Digital Assets Office Hours: Ethereum Merge

Irene:

Hi everyone. Thank you for joining today's Digital Assets Office Hours on the Ethereum Merge. With that, I'll turn it over to Matt Kress, WisdomTree's Director of digital assets for opening remarks.

Matt Kress:

Thanks Irene, and thanks everyone for joining us for this Digital Asset Office Hours with two fantastic guests who are bringing deep expertise and great insights for everyone today. So, as most people know or some people know, one of the biggest events in the digital asset space happened on September 14th. The Ethereum ecosystem transitioned away from validating transactions using proof-of-work or mining, to proof-of-stake consensus mechanism. This was called the Ethereum Merge. Now that it's been live for three weeks, we're going to explore how it went, how it's impacting investors for the future including potential implications and trade-offs. As a reminder, the presentation today is for informational purposes only and should not be construed as investment or legal advice, investment recommendations, or offer solicitation to purchase for sale any products or services including digital assets or securities. So Ben and Brett, thanks for joining, bringing your knowledge, expertise to everyone tuning in. How are you guys?

Brett Munster:

Doing well.

Ben Dean:

Just keeping it real in the metaverse.

Matt Kress:

Absolutely. Sounds good. So for people who, some of the audience might know you, some of the audience might not know who you are, can you give us a little bit more about your background, who you are, where you come from, and everything there? Brett, do you want to go ahead and jump in first?

Brett Munster:

Yeah, happy to. So I've spent my entire career in the tech industry, worked at a couple different startups and eventually then started working at a Silicon Valley based venture capital fund. Got really into crypto, Bitcoin, Ethereum, all around 2013, 2014. Over time, just went down the rabbit hole and wanted to work full time. Didn't want to do enterprise Saas, wanted to spend my 100% of my time in crypto. So left and joined OnRamp a little over a year ago as director of research there.

Matt Kress:

That's awesome. Yeah, thanks for jumping in. I'm excited. I know prepping for this call, we dove into a bunch of different things, so excited to jump into it. Ben, I think more people are going to be a little more familiar. You've popped up around a lot of WisdomTree. You're leading a lot of the effort here. Can give everyone who doesn't know who you are a little bit more background for you?

Ben Dean:

Sure thing. Well, like Matt, I'm a director of digital assets, WisdomTree. Been working with them for the last year building out variety of initiatives across the company. Talking WisdomTree Prime, if US based, go to wisdomtreeprime.com, get on the wait list. I work with the European side of the business on some exchange traded products, crypto exchange traded products, and then we've got a whole lot of other things we do like the Crypto Clarified podcast, punch Crypto Clarified podcast into your Google machine. Check it out, we do it every week or two. We've got Cammy Russo on there as a co-host. Goal is really just to explain what can sometimes be complicated technical subjects in a way that regular folks can understand and comprehend. So there you go.

Matt Kress:

Yeah, that's awesome. Thanks for jumping in. If people haven't taken a look at the Crypto Clarified podcasts, go find it on Spotify, Apple Podcast, YouTube, everywhere where podcasts are at as well. So Brett, jumping into it, there's a wide range of understanding with the space. When I ask advisors and clients, what's the first word that comes to mind when they think about cryptocurrencies, digital assets? Bitcoin's typically the top response. Can you explain at least at a high level, and then we'll start diving into it, but at a high level of how Bitcoin and Ethereum are different?

Brett Munster:

So they're very different. We tend to use the word crypto assets a lot because we don't view most cryptocurrencies or crypto assets as currencies. Bitcoin is a currency. It's a decentralized way to transfer value, money over the internet without a middleman, without a third party, without a bank, you can do directly peer to peer. It's the first time we've ever been able to do it purely peer to peer without a middleman. Ethereum on the other hand, is much more of an operating system to power decentralized applications. So you can think of this as Amazon Web Services, but without a company in the middle. It's a totally decentralized version of providing a platform in which you can build decentralized applications on top of. So solving very different problems and we'll get into kind of, because they're solving different problems, the different trade-offs they're looking to make, and that kind of gets into why Ethereum moved to proof-of-stake.

