After numerous delays, the Ethereum “Merge” finally took place last week, switching the blockchain protocol from proof-of-work (PoW) to proof-of-stake (PoS).
In short, what this means is that Ethereum’s native currency, Ether (ETH) – the world’s second largest digital asset after Bitcoin (BTC) – can no longer be mined using a graphics processing unit (GPU). Instead, participants can choose to “bet” their ETH on the network. The Ethereum network then selects which of these participants, known as ‘validators’, are allowed to validate transactions, and if such validations prove accurate and legitimate, participants are rewarded with new ETH blocks.
So what’s the catch? Well, there are a few big ones: 1) To become a validator, participants must wager at least 32 ETH, the equivalent of $43,000 at current prices, and 2) They must wager them for years.
You can then see how the Merge has transformed ETH from a decentralized asset, available to any young gamer with access to a decent GPU, to a more centralized, oligarchic asset, managed by a relatively few participants who already own tens of thousands of ETH worth dollars.
In fact, as CoinDesk reported last week, two major validators were responsible for more than 40% of the new ETH blocks added in the hours following the merge. Those validators are crypto exchange platform Coinbase and crypto staking service Lido Finance.
PoS puts ether in regulators’ crosshairs
But wait, there’s more. Moving to PoS puts Ether at risk of being seen by US regulators as evidence ofsafety Company asset. Last Friday, the White House released its first-ever crypto regulatory framework, just a day after the merger was completed.
Gary Gensler, head of the Securities and Exchange Commission (SEC), has said on numerous occasions that PoW assets like BTC are commodities, not securities, and therefore should not be regulated as securities.
That is not the case with PoS, according to Gensler. Last week, the SEC chief noted that digital assets that allow investors to stake their holdings in exchange for new coins qualify them as securities. The implication, of course, is that the oversight of these currencies could end up being as strict as that of stocks, bonds, ETFs and other highly regulated assets. Besides ETH, other popular PoS cryptocurrencies include Cardano, Polkadot, and Avalanche.
The crash of Terra’s Luna coin in May, which led to the collapse of over-leveraged cryptocurrency lenders such as Celsius, Voyager and Three Arrows Capital, was a major driver of this year’s crypto winter. Lender’s promises of high return on investment have put them in hot water financially and legally. It is very important that the Ethereum Foundation does not make the same mistakes and invites the same level of scrutiny.
As we like to say at US Global Investors, government policy is a harbinger of change. But in this case, the change may not be beneficial. Regulatory rulings could add to the volatility within the emerging cryptocurrency industry.
In the table below, you can see that ETH was one of the most volatile assets for the one-day and 10-day trading periods as of August 31 – even more volatile than BTC and Tesla stock. I can’t help but believe that this is due to investor fears about the Merger and the regulatory uncertainty surrounding it.
TSWT of volatility
Energy FUD contributed to decision to move to PoS
If everything I’ve said so far is true, then why did Ethereum decision makers choose to switch to PoS in the first place? Simply put, they shut down under the pressure of misleading allegations that crypto mining, especially BTC mining, consumes too much energy and is bad for the environment.
This is FUD, or fear, uncertainty and doubt. Yes, BTC mining requires electricity, but compared to almost every other major industry — including finance and insurance, home appliances and gold mining — energy consumption is incredibly negligible, according to the Bitcoin Mining Council (BMC). In addition, the BMC found that global BTC miners collectively use a higher renewable energy mix than any major economy on the planet.
Supporters of the ETH Merge say the move to PoS could reduce network energy consumption by as much as 99.5%. None other than the World Economic Forum (WEF) praised the Merge’s success last week, writing that crypto “waits for a recalibration of sustainability…for Web3 climate innovators, the next generation of environmental advocates, as well as U.S. climate efforts broader.”
But as many PoW proponents have rightly pointed out, the GPUs previously used to mine ETH will likely now be used for other purposes after the merger, including mining other coins, high-performance computing, and gaming. In reality, little to no energy will have been compensated.
The question is: who is funding the FUD on PoW and power consumption? It’s a complicated question.
Last week, a group of environmentalists, including Greenpeace and the Environment Working Group (EWG), announced it plans to spend $1 million on a new campaign to encourage Bitcoin to follow ETH’s lead and move to PoS. The campaign, titled “Change the Code, Not the Climate”, falsely claims that BTC is “feeding” the climate crisis.
This is the same covert tactic used by Russian President Vladimir Putin, who over the years has funded environmental groups and non-governmental organizations (NGOs) in the West in an effort to discredit and undermine the US fracking industry.
Surprise! Gold is still one of the best-performing assets of 2022
Switching, I want to say a few words about gold. BTC’s analog cousin hit its lowest price since 2020 last week, even as inflation remains near its 40-year high and fears of a recession persist. As I write this, the yellow metal is trading at about $1,666 an ounce, about 19% below its March peak this year.
Some investors may read this and conclude that gold is no longer a valuable asset in times of economic and financial uncertainty, but they would be mistaken. Although gold is lower this year, it still outperforms most major asset classes, including government bonds, US corporate bonds, the S&P 500 and technology stocks. The precious metal has therefore helped investors limit losses in other parts of their portfolio.
The latest report from the World Gold Council (WGC) also states that gold could be a powerful investment in the face of a potential economic recession. The London-based group compared the performance of a number of asset classes during the past seven recessions in the US dating back to 1971, and found that, on average, gold performed the best, excluding government and corporate bonds.
That said, I still recommend a 10% weighting in gold, with 5% in precious metals (bars, coins, jewelry) and 5% in high-quality gold mining stocks and funds. Remember to rebalance regularly.
Our resident gold expert and Metals and Mining “TopGun” manager, Ralph Aldis, attended the Precious Metals Summit last week in Beaver Creek, Colorado, where he participated in a keynote investor panel. To view a repeat of the panel, Click here.