As hype increases ahead of the Ethereum 2.0 protocol change, watch for ETH volatility
TL;DR — Trader takeaways
- Ethereum 2.0 upgrade will introduce staking-based rewards and is intended to lower transaction fees with improved gas price efficiency
- Ahead of the upgrade, markets appear bullish, increasing 32% since recent March lows
- Previous network updates failed to excite the market, but ETH rebounded afterwards with an 137% increase
- The Serenity upgrade is a protocol overhaul unlike anything the network has seen before
Quick points on Ethereum 2.0
- Referred to as ‘Serenity’ by the Ethereum foundation, the upgrade focuses on improving scalability and moves the network from a proof-of-work (PoW) to proof-of-stake (PoS) consensus algorithm and a new economic model.
- The Ethereum smart contracts protocol isn’t built for today’s volume; presently, every transaction has to be verified and executed by every Ethereum node. This makes the network slow and costly to use.
- The first phase (phase 0) of the Ethereum upgrade could take place as early as July 2020 and implementation of the upgrade is planned over several years.
- The protocol change is intended to address the network’s scalability issues and increase decentralization, increasing nodes and allowing them to validate transactions faster and decreasing transaction costs.
- Looking ahead, improving scalability of the smart contracts protocol will support DeFi: lending and borrowing applications, stablecoins, added liquidity via tokenized BTC, and more.
For more, we recently published a blog post explaining Ethereum and the upgrade.
What impact will the Ethereum upgrade have on ETH volatility?
There appears to be bullish market sentiment for the upgrade supporting an increasing ETH price (chart below). Proof-of-Stake strengthens the crypto-economic incentive for network participants and gives a wider range of users the ability to earn reward-based yields. Investors being able to earn ETH by staking also supports a buy-and-hold strategy, providing an alternative method for increasing one’s exposure to the asset. According to Consensys, 65% of ETH holders are supporters of staking.
“Cryptocurrency over-the-counter desks are also seeing increased investor demand for ether after recent March lows and heading into the scheduled ETH 2.0 launch,” said an April Coindesk article. At time of publishing, ETH sits at about USD $230 (find the latest price here).
The most recent Ethereum network upgrades took place in December 2019 with Istanbul, and in January 2020 with Muir Glacier. Markets appeared bearish leading up to those upgrades, but bullish afterwards (chart below), with ETH increasing over 137% from a low in December of about USD $120 to $284 in February. Istanbul and Muir Glacier both supported better usability for the Ethereum network, but it’s worth noting that the Serenity update is a protocol upgrade unlike anything the network has seen before.
What does Ethereum 2.0 mean for the Ethereum network?
The update is expected to reduce network costs and increase the speed at which transactions are validated and confirmed. Because demand for transaction throughput will be more evenly distributed across nodes, the cost of performing those transactions will decrease.
Transactions are made up of instructions to be performed on the network. Each type of instruction has a fixed gas price associated with it — these gas costs are expected to decrease (track ETH gas prices).
Increasing Ethereum transactions means higher fees
Recently, the surge in stablecoin and DeFi growth has brought transaction fees to a two year high. Late January 2020 marked the year’s low in transaction volume at about 429,000, with late June 2020 reaching a multi-year high of about 1.1 million transactions (chart below). The record high was about 1.3 million in January of 2018.
Transaction fees have been nearing all time highs (chart below), coming off a spike on June 11th at 3.83 ETH. As of June 25, transaction fees were sitting at about 0.6 ETH.
With the recent popularity around decentralized apps (dApps), like Compound’s tokenized lending protocol and others that run Ethereum smart contracts, there is now 3.08 million ETH, or US$1.6 billion, held in DeFi — a 70% increase since the beginning of June.
Today, BlockTower CIO and Managing Partner Ari Paul tweeted that “EIP 1559 is make or break for Ethereum.” Ethereum Improvement Proposal 1559 proposes better gas price efficiency, relating to its economics and the user experience.
“The current ‘first price auction’ fee model in Ethereum is inefficient and needlessly costly to users.” “[EIP 1559] proposes a way to replace this with a mechanism that adjusts a base network fee based on network demand, creating better fee price efficiency and reducing the complexity of client software needed to avoid paying unnecessarily high fees,” as explained in the EIP’s GitHub summary.
Staking on Ethereum: rate of return
Validators on the Ethereum network earn the right to confirm transactions based on ETH they have voluntarily locked up, or staked, to participate. Staking 2% of the network value means getting to validate 2% of blocks, and receiving 2% of all block rewards. According to Collin Myers, head of global product strategy at ConsenSys, this means validators could see a return of between 4.6% and 10.3% of ETH staked.
Does staking pose any risks to stakers, investors, or traders?
Staking provides two possible elements of risk: not being able to liquidate a position because funds are locked up, and not understanding the necessary procedures involved with securing assets while staking and incurring loss or theft.
While the Serenity upgrade is a massive event for the Ethereum network, it is an “incremental scaling upgrade, the impact of which will not be felt immediately, because current dApps and current developer workflows are all geared for normal Ethereum” said Bloq CEO Jeff Garzik in a quote from a May 1 2020 CoinTelegraph article. “However, it will have longer term impact, that is, giving businesses and developers confidence to build on ETH 2.0 due to higher scalability.”