Why Ethereum is Dropping After the Merge

5 minute read

Last week was a celebratory one for Ethereum: the world’s second-largest blockchain successfully transitioned to Proof of Stake after a painstaking eight-year development process. (Read more here about the merge’s importance.) But on Monday, investors woke up to the token’s price at its lowest point since July. While Ethereum had climbed back to over $1700 in September, it’s now around $1330, amounting to more than a 20% drop.

If the merge was supposed to fix many of Ethereum’s problems, why is its value still tanking? Here are a few reasons for the current downturn.

The merge was designed to have a long-term impact, not a short-term one.

When Ethereum merged successfully, many of the responding headlines bordered on ecstatic: “Ethereum ‘merge’ will change crypto forever,” crowed Fortune. (This publication—and writer—were admittedly not immune to excitement.)

But while the developers of the merge promised many changes—including a sharp decrease in energy consumption and increased security—a short-term price increase was not one of them. The merge didn’t fix Ethereum’s high fees or congestion. Instead it merely laid the groundwork for further infrastructure that could solve its problems in the years to come. Anyone who hoped that Ethereum would look or run completely differently on Thursday would have been disappointed.

Cryptocurrencies are heavily impacted by major market forces.

While crypto was designed to hold value independent of the stock market, the two are still very much entwined. Over the last few years, tokens like Bitcoin and Ether have risen and fallen in correlation to larger market trends. This year, Ether prices have been depressed ever since the Federal Reserve announced its intention to institute a series of aggressive interest rate hikes in order to combat inflation. High interest rates dissuade consumers from investing in more risky assets, which includes crypto.

Read More: Why Bitcoin Keeps Crashing

And last Tuesday—two days before the merge—a Consumer Price Index report showed that inflation in the U.S. remains stubbornly high. More inflation means higher interest rates: Federal Reserve Chairman Jerome Powell responded by saying that the central bank must act “forthrightly, strongly” to fight inflation. And the market responded in turn: the Dow Jones Industrial Average fell more than 1,200 points, making it the index’s worst day since June 2020. Ether, naturally, fell amidst the downturn. The Federal Reserve’s decision about a potential hike is expected to be released this Wednesday.

Investors worry about regulation.

Is Ether a security? The question has been debated since the very beginning of Ethereum, with the blockchain’s developers hoping to avoid passing the Howey Test (the set of criteria that determines whether something is a security) and thus saving Ethereum from much stricter regulatory oversight. For years, Ethereum leaders have argued that the token is sufficiently decentralized, and regulators have mostly stayed away.

But last Thursday, SEC Chair Gary Gensler said that a token using Proof of Stake might contribute toward it passing the Howey Test. “From the coin’s perspective…that’s another indicia that under the Howey test, the investing public is anticipating profits based on the efforts of others,” Mr. Gensler told reporters after a congressional hearing, according to the Wall Street Journal. Given that Ethereum just switched to Proof of Stake, many investors on social media expressed concern that Ethereum might be Gensler’s next target.

Some crypto-focused lawyers, however, say that there’s a long road from Gensler’s comments to Ether being classified as a security.“The arguments about a token turning into security are actually not that strong,” says Collins Belton, a prominent crypto lawyer and managing partner of legal firm Brookwood. “The primary differences between Proof of Stake and Proof of Work are the software you use and the hardware required.” Collins believes that even if the SEC was able successfully label Ether a security, their logic would mean they’d have to do the same for Proof of Work coins like Bitcoin, too.

Long-term investors conflict with day traders.

Internal dynamics within the Ethereum community were also at play this week. Last week, as it became increasingly clear that the merge would be successful, many fans of Ethereum bought into the token based on the belief that the transition boded well for its long-term success. Ethereum developers and boosters love throwing around the term “ultrasound money,” which describes the belief that the token’s value will be able to withstand global war, economic collapse, or other major disasters.

This activity brought up Ether’s price—which in turn, prompted day-traders who bought into the coin purely for economic reasons to cash out on the value bump. Their activity then brought the price back down. It was a prime example of a longstanding tensions in crypto: There are many different types of crypto investors, and sometimes those who believe in the technology for its long-term, transformative abilities are at odds with those simply looking to make a quick buck.

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