Matt Kress:

Yeah, the trade-offs are an interesting part and an interesting thing of what we're going to focus on today. Ben, you've talked to advisors as well. What do you think some of the resonating points are when talking about differences between the two and diving more into just Ethereum and the ecosystem there?

Ben Dean:

So I get to speak to a lot of institutional investors across the whole spectrum in Europe and, well, the first thing usually is, there's more than Bitcoin. This comes as a news flash for a lot of folks that, there's more than Bitcoin, and once we get past that, then sometimes they'll ask, "So how are they different?" Because, a lot of folks think that it's all the same. So, once you start breaking it down, as Brett just said, they're functionally different. They're trying to achieve different things. Once you start breaking down how the monetary policy is different between the networks and then how the developer communities are.

Bitcoin doesn't change very much, but the Ethereum roadmap is quite long and does go through periodic upgrades. Then they start to see that it's very different, very different investment proposition, and this Ethereum Merged proof-of-stake, it's also got a different value proposition in the form of the staking reward, which they see as the form of yield. So those discussions I wasn't having a year ago, and it's been nice to see these folks kind of learning and catching up. There is a lot to learn, but bit by bit they are starting to learn the salient points and the discussion's progressing.

Matt Kress:

Yeah, I think that's a great point, and even just the understanding and learning. Sometimes we could just be so in depth, in the weeds in it that we forget to just step back and think, "What are those future use cases?" We know what we're working towards, what potential is, but how can we explain that in just a simple way and helping people understand. With this merge, the whole purpose of this is, what were some of the trade-offs or what were some of those implications here as we get deeper and more understanding? So Brett, can you talk a little bit about, what are some of the trade-offs? And we'll start diving deeper into them and some of the potential implications with, well one, why did the merge take place? Lead to that and then we could dive into some of the different areas to be thinking about. Thinking about for right now, thinking about for the future.

Brett Munster:

Yeah, I think Ben was spot on with his comments. It's good that Bitcoin uses a proof-of-work system. Proof-of-work is the longest standing way of reaching consensus and it's the most secure, most essentialized way of doing so, and when I say consensus, it just means that all nodes on the network agree with each other. So if Bitcoin is going to be a currency, and it's going to store trillions of dollars of value and it's going to move that across the world, it needs to be stable and secure. It shouldn't be going through a lot of upgrades and changes. You want it slow to change because it gives it that stability, that's actually a feature of Bitcoin, but without giving too much into technical details, there are limitations to the number of transactions. A proof-of-work based blockchain can handle per block, in other words, scalability. This is where Ethereum starts to differ because Ethereum has, as we said, has a different goal where it wants to be an operating system for other decentralized apps. So scalability is paramount. The ability for Ethereum to increase the amount of transactions and the speed of those transactions is going to be crucial for the success of Ethereum over the long term. And so the move to proof-of-stake was around optimizing Ethereum's long term ability to improve its scalability. Now the Merge doesn't directly increase the number of transaction that Ethereum can handle. It doesn't improve the transaction speeds all that much. But what the Merge really did is, is set up Ethereum. So it paved the way for numerous protocol level upgrades such as shorting and other upgrades. That'll be far easier to implement on a proof-of-stake system. And that should lead to, especially with the advent of a lot of layer 2 networks and we can get into that, should really increase the overall scalability and the ability to program and create applications that work faster, work cheaper, all within the Ethereum ecosystem. So it's not that proof-of-work is right or proof-of-stake is right, it's not one or the other, it's just that they have different design optimizations to achieve different goals.

