Can the upcoming merge save the Ethereum price from further destruction?

Cryptos have come under tremendous pressure as global interest rates head higher for the first time in a decade.

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Key points

  • The Ethereum price is down almost 80% since 16 November’s all-time high
  • The blockchain’s so-called merge to a proof-of-stake from a proof-of-work protocol will speed transactions and slash energy use
  • Developers will introduce a ‘difficulty bomb’ to encourage crypto miners to make the switch

To say the Ethereum (CRYPTO: ETH) price has been struggling since November is akin to calling Mount Everest a challenging hill climb.

Indeed, following yesterday’s 17% losses, the Ethereum price was down just shy of 80% from its 16 November all-time high of US$4,892.

And the pain hasn’t been limited to Ethereum investors.

In November the combined market cap of the top 100 cryptos exceeded US$3 trillion, according to data from CoinGecko. Following the last seven months of selling, that figure has dropped below US$1 trillion.

Why are cryptos under pressure?

The Ethereum price, alongside most all of the top cryptos, has come under selling pressure primarily due to a huge change in the path of global interest rates.

Rates had held steady or declined for more than 10 years across developed nations, reaching rock bottom levels in the wake of the global pandemic as central banks opened the monetary taps wide to support their national economies. This saw a big lift in investor appetite for risk assets, like tech shares and cryptos.

Right through November last year, central banks, including the Reserve Bank of Australia, were forecasting that rates would remain at historic lows through 2023, with gradual increases forecast thereafter.

But inflation had a different idea.

Prices were already marching higher amid tight supply lines and growing demand as the world moved to reopen for COVID closures. Then Russia’s invasion of Ukraine added additional pressure as sanctions on Russia’s oil, gas, and coal exports sent energy prices rocketing.

With the latest inflation figures out of the United States, the world’s biggest economy, coming in at 8.6%, the highest level in 40 years, the Ethereum price and risk assets are under renewed stress this week.

Which belatedly brings us back to our headline question, can the upcoming merge save the Ethereum price from further destruction?

The Ethereum price and the difficulty bomb

Last week the Ethereum blockchain passed a critical test of what’s known as ‘the merge’, carried out on a test network.

The merge, if you’re not familiar, refers to Ethereum’s transition from a proof-of-work protocol to a proof-of-stake protocol. If successful, this will increase the speed of transactions and, importantly, greatly reduce the amount of energy required to confirm transactions and mine new ether.

Proof-of-work requires a vast amount of computing power across an army of machines. Proof-of-stake, on the other hand, will have validators stake their own ether – you need to stake at least 32 if you wish to participate – to verify transactions and create new tokens.

Which brings us to the ‘difficulty bomb’ and how that might impact the Ethereum price in the months ahead.

For insight into that question, we turn to eToro’s market analyst and crypto expert, Simon Peters.

Peters said on Friday, following the successful test:

Developers involved in the blockchain’s transition announced that they would implement a ‘difficulty bomb’ on the old proof-of-work network in order to encourage adoption on the new system…

While miners will continue to be able to operate proof-of-work, the difficulty bomb will be introduced after launch to make the process of mining much more difficult in order to dissuade them from doing so.

The implication for this is that far fewer ether tokens will be minted in future, and it is suggested that in time it will become a deflationary crypto asset thanks to the proof-of-stake model, where essentially holders are encouraged to behave like savers.

Fewer tokens in virtual circulation serving as a deflationary asset certainly sounds like the Ethereum price could be in for a run higher following the past months of carnage.

But don’t bet the farm.

“There have been reservations raised by developers, however, with some suggesting the difficulty bomb could slow down the process for the merge,” Peters cautioned.

Ethereum’s founder Vitalik Buterin forecasts the merge will happen as early as August but not later than October.

Stay tuned.

The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended Ethereum. The Motley Fool Australia has positions in and has recommended Ethereum. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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