake validation process, ether holders can earn yield on their holdings.
It’s expected that the yield will be between 8% to 12%, said Hougan in the note.
“In today’s inflationary environment, the ability to earn an 8-12% yield while holding an investment with high growth potential may be attractive to yield-starved institutional investors,” Hougan said.
Hougan also believes this will enable institutions to conduct more traditional valuation approaches on ether.
He references crypto exchange Coinbase’s forcast of more than $5,000 for ether.
In a recent note, Bloomberg Intelligence strategist Mike McGlone explored the use of discounted cash flow analysis to evaluate ether and how that would suggest the token should be trading way above where it is right now.
“Triangulation of the three DCF methods provides an average value of $6,998, 140% higher than current levels,” said McGlone in the note .
Don’t put all your tokens in one basket “Taken individually, each of these changes—lower energy consumption, reduced new issuance, or a new yield source—would be a massive story for ethereum.” Hougan said.”Combined, however, they are transformative and will likely make ethereum a focus asset in the year to come.”
While Hougan is bullish on ethereum’s prospects, he recommends investors take a diversified approach to crypto investing as protocols start to mature.
“The long-term return of any crypto asset is influenced by multiple factors, including factors that impact the crypto industry as a whole and factors that are specific to individual crypto assets,” Hougan said.
“But as crypto matures, we expect the power of idiosyncratic factors to grow,” he added.
“For instance, we expect the merge to directly influence the shape of returns for ethereum in the coming year, but to have little impact on bitcoin or other assets.”
“One approach is to own a basket and ride the overall wave,” he said.
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