Matt Kress:

Yeah. And that's something that, it's funny, right when the Merge happened, I remember people were coming up to me and saying, "Hey, these fees are still as high. We didn't see an immediate change in things like that," or people were saying, "Hey, it didn't get to such a faster set of transactions yet." The goal is to be able to do that, like you said, through some of these other solutions on top of the network. So just talk about scalability. We could focus on scalability, we could chat a little bit more. Ben, what are you seeing as some of the big kind of things going on in the space we need to think about? What are some of the scalability, like scaling solutions and things going on there?

Ben Dean:

So the Ethereum network has got a nice problem to have, which is that it is become almost a victim of its own success. So many applications have been built on top that people are using around NFTs and DeFi, decentralized finance, that the network can't hold the demand or can't process the demand. And so you have to pay a fee to use the network. The fees go up as demand increases, but the supplies constrained. And this has kind of been an obstacle for years for further adoption of the network. Not everyone can pay a hundred bucks to do a basic transaction. Maybe those who are buying like million dollar eight JPEGs can, but it limits kind of the adoption, mass adoption of the network. In the absence of solution for scaling at the protocol level, Ethereum developers call the shorting. There's been a series of alternatives built in the ecosystem to try and provide scalability that the base protocol layer cannot.

So Polygon for instance, utilizes the Ethereum based layer for security. You've also got some of what are called layer 2, sorry for the technical term, but they're essentially applications built on top of the Ethereum network that focus on roll ups, which is to say you're trying to dispatch transactions and process them in a way that uses less data space. And so you've got optimism and a few other solutions that... We don't have time to talk about the differences between them. But the important point to folks is to understand that even if shorting at the base layer comes in 18 months, it might not ultimately matter because you've got these alternative ways in which to increase the three foot of the Ethereum network that have grown up organically in the ecosystem.

Brett Munster:

Yeah and I think what makes the layer too so exciting is, Ben said it batches them all these transactions together and settles basically down on the Ethereum network. But then when you pay the Ethereum gas fee, you can now spread that cost across all those in that same batch. So you distribute that cost and therefore you've driven down fees for those end users that are using on layer 2 networks. So this could not only increase scalability, but it could also drastically reduce the fees that end users end up paying, which should enable far more innovation bends, right? If you're going to buy a $500,000 JPEG, you don't mind paying a hundred dollar gas fee, but I'm not going to pay a hundred dollar gas fee if I want to buy a $5 NFT that I want to send my niece. Right, so by driving that cost way down to pennies or maybe even potentially fractions of a penny, you now unlocked economically the ability to innovate and create many more things that just weren't feasible prior to this upgrade.

Matt Kress:

Yeah and even just the transactions per second is really making that a lot more and more useful when you think of scaling all the different solutions and use cases out there as well. So someone came in, Theodore, I appreciate the question. Please define the Merge what does that mean? Ben, I see you nodding your head. Do you want to go ahead and take that? Brett, you could add on. I'll add on as well.

Brett Munster:

Yeah, sure.

Ben Dean:

Yeah. It's called the beacon chain. So the idea was late last year, there was the proof-of-work, the original Ethereum network and then a new proof-of-stake network created in parallel. And they were operating up until September of this year when they were brought together with the old proof of work network being obsoleted. And then it just becoming one proof of state network. The idea of two chains coming together merging is why it's called the Merge. I know it's not obvious, but that's kind of in short why it's got that name and why what we're talking about.

Brett Munster:

Yeah. And the beacon chain was important because it launched back in 2020. So it gave the developers plenty of time to understand this ecosystem, build up enough capital in the system so that it's secure. And so it was this long process, but it was well thought out, well executed and the Merge happened without any hiccup, which was an engineering marvel. Just, I mean just spectacular that they were able to pull this off without a hitch, but it took years and years of planning and testing to do successfully.

