Crypto Long & Short: Why Ethereum’s ‘London’ Upgrade Matters

Plus: The risks and rewards of EIP 1559. |

Weekly insights, news and analysis for the professional investor By Galen Moore, Director of Data & Indexes July 25, 2021 Sponsored by     Bitcoin (BTC) - $34,731.45 Ether (ETH) - $2,175.84 Prices as of 07/25/21 @ 8 a.m. UTC If you were forwarded this newsletter and would like to receive it, sign up here.  Hi all!   In T-minus 10 days, the Ethereum blockchain will undergo its 11th backward-incompatible upgrade, also called a "hard fork." This hard fork, dubbed "London," contains five Ethereum Improvement Proposals (EIPs), each featuring code changes aimed at optimizing and improving the world's second-largest cryptocurrency by market capitalization.  Of these five EIPs, EIP 1559 has been the most controversial among Ethereum stakeholders due to its radical redesign of the network's fee market. Today's Briefing features an edited excerpt from CoinDesk Research's latest report, The Investment Implications of EIP 1559, that explains the risks and reward dynamics of this code change for investors.  – Christine Kim, Research Associate  A message from Crypto.com Buy bitcoin and 100+ cryptocurrencies with 20+ fiat currencies. New users can enjoy 0% credit/debit card fees on all crypto purchases made in their first 30 days. Download the Crypto.com App now. THE BRIEFING Rewards of EIP 1559 (The following is an edited excerpt from the CoinDesk Research report The Investment Implications of EIP 1559.)   One of the most common arguments against ether (ETH) as a store of value is its unbounded coin supply.  Bitcoin, the world's first cryptocurrency, has a prescribed and capped supply schedule that fuels an important part of its narrative with investors as "digital gold."  While EIP 1559 does not introduce a bitcoin-like supply cap on ETH, it does activate a mechanism to curb total supply growth over time by taking a variable amount of ETH out of circulation each time a transaction is executed. Simulations of EIP 1559 as of June 8 suggest the activation of EIP 1559 over the trailing 365 days would have burned a total of 2,967,937 ETH for a net reduction of 76% in ether supply growth over that period.  In addition to creating a bitcoin-like narrative of limited supply to ETH, EIP 1559 is expected to improve transaction wait times and remove fee-market uncertainty that damp developer and user adoption of dapps. Finally, EIP 1559 is expected to solidify ether's role as a form of payment for using Ethereum's computing resources and interacting with the network's broad system of dapps by requiring payments of transaction fees on the network to be exclusively paid in the network's native cryptocurrency.  Risks of EIP 1559  Any technology upgrade comes with risk, and the most salient risk posed by EIP 1559 comes with its proposed changes to reward dynamics and payouts to miners, who face reduced earnings for their work with the activation of EIP 1559. Instead of pocketing 100% of transaction fees, miners will only receive tips from users through an optional "inclusion fee," paid electively by users seeking priority for their transactions.  Changing reward dynamics on its own won't affect Ethereum's ability to process blocks or computations. There is the potential, however, for disgruntled miners to leave the network, sabotage it or start a competing chain. If a large share of Ethereum miners exit or revolt, block times and network security would be negatively affected.  As for users and dapp developers, the benefits of EIP 1559 may not prove to be as efficient in practice as they are in theory. A failure to deliver promised fee-market efficiencies could result in user and developer disillusionment. If that occurs, Ethereum competitors such as Binance Smart Chain and Cardano, the two largest smart contract blockchain platforms by market capitalization after Ethereum at time of writing, will undoubtedly seize an opportunity to grab market share.  To gauge the subsequent rewards of EIP 1559 and its impact on users over the long term after activation, investors can view in real time the number of transactions styled in accordance to the EIP 1559 format as a way of tracking its usefulness in practice through privately maintained nodes or public block explorers. Finally, the activation of EIP 1559 poses the risk of unforeseen bugs or malicious user behavior. A few have already been discovered during the process of testing EIP 1559 on public and private test networks.  At its core, EIP 1559 is designed to make transaction fees on Ethereum less volatile and more predictable. Beyond that, however, the code change poses several risks and potential rewards to Ethereum that will be important to watch for in August.  Read the full CoinDesk Research report about EIP 1559.   