Crypto adoption among institutional investors has been on the rise. According to a CoinShares report, institutions invested $9.3B into the crypto market in 2021, up 36% from 2020. As adoption for the new asset class continues to increase, it is important to understand the changes that are coming to Ethereum, the world’s largest programmable blockchain.
To understand the future of Ethereum, we need to remember first and foremost that it is a technology platform. Ethereum is the foundation on which the future of the internet (Web3), and the future of finance (DeFi) is being built. The second thing to remember is that more than half of the entire DeFi ecosystem is being built on Ethereum. And as with any efficient technology, the Ethereum roadmap is full of upgrades to its infrastructure that make it future-proof. The first such upgrade, called the Merge, will occur in mid-September 2022. It will be a historic moment for the nascent crypto industry and will set up Ethereum for increased security, sustainability and scalability.
Currently, the Ethereum network has two blockchain layers running in parallel – the layer running Proof of Work (PoW), called the execution layer (the historic state of Ethereum and block production), and the layer running Proof of Stake (PoS), called the consensus layer. The Merge is the event when these two layers will merge, effectively ending PoW and transitioning the Ethereum mainnet fully to PoS.
DeFi and Institutions: The Story So Far
About 60% of all DeFi activity today happens on Ethereum. The network adoption and utilization has been on the rise, which is a strong signal for network maturity. Transactions have surpassed an average of 1M+ per day over the last 12 months. In addition, over 13.3M ETH has been staked by over 415M validators, accounting for nearly 11% of all ETH supply.
This traction demonstrates that the number of users and liquidity coming to Ethereum is incomparable to other Layer 1 chains. An increasing amount of institutional activity across the network also underscores the network’s popularity.
Over the last two years, many leading institutions have taken meaningful steps into the DeFi and Web3 ecosystem by pivoting their business model to focus on Web3, and by deploying capital into the ecosystem.
DeFi Financial Market Infrastructure players have matured and created fundamental base services to accelerate adoption and trading on decentralized networks. The number of DeFi applications has exploded, resulting in the exponential increase of institutional yield opportunities. In addition, DeFi applications and protocols have begun to develop institution-focused services. Large holders of ETH—including cryptocurrency exchanges, funds, and custodians—are recognizing that holding ETH bestows a powerful position within DeFi. They have been earning rewards at 4.06% annual yield on their ETH positions.
Despite current geopolitical and macroeconomic factors, and the recent market volatility, institutional appetite for being a part of the Ethereum ecosystem has been strong. Financial institutions—investment banks like Goldman Sachs and Barclays, hedge funds like Citadel Securities and Point72 Ventures, and retail banks such as Banco Santander and Itau Unibanco—are putting their money in crypto, or furthering their plans to offer crypto investment options to their clients.
DeFi and Institutions: After the Merge
For a long time, the debate around institutional investment in crypto was about traditional finance (TradFi) vs DeFi. The increasing popularity of DeFi was often considered a death knell for TradFi. However, the digital asset management strategies of a number of TradFi companies in the downturn point to the fact that TradFi and DeFi are now coming together to complement each other. This trend is likely to increase post-Merge, as institutions acknowledge that it is all about the long game.
With the Merge, Ethereum will cut down its energy usage by 99.95%, tremendously reducing its carbon footprint. Annual ETH issuance is also expected to drop by 89.4% after Ethereum’s transition to PoS, creating a deflationary pressure on the ETH token. In addition, the Merge will change the way value is accrued across the Ethereum network. Currently, any value that ETH generates (gas fees) is paid back to the network in the form of rewards to miners. Following the Merge, the value from network usage will accrue to both the validators and token holders.
The Merge will also increase the security of the Ethereum network by democratizing network participation and improved decentralization of the PoS mechanism. As a result, the cost to attack the Ethereum blockchain will be more than $11B at current prices, roughly 10-20X more expensive vs PoW. In addition, the security of the network running PoS will rise over time as more validators will come on board, and the amount of staked ETH will increase.
On-chain apps and Layer 2 solutions will likely leverage the improved security conditions and multiply on top of Ethereum
We discuss how these changes to the Ethereum network will translate into opportunities for institutional investors in detail in our upcoming report, “The Impact of the Merge on Institutions”. You can register to receive the report in your inbox on September 5th here. On September 12th, the key contributors to the report will talk about it on our “Breaking Down the Merge for Institutions” webinar on September 12th. You can register for it here.