Matt Kress:

And on that point is, I love how you just said that it's an engineering marvel. You could think of the blockchain, you could think of this Merge and the advancements in it similar to just any sort of tech application, whether it's Zoom, where we are right now, they're going to update software. Whether it's Outlook, Microsoft, all these things, you just update software, you update it in different ways. You work as a team, you test it, you make sure it works, you push it live to production. So similar to that is similarly like what's going on is as they're figuring out the roadmap and the long term implications of figuring out how to get to that more scalable solution in the full vision with the Merge, so the chains in beacon chain, they came together.

Ben, I heard you mentioned, and I love the idea, you talked about hotel in California. So people talk about staking, people talk about staking, they ask me, "Hey, is there anything we can do for staking? How do we get this? What is it?" Ben, tell us a little bit more about staking when people can get their assets out and more information there.

Ben Dean:

Sure thing. So staking, proof-of-stake staking, this is a so what question. Basically the way in which the Ethereum network's going to come to agreement on the correct order of transactions on the distributed ledger is via a process of voting. And so what one is able to do is to allocate the voting power of one's Ether holdings to nodes on the network called valid data nodes. Each node has to have a minimum amount of Ether, 32. And in essence, you end up with a weighted voting system. Different nodes will be asked to batch and validate new transactions, new additions to the database, and they'll be chosen probabilistically based on the amount of stake that they hold, the amount of voting power they have. And so over time, the idea is that the better nodes, the ones who do a correct job honestly and most efficiently, will gain the most stake.

And for doing that computational work and keeping all the lights on inverter commerce, they're going to be rewarded with new Ether. And so this is called staking. The Ether that they're rewarded with is called the staking reward. It's roughly around 5% right now. It's paid out in the Ether cryptocurrency. And there's a whole cottage industry around staking that we can't go into today, but that this to a lot of institutional investors that suddenly like a light bulb goes off because they've been told this whole time that Bitcoin's like gold, it doesn't generate a yield. And now they've been found out that there's other networks. And then one of them moved to this proof of stake. And the economics underlying Ether holdings is now completely different with this, with staking yield. Of course there's a downside to staking that we could go into, but I hope that answers the question succinctly.

Matt Kress:

Yeah, absolutely. And just understanding that helps.

Brett Munster:

Really quickly-

Matt Kress:

Go ahead, Brett.

Brett Munster:

I was just going to say, so that's the economic incentive. There's also a disincentive. So if you were to not act according to the rules of the Ethereum network, if you try to institute a fraudulent transaction as an ETH staker, you would then lose either a portion or potentially even all of your staked ETH. So there's both a carrot and a stick built into the network to incentivize proper behavior.

Matt Kress:

Yeah, that's a great point. Especially when you think of, you see headlines talking about security and you see all the headlines. Can this be hacked? What incentives? Why can't it? Just everything around that. And I think just a simple, like you mentioned, incentive, there are pieces of code that make this happen if something, like if you do that and you do something against the network of fraudulent block and pushing it through, it automatically happens because of smart contracts and the code underlying it.

Ben Dean:

So Matt, I neglected to answer part of your question that's important as well. You mentioned, I've been going around to the press and saying, Hotel California, you can check in, you can never leave. You can stake your Ether out. In fact, you've been able to stick Ether for quite some time, but you can't unstake it. So you're locked in. And so right now, again, going back to the merge and its consequences. So what? Well, you've been able to stake for a long time, that's very nice. The merge hasn't changed anything about your ability to unstake, that is a future update that will come at yet to be precisely determined point in time. So for institutional investors, that's quite important. Do you want to be locked into a situation where you have to sit around and wait? Well, there are solutions to that actually that have emerged, but it is an important point to highlight in what really did the merge do and didn't it do?

Matt Kress:

That's a good point.

