Cryptocurrencies are gaining as investors return to high-growth “risk assets.”
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Bitcoin has perked up, gaining 8% to roughly $42,600 in the past week. But Ether, the second-largest cryptocurrency, has gained 15% and has pushed past a key level of $3,000.
Ether, the native token of the Ethereum blockchain network, seems to be getting a lift from the forces lifting cryptos in general. Investors are returning to high-growth “risk assets” as the markets digest prospects for interest-rate increases and other steps to tighten monetary policy from the Federal Reserve, along with the consequences of the war in Ukraine.
But Ether has some other tailwinds. Perhaps the most important is the view that the Ethereum network is on track for a major upgrade, expected this summer or fall. The upgrade, known as Ethereum 2.0, is expected to sharply reduce network congestion, cut transaction fees, and make the network more scalable.
It is also intended to slash the vast amounts of energy currently required to process transactions on Ethereum and other blockchains based on similar mechanisms, including Bitcoin. Investors holding the token, and platforms such as Coinbase Global (ticker: COIN), stand to gain as well if the Ethereum upgrade goes through.
“The upgrade looks like it will be successful,” said Alkesh Shah, head of global crypto and digital asset strategy at Bank of America. “This is a major change for Ethereum. It’s like Microsoft going from a DOS operating system to Windows. This will make Ethereum a network that people will want to stick with and build on.”
The upgrade, long in the works, would shift Ethereum from a “proof of work” mechanism for processing transactions to a “proof of stake” system. Proof of work (POW) is the basis for Bitcoin and other first-generation blockchains like Ethereum. It requires enormous computing resources and electricity consumption to record transactions and secure the network. Indeed, the idea of POW is that participants have to show massive energy use to essentially prove that they are validating transactions correctly.
With POS, computer operators don’t compete to process transactions in the same way. Rather, they put up cryptos as collateral, staking their tokens for the right to validate transactions and ensure that they are legitimate. Validators get paid based on the amount they stake, earning a yield on their collateral. The network itself doles out the payments, based on preset algorithms, in newly minted Ether tokens.
Far less computing power should be needed to process transactions on Ethereum after the upgrade, making it more eco-friendly than Bitcoin and others relying on POW.
“Ethereum will be more scalable, more secure, and more sustainable,” said Jean-Marie Mognetti, CEO of CoinShares , a European crypto fund manager. “It’s an important evolution for the Ethereum network.”
One benefit of the upgrade is that it is expected to reduce the rate of growth in Ether tokens. With POS, 70% of the transaction fees generated by users are expected be burned, or taken out of circulation, while 30% will be paid to stakers for validating transactions, said Shah. That should create a kind of share buyback model for Ether, helping to support prices, assuming demand for the tokens hold.
“Right now, Ethereum has an Uber-type pricing model,” said Shah. “The more congested the network, the higher the transaction fee. After the upgrade, the scalability of the network will cut back on congestion so transaction fees will be lower. People are also excited about the upgrade because it will make the tokens deflationary.”
Investors holding Ether tokens may benefit from the upgrade by delegating their tokens to crypto companies in return for a cut of the staking fees. The practice, known as yield farming, is expected to become more widespread with the Ethereum upgrade.
One potential beneficiary is Coinbase. The crypto exchange is expected to take a cut of 25% of staking rewards earned, while passing on 75% of the rewards to its staking customers, says Oppenheimer analyst Owen Lau. A 5% staking yield, for instance, would generate a 3.75% yield for a Coinbase client staking their Ether.
Staking isn’t a major revenue driver yet for Coinbase. Lau estimates it will generate $453 million in revenue this year, compared with a total companywide revenue base of $7.3 billion. But he expects it grow steadily, reaching $1.4 billion in 2025, when total revenue is expected to be $9.6 billion.
That staking growth is one of several reasons he has an Outperform rating on Coinbase stock with a $377 target.
Coinbase could certainly use a lift from staking. The stock is down 26% this year and has fallen more than 55% from its high around $430 last year.
Shares of Coinbase were ahead 5.6% in trading Tuesday to around $187.
