Countdown to Merge

With the activation of Bellatrix on September 6, we are now in the final few days before the Merge. 

The merge is still expected to happen around Sep 13-15. What's happening today is the Bellatrix hard fork, which prepares the chain for the merge. Still important though - make sure to update your clients!

— vitalik.eth (@VitalikButerin) September 6, 2022

The Merge hardfork, officially known as Paris, will activate when the network TTD reaches 58750000000000000000000, with current best estimates to be on September 14 EST. 

Ethereum Price since August 1, 2022; Source: CoinGecko

After a dip on Tuesday, September 6th during the US session where the ETH price briefly dropped to $1,500, it has since rebounded in the last few days to above the $1,600 level. However this is still below the high during mid-August where it briefly broke above $2,000.

As we enter this crucial week, many are anticipating a pump for ETH on news of successful Merge. However a bearish macro-economic outlook hangs over the crypto market, with the August US CPI print looming on September 13, just a day before the Merge. We examine the factors at play. 

Macro Risks Loom Large

US August CPI

Quick recap: The US CPI was unchanged month-on-month in July, with year-on-year inflation at 8.5%. Core CPI rose 0.3% monthly and 5.9% annually. The data was well received by the market, which perceived it as a sign that inflation in the US may have peaked. 

US Inflation Nowcast; Source: Federal Reserve of Cleveland

Ahead of next week’s August data release, the Cleveland Fed’s Inflation Nowcast is predicting an almost unchanged m-o-m CPI, with y-o-y CPI to further reduce to 8.24%. In-line with this, core CPI is also expected to moderate further. A key contributor to this moderation could be gasoline prices, which dipped significantly in August. If accurate, this represents stronger evidence that the Fed rate hikes are taking effect, and inflation has at least flattened, if not beginning to trend downwards.

A higher CPI print though, would likely spell disaster for markets.

September FOMC Meeting

Regardless of the data print however, the Fed’s resolve to rate hikes will likely remain unmoved. Following Chairman Powell’s speech at Jackson Hole, multiple Fed officials have sang from the same hymn sheet, stating their resolve to continue to hike rates until they see a clear trend of inflation moderating. 

 Source: CME FedWatch Tool

Hence regardless of next week’s CPI print, a rate hike is inevitable, and the market is now predicting a 75bps rate hike with ~80% certainty. This will put more pressure on risk-on assets such as equities and crypto, as the Fed aims to constrict economic demand to drive down inflation. Already there have been significant earnings downgrades across public-listed companies for this quarter, which are expected to continue as long as the Fed’s tightening of monetary policy persists.

At the same time, September is when the Fed’s Quantitative Tightening (QT) exercise kicks into full swing, with $95 billion targeted to be removed from the Fed’s balance sheet each month. Based on historical data, this will also affect liquidity in the equities market, and thereby valuations. 

Source: Bloomberg

More Troubles Mounting Elsewhere

We already covered some of these troubles in last week’s article, but a fresh week brings fresh challenges. 

• Russia has decided to shut down Nord Stream 1 completely, thereby entirely cutting off the supply of LNG to Europe indefinitely, citing economic sanctions imposed by the EU. Benchmark gas futures jumped as much as 35%, the most in almost six months.  

• At the same time, OPEC+ announced a surprise production cut for oil in October, driving up prices of crude oil futures. 

• The latest inflation in the eurozone hit 9.1% in August, and the ECB has responded with a jumbo rate hike of 75bps this week, signaling more pain for its economy.

• China, in a continuation of its COVID-Zero policy, extended the lockdown of Chengdu, one of its largest cities with a population of 21 million. The city was also rocked by a magnitude 6.6 earthquake, while drought still persists.

Ethereum Bulls Gear Up

Bellatrix and Validators

Let’s get the technicals out of the way. While Bellatrix did activate smoothly, post-activation there was an obvious fall-off in validators’ participation rate, and an increase in the number of offline validators, resulting in more missed blocks than usual. 

ETH2.0 Validators’ Participation Rate; Source: beaconcha.in

Most of this was attributed to validators still have not upgraded their nodes to the client versions required for the Merge. However since the upgrade this gap has significantly narrowed, suggesting that the laggards have caught up. At the very least, this issue of non-upgrade nodes shouldn’t be an issue for the Paris hardfork. Otherwise from an ETH2.0 staking perspective, the network has also reached an ATH in terms of total number of ETH2.0 validators and staked ETH. 11.3% of ETH’s circulating supply are now staked.