Brett Munster:

It's a really good ... Yeah, I was just going to say, so the reason you weren't able to take destake is they just didn't want to add any additional complexity to what was already a very complex problem of, so if people were destaking, moving ETH around, that would've just added to the complexity of the merge. So to simplify it, it was a deliberate choice. Now the Ethereum developers need to institute a change in the code base that does allow people to destake. It is a top priority, but as Ben said, currently you're not able to withdraw your staked ETH and it's likely going to be that way for another six to 12 months is the timeframe. Ben, tell me if you've heard anything different. But it should be a pretty simple, relatively simple change to execute. It's just a matter of timing. And I do know that that's one of the highest priorities coming in the most upcoming updates.

Matt Kress:

Yeah, and that's important to, Ben you mentioned as institutions think about it as advisors and their clients think about it or as just anyone here thinks about, if I want to get involved in staking, it sounds great. It sounds really interesting. It changes my understanding and feeling of it. Then knowing that you can't stake and then tomorrow say, "Ah, I want to do something else, or I'd like to pull back and do something else." You can't do that yet. And there's no hard timeframe of when that can happen. So those conversations, whether it's with an advisor, with a client, just yourself, whomever, are really important to understand that level of it when you start to think of staking with Ethereum at the moment.

Ben Dean:

There are a lot of other networks that have had staking for years. I've had some neo staking for seven years. It just ticks along. The important thing then for advisors is like we have plenty of information at WisdomTree that we put together around staking across different networks. It is very different from network to network. So if you do have clients who are interested in discussing it, there is a tremendous amount of information available to you to explain it to them concisely and accurately. But don't think that this is the first time staking has been allowed and don't think it's the only way that it's done. It is actually quite a longstanding practice and there is quite a bit of nuance to it.

Matt Kress:

Yeah, absolutely. And we could show people where to go on the WisdomTree website and places there for more information too. Another thing, so we haven't talked on it yet. We haven't talked about it. The topic comes up all the time. ESG, energy, Bitcoin is using so much. I hear those headlines topics all the time. With this merge, so in proof of stake, there's no longer these miners that are mining to and using a lot of energy to keep the network secure and keep it operational. Brett, can you talk a little bit more about, well, one, what are those miners doing? What happened? Where are they going? But then also two, when you hear the ESG words and you hear energy and there's all these headlines with it, explain a little bit more about what the impact is that you're seeing and understanding from the move to proof of stake.

Brett Munster:

Yeah, so Ethereum is transferred from a network that relies on energy, right? Solving these computational complex problems just like Bitcoin does, to one solving, validating, using capital essentially in the form of ETH. So by not having miners having to contribute this computationally intensive proof of work, you drastically lower the amount of energy the Ethereum network is going to consume. Now, that doesn't mean proof of work is necessarily bad for the environment. In fact, Bitcoin could actually be a great tool for improving our energy grid, absorbing wasted energy and incentivizing adoption of clean technologies. We're seeing that with flared gas and capturing methane and whatnot. And we could do a whole hour long, another thing on just that alone, but the move to proof of stake does drastically lower by as much as 99% less electricity being used. And it makes for a great headline, so it becomes much more carbon friendly. However, we're talking about, when you think about the Ethereum network, I think I've read something, it's like 0.2% change of electricity potentially, which doesn't really move the needle when we're talking about climate change and whatnot. So while it is a good thing, a lot of it is really around marketing and hype. And I think it's largely superficial because I don't think it's really going to alleviate any kind of environmental impact that the Ethereum network would have. It's great that it's using less electricity, it's a good thing. But Bitcoin, because it does use excess electricity and because it can capture methane and stuff, Bitcoin could actually proof of work could in time become actually carbon negative. Meaning, it takes carbon out of the atmosphere more than it consumes. We're not there yet, but we could reach a point in the future.

Brett Munster:

So all that to say, this is a very nuanced, deep conversation to have when we're talking about the energy consumption and sustainability, and impact on the environment. And we really would need a couple hours to really break this all down. But Ethereum is using far less energy, or far less electricity, than it was prior to the merge.

