The Releveraging
The Releveraging
ETH Reflexivity
ETH will experience a 0-to-1 change in buy/sell pressure post a successful Merge.
If there is a $1 reduction in sell pressure on ETH - what is the impact on price?
Several methodologies in recent years suggest that answer is at least 1 and more likely 2-3x.
As an example - researchers measure when a company goes into the SPY index and its subsequent jump as indicative of how passive flows can reorientate price.
ETH price direction and magnitude is important to consider since its network fee capture / transaction volumes are heavily correlated w/ ETH prices.
Higher ETH prices create higher ETH KPIs.
ETH is both reflexive and recursive --- prices create the fundamentals needed to create higher prices.
My explanation for this is price spikes draw in the attention economy and the gambling instincts in crypto.
This leads to more trading / buzz / culture and fee capture.
Quantitatively this is best measured by the velocity of ETH - that is how much capital is rehypothecated around the ETH ecosystem?
Here’s a flow
Buy ETH on Uniswap
Swap ETH for stETH on CRV
Depsoit stETH on as a CVX LP
Raise capital on ETH / stETH LP position
Use capital to buy ETH
And so it goes
This usage multiplier is procyclical with price.
This flow rehypothecated 1 ETH into 5 fee actions on the ETH network.
Here is some work I’ve done in the past on measuring ETH’s network capture / monetary permium.
Releveraging
After a successful merge crypto will have a core asset with a high single digit staking yield – this has implications for DeFi.
ETH will emerge with a 6-10% staking yield depending on a variety of estimates.
These estimates have been revised down over time and are slippery to measure.
DeFi is oversupplied with stablecoin dollars given low volumes, narrow arbs and pervasive negative funding.
Nobody sitting here a year ago imagined a world where DeFi yields would be lower than TradFi.
The great releveraging thesis begins when a core crypto asset has positive yield dervied substantially from fees.
Let’s say ETH will offer a clean 8% yield after the Merge.
There will be an ability to lock-in 8% yield through various delta neutral tools on-chain / CEX.
There is no scalable token that offers this today.
The move from nothing in DeFi being investable to having a multi-billion dollar token with a clean staking yield to farm will capture stagnant liquidity in DeFi.
Carry trades will suddenly become evident and the DeFi flywheel will begin spinning.
How can this occur?
A few ideas:
Leveraged looping on AAVE between ETH / stETH will force ETH supply/borrow prices to approach staking yields.
Higher ETH supply yields will encourage spot ETH to enter into money market protocols.
There are knock on effects.
ETH is correlated to all non-stablecoin TVL in DeFi — ETH price increases lead to alt coin price increases.
Alt coin dominance increasing create more fees for ETH — this increases ETH’s staking yield - creating another round of leverage looping.
How to Play?
To get the benefit of staking yields of ETH on-chain – you will need to carry stETH – the main liquid staking ETH choice in DeFi.
Because ETH cannot be redeemed until the Shanghai upgrade --- to benefit from staking yields – stETH is the ONLY way to access staking yields on ETH with liquidity and on DeFi.
The window between the merge and Shanghai upgrade will create large ETH to stETH inflows --- furthering LDO’s dominant mkt position.
stETH trades at a discount to ETH on its CRV pool — I expect this number to flip to above 1.00 given validator restrictions.
Why? The amount of stETH that can be created will be small versus the demand to hold an interest bearing ETH asset.
Where else can you get staking yields and have liquidity?
But LDO has another useful angle.
In crypto a project’s largest expense is emission.
LDO token emissions have allowed for 2 sided liquidity between ETH / stETH.
LDO has done an admirable job using tokens to peg stETH but its taken a heavy toll via inflation.
Post the Shanghai upgrade LDO emission will plummet --- why?
Well post Shanghai you will be able to swap stETH to ETH subject to a cool down period.
Fixed redeemability does not need token incentives.
This will result in a 6% reduction in annualized emissions.
This equates to 7x the impact of the BTC halvening and 1.5x the expected impact of the ETH Merge.
Conclusion
The attention economy is difficult to anticipate because it is predicated on coincident factors.
Outside of the technical issues with a successful merge like validation/consensus - the ETH merge should lead to a releveraging bout.
Signs are emerging in retail pockets that conditions are ripe (see DOGE/SHIB in crypto and BBBY/PLTR in equities).
But whatever releveragning that does take place will be a lower high than the previous cycle given the ETH Merge will take place without a “Liquidity Splurge” as rates/QT continue to tighten conditions.
Market design and trading lessons have been learned by median participants such that low market cap to high FDV valued projects predicated on emissions will not see usage velocity / excitement as they did in 2020-21.
Eventhough one knows crypto markets can behave in surprising way (well any markets do for that matter), it still seems reasonable play long ETH, LDO, short BTC for next 6 - 9 months based on your article. Lets see, how this turns out.
Hey- noticed I couldn’t see your tweets anymore. Just wanted to say- you had a great account. Very insightful information - I learned more from your account that probably anyone on Twitter. Thanks for your work!