Spot Market

On the spot end, there seems to be two narratives at play that is driving accumulation of ETH:

1. Traders are bullish ETH and think that the price will pump on Merge

2. Traders are maximizing the ETH they hold in order to receive the maximum amount of ETHPoW tokens

With less than a week left to the Merge, Ethereum has reached ATHs in terms of total addresses with non-zero balance. Traders have also turned to leverage to increase their ETH stash. The two major lending protocols on Ethereum, AAVE and Compound, have had to put in certain measures to limit ETH borrowing on their respective protocols, and at one point, the returns for providing ETH liquidity to both protocols spike significantly before moderating.

Source: CoinGecko

The other source of ETH liquidity seems to be the pools of staked-ETH:ETH. Prices of stETH, rETH2 (Stakewise Staked ETH), and cbETH (Coinbase Wrapped Staked ETH) have widened in the past few days relative to ETH, though rather strangely RETH (Rocket Pool ETH) have stayed above 1. For longer-term accumulators of ETH, this could represent a way to buy ETH at a discount, though do bear in mind that your staked-ETH will only be unlocked with the Shanghai upgrade, which will only come 6-12 months post-Merge.

Source: Glassnode

Interestingly, the balance of ETH on centralized exchanges is close to its yearly low, despite seeing some net inflows in the past few days. It seems a majority of traders are preferring to hold their ETH in their own private wallets, again perhaps in hopes of farming tokens on the PoW fork.

Futures Market

Open Interest (OI) for ETH Futures have remained relatively stable at ~$8B since the start of August, though has been steadily creeping up over the last few days. This is similar for ETH Options, where OI is at ~$7B but also steadily creeping upwards. 

Source: Glassnode

From a funding rate perspective, the sizeable negative funding rate that we pointed out last week seems to have narrowed, though still in the negative zone. Based on data from Coinglass, funding rates on on-chain perpetuals DEX dydx have actually turned positive, in comparison with their centralized futures exchange counterparts. Perhaps this is a sign of growing confidence in the ETH Merge, though overall funding rates may yet remain negative as certain traders pursue delta-neutral strategies. 

ETHW: Dead on Arrival?

ETHW Price; Source: CoinGecko

Prices of ETHW, as tracked across the few CEXes already trading its IOU, has continued to slip to now trading at only ~$30. The price action could signal diminishing confidence of the PoW fork relative to the PoS ETH. 

The Ethereum Merge is scheduled to take place on 13 September. Christmas season is here again.

ETH holders will soon be airdropped ETH PoW tokens. What should you do to best position yourself?

Here are 7 steps you may consider to fully take advantage of the Merge:

— Bobby Ong (@bobbyong) September 5, 2022

Speculators hoping to benefit from the fork tokens ought to read Bobby’s tweet thread here on how to prepare, but do bear in mind that while things like Metamask will still work, you may likely need to know how to interact with the network directly, instead of waiting for front-ends to be spun up. Also keep an eye out for scams.

Finally and perhaps more importantly, we are waiting for official announcement of when the PoW ETH chain will go live. While many will assume that it will go live together with the Merge, there has been no official confirmation, with conflicting sources of reporting. 

Some Thoughts

Currently it would seem like the sequence of events are:

• Tuesday, September 13 8:30AM EST: August US CPI Data

• Wednesday, September 14 EST: Ethereum mainnet Merge

• Wednesday, September 21 2:00PM EST: FOMC Meeting and Fed Interest Rate Decision

Of the three events above, a 75bps rate hike during the FOMC Meeting is all but a certainty at this point. With further constriction of economic demand on the horizon, it’s hard not to recall this bear market cycle’s oft-repeated mantra of “don’t fight the Fed”. For ETH to experience a sustained pump would probably require it to decouple from the broader movements of the equities market, a monumental feat given that they have pretty much moved in lockstep for the entire bear market cycle.

While the PoW ETH fork gathered a lot of hype at its initial announcement, it’s progress (well, lack thereof) towards going live, especially so close to the Merge, has significantly increased the risk and complexity for traders who may have hoped to benefit from it upon launch. It’s likely that a few degen maxis who would be able to navigate the chaos would be the ones to extract the most value from the chain; others who are not as proficient may suffer.

Regardless of the eventual price movement next week, a seamless Merge is a monumental technical achievement for the Ethereum Core Devs, as well as the Ethereum community as a whole. Large protocol upgrades are already hard, and to do this without any downtime is akin to successfully swapping out the engine of a plane mid-flight. Pulling off such a feat would inspire significant confidence in the chain, and would hopefully pull in more builders, developers and users into this space. The Merge would also set the foundation for the next phase of the network’s development to become more decentralized, secure and scalable. It has been a long time coming, and we wish the devs a smooth Merge next week.