HOW THE PLAY THE MERGE ?

In a proof-of-stake system, computers don’t burn energy racing to verify transactions. Instead, crypto investors deposit a certain number of digital coins in a shared pool, which enters them into a lottery. Each time an exchange happens, a participant is selected from the lottery to verify the transaction and win the rewards.

If the Merge won’t eliminate the current high gas fee, developers say it will lay critical groundwork for future upgrades designed to minimize fees.

This long awaited event may well go smoothly, but in any case it is a dangerous and difficult affair. As one crypto industry veteran reported, “it is flying the jet and changing the engine in the sky”. In this context, we will try to spot if any good trading opportunity arise and see how to play it on the market.

1. ETH Market analysis

• ETHUSD is down 65 % from its 2021 peak and up 85 % from its 52 weeks low. The summer rally, from 1’000 to nearly 2’000, has been attributed to positive anticipation before the Merge. We must nevertheless witness that ETH did not outperform other assets by a large amount and the rise has more to do in our opinion with a relief rally after an 85 % fall. As the time of writing, it is difficult to state a pre-event rally has taken place on ETHUSD.
• The ETHBTC cross technical analysis shows a very bullish picture. If correct, we may see very soon a strong increase of the over performance of Ether against BTC. This trend is already here since a while now, but we anticipate a net acceleration.
• Looking at volume and open interest on Futures contracts, we cannot detect any peak in activity. It would be hard to say some players have engaged big bets ahead of the Merge.
• On the option market, we can notice huge positions on the September call contract, strike 3’000. Player who bought these September 3’000 call bet that ETH will be above the 3’000 mark by the end of September. This is a bullish anticipation.
• Futures contracts are generally in a contango. This is a situation where the price of each maturity is higher than the previous one. An example is September contract trading at 100 when December contract is at 120. One can notice than there is a small backwardation (inverse situation) on ETH structure of the forward curve. In short, October contract trade at a discount compared to September one. This means market players may anticipate a “buy the rumor, sell the fact” situation after the merge has taken place. We don’t subscribe to this theory but indeed believe Ethereum will benefit from a deflationary status once the Merge has occurred. This will be the result of the EIP-1559 proposing to burn ETH instead of giving it to miners.

To sum up, our market analysis doesn’t show evidences of big bets being at play. It looks more like the market has a “wait and see” attitude, with maybe a quick “buy the rumor and sell the fact” play in mind.

2. What can we expect after the Merge?

• Even if unlikely, we can’t rule out a few days crash of the Ethereum blockchain. This would of course be the worst case scenario and may provide a panic sell-off.
• More credible would be a long serie of misfunctions among Dapps, Defi protocole or from any other actor of the ethereum ecosystem who were not technically well prepared. These local and punctual disruptions may paralyze some services, but the overall impact shall stay minimal.
• The Merge will lead to the end of a multi-billion-dollar industry made by the Ethers miners. Some investors are worried that part of these miners will try to manipulate the Blockchain to prevent the Merge, or even initiate a hard fork and create a new Ether based on the Proof of Work. At this time, there is no evidence such hard fork will emerge. The largest mining pool has already announced that it will switch to Proof of Stake. In the case a hard fork is done, we will be left with three Ethers: the actual one on PoS, a new one on PoW and the classic Ether, born after the first original hard fork. If this situation may seem confusing, odds are high that most of Dapps, protocol, Defi services and other will keep working with the Proof of Stake. An Ether based on Proof of Work will thus become quickly marginal and near useless.

The Merge shall not trigger any major technical issue on the Ethereum Blockchain. A potential hard fork from miners don’t seem to have the potential to create sustained troubles, split the community and paralyze the whole eco-system.

3. What strategy?

In this paper, we have seen than:

• There is no major market moves we can directly impute to the upcoming event. There is a “slightly bullish” mind but with no excess at all.
• The Merge may trigger some punctual disruptions of Defi protocols or Dapps, but they may not impact the blockchain in a decisive manner.
• A hard fork is possible, but the new created Ether may quickly be little useful and join the Classic Ether in the category of useless token.

• Selling short ETHUSD to play a huge technical issue. This outcome looks like very improbable and with crypto markets probably in a bottoming process, one can be caught on a nasty short squeeze.
• Buying Ethereum blockchain competitors, like Polygon, Solana or Harmony. In case there is a huge disruption, these competitors may benefit from buying spirit. In our opinion, such a move should be short lived.
• Buying spot ETHUSD and selling short Futures for the same amount. In this case, your position will be market neutral and after the Merge, if a hard fork occurs, you may be given some free new Ethers. In case of no hard fork, you just close your position with no gains no losses.
• Buying spot ETHUSD and keep the position much after the Merge to benefit from the deflationary effect of the new Ether. Current ETHUSD levels look attractive on a long time frame and this shall limit the downside.

In our opinion, the last trade is the best one to make at work. The bullish construction of ETHBTC cross tells us we could see a very sharpe over performance of ETH over BTC in the coming months. This would fit with a successful event and plenty of Ethereum blockchain improvements in the cards.