The 'Merge Trade' Has Begun, Experts Say, as Ether Surges and stETH Discount Narrows

"ETH has undergone a rapid change in narrative over the past week, with speculators purely focused on the upcoming 'merge' as a catalyst for appreciation," one observer said.

AccessTimeIconJul 18, 2022 at 11:31 a.m. UTC
Updated May 11, 2023 at 4:37 p.m. UTC

Renewed clarity about the timeline of programmable blockchain Ethereum's highly anticipated transition to a proof-of-stake consensus algorithm, seems to have galvanized investor interest in ether (ETH) and its staked derivative on Lido finance called staked ether (stETH), offering a reprieve to the battered cryptocurrencies.

On Thursday, Ethereum Foundation member Tim Beiko suggested Sept. 19 as the provisional launch date for the Merge, which will see the world's biggest smart contract blockchain transition from the energy-intensive proof-of-work consensus mechanism to a more environment-friendly proof-of-stake mechanism.

Since Beiko's announcement, ether has rallied roughly 22%, hitting a one-month high of $1,475, according to CoinDesk data. The token registered a 15% gain in the seven days to July 17, the biggest jump since March.

The staked ether's discount relative to the price of ether has narrowed to 0.98 from 0.96 since Thursday, per data source CoinMarketCap. The token representing an equivalent amount of ether staked in Lido Finance is supposed to trade at a price closer to ether. stETH's price fell into a discount of 0.93 to ETH following the collapse of Terra in May and has not been able to recover since. Lido Finance is a liquid staking protocol allowing users to stake coins while retaining liquidity and bypassing the burden of owning a minimum of 32 ETH to become a staker. Users can redeem staked ETH for ETH only after transfers are enabled on Ethereum 2.0.

"ETH has undergone a rapid change in narrative over the past week with speculators purely focused on the upcoming 'merge' as a catalyst for appreciation," said Matthew Dibb, chief operating officer and co-founder of Stack Funds. "Adding to this, we believe that there is a significant amount of sidelined capital that has been waiting on bullish momentum to establish new positions."

Staked ether's discount to ether. (CoinMarketCap)
Staked ether's discount to ether. (CoinMarketCap)

Several observers consider Ethereum's impending transition equivalent to three Bitcoin halvings – a programmed code that halves the per block bitcoin (BTC) currency supply every four years – that will lead to a 90% reduction in ether's annual issuance. Simply put, the transition is likely to bring a store of value or deflationary appeal to ether. The upgrade has been long pending.

Like other market participants, ether investors tend to factor in bullish developments in advance. For instance, ether rallied over 60% to $2,800 in the three weeks leading up to the London hard fork implemented on Aug. 5, 2021. The hard fork activated a mechanism to burn the portion of fees paid to miners.

The Ethereum 2.0 upgrade has been long overdue and has seen several delays. However, the recent successful merges of the Ropsten and Sepolia testnets and the Goerli testnet's planned transition to proof-of-stake on for Aug. 11 has raised hopes for the mainnet merge in September.

The foundation's strongest hint of the tentative date of the Merge on record came as the crypto market looked for reasons to bounce, having priced in much of the bad news over the past two months.

Ether tanked 60% to less than $1,000 from $2,700 in the past two months as fears of faster liquidity withdrawal by the Federal Reserve, Terra's collapse and eventual bankruptcies of crypto hedge fund Three Arrows Capital, several crypto lenders saw investors dump crypto holdings.

"Any positive news at this point is a welcome thing for markets," Jason Pagoulatos, markets associate at Delphi Digital, told CoinDesk TV on Friday. "But it's definitely not the only reason ETH is up."

Pagoulatos added that the bounce is typical of market action expected following the collapse of May and June.

John Ng Pangilinan, a managing partner at Singapore-based Signum, voiced a similar opinion, saying the market has priced in macro and crypto-specific risks and is now focusing on the upcoming positives.

"My opinion is ETH is rising in anticipation for Ethereum 2.0," Pangilinan said. "Also, major firms that have collapsed and inflation announcements, I believe, have all been factored in. I do see recovery for both ETH and BTC should this accumulation phase hold throughout July, but we have to be mindful of regulatory impact, which I believe is coming. I do not see that dampening the markets."

Ether's bounce is accompanied by renewed user demand for the blockchain, a sign the rally may have legs.

The amount of gas, or a measure of what users pay to use the Ethereum network, has increased from roughly 82 billion gwei to 100 billion gwei this month, according to data from Etherscan tracked by Galaxy Digital Research.

"The amount of gas used on Ethereum has spiked this month after several months of precipitous decline, indicating that Ethereum usage and demand for block space is returning following a period of relative disinterest," Christine Kim, research analyst at Galaxy Digital, wrote in a weekly newsletter published Friday. "Notably, recent spikes in transaction activity are coming from transfers of ERC-1155 tokens, which are tokens that can possess either fungible, semi-fungible, or non-fungible properties."

Ethereum daily gas used (Galaxy Digital Research, Etherscan)
Ethereum daily gas used (Galaxy Digital Research, Etherscan)

What's more, whales, or large investors, have recently bought the dip in ether. "Addresses holding over 1% of the ETH in circulation have increased their positions, blockchain analytics firm IntoTheBlock's weekly newsletter published Friday said. "The total ETH balance held by addresses labeled as whales reached an all-time high this week. While this includes centralized exchanges, their specific holdings have been mostly trending downwards, while the staking contract and unidentified entities have been growing their assets."

However, while the path of least resistance is on the higher side, it's probably contingent on the September Merge, as developers have hinted. A potential delay could demoralize buyers.


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Omkar Godbole

Omkar Godbole is a Co-Managing Editor on CoinDesk's Markets team.