Ether (ETH) has outperformed bitcoin (BTC) in recent months, likely in anticipation of the planned Merge upgrade to the Ethereum blockchain, Citi (C) said in a research report Friday.
The Merge, or the switch from a proof-of-work (PoW) to a proof-of-stake (PoS) consensus mechanism, is the first of five enhancements planned for the blockchain, and is expected to happen later this month.
Ether has gained 43% since the “post-LUNA crunch” in mid-June, while its main competitors have lagged, with BTC declining 1.4% over the same period, the report said.
The bank observed that ETH gained following previous upgrades, but not relative to bitcoin. While it has outperformed recently, it is hard to say how much of the Merge is priced in, Citi said.
The most comparable event was the launch of the Beacon Chain in 2020, a “defining moment for the transition to PoS,” where ETH posted strong gains, the note said.
Citi notes that while there have only been three similar events in bitcoin’s history, there has been a tendency to rise in the ensuing 50 days. While BTC “halving” events only halve block rewards and – as a result – net issuance, ETH issuance is expected to decline by as much as 89%.
ETH September futures have moved into backwardation, a situation that occurs when the spot price of an asset is higher than the future’s, in expectation of an ETH PoW airdrop, the report said. That could occur if Ethereum forks into a PoW blockchain in addition to the PoS one, because holders on the Merge date would be eligible to receive a new token.
The futures market is now at a $20 discount to spot after having traded at a premium until the start of June. Perpetual future funding rates have also turned increasingly negative as users sell short the perpetuals and buy spot ETH in order to be eligible for any potential airdrop, the report said.
The bank cautions that while historical events can be a useful indicator for the future, they only offer a broad guide with a wide range of outcomes, and there are important differences between previous upgrades and now, as “for the first time in their history, digital assets are facing tightening financial conditions.”
With a large amount of ETH already having been staked, increasing from 10 million in March to 13 million currently – or about 11% of total supply – “a successful [M]erge is a critical technical step to support the future of ETH scaling,” the note said.
A decline in on-chain activity is a sign of slowing demand, but ultimately “crypto-network utility will be determined largely by growth in usage, which should be more consequential than the merge itself,” the note added.
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