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Digital Assets

A Closer Look at the new Ethereum:


Richard Barnett, CFA

We have given a lot of coverage to “The Merge” of the Ethereum blockchain in our Digital Assets Weekly Newsletter this year, and the merge finally happened yesterday.  Ethereum holds a unique place in the cryptosphere as the second largest currency, and as the pioneer and still leading coin for smart contracts.  ETH is completely changing its most fundamental characteristic, moving from Proof of Stake to Proof of Work, so what does the investment case for the new ETH look like?

While there are many opinions on this, we think the investment and use cases for ETH in DeFi, NFTs, and tokenization of assets get stronger after a successful conversion to proof of stake.  The primary post-merge value drivers include:

Institutional Interest:  With the carbon footprint of POS Eth lower by an estimated 99.9%, institutions that reflect ESG considerations in their decisions should find ETH much more attractive.1

Alternative to BTC: ETH should become a more compelling alternative to Bitcoin, which has no plans to switch to POS and which has been subject to “ban Bitcoin” talk lately.  Proof of stake also should also encourage institutional investors to buy large amounts of ETH, so they can have greater influence over the future of the project. 

Easier staking: The process for staking ETH for validating transactions on the blockchain will be greatly simplified, allowing investors to stake ETH directly and earn returns from the validation and network security revenue stream.

Layer 2 scaling: While the Merge will not reduce ETH’s high gas fees, which will require further upgrades to the blockchain, ETH has a very strong ecosystem of Layer 2 scaling solutions including Polygon, Arbitrum, Optimism, and others, which may see even more transactions, usage, and development after the move to POS. 

Why This Matters to you:

The Ethereum transition from proof of work to proof of stake is one of the biggest events in Crypto in recent memory.  Now that it has been completed, it has eliminated a major source of uncertainty in the market and should be a catalyst for greater usage in DeFi, NFTs, and asset tokenization.  POS ETH might even shift the center of gravity in Crypto from Proof of Work Bitcoin to ETH and the many other POS Altcoins.

1Blockworks, The Merge 'Completely Changes’ Ether’s Investment Case for Institutions, Sept 12, 2022. 
Seeking Alpha, The Ethereum Merge Is Finally Here: What Investors Need to Know, Aug 22, 2022
Jack Niewold Twitter thread, Aug 29, 2022