A message from Copper Copper provides a gateway into the cryptoasset space for institutional investors by offering custody, prime brokerage, and settlements across 250 digital assets and more than 40 exchanges. We are committed to providing flexible solutions that adapt to the changing cryptoasset space, while enabling far greater transparency, control, and security for asset managers.    To learn more visit copper.co/interest CHAIN LINKS Bank of America's prime brokerage has started the clearing and settlement of crypto exchange-traded products (ETPs). TAKEAWAY: Demand for crypto exposure from European hedge funds is increasing. A virtual conference aimed at demystifying bitcoin for institutions called "The B Word" kicked off on Wednesday, with its flagship track featuring a live panel discussion between Cathie Wood, Jack Dorsey and Elon Musk. TAKEAWAY: While entrenched bitcoin investors were disappointed at the lack of hard-hitting discourse about technical topics, others who attended, like American rapper Busta Rhymes, bought into bitcoin for the first time after seeing these individuals agree that bitcoin is going to change the world.    Circle and Paxos released breakdowns of the collateral used to back their stablecoins. Circle's USDC is backed by 61% cash and cash equivalents, while Paxos' BUSD is sitting at 96%. TAKEAWAY: Investor demand and regulatory pressure is mounting for greater transparency from stablecoin issuers.  Crypto exchange FTX raised $900 million in a Series B funding round that valued the company at $18 billion. The funding round was the largest in crypto history backed by notable names like SoftBank. TAKEAWAY: Institutional investors have shown they still have interest in the digital asset market, even as the prices of major cryptocurrencies stall. Mastercard announced a pilot program to test USDC for payments. Earlier this year, Visa also announced a pilot to accept payments from companies like Crypto.com in USDC. TAKEAWAY: Stablecoins have proven useful for cryptocurrency exchanges and on-chain transactions, but could soon be integrated into mainstream payments networks reaching millions of merchant locations around the world.  NFT marketplace OpenSea raised $100 million in a Series B funding round that valued the startup at $1.5 billion. TAKEAWAY: Venture funding in the cryptocurrency and blockchain industry continues to soar in 2021.  Rothschild Investment Corp, with over $1 billion in assets under management, tripled its position in the Grayscale BTC Trust. The fund now holds around $4 million worth of bitcoin and $5 million worth of ether. (Disclosure: Grayscale is owned by Digital Currency Group, the parent company of CoinDesk.) TAKEAWAY: As cryptocurrencies become more mainstream, retirement and pension funds are gaining exposure to the asset class.  A message from CoinDesk The CoinDesk Quarterly Review 2021 Q2   After two consecutive quarters of strong price gains for most of the top crypto assets, Q2 2021 finally brought an end to market euphoria with a resounding crash. Most CoinDesk 20 assets, which constitute 99% of the crypto market by verifiable volume, ended the quarter with negative returns.   Meanwhile, protocol development for the world's largest cryptocurrencies by market capitalization, Bitcoin and Ethereum, reached new milestones.   CoinDesk Research's latest Quarterly Review dives into the trends, developments and technological progress that shaped the crypto markets from April to June 2021.   The full report is now available from the CoinDesk Research Hub. Podcast episodes worth listening to:  Lyn Alden: Bitcoin Has Proven Itself Over Time – Natalie Brunell, "Coin Stories." 'Time Bandit' Attacks on Ethereum: What They Are and How They Work – Christine Kim and Ben Edgington, "Mapping Out Eth 2.0." Will DAOs Transform Power in Venture Capital Fundraising? – Nathaniel Whittemore, "The Breakdown." A message from Coindesk The CoinDesk DeFi Index (DFX), benchmarking the investable DeFi sector, is now available for investors watching decentralized finance, the first true "sector" in cryptocurrencies.   It is the latest index by CoinDesk Indexes, the market standard for crypto assets since 2014. The DFX provides a market-cap-weighted benchmark for a representative basket of DeFi-sector cryptocurrencies, composed of assets suitable for long-term holding.   Find out more at coindesk.com/indexes/dfx, or email indexes@coindesk.com.  ATTENTION: Scammers have been sending fraudulent emails with links to sites disguised to look like coindesk.com. If you are in doubt about a link, type https://www.coindesk.com directly into your browser; do not copy and paste. Remember, if something seems too good to be true, it probably is. 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