The Merge is coming, but will it help Ethereum dominate the world?

Amidst the doom and gloom of ‘Crypto Winter’, there are some bright spots: Ethereum’s transition to a proof-of-stake consensus algorithm slated for completion by 2022 is one and a much anticipated event. In fact, when the date of ‘The Merge’ was recently announced to be 19th September 2022, an injection of much needed enthusiasm galvanised the investor sentiment in the crypto sphere. Within a mere week of the announcement, the price of its native token, ETH, rose by about 50%, from ~US$1,000 to ~US$1,500.

Ethereum cofounder Vitalik Buterin shared that following the Merge, and subsequent phases in the Ethereum transition developer roadmap known as ‘the Surge, Verge, Purge, Splurge’, Ethereum will be able to support over 100,000 transactions per second (tps), a monumental leap from its current capacity of about 15 to 20 tps. The Merge dramatically lowers energy consumption, and is claimed to become the foundation that removes much of Ethereum’s scalability constraints, unlocking its full potential. This is probably what fuelled the community’s recent optimism.

At the height of crypto’s run up last year, bullish investors of Ethereum proclaimed price targets of US$50,000 / ETH or higher, based on the belief that Ethereum will eventually monopolize or entrench its market dominance in the smart contract blockchain segment. This was certainly a plausible prediction given Ethereum’s immense popularity –at the peak of network congestion, users have paid hundreds of dollars in gas fees per transaction and waited days for these transactions to be processed. Miners have meanwhile collected billions in gas fees per month as incentive for verifying these transactions. Intuitively, scaling up Ethereum is expected to compound the value being created and captured, thereby aiding the price appreciation of ETH.

However, despite current optimism in the market, the reality is often much more nuanced. Even as the Merge draws near, I contend that it is still everyone’s guess if the present ETH bull run will last for the longer term.

Will Ethereum Emerge as the Winner?

While the technological roadmap for Ethereum to scale up to 100,000 tps seems straightforward at first glance, it is a lengthy process undoubtedly filled with hiccups. Since the news first surfaced, key developments for Ethereum 2.0 have been repeatedly delayed. Furthermore, the Merge is not the endgame, merely one of many milestones in the pipeline, with another 4 scheduled ahead – The Surge, Verge, Purge, and Splurge, and as Buterin remarked, the protocol will only be "55% complete once the Merge is complete”. If we go by its track record, we cannot guarantee that Ethereum 2.0 will be delivered on the proposed timeline, let alone expect its 100% completion, which is still far beyond the horizon right now.

The development of Ethereum 2.0 is also racing against time, as other developing blockchain networks are rapidly gaining ground. For example, Solana has been able to attract a sizable community with its fast transaction speed and low latency. Avalanche was also dubbed as an ‘Ethereum 2.0 killer’, quickly gaining traction because of its developer friendliness and blockchain interoperability among other reasons. In addition, many new blockchain networks are entering the fray - there are now over hundred blockchain network offerings at various stages of development. Aptos is just one of many examples, and it is rumored to have raised at a whopping US$2.7 B valuation prior to its launch.

Even if Ethereum 2.0 were to deliver on its vision, it is an oversimplified assumption to think all or even most of its existing users will adopt it. Notably, dYdX, the leading decentralized margin trading platform that first was building on Ethereum, announced in late June that it is leaving Ethereum for Cosmos - the Ethereum ecosystem is simply unable to support the customisations that dYdX requires for its order book design, such as fee structures and transaction speeds. Meanwhile, the Cosmos Network allows dYdX and other projects to build custom tailored, native blockchains with the ability to make transactions with other blockchains within Cosmos’ ecosystem, all without astronomical gas fees or compromising on transaction throughput. Where other blockchain network ecosystems are increasingly successful and adapting to ever changing needs of users, the Ethereum ecosystem may fail to support the heterogeneous needs of future decentralized applications.

Putting the promise of those blockchain network projects aside, the reality is that all of these blockchain networks are facing their own technical challenges, and competing to deliver their scalability solution or other value propositions – naturally, the first to succeed will tend to gain more market share.

Can Ethereum capture enough value?

Another key question is – even if Ethereum were to capture a significant share of the future smart contract market, will it be able to capture enough value? Delphi Research elaborated its thesis on ETH’s potential for value and revenue capture for this base asset in Valuing Layer 1s - Memes, Money, or More? In essence, ETH captures three streams of value – productive asset yield through staking, consumable/transformable value as a rare commodity, and store of value asset as the quote currency - similar to the petrodollar system due to its ecosystem value and stickiness. However, I would like to highlight that all these value streams are underpinned by one assumption – Ethereum blockspace is a hard to replace, scarce computing resource that is highly sought after, thus allowing its base asset to command a premium.

But what if decentralized computing resources were heavily commoditized? The Ethereum blockspace is a scarce resource, evident from its high transaction fees and users’ willingness to pay at its peak. However, other blockchain network offerings have only become more valid alternatives recently, and evidently a lot of developers and users have already migrated out to others despite the pain of moving to a new ecosystem. Furthermore, with more and more vibrant blockchain network offerings emerging, significant effort is pouring into cross-chain bridging projects (and layer 0 technologies) connecting blockchain network chains together, such as Layerzero, Polkadot, and Cosmos etc. These protocols would allow developers and users to tap on multi-chain linkages and interactions in a frictionless way.

In our physical world organized by sovereign states, multi-chains which are interlinked is much like how citizens of European Union’s (EU) member states can travel, work and live freely without border checks under the EU’s open border policy. Under such a scenario, the existence of other blockchain network chains may not diminish Ethereum’s market share substantially, but it might lead to a race to the bottom with lowering fees as Ethereum’s stakeholders try to retain their user pool, culminating in commoditization of the Ethereum blockspace value.

De-monopolising the blockchain network universe in such a way will certainly diminish Ethereum’s control over value capture. Thus, Ethereum blockspace is probably less like petrol which shaped our current geopolitics, but more like the current evolution of electricity where solar, wind, nuclear and many other new power generation technologies are competing for the future and will co-exist.

Supporters will argue that Ethereum is more decentralized than others but remember, most users will mainly care about general user experience and cost.

Lastly, I believe that Ethereum will eventually lose its monopoly, eroding the strong premium that ETH currently commands. ETH‘s potential as a store of value and quote/reserve currency adoption will also need to be further questioned in a multi-chain world.

Overall, the multi-chain scenario is an intriguing vision, and if realized, opens up unparalleled developmental opportunities in the coming years. Thus, I retain my cautious view even as the market reacts very favorably to the announcement of the Merge. While the short term event-driven trade sounds like a workable idea, the long term investment thesis for Ethereum is much less straightforward.

Like this article? Read more of Genping’s Crypto Watch Column here.

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