This year a major catalyst awaits Ethereum and the whole crypto industry. It’s called “The Merge” and it will mark the end the proof-of-work mechanism of validating blocks (i.e. mining) and full transition to proof-of-stake (PoS). If successful, this will push gas costs down and radically increase network throughput.
As a result, there will be no more mining of Ethereum and instead ETH tokens will need to be staked on the blockchain into certain smart contracts. This has huge environmental (no more wasteful electricity burning) and economic implications. Bloomberg covered the latter one well.
What does this mean and what opportunities does this open up?
My coin is my bond
Why is mining a great nickname for the current method of block validation? Well, the metaphor is very strong - you have to buy equipment, consume electricity to run an algorithm which rewards you if you ‘find the gold nugget’. The miners have to therefore cover upfront Capex and ongoing Opex. Then they earn ETH tokens as reward for their activity and sell them to cover their USD costs. From the supply / demand perspective, this means there is continuous ETH issuance and a selling stream.
Proof of stake works differently. One has to buy ETH and lock it in a validator to ‘protect’ the chain. In return, there is going to be an income stream of ETH rewards coming your way. This effectively turns ETH into a bond yielding 3-11% (depending on your assumptions).
It’s a substantial change in ‘tokenomics’, but more importantly, allows for creation of new types of financial products.
Depositing ETH into a validator implies a lock up. It was therefore only a matter of time until someone would create a liquid version of that (effectively a zero coupon bond).
In fact, there are several providers out there with Lido - the leader - boasting $19.5bn of assets staked into its wrapped products.
Lido’s liquid ‘staked ETH’ product is called stETH and there is currently over $5bn sitting in the Curve exchange providing secondary market liquidity to it:
stETH has experienced phenomenal growth and is widely deployed across many DeFi platforms:
We believe PoS is the future standard for most chains and therefore derivatives like these are expected to become a key part of the DeFi universe.
Author is the Managing Partner of Re7 Capital - a stablecoin centric DeFi fund.