You must evaluate your financial circumstances to determine if trading cryptocurrencies is appropriate for you. You should not invest funds in cryptocurrencies that you cannot afford to lose. The trading of cryptocurrencies can result insubstantial losses, including most if not all of your investment.  For that reason, you should not use funds that are earmarked  for special purposes, such as retirement funds, debt repayment funds, amounts needed for emergency expenses, tuition or household expenses or funds otherwise required by your lifestyle, to trade cryptocurrencies.
Unique Features of Cryptocurrencies: Cryptocurrencies are digital instruments that are intended to function as a store of value or a medium of exchange. Although cryptocurrencies are often exchangeable for various fiat currencies, unlike fiat currencies, cryptocurrencies are not backed by any government or central bank and do not constitute legal tender. Cryptocurrencies have no intrinsic value and there are no investment underlying cryptocurrencies.  The price of cryptocurrencies is  based on the agreement of the parties to a transaction, which may or may not be based on the market value of the cryptocurrency at the time of the transaction.
Price Volatility: Cryptocurrencies derive their value from the markets in which they trade, and the markets for cryptocurrencies are global.  The price of cryptocurrencies is based on the perceived 
value of the cryptocurrency and subject to changes in sentiment, which make these products highly volatile and unpredictable.  The fluctuations of cryptocurrency prices are much greater than the price fluctuations of fiat currencies, which are also risky to trade. Certain cryptocurrencies have experienced daily price volatility of more than 20%, including sudden drops in price. If participants in a given cryptocurrency market change their view about the value of a given cryptocurrency versus fiat currency, the price of the cryptocurrency can decline precipitously. It may be difficult to liquidate a position in cryptocurrencies at all or, if possible, such liquidation may occur at a significant loss. It is possible that the market for a given cryptocurrency can collapse altogether.
Valuation and Liquidity: Cryptocurrencies can be traded through privately negotiated transactions and through numerous cryptocurrency exchanges and intermediaries around the  world, each with  its own pricing mechanism and/or order book. Generally accepted auditing methods for cryptocurrencies do not exist, and cryptocurrency platforms do not have consistent methods for auditing their holdings and some do not have audits at all. The lack of generally accepted auditing methods and a centralized pricing source pose a variety of valuation challenges. In addition, the dispersed liquidity may pose challenges for market participants trying to exit a position, particularly during periods of stress.
Cybersecurity: Cryptocurrencies and digital assets are commonly targeted by hackers and criminals  who commit fraud, especially through social media platforms. The cybersecurity risks of cryptocurrencies and related “wallets” or spot exchanges include hacking vulnerabilities, cybersecurity attacks and a risk that publicly distributed ledgers may not be immutable. A cybersecurity event could result in a substantial, immediate, and irreversible loss for participants that trade cryptocurrencies. Cryptocurrency transactions may be irreversible, and, accordingly, losses due to a cybersecurity event are not recoverable.  Even a minor cybersecurity event in a cryptocurrency is likely to result in downward price pressure on that product and potentially other cryptocurrencies.
Opaque Spot Market: Cryptocurrency markets are volatile and are subject to fraud and other trading aberrations. Cryptocurrency balances are generally maintained as an address on the blockchain and are accessed through private keys, which may be held by a market participant or a custodian. Although cryptocurrency transactions are typically publicly available on a blockchain or distributed ledger, the public address does not identify the controller, owner, or holder of the private key. Unlike bank and brokerage accounts, cryptocurrency exchanges and custodians that hold cryptocurrencies do not always identify the owner. The opaque underlying spot market poses asset verification challenges for market participants, regulators and auditors and gives rise to an increased risk of manipulation and fraud, including the potential for Ponzi schemes, bucketshops and pump and dump schemes, which may undermine market confidence in a cryptocurrency and negatively impact its price. Most cryptocurrency platforms do not have surveillance systems and rules intended to prevent market manipulation or other forms of abusive trading nor do they have the ability to enforce such rules.
Cryptocurrency Exchanges, Intermediaries and Custodians: Cryptocurrency exchanges, as well as other intermediaries, custodians and vendors used to facilitate cryptocurrency transactions, are relatively new and largely unregulated in both the United States and many foreign jurisdictions. There are no standard capital requirements for cryptocurrency platforms nor are their guarantors in the event a cryptocurrency exchange fails. The opaque underlying spot market and lack of regulatory oversight creates a risk that a cryptocurrency exchange may not hold sufficient cryptocurrencies or other funds to satisfy its obligations and that such deficiency may not be easily identified or discovered. In addition to a higher level of operational risk than regulated futures or securities exchanges, cryptocurrency exchanges can experience volatile market movements, flash crashes, fraud, various forms of market manipulation, theft, transaction processing delays and other cybersecurity risks. Trading in cryptocurrencies may be halted by the various trading venues due to unusual trading activity, outages or other problems with a cryptocurrency platform. Those difficulties could prevent you from accessing the cryptocurrency in your account. Crypto traders and exchanges may not have sufficient financial coverage through bonds, insurance or other products to repay your losses.
Before you engage in trading cryptocurrencies, you must become familiar with the platform on which the relevant cryptocurrency trades. Generally, there is limited information about the various cryptocurrency platforms and because these platforms are complex and technically difficult for the average person to understand, you will need to put forth substantial effort to obtain the information necessary to understand the risks you are undertaking. You should understand the functions, operations and uses as well as the history for the platforms on which you invest. As described above, some platforms are subject to a variety of serious attacks, which may result in the loss of your cryptocurrency.
Regulatory Landscape: Different geographic locations have different rules, or oftentimes no rules, which apply to the trading of cryptocurrencies. One or more jurisdictions may, in the future, adopt laws, regulations or directives that affect cryptocurrency networks and their users. Changes in government regulation, such as the suspending or restricting of trading activity in a particular cryptocurrency or currencies, may adversely affect your ability to trade and exchange your cryptocurrencies and may decrease the value of any cryptocurrency in your account.In the United States, cryptocurrency markets are not subject to federal regulatory oversight, but  cryptocurrency  exchanges  are  subject  to  federal  anti-money  laundering  regulation  and  may  be  regulated  by  one  or  more  state  regulatory  bodies.  As compared to regulated  markets, such as the U.S. securities markets, there are no uniform regulations governing trading or other mechanisms to prevent market manipulation or to  normalize  the cryptocurrency markets when they experience volatility issues. Unlike the laws, rules and regulations governing the U.S.  securities  markets,  there  are  generally  no  laws,  rules  or
regulations that require anyone to continue to support a cryptocurrency market, and there is no assurance that a person who accepts a virtual currency as payment today will continue to do so in the future.
Notwithstanding the foregoing, many cryptocurrency derivatives are subject to regulation by the CFTC. In addition, the SEC has cautioned that many initial coin or “token” offerings are likely to fall within the definition of a security and subject to U.S. securities laws. As a result, cryptocurrencies currently face an uncertain regulatory landscape in the U.S.  and  many foreign jurisdictions.
Transaction Fees: Many cryptocurrencies allow market participants to offer miners (i.e., parties that process transactions and record them on a blockchain or distributed ledger) the ability to earn a fee. While not mandatory, a fee is generally necessary to ensure that a transaction is promptly recorded on a blockchain or distributed ledger.  The amounts of these fees are subject to  market forces, and it is possible that the fees could increase substantially during a period of stress. In addition, cryptocurrency exchanges, wallet providers and other custodians may charge relatively high fees as compared to custodians in many other financial markets.
Investor Alerts: A number of governmental and self-regulatory agencies have published information alerting the public of the risks of digital currency. For example, see the CFPB’s Consumer Advisory (https://files.consumerfinance.gov/f/201408_cfpb_consumer-advisory_virtual-currencies.pdf), the CFTC’s Customer Advisory (https://www.cftc.gov/sites/default/files/idc/groups/
public/@customerprotection/documents/file/customeradvisory_urvct121517.pdf),the SEC’s Investor Alerts (for example, https://www.sec.gov/investor/alerts/ia_virtualcurrencies.pdf) and FINRA’s Investor Alerts(https://www.finra.org/investors/alerts/bitcoin-more-bit-risky,https://www.finra.org/investors/highlights/getting-a-handle-on-virtual-currencies,https://www.finra.org/investors/bitcoin-basics-9-things-you-should-know-about-digital-currency).
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