How can investors profit from Ethereum mergers?

By: Ben Giove, Analyst, Bankless

Compiled and edited by Amy Liu

Following the successful completion of the Goerli testnet merge, the Ethereum merge is expected to arrive between September 15th and 16th, and many investors are wondering if there is a profit opportunity.

The merger is one of the most important catalysts in Ethereum’s history as it affects the network in multiple ways. For example, the merger will significantly reduce Ethereum’s energy consumption, allaying critics’ concerns about its environmental impact and making the asset more attractive to ESG-conscious institutional investors.

The merger will greatly increase the attractiveness of ETH assets. The issuance of ETH will be reduced by about 90%, which may lead to deflation, while also providing stakers with the ability to earn returns on the assets they hold.

The most obvious way to take advantage of this momentous event is to buy ETH, but there is more to it than that. There are many other ways for investors willing to take the risk. Let’s explore four different ways investors can profit from the merger.

1️. Liquid Staking Tokens

For example: LDO, RPL, SWISE

Liquid staking services are the most immediate beneficiaries of the merger, with non-custodial protocols likely to experience significant growth in the months following the transition to PoS.

The value proposition of liquid staking is simple - it allows users to do all three of the following at once: maintain custody of collateral, earn staking rewards, and deploy assets in DeFi by issuing Liquid Staking Derivatives (LSD).

A merger would greatly accelerate the growth of these protocols as it would reduce risk by eliminating pre-merger technical and execution risks.

Additionally, the Liquid Staking Protocol may increase deposits as staking yields are expected to increase. Today, beacon chain validators only receive block rewards. After the merger, stakers will be able to receive transaction fees and income from MEV, which is expected to significantly increase staking yields from the current ~4% to 6-12%.

These growth drivers will also lead to increased revenue for liquidity staking protocols as deposits, higher yields, and potentially higher ETH prices will boost their income.

There are currently three liquid staking protocols with publicly traded tokens: Lido (LDO), Rocket Pool (RPL), and Stakewise (SWISE).

Each token can play a different role in the portfolio:

Investors looking for blue chip stocks may want to look at LDO as it is the largest entity on the Beacon Chain with a 31.2% share of deposits. Lido has a greater control over the liquidity staking space, where it has a 90.3% market share.

Investors oriented towards token economics may look at Rocket Pool’s RPL, the second largest liquidity staking protocol with a 1.6% share of beacon chain deposits and a 4.5% share of the liquidity staking space. RPL has unique token economics in that micro pool operators, or entities validating through Rocket Pool, are required to purchase 1.6 ETH worth of RPL for each new validator they launch, which ties the demand for the token to the growth of RPL.

Investors who want to maximize risk can look at StakeWise (SWISE). While the protocol only accounts for 0.4% and 1.3% of the beacon chain and liquid stake deposits, respectively, it is likely the highest beta token of the three due to its smaller size and low circulation.

2️. Event-based DeFi betting

Buying tokens isn’t the only way to participate in the merger, and savvy market participants can take advantage of DeFi in a variety of different ways.

One way is to lend ETH on money markets like AAVE , Compound , and Euler . Why? The demand for borrowing ETH could increase significantly during a consolidation period as investors look to accumulate as much of the asset as possible in order to get an “airdrop” from a potential PoW-based Ethereum fork.

Since the interest rates on these protocols are based on utilization (i.e. how much of an asset is borrowed), a large spike in borrowing demand would result in incredibly high deposit rates for lenders.

Of course, this strategy is not without risk. In extreme cases where borrowing demand is very high, meaning there is little ETH liquidity in Aave, lenders may be temporarily unable to withdraw their assets until borrowers repay or more deposits flow into the protocol.

The second method is to use the Voltz Protocol, an AMM for interest rate swaps, to bet on the LSD staking yield.

Since staking returns may increase after the merger, market participants can use Voltz by using ETH as margin and purchasing stETH or rETH tokens. Users can amplify their returns by using leverage, but this comes with greater risk as it exposes them to liquidation risk. Please be careful when using any form of leverage!

3️. PoW Airdrop

Many high-profile industry figures, such as Justin Sun and his exchange Poloniex , have pledged their support for the hard fork and plan to list the ETHPOW token.

While it’s unclear whether the chain has any long-term viability, or how valuable ETHPOW will be, there are still a number of different ways users can access the airdrop.

The easiest way to qualify for airdrops is to hold your ETH in a non-custodial wallet ( Metamask , Coinbase Wallet, etc.).

However, if you are looking for a higher risk opportunity, one way is to take on the other side of the bet by borrowing ETH on the money market, potentially profiting if the value of the airdrop is greater than the cost of borrowing the ETH. This strategy comes with considerable risk, though. Not only is the borrowing rate likely to exceed any gains from the airdrop, but borrowers will also be liquidated if the price of ETH spikes or the value of their collateral drops. Given the high likelihood of large volatility on the day of the merger, investors will need to proceed with extreme caution.

Another way investors can access airdrops without taking on any price risk is by creating a delta-neutral ETH position using perpetual futures. To do this, a user would buy spot ETH while simultaneously shorting an equal amount of ETH using perpetual futures on a CEX or DEX. This way, users have access to ETH, so they can receive the airdrop, while not taking on the price risk that comes with holding the asset. This strategy would be profitable if the value of the airdrop exceeds the funding.

However, there is no free lunch. This strategy is very risky because funding (such as lending rates) may spike as the merger approaches. Any leveraged strategy like this, coupled with volatility, puts users at great risk of being liquidated.

Proceed with caution!

4️. Subsequent beneficiaries

Finally, merged Ethereum is expected to have a transformative impact on other sectors of the Ethereum economy.

One of these beneficiaries is Layer 2 (L2), as the transition to PoS will pave the way for scalability upgrades such as EIP-4844, which will significantly reduce Rollups transaction fees for end users by reducing the cost of storing data on-chain. This fee reduction should help promote L2 adoption by increasing the number of users who can transact on the network and unlocking the ability to build new, novel dapps.

Investors can take advantage of this by investing in the entire L2 ecosystem, such as the L2 base layer (OP), or L2 native DeFi such as Synthetix (SNX) and GMX (GMX). Don’t forget to support L2 infrastructure, such as fast bridge services such as Synapse (SYN) and Hop Protocol (HOP).

Another industry that will change after the merger is MEV. The competitive dynamics of MEV will change dramatically with the implementation of the proposer-builder separation, which will separate the production of blocks (deciding which transactions go in) from the verification of blocks.

There are a number of projects in the MEV stack with publicly traded tokens that could provide a way to gain exposure to this transition, such as Manifold Finance (FOLD) Rook Protocol (ROOK) and Cow Protocol (COW). They are expected to be long-term beneficiaries of PoS Ethereum.

Conclusion: Choose the method that suits you

The merger is coming soon and is expected to bring major changes to the Ethereum economy, as well as short-term chaos on the chain.

The safest way to gain exposure is to simply buy ETH.

We live in a DeFi world, and there are many other ways for investors to participate in Ethereum consolidation, whether it is through investing/trading liquidity staking protocols, using DeFi to earn yield, or receiving ETHPOW airdrops. So, which way will you choose to earn yield?