Ben Dean:

Yeah, Brett's right. You could spend ages speaking about this, go to the latest Crypto Clarified podcast where we spend copious amount of time unpacking what is a very nuanced topic. I mean, the ESG is like that. You've really got to think very hard. Anyway, we've done that. So you find the Crypto Clarified podcast on YouTube, Spotify, all good purveyors of podcasts. There's a tremendous amount of depth there to go into that you should really think through before drawing any conclusions based on headlines that seem to be repeated at infinitum.

Matt Kress:

Yeah. And that's one of the hard things is, we don't know what to think until we see headlines or until we see someone talk about it. So just having those starting points and knowing we need to do our own research. The importance of due diligence on all the digital assets, all the custodians, just everything cryptocurrencies. I think CoinMarketCap last time I saw, said there were over 19,000 different cryptocurrencies. So if you're thinking about this space, then how do you do all the research and knowing who to trust? And that's why it's really important to find sources, and find teams, that you could really trust and understand.

So I know I have a few more minutes left. If you have any questions, toss them in. Toss in the Q&A. Theodore, I appreciate that question. Another question came in, so I'm asking if we can get regular updates on the WisdomTree model and rebounds, alerts. Absolutely. There should be one being published shortly, and so that should be being updated and we'll update everywhere that needs to go, and we'll make sure those regular updates are coming out and you see it. If you have any questions at all... So Brett, I appreciate you jumping on. Do you want to shout out anything really quickly, and then I'll pull up the Crypto Clarified podcast, show people where that's at, and show people where they can get in touch with us if they have any other questions after this.

Brett Munster:

Yeah, I mean, if you're a financial advisor, you probably have clients that are asking about cryptocurrencies, probably own cryptocurrencies, whether it's you can view it, or they own it in Coinbase, or some other platform. And what On-Ramp really does is it allows you to get a view into your client's crypto holdings, and incorporate that into a holistic view of their entire portfolio. So you're not just missing out on their crypto holdings. And it lets you then manage within your own workflow so you can get a read only view. You can also buy, sell, help manage. We've got WisdomTree models on our platform that are great, that you can allocate to, that you can kind of just set it and forget it. So there's a lot of functionality in Onramp. So if you're a financial advisor and you want to offer the ability to do cryptocurrency, or you just want visibility into your client's cryptocurrency holdings, strongly encourage you to check out Onramp.

Matt Kress:

Yeah, and I appreciate that. I want to answer one last question since it just came in, from Jeff Thompson, and then maybe another one as well. Jeff said, "Where do we invest in Ethereum?" So there are a whole lot of places that you can invest. Jeff, I don't know, depending on if you're an advisor, where you're at, if you're just an individual investor, you can look at different exchanges out there. We tossed around a couple of the names, places like Gemini, places like Coinbase, and other ones out there depending on where you're are at in the world. Or if you have a financial advisor, then go talk to your financial advisor. Like Brett just mentioned, there are a couple different solutions and platforms, like Onramp, out there as well.

So then other than that, if you're interested, I'll share my screen here. You can go find the Crypto Clarified podcast. You can just Google Crypto Clarified podcast. This is the Apple Podcasts preview. Ben, Jason, and Cami do a fantastic job here. And then if you want to keep up to date with what WisdomTree is doing as well, if you go to our blog, you'll actually see, so our head of digital assets, Will Peck, recently put together a fantastic article on a new digital fund opportunity we have there. You can go over to strategies, go over to the Evolution of Crypto, and you'll be able to see more where we have more resources. There's a place that you can actually subscribe for more information, and keep up to date with everything we're doing and going on there.

So I appreciate everyone joining. I hope you found this interesting. If you have any other questions, you can email us at crypto@wisdomtree.com. It'll come across my radar, and we'll be able to answer it for you there. So thank you. Thank you, Brett. Thank you, Ben. Thank you, Irene. And everyone, have a good rest of the day.

Brett Munster:

My pleasure. Thanks for having me.