As the Ethereum (ETH-USD) Merge approaches, investors are hoping that it will act as a bullish catalyst. Essentially, the Ethereum Merge is an upgrade from a comparatively antiquated method of consensus-driven transactional verification to a much more efficient protocol. Ethereum’s pivot, while notable for environmental stability and resource management, may not necessarily yield the bullish results investors are hoping for. I am near-term bearish on ETH.
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While utilitarian blockchain networks like Ethereum introduced decentralized, trustless mechanisms to the broader business ecosystem, they carried unwanted baggage: high-energy consumption. Ethereum is potentially on the verge of a paradigm-shifting breakthrough. By delivering the same smart-contract-driven architecture that developers have come to enjoy through an energy-sustainable mechanism, the underlying ETH coin may be that much more fundamentally valuable.
As TipRanks contributor Reuben Jackson explains, the costs of legacy blockchains conducting business the old way simply don’t jive with current social and economic mores. For instance, the Bitcoin (BTC-USD) network’s “annual energy consumption stands just shy of 90,000 Gigawatt hours (GWh). Also, Ethereum used around 17,000 GWh.
In contrast, current generation blockchains like “Polkadot and Tezos’ annual energy consumption are merely 0.1 GWh, outperforming nearly all major peers by a wide margin while underlining their significantly lower carbon footprint relative to the Bitcoin network.”
Nevertheless, below are three reasons why investors should be cautious about the upcoming Merge.
Buy the Rumor, Sell the News on Ethereum
When assessing various investment opportunities, market participants will invariably at some point come across the expression, “buy the rumor, sell the news.” Basically, investors (particularly retail investors) should avoid betting too heavily on the obvious catalyst. In other words, if everyone bets on the same horse, the subsequent rewards – assuming the wager pans out favorably – will be limited. The concept really speaks to Ethereum and its implication for the ETH coin.
On paper, it appears that the Ethereum Merge allows the ETH community to have their cake and eat it too. As Jackson explains, legacy architectures like Bitcoin and Ethereum (prior to the Merge) utilize consensus mechanisms called proof of work (PoW).
These chains “incentivize network participants to provide the computational power required to operate a network and maintain its security. As the network expands, the need for computational power continues to increase. To provide the required power, the network participants (miners) required to validate transactions and mine new coins must invest in high-end devices (mining rigs), consuming vast amounts of electricity.”
On the other hand, Ethereum is pivoting to a consensus mechanism called proof of stake (PoS). “Instead of each network participant competing to provide the highest computational power, the selection is made based on the participant’s stake in the network. So, participants who own a certain number of the platform’s native tokens are randomly picked to participate in validation and block creation.”
Again, the fundamental nature of this developmental transition is technically impressive. However, the idea that such a technical breakthrough will automatically translate to increased market value for ETH is problematic. Primarily, the Merge has been a long-discussed topic.
If it were so easy to accrue wealth in investment markets, avid readers would consistently rank as the top participants. However, that’s not always the case. Indeed, the best investments stem from visionary wagers, which initially lack mainstream belief.
The Effort Component of Economics May Disrupt Ethereum
While the energy efficiency angle delights longtime supporters of Ethereum, it might impose an ironic result for the ETH coin. By making a process too efficient, it may disrupt the underlying investment market. In other words, anything worth doing requires effort. Mitigating the said consequences of effort (i.e., high energy consumption) could then reduce the economic value of the underlying asset.
Take the flatscreen TV as an example. Long before it became a consumer electronics commodity in modern households, the concept was first introduced in 1964 by a team at the University of Illinois. After decades of research and development with liquid crystal displays (LCDs), in 1996, Sony (SONY) and Sharp (SHCAY) collaborated on a joint venture to produce large flatscreen TVs.
One year later, the two firms introduced the first such TV to the retail market. Featuring a 42-inch display – a record size at the time – this first model sold for more than $15,000, easily putting it out of the reach of everyday Americans.
Back then, Sony and Sharp could theoretically develop a business arm catering exclusively to the demands of the ultra-wealthy. However, as technology advanced (and became more efficient) and economies of scale improved, flatscreen TVs became rather mundane. Today, anyone can afford one, translating to reduced margins for legacy outfits like Sony and Sharp.
In fact, Sony eventually spun off its TV division, and a similar outcome could await Ethereum. Without much effort (energy consumption) undergirding each newly minted ETH – and considering that old and new ETH units are fungible – the relative ease of production could negatively impact its market value.
Asked differently, would you pay $15,000 for a 42-inch flatscreen TV today?
Blockchain Control Might Not Work for Ethereum
With soaring real estate prices spilling over into the rental market, many metropolitan residents have demanded rent control. In their ways, government enforcement represents the only mechanism to stop landlords’ excessive greed. However, research indicates that rent control is ineffective in the long run. Similarly, the PoS mechanism that Ethereum developers are supporting may be a form of blockchain control – with arguably the same disastrous results.
According to the Brookings Institution, rent control can create broader residential unit misallocations, whereby tenants stay put in their units due to favorable rates, irrespective of the change in their living situation. More importantly, “Rent control can also lead to decay of the rental housing stock; landlords may not invest in maintenance because they can’t recoup these investments by raising rents.”
Interestingly, Jackson mentioned that “PoS removes all forms of competition.” Since the validation and block creation privileges are distributed via stake in the network as opposed to ownership of raw computing power, there’s little incentive for newcomers to develop creative or innovative solutions to address the computing power gap. On the other end, those who already have a massive stake have no rational reason to give up their equity.
The result? Blockchain engagement for Ethereum erodes, and former participants seek viable PoW-driven blockchains since such mechanisms are inherently capitalistic.
Make no mistake: PoW is by no means perfect, just like capitalism itself isn’t perfect. However, it offers a merit-based system where free-market forces determine the underlying sector’s risk-reward profile.
Ironically, while PoS may be the more energy-efficient protocol, PoW is the most economically efficient. As with capitalism, PoW feeds supply to where demand is the greatest – not to artificially concocted pools where correlations to actual demand may be questionable at best.
