Ropsten testnet successfully merged, what obstacles does Ethereum's "bullish narrative" still face?

Ethereum prices were doing relatively well in the early part of 2022, until the Luna/UST crash, which Ethereum fans touted as a sign of “Ethereum dominance.” Indeed, Ethereum is “stable,” down only 60% from its all-time high.

Moreover, the recent trend is not optimistic.

This is evident when we look at the ETH-BTC chart. The shaky dominance began around the Terra crash on May 10, but only two weeks after Ethereum finally broke strong support against BTC. After maintaining just above $2,000 for several weeks, Ethereum finally fell below $2,000.

Ethereum’s longest-running testnet, Ropsten, completed a merger this week. The merger is the bullish “narrative” that every trader is waiting for. Before the merger occurs, Ethereum is expected to maintain or even break out as this is a bullish signal, but in fact, we still haven’t seen a breakthrough.

More Than Just an Upgrade: What Is the Ethereum Merger About?

The merger is perhaps the most anticipated event, not only for Ethereum , but for the wider crypto industry as well. The transition to proof-of-stake, which has been delayed for many years, is the crypto industry’s way of proving to the world that it has the potential to be the future of finance.

The merger is a very delicate event, and many details are at stake. Moreover, it is not an easy task on a technical level. As Ethereum co-founder Vitalik Buterin said, it is like upgrading an airplane while it is in flight.

The Beacon Chain is a parallel Ethereum chain where the Proof of Stake (PoS) mechanism was born. As the coordinator of the migration, the Beacon Chain will merge with the Ethereum mainnet, hence the name: The Merge . After the merger, the previous Proof of Work Ethereum mainnet will transition to the new PoS mechanism to reach consensus. As a general concept, it may seem simple, but there are many small problems in this process.

Indecision and wavering confidence

As we get closer to the merger, investors are becoming more and more nervous. Some would say it’s because of the recent pessimism sweeping the broader market, but macro isn’t the only issue. The merger itself has been accompanied by several events and errors that are enough to make people question their hodl strategies on Ethereum.

The first is the continued delay. The Ethereum POS merger has been delayed several times in the past. But this year’s delay is somewhat of a done deal. At the beginning of the year, it was speculated that the merger would happen in June. However, the core developers disagreed and suggested “a few months later.”

“Merging Ropsten is a huge testing milestone towards merging with Ethereum mainnet later this year,” Ethereum core developer Preston van Loon wrote last month.

However, the process has been going on for several years, with multiple delays causing waves of frustration among the community and investors.

From a development perspective, the string of delays makes sense. Developers don’t have to rush to merge, putting billions at risk. But it’s hard for the average person to understand the situation. In their view, the longer the delay, the less confidence people have in Ethereum. Can it really upgrade successfully?

Secondly, stETH decoupling.

Users can participate in the Ethereum Beacon Chain by staking Ethereum to validators. Stakers will receive rewards, however, they cannot unstake their ETH until the merge is complete.

This is why many investors prefer staking through the popular ETH staking service Lido.

On Lido, you stake ETH and get stETH in return - similar to a receipt (or IOU) in everyday life. You can use this stETH in various DeFi applications (e.g., for lending, liquidity mining through LP) Staking through Lido is the first choice for many people, not only because you can improve capital efficiency, but also because when you no longer want to stake, you can just "unstake" ETH. To do this, you can exchange stETH for ETH on an open market such as UniSwap DEX. If you stake ETH directly, you cannot sell it.

In a healthy market scenario, 1 stETH should be worth 1 ETH, and the ratio between the two assets should be 1:1. However, this has not been the case recently.

Currently, 1 stETH is worth -1.94% less than the original ETH. If you use the Lido app, the app will actually recommend that you buy stETH on the open market instead of staking your ETH on Lido itself. Buying stETH is cheaper than staking ETH and then minting stETH.

The decoupling happened shortly after the UST decoupling event, so you could say the spillover effects of risk are kicking in. Whatever the reason, this doesn’t look good on Ethereum.

After Ethereum completes the merger, the staked ETH can begin to be unstaked. The current low market demand for stETH can reflect people's pessimism. They expect that once allowed, stakers will cancel their ETH, so a large amount of liquid ETH will flow into the open market, increasing supply and lowering prices.

Block reorganization

The existing situation has not yet been resolved, and we have seen another incident that makes investors more worried about Ethereum.

On May 25, the Ethereum beacon chain underwent seven consecutive block reorganizations (Reorg).

After block 73 was generated, the chain "branched" into two, adding blocks 74 and 75 almost simultaneously. Block 75 then continued to add several blocks (76-81) until the voting mechanism voted on block 74 and added a new block 82 after it, and blocks 75-81 were forked.

Below is an infographic that visualizes the whole situation.

Experts claim that the block reorganization is not a big problem - although unexpected - and it will not happen again once the merge is successful. After the merge, all validators need to have the same configuration, so this "chaos" cannot happen again. However, once again, the incident adds more doubts in the eyes of ordinary non-technical users/investors. What if there are other unforeseen problems? Can Ethereum upgrade smoothly without any incidents that could disrupt the network?

A few things not related to the merger

Unless the Ethereum merger occurs during a bull run, the liquidity issues mentioned in the tweet below will have to be taken seriously.

Andrew Kang believes that Ethereum has a serious liquidity imbalance. In the traditional market, stocks have a strong structural buying flow, while the structural flow of cryptocurrencies is weak and it is difficult to resist a large sell-off. Andrew believes that it is more realistic for Ethereum to pull back to $1,000.

In addition to what happened to Ethereum itself, macro sentiment also played a role in the recent price drop. One thing that struck me the most was the argument about large funds and venture capital being illiquid, and it is hard to disagree with this argument. If sentiment deteriorates, many funds that still hold ETH as a last defense will be forced to sell to maintain liquidity, especially for funds like Three Arrows Capital that were severely affected by Luna/UST.

Is the market too pessimistic about ETH at the moment?

One thing to note is that the current market sentiment is indeed too negative for Ethereum for consensus to work. For reference, the current bearishness on ETH feels like a year ago — from June to July 2021 — before EIP-1559, when the market was slow to react to EIP-1559 (although due to the early NFT boom, there were fewer sudden events and demand for ETH was stable). But once the market reacted, ETH reached another new high.

Therefore, the Ropsten testnet merge was successfully completed, and perhaps it can restore people's confidence in Ethereum.